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EVOLUTION AND VALUE OF A SHORT TERM LNG MARKET: PROVIDING SUPPLY TO A GLOBAL GAS MARKET
Suryan Wirya-Simunovic LNG Structuring & Trading Development Manager Brian Mumme COO Traded LNG BP Plc London, UK www.bp.com

ABSTRACT Over the past 10 years, a short term LNG market has developed with uncommitted and divertible LNG volumes flowing to regional gas markets that find themselves in need of sporadic incremental gas supply. Although only a fraction of the worlds overall physical trade, spot and short term LNG are becoming fundamental ingredients in growing the worlds disparate gas markets often acting as a bridge to connect supply with demand when needed. In a globalised gas market, short term LNG transactions serve to instill market discipline by providing pricing signals to the different participants of the marginal market price of LNG at any specific moment in time. Uncommitted LNG volumes can flow to the gas markets that most require them earning resource owners the best returns, meeting customer demand and adding to the worlds flexible gas supply. This paper presents statistical data on the evolution of the short and spot LNG market over the last ten years. It outlines the benefits to all market participants of shorter term LNG sales, as a complement to traditional long term contracts, and concludes by attempting to anticipate future trends.

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INTRODUCTION LNG trade flow has increased dramatically over the past 10 years and, with it, the non-traditional shorter term market for LNG. For several reasons most LNG export and import projects have relied and will continue to rely on long term sales and purchase contracts1. With the rapid recent development of the industry, shorter term LNG sales and purchase agreements have increased dramatically as LNG adopts characteristics of a free market driven commodity that is increasingly linked to regional gas prices. The diagram below shows both the quantity of LNG that has been sold and purchased on a short term basis and the proportion of total LNG that this represents. Short term LNG transactions have increased at a rate of approximately 15% per annum, approximately 5% higher than the growth rate of total LNG transported.
Short Term LNG Volumes & Proportion of Total LNG
30 14%

25

12%

10% 20

bcma

8% 15 6% 10 4% 5

2%

0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0%

Year Total Short Term LNG % of Total LNG

Source: BP Statistical Review, PIRA and GIIGNL EVOLUTION OF SHORT TERM LNG MARKET: 1995-2005 The short-term LNG market has grown substantially over the period 1995-2005 due to a number of factors. These factors include: the availability of excess supply; increased gas demand combined with under-utilised LNG import capacity; and the rapid development of shipping capacity. The following section looks at each of these factors in turn.

Long term in this context will refer to contracts greater than 5 years in duration.
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Percentage of Total LNG

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Excess Supply In the mid to late 90s, actual LNG production capacity exceeded expected name plate liquefaction capacity destined for long term sales commitments thereby making volumes available for the short term market. Furthermore, several de-bottlenecking exercises provided additional LNG that was sold on shorter duration terms to buyers who had the flexibility to absorb these volumes or who required seasonal LNG volumes. Prior to the 21st century, Indonesia and Malaysia supplied most of the short term LNG feeding mainly the extremely seasonal Korean demand. With the introduction of new Middle East and Atlantic liquefaction facilities in the late nineties and early 21st century, as well as an energy industry liberalizing and deregulating in the US and Europe, the stage was set for more short term LNG trade to develop. To provide a recent picture of short term LNG, during 2005 about 80%, or 20 bcma, of short term LNG was sourced from Trinidad and Tobago, Egypt, Algeria and Qatar. While most, if not all, of this LNG was originally sold under long-term contracts, short term trade has developed as some of the original buyers of that LNG engage in diversions of cargoes to destinations other than those originally contemplated. Countries such as Nigeria and Oman have also been and will continue to play an active role in supplying LNG for the short term trade. During this same period much of Trinidad and Tobagos short term LNG moved to the US while Algerian volumes oscillated between the US and Spain. Qatars short term volumes mainly moved into Spain and South Korea and, when the first Egypt LNG cargoes were produced many that were not ready to be sold into long term European contracts ended up landing in the US.
Volume of Short Term LNG Exported by Country
25

