Pipeline natural gas and liquefied natural gas (LNG) have been readily available in some geographical markets. Thanks to diversification, LNG now has the potential to become easily available, worldwide. Read on.
For more information, please visit our website.
Pipeline natural gas and liquefied natural gas (LNG) have been readily available in some geographical markets. Thanks to diversification, LNG now has the potential to become easily available, worldwide. Read on.
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.
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.
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.
The contract length is often determined by the financing needs of the parties as financial institutions require certain guarantees. For a utility looking to build an LNG terminal for its power plant, this means a fuel supply contract that is back-to-back with the length of the power purchase agreement. But even without such requirements, a medium-term contract might be preferred. The trend in large-scale LNG is towards shorter contracts and spot deliveries, but in small-scale LNG one wants to make sure that supply of fuel is guaranteed for a longer time. However, if one expects that the number of suppliers in the region will increase, it might be a good idea to have a shorter contract, so that a new contract can be negotiated when the buyer’s bargaining position is better.
One challenge with a long contract is that the quantities required may change considerably. Given the fact that a liquefaction facility wants to produce at a steady rate and there seldom are other takers for a cargo, the seller wants to make sure that the buyer takes the cargoes that have been assigned to him. Also, the buyer wants to be certain that his fuel needs can be met. Therefore, the contract specifies an Annual Contract Quantity (ACQ). These clauses generally allow for some downward flexibility. The buyer has to pay for the cargoes whether he takes them or not (Take-or-Pay), but the outstanding cargoes should be taken the following year, in addition to the normal ACQ. Strict ACQs and Take-or-Pay work fairly well for national gas grids and baseload electricity production, but for power plants running peak loads, the buyer would like considerable flexibility when it comes to annual quantities. If the LNG supplier is the only source of fuel (meaning there are no alternative suppliers and alternative fuels cannot be used), it is also important to specify what happens in case of failure to deliver.
The timing of negotiating an LNG sales agreement also matters as these contracts contain a price review mechanism with the purpose of restoring the conditions of when the agreement was signed. The base period of an index is defined in the contract and constitutes the reference period for the price. The base period values will affect future prices, so it is important not to accept one that would result in a future disadvantage.
A review period for determining the index to be applied is also specified. Instead of choosing a particular day as reference point for the index, an average over a longer time period is chosen. The intention of this is to smoothen out peaks. The period is usually with a lag if time is needed in order to collect the data for calculating the index.
If the contract is increasingly disadvantageous to one of the parties of the contract, it should be returned to equilibrium. The contract should state a price adjustment frequency. With a suitable frequency, the price is kept close to the market level. Buyers would ideally want to mirror the same price adjustment frequency they have with their own customers.
The price of LNG is obviously one of the most important points when negotiating an LNG sales contract. With few suppliers to choose from and a low level of experience among buyers, it is often the suppliers that have the upper hand in deciding the terms. The principles of a fair agreement should be that the price provides an acceptable return on investment for its facilities and operates at a reasonable profit. The seller wants the price to reflect the market value of the gas, while the buyer wants an advantage over competing fuels. Buyers also want the price to mirror the price risk in the sales of their products or services (e.g., electricity). In case of a new market with poor credit ratings, the seller would also require a premium in order to cover the credit risk.
Prices are linked to different indices in different parts of the world, and generally small-scale LNG is influenced by large-scale LNG. Most often in South-East Asia, prices are linked to Brent crude oil, in Northern Europe to TTF hub prices and in the western hemisphere to Henry Hub. This is understandable as LNG suppliers don’t want to absorb the price risk of buying according to one index and sell according to another. But this is not necessarily in the interest of the buyer. Ideally, a consumer wants to make sure his fuel costs are lower than the competitor’s. If the competitor is using HFO or LFO, this is the preferred index. For the buyer, it would be ideal if the price would be linked to a local index, but as they seldom have sufficient liquidity, the seller probably insists on an international index. It is common to use Brent crude as an index, which is beneficial since it is easy to hedge, but there is no guarantee that the price of crude oil and refined products cannot diverge in the future.
Other, more experimental indexing can be considered if the buyer, e.g., a dual-fuel power plant, can use other fuels. Then a different index can be chosen, e.g., Henry Hub or NBP, so that one can play with price differences and produce using the fuel that is currently most affordable. Such a strategy might, however, be difficult to align with the Annual Contract Quantities.
What can be seen in reality is that suppliers of small-scale LNG offer a hub or oil products index plus a fixed component. The fixed component comprises not only the logistical costs in a DES contract, but also reduces the transparency of the pricing mechanism. By coincidence or not, the final price often ends up close to the cost of the competing fuel.
A few cents per MMBTU might sound trivial, but it has a substantial impact on the cost price of gas for the LNG terminal. Figure 1 illustrates the significance of a discount on the FOB LNG price compared with a reduction in total infrastructure cost for a generic LNG terminal (including marine infrastructure) designed to supply gas to a 50, 100 or 200 MW power plant located at a distance of 300 and 600 nautical miles, respectively, from the LNG supplier.
From the figure, it is apparent that even a minor discount on the LNG price has the same impact as reducing CAPEX spent on the LNG terminal by several million USD. While spending less on the LNG terminal will result in lower performance, reliability and perhaps safety, the properties of LNG will not change when lowering the price. The savings also remain more or less the same in both low and high price environments. Therefore, the LNG sales contract should be given considerable deliberation and if needed, an experienced consultant should be brought in to support negotiations.
