With a new fuel comes the question: How much is it reasonable to pay for it? Crude oil is traded globally on a scale that leads to a completely liquid market with transparent pricing. It is not difficult to contract heavy fuel oil (HFO) or light fuel oil (LFO) as there are benchmarks and multiple suppliers available. It is also feasible to transport these fuels fairly long distances. The picture is very different for small-scale LNG. In many parts of the world, there is only one supplier or, in the best-case scenario, a few. Furthermore, the prices published for conventional, large-scale LNG deliveries have very little use for someone interested in contracting smaller quantities.
When the buyer has no or little experience, the seller has the power in negotiations. Therefore, this article aims to provide a few pointers to level the playing field. In order to understand the small-scale LNG contracts, one has to have some knowledge about how large-scale LNG is contracted.
Unlike the crude oil market, the gas market cannot be considered a uniform international market, as regions are not interconnected and trading is still fairly uncommon. Therefore, pricing mechanisms have developed differently in different parts of the world. So while LNG prices have largely been linked to crude oil or a basket of oil products in Asia, they were initially linked to Brent oil in Europe, but are now increasingly moving towards hub prices following the increased liquidity of the NBP (United Kingdom) and TTF (Netherlands) gas hubs.
In North America, gas markets are hub based, with Henry Hub being the most well-known. When prices diverge between regions, arbitrage opportunities are created. This means excess large-scale LNG will go to the region that is willing to pay the highest price. There is currently, and for several years to come, an oversupply of LNG, which has improved the bargaining position of buyers. This is leading to more variation in price indexation, more spot trading, shorter-term contracts (previously 25-year contracts were common) and destination flexibility: Free On Board (FOB) instead of Delivered Ex-Ship (DES).
Large buyers hedge their LNG prices by having a portfolio of contracts with different suppliers and pricing mechanisms. This is a luxury small-scale buyers do not have. If a small-scale buyer has only one supply contract, there is less room for error. Therefore, there are some clauses in an LNG sales agreement which small-scale buyers should pay extra attention to.
Start date
Since there are not many alternative buyers and sellers for small-scale LNG, the delivery of LNG in accordance with the timetable of the contract is crucial for both parties. But during this time, if either the buyer or the seller of LNG is constructing a new facility, this could present a major risk. As LNG sales agreements should be negotiated and signed before the construction of the facility, assigning a realistic start date is of utmost importance. There should be a funnel where the start date of the contract is specified in an increasingly tighter time range as the facility comes closer to commissioning. Schedule slip could have serious financial consequences.
Logistics
In large-scale LNG, the trend is towards increased destination flexibility. The buyers want FOB contracts instead of DES, so that they can divert cargoes to spot buyers in case they do not need them. This is not really applicable in the small-scale market, since LNG cannot be economically transported very far on small-scale carriers and there are few alternative customers. However, having the shipping component in one’s own hands might save some money for the buyer, but FOB contracts would also require the buyer to assume responsibility for ship charters, insurance, boil-off gas and port costs. In some cases, DES contracts are advantageous if the supplier can utilise the same ship for other customers and share the costs. Those new to the market would be better off with a DES contract. But to shave off some hidden cost, considering FOB may be a good option.