20

15

bcma
10 5 0 1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Year Abu Dhabi Malaysia Algeria Nigeria Australia Oman Brunei Qatar Egypt Trinidad Indonesia Others

Source: GIIGNL & PIRA

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Increased Demand Demand for short term LNG supplies matched (if not exceeded) availability during the 1995-2005. This was seen initially in South Korea and, since the start of the new millennium, also in Taiwan and Japan, prompted in the case of the latter by the closure of nuclear power plants. Although Asian buyers maintained a relatively even purchase profile in the period in question, the US and Spain started increasing their consumption of short term LNG as gas prices in the US made LNG imports competitive. Similarly, rapid growth in the Spanish economy led to an expansion of gas-fired power generation capacity which drove a sharp increase in demand. Although some of the additional gas demand was matched with long term contracts, the timing of power plants, US demand and price rises and increasing availability of Middle East supply led to Atlantic Basin sourced volumes being diverted to the US and Spanish demand being met by some short term Middle East supply. Imports of these spot volumes were enabled by existing underutilized regasification capacity in both countries, plus the addition of new build terminals in Spain (e.g. Bilbao) and re-activation of two mothballed terminals in the US (Cove Point and Elba Island). The graph below shows the amount of short term LNG imported by each nation on a yearly basis.
Volume of Short Term LNG Imported by Country
25

20

15

bcma
10 5 0 1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Belgium Portugal

France Spain

Italy Taiwan

Year Greece Turkey

India U.K.

Japan U.S.

Korea

Source: GIIGNL & PIRA Excess Shipping Capacity Another key factor that has enabled the rapid development of short term trade has been excess shipping capacity.

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With many projects only securing enough shipping for their long term contracts, excess supply needed to be transported on non dedicated ships. In the initial years, Indonesia and Malaysia used some of their spare capacity to supply South Korea. In the new millennium, several of the majors contracted vessels seemingly without having firm volumes to transport for the life of the vessels, but with a pipeline of LNG projects in the future that would likely need shipping. Golar LNG was one of the ship owners pioneering the short term shipping market. The demise of Enron and the withdrawal of El Paso also released several ships that have found their way mainly into the short term market. Exmar as owners and now Excelerate as current operators of some of this released tonnage are effectively using the vessels to trade in the short term market. The above mentioned developments were augmented in 2001-3 when a number of traditional tanker owners, buoyed from several boom years in the oil tanker trade, started expanding into LNG. Some of these owners decided to fix their ships for the long term while a majority of the others have allowed their speculative tonnage to trade short term or spot. Lastly, the industry also received a boost from ship brokers and advisors who, over the past few years, have become more versed in the LNG world and have brought their specialized knowledge of how to link owners with charterers to assist the short term market to develop. All these factors have led to the development of a healthy short term shipping market that has enabled short term LNG trade to flourish as tonnage is made available and commercial experience brought from that industry has allowed for efficient execution of short term shipping charters. BENEFITS OF A SHORT TERM MARKET The development of a short term LNG market has brought a number of benefits to both the participants and the wider LNG and gas industries. The key benefits are: a reduced volume risk; a redistributed price risk; and new business opportunities. The following section discusses these key benefits in more detail. Reduced Volume Risk Under traditional long term contracts the buyer has historically taken the volume risk by guaranteeing the off take through take or pay provisions in the Sales and Purchase Agreements (SPAs). In order not to over contract, buyers need to accurately forecast both supply and demand. Unpredictable events, such as the reduction in nuclear power capacity in Japan, a lack of rainfall in Spain and the sudden advent of cold weather in the UK and Korea, can result in significant deviations from the forecasts and opportunities within the short term LNG market. In the past few years, LNG volumes that are not sold under long term contracts to traditional markets now have new flexible short term alternatives in the USA and to a lesser extent, Spain and the UK. The reactivation and building of additional regasification capacity in the sizeable US gas market has allowed LNG players to use it as a flexible,

