It will take at least five more years for the global liquefied natural gas (LNG) market to become a fully hedgeable market like oil, said Tellurian Inc. chairman and LNG pioneer Charif Souki in an interview posted Thursday by IHS Markit.

The LNG market, which originated decades ago as a point-to-point business with long-term contracts indexed to oil prices, has “made enormous progress in terms of liquidity” in recent years, Souki said in an interview with IHS Markit Vice Chairman Daniel Yergin as part of a CERAWeek conversation series. 

“But the market has not evolved sufficiently where the financial instruments represent a big premium to the physical movement of the commodity,” Souki said.

For example, financial trades in the oil market outnumber physical trades by a ratio of 30 to one, but in the LNG market financial trades can range from roughly the same level as physical trades to about twice the number of physical trades, he said.

“So we’re still a long way from having a market that you can actually hedge in order to be able to understand where your flows are going to go,” Souki said.

The International Gas Union (IGU) said in July that spot deals accounted for 31.3% of LNG sales in 2019. It added that LNG purchases indexed to prices at global gas hubs or indices had increased to 41% of all transactions last year, from 25% in 2016. Still, 59% of LNG transactions last year were linked to oil prices, the IGU said. Many Asian countries that import LNG do not have domestic natural gas markets, so buyers there are often more comfortable indexing long-term LNG contracts to oil prices.

Souki said a significant spike in global LNG production in recent years has led to more spot transactions.

“We now have a market that is over” 400 million metric tons/year (mmty), he said. “That’s probably around about 50-60 Bcf/d, that’s close to two-thirds of the size of the American market. So, that’s a very significant market and it’s very fungible. You’ve got a tremendous amount of inventory on the water, because you have at any time 300 ships that can carry a total of a [trillion cubic feet] worth of gas, which is very flexible. You can make a phone call and call a ship and have it redirected.”

A global supply glut and significantly reduced gas demand because of the Covid-19 pandemic have caused spot LNG prices to be lower than long-term prices for much of this year. The models of financing LNG export projects at contracts linked to oil prices or to U.S. Henry Hub natural gas prices are “broken,” Souki said.

LNG developers “have not figured out what is the new business model that actually works,” he said.

He added that Tellurian’s proposed 27.6 mmty Driftwood LNG project in Louisiana has an innovative model that would be viable in an increasingly liquid global gas market.

Tellurian expects to offer partners a free-on-board price of $3.50/MMBtu as its business model owns upstream assets and pipeline transportation. However, Tellurian requires partners to invest $500 million in the company for every 1 mmty of guaranteed offtake.

All six existing U.S. LNG export terminals and most of the proposed U.S. projects have charged a take-or-pay liquefaction fee in the range of $2.25-$3.50/MMBtu and customers would additionally pay for feed gas at Henry Hub prices when they want LNG. That model is premised on the expectation that Henry Hub prices would be significantly cheaper than global gas prices for the long term because of the vast shale resources in the United States. Companies that signed long-term deals to finance the existing U.S. projects have likely lost money on many cargoes and this year they cancelled many loadings while still paying their liquefaction fees.

Global gas prices have become increasingly linked to Henry Hub prices, Souki said, reiterating what he said last month during an interview with Columbia University. That has exposed buyers to potential Henry Hub volatility and has eroded the large arbitrage opportunities between U.S. and global gas prices, he said.

Tellurian in June delayed an FID on its Driftwood project by one year to 2021, with production projected to start in 2024.