Poten: collapse in LNG contract lengths raises future supply concerns

The average LNG contract length fell to a record low in 2017, according to the consultancy Poten & Partners, raising concerns on the future supply of the chilled fuel.

Average contract lengths for deals signed in 2017 fell to 6.7 years – the lowest ever recorded – compared with 11.5 years in 2016, the consultancy said in a report.

With many options for supply and uncertainty over future prices, last year buyers signed dozens of short- and medium-term contracts rather than commit to long-term deals that could help support the construction of new capacity that is expected to be needed by the mid-2020s.

This trend suited sellers who view the shorter contracts as a way to wait out the current soft market, and aggregators who have large volumes of LNG to sell over the next few years as US projects come online, the report said.

But, with just two new LNG projects greenlighted over the past two years, concern is growing that the market may be undersupplied in the medium-term, according to Poten.

Specifically, without long-term contracts that will enable more projects to be financed, the construction of new capacity may lag demand growth and set the stage for tighter markets and higher prices in the future, it said.

Short-term contracts more than doubled

The number of short-term contracts – those two to five years in length – more than doubled from nine in 2016 to 20 in 2017, after holding steady at an average of about five between 2013 and 2015, Poten’s report reveals.

On the other side, the number of deals with tenures of six to 10 years fell to just four in 2017 from 10 in 2016. And the number of deals over 10 years collapsed from 14 to six, after nearly five years during which long-term contracts were the most common form of contract signed.

Overall contract sales fell to less than 22 million tonnes per year in 2017, down from more than 30 million per year in 2016, Poten said.

Another feature of 2017 LNG contracts was a decline in the average volume per contract across the board.

The average volume covered by a contract signed in 2017 was just 660,000 t/y, down nearly 27% from 900,000 t/y in 2016, the report notes.

This trend was most evident in contracts of six to 10 years, where average volumes per contract fell 72% from 760,000 t/y in 2016 to just 210,000 t/y in 2017.

Oil-linked contracts prevail

Of the 20 signed bilateral contracts with tenures of five years or less, 14 were oil-linked, with most priced against Dated Brent.

Three others were priced against European gas indices, two on a hybrid basis (Brent-Henry Hub) and one against the JKM marker in Asia, Poten said.

Pricing for short-term deals has come down as buyers have taken advantage of the abundantly supplied market and sellers have competed to secure outlets for their supplies.

Most contracts shorter than five years were priced as a percentage of Dated Brent ranging from low-11% to mid-11%, down from prices ranging from mid-11% to well above 13% in 2016, the consultancy said.

Pricing was a bit higher for medium-term deals, with all contracts observed priced against oil benchmarks. Prices ranged from about 11.5% to 12% of Brent or JCC for delivered supplies.

The strong move toward Brent and away from a variety of other benchmarks that have proven popular in recent years – European gas hubs, Henry Hub, LNG
indices, gas-oil hybrids, for example – indicates that market participants have yet to gain confidence in alternative benchmarks, Poten said.

Return to long-term contracts?

Just six long-term contracts were signed last year, and with one exception, none were for supply from an LNG project under development.

This lack of deals associated with projects under development highlights concern about future LNG supply, Poten said.

With only one final investment decision in 2017, the excessive investment in LNG capacity early in the decade may now be followed by a dearth of commitments as buyers – believing they have
many options and that prices may yet decline more – are reluctant to sign long-term contracts that will enable project sponsors to finance new capacity, it said.

According to the consultancy, this shortfall in investment activity could trigger future price volatility in much the average volume per contract same way that the commodity investment cycle in crude oil leads to market turbulence.

“The question now is whether project sponsors can convince enough buyers to return to long-term contracts to ensure that additional liquefaction capacity is built in time to avoid potential supply constraints in the future,” Poten said.