The Changing Face Of The LNG Industry

by Trefis Team
Royal Dutch Shell Plc.
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As the world is rapidly moving towards the use cleaner fuels, Liquefied Natural Gas, or LNG, has emerged as a flexible and competitive fuel over the last decade. Since a global benchmark for LNG pricing is difficult to ascertain, the majority of the LNG supply is contracted at oil-linked prices for a long duration. However, the slump in commodity prices over the last three years has led to a slow, yet gradual, shift in the dynamics of the LNG pricing and contract duration.

The latest instance of this changing trend is the re-negotiation of an LNG contract pricing between Exxon Mobil (NYSE:XOM) and India’s Petronet. Under the re-negotiated deal, Exxon Mobil has agreed to reduce the price at which it would supply LNG to Petronet from its Gorgon project in Australia in return of a higher volume purchase commitment by the latter. The revised deal will not only hamper Exxon’s revenues and valuation, it will also increase the risk of other LNG buyers in the region demanding re-negotiation of their existing contracts, creating an unwarranted pressure on the LNG supplier in a potentially oversupplied LNG market.

Current Dynamics Of The LNG Market

In order to meet the rising demand for LNG, integrated oil and gas companies, such as Exxon Mobil and Royal Dutch Shell, have invested heavily in gas projects worldwide over the last few years. Based on the current project pipeline, the global LNG liquefaction capacity is expected to reach to around 450 million tons by 2020. One-third of this new supply capacity has already come on-board in 2016 particularly in the US and Australia, while the remaining two-thirds is expected to come on-stream in the next couple of years.

While most of the new supply was absorbed by the existing and new buyers in 2016, many industry experts predict that the LNG markets will remain oversupplied for the remaining years of this decade. This is because a majority of the projects that are currently under construction will be operational soon, and will reach their peak capacity by 2020. However, the pace of growth in demand, although sharp, may not be sufficient to consume the increased LNG supply. That said, this scenario could gradually reverse post 2020, when the LNG demand growth is expected to outpace the supply growth in the industry due to a lack of new gas projects.

Source: Royal Dutch Shell, LNG Outlook 2020

On the other hand, the commodity slowdown has resulted in a steep decline in crude oil and natural gas prices over the last three years. Since a large portion of LNG contract prices are linked to oil prices, the buyers are forced to pay a higher price for LNG due to the previously agreed oil-linked prices as opposed to much lower current gas spot prices. This has instigated large LNG buyers to leverage their bargaining power to re-negotiate their existing contracts and attract better terms for the long term.

As a result, LNG suppliers are now adapting to the evolving needs of buyers in order to maintain their share in the market. This is evident from the decline in the average contract duration and volumes for LNG contracts over the last few years. In fact, LNG suppliers are now willing to carry out business with buyers from developing countries as well as with those who have relatively challenging credit ratings. This clearly indicates that there has been a shift in the dynamics of the LNG industry, because of which the bargain power has moved from the suppliers to the buyers, at least for the next few years.

Source: Royal Dutch Shell, LNG Outlook 2017

Stay tuned for our next article, where we will talk about how the renegotiation of the Exxon Mobil-Petronet deal has accentuated the bargaining power of LNG buyers, and the impact it could have on LNG suppliers such as Exxon Mobil.

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