Global LNG: New pricing ahead?

The overarching economic issues

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LNG project proposals are growing faster than the industry’s capabilities to develop them.

Notional LNG contract
slopes

Notional LNG contract slopes

Generally at the high end of the cost curve, with development bottlenecks and spiraling construction costs, Australian projects are typically suffering the most problems. Sanctioned projects are generally less significantly impacted (unless contracts are reopened or renegotiated), but projects still seeking contracted off-take are at substantial risk.

To further add complexity, some contracts will have varying slope percentages used at different oil price levels. Broadly speaking, there can be four basic forms:

  • The simplest is a straight-line constant slope that exposes both the buyer and seller to adverse price movements.
  • A second type is the so-called “S-curve,” which will have a flatter slope at low oil prices to protect sellers and a flatter slope at high oil prices to protect buyers.
  • The other two types are variations on the S-curve, where either only the seller has some protection (an oil-linked contract with a floor) or only the buyer has protection (an oil-linked contract with a ceiling).

Indexing and convergence

High LNG development costs will require ironclad long-term off-take agreements. But more recently, the market is witnessing the inherent conflict of increasingly more expensive projects trying to sell to increasingly more price sensitive buyers. From the supply side, oil is becoming somewhat scarcer while gas is more plentiful. As a result, there is the inherent conflict of persistently high oil prices and a growing surplus of natural gas, with strict oil indexation becoming less tenable.

Oil indexation of gas contracts will become more difficult with:

  • greater competition between sellers
  • more price-sensitive buyers
  • increasing energy deregulation
  • increasing gas-on-gas competition from new pipeline infrastructure
  • increasing spot market liquidity
  • and, most importantly, increasing availability of spot-price-based LNG exports

Developers of high-cost projects will find it harder to find shelter in bilateral contracts and high-cost sellers will struggle to preserve pricing power.

Notional LNG contract slopes

Notional LNG contract slopes ×

Source: EY adapted from Deutsche Bank Markets Research, The Australian LNG Handbook, 6 September 2011