
The LNG market is holding its breath over a price review arbitration case between South Korea’s Kogas, the world’s second biggest LNG buyer, and North West Shelf, Australia’s first and biggest LNG exporter.
The deal at stake, a 500,000 mt/year legacy contract that expired in March 2016, would seem insignificant given the size of the companies: the equivalent of 3% of NWS capacity of 16.9 million mt/year, and only 1.3% of South Korea’s total imports of 37.2 million mt in 2017, according to S&P Global Platts Analytics.
The parties hold no other LNG contracts with each other, their current bilateral trade is marginal — Platts trade flow software cFlow shows about one NWS cargo a month was delivered to South Korea in 2017 — and the prospects of closer ties are low as Kogas seeks to diversify its portfolio away from oil-linked prices.
Therefore, the impact of the contract price review on the companies’ cash flows would probably be small, while the LNG supply portfolios at either side of the dispute are unlikely to be significantly affected by any potential damage to bilateral trade relations.
THE BIGGER PICTURE
However, this arbitration case, the first to settle an Asian LNG contract dispute, is much more than a disagreement about pricing, with plenty at stake, not only for Kogas and NWS, but for the LNG industry as a whole.
First, it comes at a time when structural oversupply, growing market flexibility and downstream liberalization are threatening the traditional LNG business model — based on long-term contracts, oil-linked prices, destination restrictions and take-or-pay clauses — and gradually shifting risk up the supply chain from buyers to sellers.
Second, it has arisen ahead of the expiry of several legacy long-term LNG contracts. Approximately 15% of global contracts — about 43 million mt — are set to expire in 2018-20, and another 42 million mt in 2021-23, according to a recent report by Macquarie Research.
With the global supply glut likely to continue into the 2020s, this will give buyers more options. They can either replace contracts with spot volumes or re-contract under more favorable conditions, such as shorter duration, smaller volume, more flexibility or different indexation. But a continuation of the old supply model seems unlikely.
The Macquarie report pointed to an additional layer of risk, the contractual volumes up for pricing review. These include 187 million mt due for re-pricing before 2020 — around half of the estimated global LNG supply for that year — and another 146 million mt between 2021 and 2023.
Therefore, the NWS-Kogas pricing dispute could set an important precedent and open the floodgates for future contractual renegotiations and pricing reviews in the global LNG industry, with potential implications for all its stakeholders.
“Given the evolution of arbitration in pipeline gas contracts, we would not be surprised to see further buyers of LNG aiming to renegotiate their long-term contracts,” head of LNG Analytics with S&P Global Platts Frank Konertz said. “We clearly see a shift in the market to more spot, or gas-to-gas pricing, and a desire of importers to have this reflected in long-term contracts.”
Publicly available arbitration decisions over the past few years have all been in favor of the buyers, the Macquarie report said, with spot prices judged to be at least part of the market price.
WHAT’S AT STAKE FOR NWS?
More than half of NWS’ combined contracted portfolio of nearly 14 million mt/year is due to expire before 2024, according the International Group of Liquefied Natural Gas Importers’ 2017 report.
In addition, Woodside Petroleum, the operator and majority stakeholder of NWS, and Shell, its second largest investor, are, together with Malaysia’s Petronas, the world’s LNG sellers with the highest pre-2020 exposure to pricing review risks, the Macquarie report said.
“Using recent examples of slopes falling to approximately 11% from more than 14%, we see a substantial risk for sellers’ earnings,” the report added. The other stakeholders of NWS are BHP Billiton, BP, Chevron and Japan Australia LNG.
NWS’ ability to mitigate risk in a changing LNG business landscape is further weakened by the heavily concentrated nature of its supply portfolio, with nearly 80% of its LNG portfolio– more than 10 million mt/year — contracted with Japanese power and gas utilities, which are following the NWS-Kogas dispute very closely.
Japan, the world’s largest LNG consumer, has been at the forefront of global efforts to increase flexibility and improve LNG contractual terms for its buyers to mitigate the new risk emerging from a deregulating downstream market.
The first phase of Japan’s LNG liberalization saw it open up its domestic power and gas retail sectors in April 2016 and April 2017, respectively.
Further liberalization is on its way, with the division of former regional monopoly power-generation plants and transmission and distribution systems by 2020 and the unbundling of gas pipeline operations by 2022.
This is pushing Japan’s incumbents in new directions where managing price risk and ensuring profitability take priority over security of supply.
WHAT’S AT STAKE FOR KOGAS?
The inherent risk of pricing long-term LNG against a different commodity — which creates a disparity between expected delivered prices when the contracts are signed and market prices when deliveries begin — and the difficulty of placing those volumes in an increasingly competitive downstream market are becoming all too familiar for Kogas too.
In South Korea, the emergence of new importers unrestricted by long-term contracts, and increased access to import terminals are encouraging more competition in downstream markets.
SK E&S, a city gas company that has expanded into gas and renewables power generation, has been active in buying spot cargoes, after its own LNG receiving terminal in Boryeong started in 2017. The facility, which SK E&S owns with GS Energy, is the second private LNG terminal after Gwangyang. More importers mean more competition for Kogas.
Seoul’s move to allow private companies to import LNG directly and resell in the domestic market from 2025 coincides with the expiry of two large contracts by Kogas — a 4.1 million mt/year contract with Oman and a 4.9 million mt/year contract with Qatar.
“Kogas’ case for arbitration seems more aimed at winning better terms for future contracts, such as price, ‘take or pay’ clauses and ‘destination’ restrictions,” a South Korean source familiar with the arbitration case said.
WHO OWES WHOM?
A Kogas spokesman Monday told S&P Global Platts NWS owed the former money over a mid-term contract price dispute that has recently ended in court-administered arbitration.
The comments came after remarks last week by Peter Coleman, chief executive of NWS operator Woodside Petroleum, saying it was the South Korean buyer that owed money to the Australian joint venture.
“The contract allowed Kogas to call for price renegotiation to reflect major changes in the LNG markets,” the Kogas official said, adding that the two sides failed to reach an agreement before contract expired in March 2016. In a statement last week, Coleman said it was the NWS joint venture that had taken Kogas to arbitration.
“This was an old legacy contract that was at actually very low slopes,” he said. “The North West Shelf view is that Kogas owes the North West Shelf money, not the other way around.”
In the early years of this century oil prices were very low, with Brent averaging $18.65/b in late 2001, and a weak LNG market, independent oil and gas consultant and managing director of DataFusion Associates Tony Regan said.
China’s first LNG importer CNOOC was able to capitalize on this in its first LNG deal with NWS, concluded at a 5.25% linkage to the three-month average of the Japan Crude Cocktail plus a $1.55/MMBtu constant, and a ceiling of $25/b JCC, Regan said.
The NWS-KOGAS deal was done just after the NWS-CNOOC agreement and it was reported at a slope of 6.4% at the time, with a first price review after approximately five years, he added.
“The price would have been reviewed up considerably as we moved back into a sellers’ market, and the dispute suggests there was a loose end regarding future pricing that they were unable to resolve at the time. Volumes under the contract were heavily skewed to winter months so this back-end loading may also have created a pricing issue,” Regan said.
Source: Platts
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