The new price environment of the LNG industry has been a painful reality for buyers across the globe. Contacts with links to long-term moving averages of oil prices still often yield higher prices than those on the spot market. In response to this, and using the global oversupply of LNG as leverage, buyers of growing importance have taken a hard stance toward renegotiating those existing deals. Using its power as an emerging importer of LNG, major Indian buyers have been at the forefront of these efforts.
At first, Petronet targeted Qatar’s supply. The Gulf state’s fully integrated project allowed for Qatargas to control their price more than most global producers; because of its low costs and the acknowledgement that the Indian market would be important going forward, Qatar capitulated to Petronet and renegotiated their contracts to better reflect the current spot market.
Following that, GAIL pursued a renegotiation with Australia’s beleaguered Gorgon LNG project. At the agreed upon slope of 14.5%, Gorgon’s LNG is set to cost GAIL up to $3/mmBtu more than the prevailing spot market rates. Gorgon, in a tough spot itself following massive overruns and delays, has yet to give in to the demands from GAIL.
As such, GAIL has now turned to its contracted U.S. supplies. The contract that GAIL has with Cheniere Energy Inc. (NYSE MKTS: LNG) is different from the above mentioned ones due to its nature as a hybrid tolling model. The price is not linked to any oil price; rather the two companies agreed upon a fixed liquefaction fee of $3/mmBtu, plus the cost of Henry Hub gas (with a small markup) that would be passed through to the buyer. Given that Henry Hub remains the lowest gas hub in the world by a good margin, this seemed like a favorable deal for both sides.
How Cheniere handles this will be most interesting to observe. The Qataris had decades of uninterrupted production and sales, including a number of high-price years, and were able to keep gas production and liquefaction construction costs low. So after 20 or more years, Qatargas was able to be more flexible and was amenable to booking slightly lower revenues. Cheniere has not experienced the cost overruns and delays that the Australian projects have, but the liquefaction project is still brand new and has yet to produce steady revenues.
The purpose of the tolling model employed by this—and most U.S.—liquefaction plants was to eliminate the commodity risk of the oil and gas industry. Having locked in large credit-worthy buyers on decades-long contracts, there was virtually no risk for these liquefaction projects. The fixed fees were easily calculated and readily apparent and while they would never benefit from a skyrocketing LNG price, they would also presumably never suffer in a low price environment. Changing these terms would introduce an enormous element of risk that was not accounted for nor expected when the project was planned and a final investment decision was made.
Stratas Advisors does not expect that this effort will yield any substantial results. Rather, we view this as more of a fishing attempt by a hamstrung buyer to squeeze any extra savings they can after having overcommitted at the wrong point in the buying cycle. With Cheniere’s status as a publicly-traded company, there is an added wrinkle of investor confidence and a share price that could suffer if the expected revenues for the next twenty years suddenly change. With that in mind, the LNG industry has proven to be in a state of serious change, so while a capitulation by Cheniere is not likely, it is always a possibility.
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