A little more than a year ago, on Feb. 24, 2016, Cheniere Energy (NYSEMKT:LNG) shipped the first cargo of liquefied natural gas (LNG) from its Sabine Pass liquefaction facility in Louisiana. Since then, almost 90 vessels have docked at Sabine Pass and dispatched some 300 billion cubic feet (bcf) of American natural gas to as many as 18 foreign states. In this article, we outline key features of the LNG market, describe critical market variables, and take an analytical look at the position of U.S. in the global LNG trade.
LNG is essentially natural gas (methane), but in a liquid state, which is achieved by cooling it to -260 °F (-161.5 °C). The liquid volume of natural gas is approximately 600 times smaller than the equivalent volume of methane gas, which makes its transportation (by ship) easier and more economically viable. According to the Oxford Institute for Energy Studies, LNG transportation has a clear economic advantage over pipeline construction and trading when the distance between supplier and a consumer is greater than 2,500 km.
The LNG value chain consists of three discreet stages:
- Upstream - natural gas extraction
- Midstream - natural gas treatment and LNG production (cryogenic cooling)
- Loading of LNG on a tanker
- Voyage to the port of entry
- Ballast voyage (the return of empty ship for a new loading)
Marketing and Distribution
- Regasification of LNG (transformation into dry natural gas) at the port of entry
- Distribution of dry natural gas to consumers
Units of measurement in the LNG trade are very confusing. In the U.S., dry natural gas that is purchased for liquefaction is usually measured in cubic feet (CF). Once it is liquefied, it is then measured in mass units, usually million tons (MT). However, the capacity of LNG tankers that transport the commodity is measured in cargo volume, usually cubic meters (CM).
1 million metric tons of LNG
= 48.7 billion cubic feet of dry natural gas
= 1.38 billion cubic meters of dry natural gas
= 52 trillion British thermal units
= 8.68 million barrels of oil equivalent
At the start of 2016, a global LNG fleet consisted of 499 tankers with a total shipping capacity of 64.6 mcm of LNG (1,350 bcf of dry natural gas). The fleet is constantly expanding and the size of an average LNG carrier is also increasing. In 2015, it was already 164,000 cm of LNG (3.4 bcf of dry natural gas).
LNG is currently one of the fastest-growing internationally traded commodities in the world. According to GIIGNL, LNG trading made up less than 5% of global trade in 2000, whereas today its share is close to 25% and growing. Global trade in LNG has increased by 2.5% in 2015, with total quantities reaching an all-time high of 245.2 MT over the year. The data for 2016 has not been released yet, but there is a good chance that traded volumes have set another record.
The majority of LNG sale and purchases agreements (SPAs) are long term (sometimes more than 20 years). The total volume of LNG contracted under short-term or spot deals is still negligible, but is growing fast. 85% of all deals are accomplished under two types of delivery conditions: Free-on-Board (FoB) and Delivered Ex-Ship (DES). Under FoB, the ownership of the LNG is transferred once the ship is fully loaded at the liquefaction terminal. Under DES, the supplier retains the ownership of LNG until the ship has arrived at its destination point.
As of 2016, there were no less than 21 states (including European re-exporters) supplying LNG globally. Qatar remains the largest LNG producer and exporter in the world, with a market share of about 30%. However, the U.S. is on track to challenge that position.
Figure 1 - Major LNG Flows
The import side of the trade is dominated by Asian economies -- particularly, Japan, South Korea and Taiwan and, more recently, China and India. Europe also has a large LNG import capacity (regasification plants), but it has not been using it to its full potential. Other important LNG importers include Mexico, Brazil, and Turkey.
Globally, natural gas is priced using either of the three mechanisms:
- Oil-indexation (natural gas price is a derivative of oil price, usually quarterly average)
- Oil price escalation (natural gas price is a derivative of a price on the basket of oil commodities such petroleum and other liquids)
- Market-based (natural gas price is determined by supply and demand factors only)
Currently, the North American market (United States and Canada) is the only place in the world where price discovery is based on purely market mechanisms (the interaction of supply and demand). The most important regional benchmark is the American NYMEX Henry Hub natural gas futures contract.
Europe is slowly moving toward market-based pricing. According to the International Gas Union, about 50% of natural gas supply in Europe is linked to regional hubs, such as NBP in the United Kingdom and TTF in the Netherlands.
The Asian LNG market is dominated by oil-indexation, but there are also many short-term and spot transactions taking place in that part of world, which are in principle very similar to market-based mechanism. Asian LNG spot prices are assessed by specialized news agencies, such as Platts and ICIS Heren. They publish LNG price indices -- notably, Japan Korea Marker (JKM) and East Asia Index (EAX), which serve as important benchmarks for traders.
