LNG: Why unwieldy long-term contracts?

My question is why to make the LNG project so bulky as to render it subject to all kinds of political, financial, and other threats. Perhaps the argument is that a larger and longer-term deal would fetch better prices? Or it was feared that a lack of long-term commitment from credible suppliers may bring in supply risks to the projects. Some bankers may also have put such conditions for financing the capital investment. As we will examine in this space, none of this may not be true. We examine and propose alternatives in this respect.
Although, LNG is supplied mostly under long-term contracts, spot market share is increasing and has reached a level of 20% or so of the total LNG trade. Most of the spot trade is in the four major importer countries, the US, Japan, South Korea and Spain. Algeria, the UAE, Trinidad, Qatar, Australia and Oman are the other major spot market players. Spain is emerging as a major LNG player in the European market as a counter to cheap Russian pipeline gas. LNG trade did not grow as much as it could have after recent Russian blockade of gas to Kazakhstan, which did affect European gas supplies as well, some market shift to LNG will take place.
LNG pricing issue has remained contentious among buyers and sellers. No satisfactory or universal market price exists ala oil price. Let me digress a little and apprise the readers with a background on it, and then we revert to our core argument and proposal.
LNG prices, under long-term contracts, have been settled as per general pricing formula; following conclusions can be drawn from the application of these formulae in various market regions;
Japanese formula results in highest LNG prices at various oil prices; (13.02- 13.50 $per Mbtu) at $100 per barrel; Japanese and Qatar formulae give identical/close prices to each other.
Chinese and India-Iran model approximate each other. These result in the lowest (7.31- 7.70) LNG prices, at high oil prices of $100 per barrel; Chinese model appears to be more balanced, perhaps fairest of all. At low oil prices of 20 $ per barrel, simulated LNG prices are higher than India-Iran formula (3.1533 $ per Mbtu). While at high oil prices, US $100 per barrel, Chinese model gives the lowest LNG price of all other formulae ie 7.13 $ per Mbtu vs 7.70 $ India-Iran, 13.22-13.50 $ Japan and India-Qatar.
Recent spot prices as reported in July 11 PLATT" issue of LNG daily" survey reports following prices in USD per mmbtu; Japan/Korea 13.95, South West Europe 10.19, North West Europe 9.65, FOB Middle East 12.55, West India 13.17 and FOB Australia 12.67.
Long-term bilateral contracts are increasingly becoming a matter of the past. Even short-term contracts are being replaced by spot purchasing arrangements. We do not have the specific details of what bid terms were asked and what was offered. What has come out in the press tells that offers were priced at LNG price equal to 80% of the prevalent oil price. At the prevailing oil prices, supposing a 100 USD per barrel price tag, this would amount to a rate of 13-14 USD per mmbtu, which is three times the price currently prevailing in Pakistan. In Pakistan, it may be argued, gas is under-priced, and the US low prices may also be similarly rejected for reference purposes. Let us take the European prices, which have traditionally been high or even the Japanese prices, which have always been the highest. Europe has gas (Netherlands and the UK) and is connected with the world's most extensive gas network fed by the gas from Russia and Ukraine, etc Europe also has arrangements to get LNG from Africa.
It has been reported in recent publications on the subject and verified by this scribe that the gas-to-oil price ratio has come down to around 52%, as opposed to the offer of 80% that we have received in the past tenders. Long term supplies agreements and warranties bring in unnecessary risks which is often un-measurable for so much into the future. What suppliers or bidders would naturally do is to build in a heavy risk margin to save itself. And probably, that is what that has been done in the cases of previous tenders.
A short-term (5 years) contract would have been much more preferable and would have got better prices and contract terms. In fact this is what that happened. The offer of Fauji/Viton was reportedly cheaper, precisely for the shorter contract period. In fact, we would suggest that 50% of the capacity be covered under a short-term contract and 50% be left for spot purchases. These days 20% of all LNG trade is being done under spot purchases. This share may grow higher in future. Also the gas supplies business has to be separated from the operation of the re-gasification and storage facility. The owner-investor of the RLNG is to be paid under a cost-plus tariff on the lines of the IPPS. Let me quote here from PLATT.
In the liquefied natural gas (LNG) market space, traditional patterns of trading are evolving fast. Where cargoes once changed hands only through opaque bilateral deals, the market now exhibits open sell tenders for multiple and single cargoes, brokered trades, cargoes sold in longer trading chains, and speculative trading positions taken up by non-traditional participants including banks. Over time, as in other commodities, long-term LNG contracts may adapt to spot LNG price discovery, and will no longer be dependent upon weaker correlations to oil or piped gas prices. Upstream, an increasing volume of non-associated gas supplies is breaking the production link with oil, while downstream gas demand has broadened as a new fuel for transport and industry. Market pipeline prices of natural gas are delinking from oil prices, and buyers and sellers are looking for price benchmarks that reflect the real world of shipped gas.
Market observers estimate that spot trade already represents about 20% of LNG volumes produced each year. This trade includes bilateral deals, inter-regional diversions, tenders, chained cargoes, and a variety of other transactions. The LNG market demonstrates a greater proportion of spot trade than most commodities, which typically are supplied under a term contract to spot ratio of 90:10. As much as 40 million metric tons (mt) of LNG, equivalent to 650 cargoes a year, are being traded on a spot basis. As global supply volumes and market participation grow, spot market liquidity will continue to build. Price transparency and market sophistication accelerate this process, by raising comfort levels behind each act of spot trade.
An annual or multi-year contract price cannot capture the daily fluctuations in market value that occur in LNG, LNG shipping, and associated piped gas and oil markets around the world. Long-term LNG contracts expose either the buyer or seller to market price risk. Daily spot prices mitigate this risk by representing actual market value for product bought and sold each day. In many commodities, annual or monthly averages of daily spot prices (called floating prices) are therefore preferred for negotiating and settling long-term contracts, with location, quality or customer-specific differentials typically applied to the underlying benchmark. Daily prices do not introduce volatility - rather, they make inherent market volatility both visible and manageable. Source: Platts Daily Spot LNG Price Assessments
In this country, oil imports to the tune of 1 billion US dollars per month are being made without any long-term contract of the sort that has been required for LNG. Edible oil is another example. Finally, if it is to be a long-term deal, why can't it be on a government-to-government level. One should be able to get better terms without intermediaries. Gas is with Qatar. Western companies are required to build and operate the Re-gasification terminal. Separating gas supplies and distribution from terminal operation and ownership would facilitate such arrangements. Pakistan has a large gas demand potential at reasonable prices. It is similar to the mobile telephony and generally the whole communication sector; the latter has been able to attract a lot of DFI and has lowered the prices as well. Similarly opening up the gas sector may be able to attract DFI and be able to maintain affordable gas prices. Qatar has a lot of gas, which is almost stranded. It needs market, which Pakistan can offer. A two-track market with both regulated and open segments may be able to attract foreign interest and investment.