Pricing structures will be key in determining the future of LNG exports, says EY in a new report, Competing for LNG demand: the pricing structure debate.
The report describes the effect potential Canadian and US LNG exports might have on global LNG contract pricing structures.
“It’s one of the most complicated issues for the LNG sector,” says Barry Munro, EY’s Canadian Oil and Gas Leader. “High LNG development costs have generally required ironclad long-term off-take agreements. And those have historically been oil price based.”
But the issue now, he explains, is that recent high oil prices have translated to high LNG prices for Asian buyers — much higher than, on the surface, the current price of North American natural gas suggests should be the case.
“We’re seeing expensive projects trying to sell to increasingly more price-sensitive buyers,” says Munro. “High oil prices and low natural gas prices in North America have strained the traditional approach to LNG pricing. Asian buyers are now looking to modify or possibly replace their long-standing and, in the current environment, expensive pricing model of gas prices tied explicitly to oil prices.”
“When it comes to pricing, LNG developers will have to balance pressures to be competitive with the need to generate sufficient returns,” he adds.
“Proposed increases in LNG supply have made the traditional oil-linked pricing structure more difficult to justify,” says Munro. “We’re seeing industry players now explore alternative pricing structures to remain competitive — often referenced to Henry Hub prices.”
While initially challenging to LNG project developers, the move toward Henry Hub pricing may increase buyers’ and sellers’ choices, adds liquidity to markets, and allows buyers to hedge financially and physically. It also gives suppliers the confidence to sanction projects before securing export contracts.
At the end of the day there will always be competitive pressures from new suppliers, and at the same time, buyers will always look to obtain the lowest cost, least-risky supply, with the explicit understanding that security-of-supply is of high strategic value but comes at a cost.
“Solving the pricing structure puzzle is just one of the many challenges Canadian LNG players must manage to compete for capital,” says Munro. “When the price structure is right, both LNG buyers and consumers will win. But remember — we’re not the only country looking to establish a LNG export industry. Competition will be fierce.”