LNG MARKETS
Some Examples of Common Sources of LNG Contract Complexity
Price Caps and Floors: It is common for LNG contracts to have embedded price cap and floor terms that dampen oil indexation linkage at high and low oil prices. This may apply to the whole contract price index or specific components of the index. The end result causes the “S-curve” shape common in LNG contracts.
Producer Upside Sharing Conditions: LNG purchase contracts often contain provisions for the sharing of any upside created from cargo diversion with the producer. These are typically specified as a formula defining the upside as a function of the destination. For example, if a cargo is delivered to Henry Hub (HH) in the US: margin = a+ b * HH – cost, if a cargo is delivered to NBP: margin = c + d * NBP – cost. As a result of these conditions it is not always profitable to divert to the highest priced market.
Marginal Tax Deltas: Many LNG portfolios will have commercial activities spanning different legal entities and tax jurisdictions. The optimal destination of a cargo can be a function of the legal entity cargo ownership structure based on the margin accrued in each entity and the corporate tax it attracts. There may be a simple marginal tax rate differential across jurisdictions or more complex considerations. For example, a trading and marketing based entity will attract tax based on the difference between the price it receives for a cargo less the price it pays, whereas an E&P entity will generally be charged the difference between the sales price and production costs. Optimising these tax liabilities across an LNG portfolio can be a key value driver.
be profitable on a standalone basis due to the price premium, but the commitment to deliver will reduce portfolio flexibility to move gas in response to price changes. The loss of the extrinsic value associated with reduced portfolio flexibility should be included in assessment of deal value.
Building LNG Portfolio Value One of the key challenges facing
LNG investors is understanding how an incremental asset investment can unlock portfolio value. This problem requires an ability to analyse asset value at a portfolio level as well as at an individual asset level. In order to tackle this problem a portfolio valuation model is required. This is not a model focused on the short term hedging and optimisation of the portfolio, but an analytical framework that can determine how incremental asset investments can add value by alleviating portfolio flexibility constraints. Take an example of a European
gas portfolio looking to sign a US LNG supply contract to complement an existing dedicated LNG supply source from the Middle East. The US supply contract provides access to liquefaction capacity, enabling the
72 December 2012
owner to buy gas at Henry Hub and transport it to Europe. The intrinsic value of this contract is driven by the price spread between Henry Hub and European hubs, adjusted for transport cost. But significant value can also be realised by using the flexibility of the contract to respond to changes in market prices. For example the US supply contract may enable European portfolio load to be serviced by swapping Henry Hub sourced cargoes for LNG from
There is currently a formidable momentum in growth across the global LNG supply chain
the Middle Eastern supply source, freeing up cargoes to be sold to Asian buyers in response to a winter price premium. The value of adding a US LNG supply contract depends on how its flexibility can be monetised in the context of the surrounding portfolio. There is currently a formidable momentum in growth across
the global LNG supply chain. A relatively immature market, constrained flexibility and the complex nature of LNG asset exposures make for a rich environment in which to build portfolio value. But the engine behind value creation is an effective portfolio analytical framework that can drive an understanding of the interaction between portfolio asset exposures and underlying markets. •
David Stokes & Olly Spinks are Directors with Timera Energy.
Timera Energy offers senior consulting expertise on the management of value and risk in European power and gas markets. They are experts in the analysis of energy assets,
contracts and portfolios and the markets in which they operate.
www.timera-energy.com
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