Figure 2 - Global LNG Prices
Source: GeckoiCapital website
The United States
The U.S. is destined to play a major role in the global LNG market for three reasons:
1. Huge reserves: According to CIA World Factbook, proved reserves of natural gas in the U.S. are fourth largest in the world (more than 300 trillion cf).
2. Growing liquefaction capacity: In addition to the projects already operating and under construction, some 330 MT per year of new LNG projects have been proposed in the U.S., mainly in the Gulf of Mexico. It is an enormous amount and, if realized, would double global liquefaction capacity.
3. Low prices: United States businesses and households enjoy some of the lowest natural gas prices in the world, which adds extra competitiveness to American LNG.
A retail trader with exposure in natural gas futures would probably prefer not to delve too much into the intricacies of global LNG trade. Therefore, we will just outline two important themes:
- LNG exports from the U.S. increase aggregate demand for American natural gas and decrease net imports of natural gas into the country. Therefore, LNG exports have a negative impact on total natural gas balance within the U.S., which should (in theory) exert upward pressure on natural gas prices, ceteris paribus.
- Future export of LNG from the U.S. is a function of a number of variables, the most dynamic of which is export cost.
Historically, the U.S. has been consistently importing more natural gas than it was exporting. The average net import rate over 2011-15 was 5.21 bcf per day. Then, on Feb. 28, 2016, an LNG tanker named Asia Vision docked at Sabine Pass and took the first cargo of American LNG to Brazil. On that specific day, the U.S. briefly became a net exporter of natural gas for the first time in its history. Since then, there were another 62 occasions when daily exports exceeded daily imports (see Figure 3 below), and in all cases it was because some ship was loading at Sabine Pass.
Figure 3 - Daily Net Imports of Natural Gas Into the United States
Source: EIA, GeckoiCapital calculations; Net imports = total imports minus total exports
As you can see from the chart above, LNG exports are clearly leaving a mark on the statistics of net imports. In 2016, the net import rate dropped to just 1.88 bcf per day and is declining further in 2017.
The contribution of LNG exports to the aggregate demand has risen from 0.5% in 2016 to more than 2.50% in March, 2017 (see Figure 4). However, its future growth will be restricted by existing liquefaction capacity. Currently, Cheniere Energy operates three trains designed for approximately 13.5 million metric tons of LNG per year (mtpa), or 657 bcf of dry natural gas per year. Train 4, with a total capacity of 4.5 mtpa of LNG (219 bcf of dry natural gas per year), should be completed by the end of 2017. Some 30 mtpa (1,461 bcf) worth of LNG capacity is scheduled for commissioning in 2018 (Freeport, Cove Point, Elba Island and Cameron).
Figure 4 - LNG Exports Contribution to Total (Aggregate) Demand
Source: GeckoiCapital calculations
Under ordinary conditions, future LNG flows from the U.S. will depend on a number of factors. A simple formula looks like this:
Future LNG exports = liquefaction capacity + global demand + [export contribution margin (overseas landed prices - Henry Hub price - export cost (liquefaction cost - freight rate))]
Forecasting global natural gas demand and overseas prices for LNG is beyond the scope of this article. For now, we would just like to look at the export cost and export contribution margin, which are two very important metrics in global LNG trade.
Export cost is made of two elements: liquefaction cost and freight rate.
- Liquefaction cost is the price paid for converting dry natural gas into LNG. As a general rule, liquefaction cost = natural gas price multiplied by 1.15. Therefore, in case of the U.S., it will be 115% of the Henry Hub price.
- Freight rate (or transportation cost) is the price of delivering LNG from one location to another. As a general rule, freight rates depend on the distance between supplier and consumer. However, rates on LNG tankers specifically are currently among of the highest in the world.
By combining export cost with local natural gas prices, we get a key metric called export contribution margin.
Export contribution margin (ECM) = overseas landed price for LNG minus Henry Hub price minus export cost.
ECM answers three questions:
- Does the export of LNG make economic sense?
- What is the potential reward?
- Where (in what markets) is the greatest reward?
In Figure 5 (see below), we have calculated the evolution of U.S. ECM for Japan, the biggest importer of LNG in the world. Please note that ECM has to be analyzed separately for each market because freight rates and local LNG prices are different in all markets.
Figure 5 - U.S. Export Contribution Margin for Japan
Source: ICE, Hellenic Shipping News, GeckoiCapital calculations
As you can see, despite the fact that LNG price in Japan is down 36% from its recent peak, U.S. export contribution margin for that market is still positive -- around $2 per mmbtu. In fact, we assess that U.S. ECMs are some of the best in the world (if not the best) because of its strategic geographical location between two major consumers (Europe and Asia), and also because of cheap and abundant natural gas.
On balance, the U.S. has all the preconditions to become a leader in global LNG trade.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.