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The LNG trade - Time for remodelling?

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Jakub Walenkiewicz Jakub Walenkiewicz
Principal Market Analyst

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Rising demand, especially from Asia, is lending new impetus to the LNG transport market.
Amid a growing number of LNG importing nations the demand for natural gas is increasing, especially from Asia. With new players, a growing tanker fleet and changing patterns, the LNG trade is undergoing a remarkable transformation, becoming more international, flexible and dynamic.
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  • Keywords: Maritime

While current LNG tanker earnings are not something to write home about, the ongoing transformation of this market is worth paying closer attention to. Until recently, the LNG seaborne trade represented only eight per cent of the total gas trade and was limited to a few large importers such as Japan and South Korea. Oil-linked gas prices prevailed and almost all contracts were signed as long-term charters with very few ships involved in spot activities. 

However, a substantial increase of gas production, combined with significant additions to both liquefaction and regasification capacity have changed the market fundamentals. Let’s try to examine some of the most critical ones. The seaborne trade, after years of stagnation, grew by seven per cent, adding 17 million tonnes of new cargo. The demand growth was driven predominantly by China and India, but also by newcomers such as Pakistan, Egypt and Jordan. These countries will continue to drive demand, however we also expect other countries such as Thailand, Vietnam and Singapore to play an increasing role as importers. As 85 per cent of newly constructed import terminals (or FSRU projects) are located in Asia, it is obvious that a substantial part of the new demand will be satisfied by sea transport. Clarksons Research expects a continued strong growth of seaborne trade, reaching eight per cent in 2018.

Expected increase of liquefaction capacity - capacity added in bcm/y
Expected increase of liquefaction capacity - capacity added in bcm/y

Growth factors

Most of this growth is driven by Australian and US projects. Last year, newly opened terminals such as Australia-Pacific and Cheniere Sabine Pass (T1 and T2) in the US generated the majority of new cargoes. In 2017, we expect a modest 25.5 billion cubic metre (bcm) increase in liquefaction capacity, mainly coming from Australian Gorgon (T3), Wheatstone LNG (T1), and Cheniere Sabine Pass (T3 and T4) in the US. A much stronger increase is expected in 2018 when 43.8 bcm of new capacity will come online, and in 2019 when another 47.8 bcm will be added. 

Next year most of the additions will come from Australia whereas 2019 growth will be dominated by US export facilities. The US as a “new kid on the block” seems to be introducing new dynamics such as an increased tonne-mile demand, attractive price arbitrage and much more flexible contract terms. US gas is still establishing its footprint and is testing all potential markets, such as Latin America and Europe as well as the Far East, which, due to the distance, generates the highest tonne-mile demand. Shipping one million tonnes of US gas to the Far East (per annum) requires around 1.7 ships, whereas the comparable trade originating in Australia generates a demand for 1.1 ships only. So, the tonne-mile effect generated by US exports is currently more rewarding than anywhere else.

Market forces

Another interesting factor is the pricing and competitiveness of US gas. Most of the traditional Asian gas contracts are based upon oil-linked prices. In the US however, gas is priced according to the Henry Hub Gas Index and as such is not sensitive to changes in the oil industry. Needless to say, it is not only decoupled from oil but also cheap. In fact, with current freight rates of some 40,000 US dollars per day (USD/d), a price difference of six USD/mBTU FoB in the US versus eight USD/mBTU in Japan may create an arbitrage of some 0.5 USD/mBTU, which translates to one million USD per cargo. 

It is important to note that charter rates assumed for the calculation are very low, due to the current oversupply. Rising rates (something the market hopes for) would require a wider price differential to create arbitrage. US contracts also bring a great deal of flexibility regarding terms and conditions. Contracts can be signed for any duration and quantity. There is also a lower penalty for not picking up the cargo (ToP), as in the US only the liquefaction fee is charged. In addition, no fixed delivery locations are required, which is of particular interest for traders who, in case of overcontracting, are able to resell their surplus of cargo somewhere else. 

All of these new developments have changed the LNG trade substantially, making it more international and flexible. On the one hand, a growing number of importers are generating a steadily increasing demand while, on the other hand, forcing suppliers to demonstrate more flexibility. According to IEA, more and more contracts are being signed for shorter durations and smaller quantities, without fixed destinations, and decoupled from oil prices. For the shipping industry this translates to more spot trading and more diversified trade patterns. In general, more competitive US pricing should have a positive impact on the tonne-mile parameter, however on the flip side it also introduces a risk of redirecting some of the cargoes to shorter routes; for example, Japanese traders might resell their US-purchased gas in Europe.

Deliveries of LNG carriers - vessels added to the global fleet
Deliveries of LNG carriers - vessels added to the global fleet

Rate increases will take time

It may still take a while for LNG carriers to experience higher earnings. The order book is still over 120 ships strong. Deliveries in 2017 will reach 53 vessels and in 2018 the fleet will grow by another 41 tankers – an estimated growth of 10 per cent and 7 per cent, respectively. In light of the plans for major export terminal expansions in 2018 and 2019 (unless delayed), freight rates are likely to remain low throughout 2017. Nevertheless, the current remodelling of the market creates new opportunities in the longer perspective.