Clyde Russell, Reuters

ExxonMobil’s deal to cut the price of LNG supplied under long-term contract to an Indian buyer has largely been viewed as a bad outcome for producers of the super-chilled fuel.

Certainly the trade made by ExxonMobil to supply more LNG to Petronet LNG, but at a lower price, does seem to favor the Indian utility.

ExxonMobil will increase the volume supplied from its share of the Chevron-led Gorgon project in Western Australia by 1 million tonnes a year to about 2.5 million tonnes, but at a lower cost than originally agreed in 2009.

The revised deal has sparked market speculation that this is the first domino to fall and that more re-negotiations of long-term LNG contracts are likely. Up until now it has been extremely rare for these agreements to be amended, and so far, it has only been in India, where a deal with top LNG supplier Qatar was re-worked in 2015.

Producers are probably nervous that major buyers in Japan, South Korea and China, which account for more than half of the global LNG market, will be tempted to seek better terms. Already there are some moves toward this end, with utilities in Japan banding together to pool their buying power and seek more flexible and shorter-term deals.

What the ExxonMobil-Petronet deal is a further sign of is the era of long-term LNG contracts with prices linked to moves in crude oil are going the way of the dinosaurs. The market is already moving toward both spot and short-term deals, ranging from several months to a few years.

Restrictive destination clauses are also being stripped from contracts, allowing buyers to on-sell cargoes, and thereby adding liquidity to the burgeoning spot market.

Short-term Pain, Long-term Gain

The LNG market was always going to change as a result of the massive increase in liquefaction capacity in recent years, with eight new projects in Australia and at least six in the U.S.

The last of these new plants are scheduled for completion next year, and they will result in global LNG liquefaction capacity of around 450 million tonnes by 2020, representing a doubling in the space of a decade.

This ramp-up was bound to have the effect of upending the rather cozy LNG club that prevailed between producers and their long-term customers.

Oversupply has seen the price of spot Asian LNG drop to $6.40 per million British thermal units (mmBtu) as at the end of the week to Sept. 8, down from a record high of more than $20 at the start of 2014.

The reworked ExxonMobil agreement with Petronet reflects that reality of both ample supply and lower spot prices.

While market observers have tended to focus on the lower price ExxonMobil will receive, of perhaps greater importance is the fact that Petronet will buy 1 million tonnes more a year.

LNG is continuing to make inroads into Asia, with rising demand from traditional buyers such as South Korea and China, and from emerging players like Pakistan, Sri Lanka and Bangladesh.

It also appears LNG is to some extent winning the battle with coal when it comes to building electrical generation in Asia, with its current price disadvantage offset by its lower pollution levels and coal's greater political and social unpalatability.

The market narrative for LNG is starting to change, from one where oversupply was seen as a problem that would last until the middle of the next decade to a view where demand is likely to rise quickly in the next few years, soaking up available supply and even tipping the market back into deficit.

In this light, ExxonMobil’s deal doesn’t look bad. Yes, the U.S. giant is taking a hit on prices now, but it is also clearing volumes that it may have had difficulty selling otherwise.

If buyers do seek to renegotiate other long-term deals, they do so at their own risk.

They will have to balance the short-term advantage of lower prices against the potential longer-term problem they will have in competing for cargoes, maybe paying higher spot prices for them sometime in the next five to 10 years.

Producers, for their part, should not resist the move to a more flexible LNG market, because a freer market will allow them to profit more when the supply-demand balance moves back in their favor, and also to survive low-price times by accessing a more liquid spot market.