In the past few months, two relatively new LNG buyers—Pakistan and Egypt—issued unprecedented tenders for short-term LNG supply. The deals, though not fully completed, reflect the convergence of two mutually-reinforcing trends: the rapid emergence of new importers and the heavy surplus of LNG set to hit the market in the next few years.
In late October, Egypt’s state-run importer, EGAS, issued a tender for 96 LNG cargoes to be delivered over 2017 and 2018. It is, by a considerable margin, the largest short-term tender ever issued and was valued at several billion dollars. Shortly thereafter, Pakistan’s state-run importer (Pakistan LNG), issued a tender for 60 cargoes over five years, as well as 180 additional cargoes spread over the next 15 years.
For a market traditionally dominated by long-term, point-to-point contracts, the tenders reveal considerable confidence in the liquidity of the growing LNG spot market. Yet, the tenders were unique not just for their magnitude, but also the issuers. Both Egypt and Pakistan began importing LNG only in 2015. Previously, Egypt had been a major LNG exporter, peaking at 10 MMT in 2009. It shut-down its two export plants in late-2014 redirecting gas production to meet sharply rising domestic demand. LNG imports reached 2.6 MMT in 2015 and appear set to exceed 5 MMT in 2016, a remarkable reversal in such a short time period.
Unlike Egypt, Pakistan has negligible domestic gas production, but does have rapidly rising demand. LNG imports began in early-2015, reaching 1.1 MMT for the year and likely reaching 3 MMT in 2016. In addition to the late-2016 tender, Pakistan energy officials suggested an additional tender, of similar size, would be released in mid-2017.
The tenders have not been completed but have drawn heavy interest from LNG exporters and traders. This despite the fact that both countries represent considerable credit risks as a result of fragile economies, political corruption and other concerns. Egypt already has fallen behind on payments for existing contracts and has requested the new tender allow for more lenient payment timelines.
Historically, LNG sellers would have largely shunned buyers with such risks, expressing a strong preference for established LNG importers in Japan, Korea and elsewhere. But with massive new capacity coming online in Australia and the U.S. over the next few years, the LNG market is clearly heading into a considerable oversupply. Sellers—especially portfolio players with large amounts of flexible LNG—are increasingly desperate to find buyers to bolster their position before the glut worsens.
Existing LNG buyers are using their new-found leverage in a variety of ways. Several have successfully renegotiated long-term contracts by reducing oil-linkage, moving to get rid of the fixed destination clauses or taking full advantage of the downward tolerance (i.e., taking the minimum volume allowed) as cheaper spot cargoes become available on the market.
Sellers have begrudgingly relented, leaving them that much more eager to sign new contracts with additional buyers. With many of the traditional importers fully contracted through the next few years, sellers have little choice but to arrange deals with newer importers, even those with questionable credit.
Pakistan and Egypt are just a few of the many new importers set to emerge over the next few years. The list of importers, currently numbering 35 countries, could expand to nearly 50 over the next several years. Nearly all of the proposals put forward by the emerging nations are dependent on floating storage and regasification units (FSRUs), which offer much lower costs than onshore options and shorter construction timelines. Their offshore location also encourages foreign capital investment due to the lower risk profile. Thus, for the first time, LNG is a feasible option for many of these countries.
FSRUs do not eliminate all risk, however, and traditional LNG sellers may hesitate to supply emerging markets. Most of these potential importers share common characteristics—rapidly rising gas and power demand, lack of domestic resources and infrastructure, and questionable political stability. Lenders may also express discomfort and consider such contracts largely un-bankable.
For that reason, it is likely that trading houses more comfortable with the nature of the risk will take on a larger role in supplying these markets. The rising surplus of LNG facilitates this shift—emerging importers would face much greater scrutiny in a tight market.
Even as the glut is absorbed and the market moves back into balance, buyer behavior is unlikely to revert to the traditional form of contracting. JERA, the Japanese conglomerate that is the world’s single largest LNG buyer, has stated that it will sign relatively few long-term contracts in the future. It will diversify its supply portfolio to include a near-equal mix of long-, mid- and short-term (spot) purchases. Other buyers are likely to adopt a similar strategy.
In turn, this will force LNG project developers to modify their strategies, as well. Historically, projects have been underpinned by long-term contracts covering nearly the full project capacity. How developers respond will be discussed in greater details in subsequent issues of this newsletter.