If you’re a ship owner or operator sailing into, out of or within EU waters, the EU Emissions Trading System (ETS) affects you. What does the ETS mean for your business? Could it save or even make you money? Here are four top tips.
Key takeaways
In January the maritime industry joined the world’s biggest carbon market – the EU ETS. The potential savings you can make as a ship owner or operator depend heavily on three key things:
This article covers the basics of the ETS and then explains four tips that will save you a lot of money:
Goto SERLNG to know more.
Want to start with the basics? In the next section you can learn what the ETS is – and how it works. If you’re already familiar with the ETS, click here to jump to the first money-saving tip.
Knowledge is power, and understanding the ETS properly will help you save money – and could even make you money! The ETS operates on a ‘cap and trade’ system. The cap is an absolute limit on how much greenhouse gas can be emitted across all industrial sectors covered by the ETS. In terms of the maritime industry, the system applies to all ships of 5,000 gross tonnage and above that enter EU ports. This amount includes all emissions from intra-EU voyages and 50% of the emissions for voyages to or from non-EU ports.
The trade element is how you pay for the emissions from your ships. European Emission Allowances (EUAs) cover one tonne of CO2 emissions per year. You buy EUAs to pay for your emissions and can sell any surplus at the end of the year – potentially for a profit.
For example:
If you emit less than 10,000 tonnes of CO2 and have 10,000 EUAs, you could sell your surplus for a profit if the current market price exceeds what you paid for them. In practice, the most likely scenario is that you will hold onto any excess EUAs to count towards future emissions.
The price of EUAs is expected to increase over time as the cap – the limit on the total amount of greenhouse gases that can be emitted – decreases. According to global data and business intelligence platform Statista, in the average EUA price was €65. According to Statista, the price is expected to more than double within a decade, hitting close to €200 by .
TThe bottom line to saving money? Know how much you’re going to emit in the coming year and buy your EUAs accordingly. As a ship owner, you’re responsible for monitoring and reporting the emissions from your vessels annually as part of the monitoring, reporting and verification (MRV) procedure.
Handpicked related content:
Did you know? The handy EU Emissions Compliance application helps you plan, measure and report EUA costs accurately and easily!
To avoid financial penalties it’s important that you are on top of your emissions data. You need to think about the amount of emissions you will produce in the future and have a system in place to control costs and ensure compliance. Without this, you could be surprised by heavy financial penalties for exceeding your emissions allowance.
“In the complex world of ETS regulations, having in-house experts is crucial to help you keep up and avoid potentially expensive surprises.
Minimising the impact of the ETS on your shipping operations essentially comes down to better voyage planning and making your vessels as efficient as possible. Both approaches will save fuel and minimise the emissions your ships generate – saving you money in the process.
Energy saving technologies (ESTs) can help you improve efficiency and reduce emissions, but it can be difficult to choose the right combination of solutions without expert advice.
“The more efficient you can make your ships, the less cost you will have to pass on to your customers. In this way, ESTs offers a great opportunity to make your vessels more attractive than the competition.
The bottom line to saving money? Clear, data-led advice from an experienced partner. Wärtsilä Decarbonisation Services can help you sort through all the options open to you to determine the optimal combination. These options include:
Handpicked related content:
See how Wärtsilä Decarbonisation Services can help you choose the right decarbonisation solutions for your vessels and business in our Insights article: Strong decarbonisation strategy for your ship? 3 simple steps to success.
Ship owners and operators are increasingly finding that data is the key to optimising routes, improving transparency and identifying ways to make vessels less costly to run. DNV, the world’s leading classification society, estimates that the EU ETS will lead to additional annual costs for the industry of up to €10 billion. Could data hold the key to offsetting part of this extra cost?
The answer has proven to be yes. Gathering, monitoring and managing data properly will help you comply with emission-related regulations and avoid penalties. Data-enabled decision-making holds the key to finding cost savings and optimising every voyage, helping you to improve efficiency. These cost savings also free up money to invest in energy-saving devices that will further improve vessel performance.
Handpicked related content:
If you want to learn more about how to use emissions data and other vessel data to benefit your business, this Insights article – Expert advice: 7 benefits of data in improving vessel performance – has plenty of great tips.
Ship owners also need to remember that although the ETS only initially covers CO2 emissions, in it will be extended to cover methane and nitrous oxide emissions. If any of the ships in your fleet use liquid natural gas (LNG) as fuel, methane slip is something you need to know about and take care of.
Methane slip refers to the small amount of the fuel that doesn’t burn in your ship’s engine and escapes with the exhaust gases instead. It’s a challenge that engine manufacturers like Wärtsilä have been working on reducing for years.
If you fail to address the issue of methane slip, then the ETS could hit your business harder than it needs to.
The bottom line to saving money? Be smarter about methane slip, learn why you need to reduce it and discover simple, smart solutions that will deliver results – fast. This Insights article is a great place to get started: How to be smarter about methane slip – right now.
When you want to minimise the impact of the EU Emissions Trading System on your shipping operations, make sure that your vessels are as efficient as possible. An easy next step is to look at energy saving technologies. Download this white paper: “CII rating: 11 smart ways to boost it while staying competitive – A quick guide to energy saving technologies”
If you want to learn more, please visit our website LNG Skid.