Protecting the LNG value chain through proactive risk management
Reza Simchi, Principle Consultant FGE
December 08, 2015
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Recent market developments have evermore highlighted the risks inherent across LNG’s value chain.
Low oil prices have threatened investment in upstream activities and downstream we can observe increased usage of alternative fuels such as diesel and fuel oil. Moreover, lackluster demand combined with uncertainty caused by downstream market deregulations in Asia have increased the risks for both buyers and sellers. Such developments combined with the rigid structure and illiquidity of forward contracts have made management of such risks more difficult.
As such, LNG risk management has been taking center stage in LNG value chain management. Among the traditional methods one could mention S-curves and DQT/UQT clauses. In addition, newer areas such as more contract flexibility, active spot markets and exposure swaps have come to see the light of the day. This article briefly discusses a few of such methodologies from a more quantitative point of view.
Forward Exposure Management
One of the main issues of exposure management in the LNG industry is the lack of a liquid forward curve for LNG. In fact, long term forward LNG contracts are still predominantly oil-linked whereas the LNG spot market is based on short term supply and demand fundamentals.
Flexibility in LNG contracts can offer both operational and financial benefits. These include diverting cargos to proper demand centers or those of higher value, optimizing of storage tanks and meeting of seasonal demands.
Let’s consider a buyer who needs to decide how to match his summer LNG demand profile. The buyer needs to strike a balance between his long terms and spot market as well as making optimal use of his storage facilities.
Rapid development of liquefaction in the USGC has introduced Henry Hub-based LNG pricing to the market. Moreover, JKM and European-based pricings such as NBP and TTF have been on the rise. As a result both buyers and sellers need to strike a balance between their pricing formulas and their associated risks.
Let’s assume a buyer who is targeting a long term $10.50/mmBtu LNG portfolio and needs to decide the portion of Henry Hub pricing in his portfolio. As such, the buyer needs to optimize his portfolio such that his cost of procurement, seen as of today, stays around $10.50/mmBtu and is such that his price risk stays within his risk tolerance limits.
As the LNG markets are evolving fast and the risks for market participants are becoming more pronounced, proactive risk management has become an essential part of protecting the LNG value chain. Moreover, proper risk management not only can protect the value but through optimization can improve market participants’ bottom line.
Written by Mr. Reza Simchi, Principle Consultant FGE Singapore, for Gazprom Export Global Newsletter, Blue Fuel, December 2015, Vol. 8, Issue 6