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price driven outlet. This significantly reduces volume risk globally as the US market is able to absorb a big portion, if not all, the short term LNG volumes. Similarly, the UK with dwindling indigenous production is also re-emerging as an important market for LNG taking its place alongside existing and proposed new import facilities elsewhere in Europe. The addition of sophisticated gas markets in North America and Europe enables new and existing energy players across the globe to adopt more of a portfolio supply mentality that provides supply diversity not only in terms of geography, but also in terms of the duration of contracts. Counterparties can benefit from having the choice of shorter term contracting to meet uncertain demand. As participation increases, liquidity in the market will grow and effectively reduce volume risk resulting in a more efficient market. Redistribution of Price Risk Under traditional LNG contracts price risk has been solely borne by the seller when sold on a net back basis or until a price re-opener can be pursued and historically linked to oil prices. Most have been netback contracts with fixed formulas that allow for all the midstream costs to be covered (shipping and liquefaction) and returning the remainder of the benefits to the upstream resource holder. Shorter term deals allow for more flexible distribution of price risk between buyers and sellers. Although upstream ventures have historically taken LNG price risk on long term deals, buyers are increasingly willing to take fixed price deals or purchases indexed to different formulae to those of their traditional market on short term deals downstream. For example, spot and short term LNG prices for marginal molecules in Europe have at times been linked to the US Henry Hub index. In these transactions buyers have assumed a price risk which they are exposed to if they sell into their markets. To mitigate some of these risks an increasing number of players are choosing to hedge their risks using energy derivatives such as NYMEX Henry Hub future contracts which allow them to lock in their sales and/or purchase prices. The shorter term market has shown great flexibility in terms of pricing LNG. This flexibility is very much dependent on what the buyer and seller can negotiate at the time and how they use the energy derivatives market to manage their exposure to price risk. For companies actively present in more than one gas market, the option to be flexible on pricing terms increases with their exposure to different commodity prices and their ability to take or pass on price risk. New Business Opportunities With an increased number of short-term transactions, the principal market participants have become more accustomed to executing these deals in a faster and more efficient manner. This has meant that, yearly, an increasing amount of volumes not committed to long term contracts are finding their way to buyers who need them for their specific unforeseeable reasons. Where long term SPAs can sometimes take years to negotiate, shorter term agreements have, at times, been completed in less than a week. Establishing Master Sales and Purchase Agreements, contracts which allow buyers and sellers to transact in the
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future having previously agreed most of the numerous lengthy standard terms, have greatly assisted quicker execution. The majority of short term deals only require counterparties to agree the remaining terms such as price, volume, quality, delivery location and other special terms which they are able to quickly discuss and then formalize in a short confirmation notice. New business opportunities in the LNG market will continue to develop as the number of buyers and sellers and their different needs increases. Pursuing and completing these opportunities will drive further efficiencies into the LNG market that will allow the final customer to benefit. CONCLUSION As the LNG industry has evolved over the past ten years, the short term LNG market has gradually grown alongside its more conservative and traditional long term cousin. With fluctuations in gas demand around the world due to seasonality, political uncertainty and force majeure events, the short term market has developed and is likely to continue growing at impressive rates to meet these fluctuating demands. Existing and new short term spare asset capacity throughout the value chain, but particularly pronounced in regasification and shipping, will assist this growth. Ships coming off long term contract will likely continue trading in the short term market. Supply sources with expiring contracts and uncertain reserves will also likely become available on a short term basis as potential buyers and sellers become unsure about the ability of depleting reservoirs being able to meet renewed longer term commitments. This non-firm supply will feed the excess flexible regasification and shipping capacity around the globe and allow the LNG market to fully develop into a mature market with a series of long, medium, short and spot contracts which allow different counterparties to share the risks mainly pricing and volume - and rewards accordingly. The maturing of the LNG market will drive efficiency throughout the value chain as different participants assume and manage the risks that they feel most comfortable managing. The short term LNG market is likely to play a key part in helping the industry become more cost efficient which ultimately will be of benefit to the end consumer.

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