By Anna Shiryaevskaya
With the price gap between the regions shrinking more than 70% since then, it has become challenging to economically bring U.S. fuel to Britain when the Windsor, England-based utility takes its first contractual delivery from the Sabine Pass plant in Louisiana in September.
“Right now we anticipate lifting the cargoes,” Jonathan Westby, co-managing director of Centrica’s energy marketing and trading unit, said in an interview at his office in west London, a hub for LNG trading.
“While the spot market is looking particularly oversupplied right now, we have been undertaking a big risk management program and therefore have managed the front end of the Sabine Pass contract quite considerably,” Westby said.
Utilities, trading houses and oil majors have been lured by LNG as buyers from China to Pakistan seek cleaner fuels. As increasing global supply and flexible contracts help make LNG the fastest-growing fossil fuel, market players are searching for niches and navigating challenges such as where to place cargoes and how to manage price risks.
Since trading its first spot cargo in 2014, Centrica has transformed from a regional buyer importing cargoes to a terminal near London into a global player, targeting 5 million to 6 million tons of LNG next year. That’s more than half of what some of the largest commodity trading houses deliver annually. Centrica has built a diverse portfolio of long-term contracts with major producers and found demand from its European hub to the Middle East to Asia to the Caribbean region.
Centrica’s Long-Term LNG Contracts
|Qatargas||>2 million tons a year||5 years from January 2019; extension of earlier contracts going back to 2011|
|Cheniere||1.75 million tons a year||20 years with option for a 10-year extension from September 2019|
|Mozambique LNG||2.6 million tons a year jointly with Tokyo Gas||From start of production to early 2040s|
Signing up to buy volumes from Cheniere, which revolutionized the U.S. energy landscape by becoming the first exporter of American shale gas in the form of LNG, was a major milestone to kickstart Centrica’s LNG business. Centrica will be buying from the fifth unit of Sabine Pass, which started commercial operations earlier this year, and will need to pay fixed fees. It has the right not to lift cargoes, but would need to notify the seller in advance to do so.
Under the terms of the agreement, Centrica will pay Cheniere a fixed fee of $3 per million British thermal units and a commodity fee of 115% of the prevailing Henry Hub price, for the procurement and liquefaction of the gas.
While U.S. supply is abundant, rapidly expanding, relatively cheap and unrestricted by traditional limitations such as destination clauses, it exposes European buyers to a price index that is different to the ones they use to trade at home. The Cheniere contract is based on U.S. benchmark Henry Hub, needed to raise financing to build American plants.
“One of the big issues facing the industry is how to manage price risk and volume risk in long-term contracts because it costs a lot of money to develop LNG liquefaction,” Westby said. “Market participants would find it a lot easier if the financial markets provided the ability to hedge for 10 years out, they currently don’t.”
By using the paper markets and securing physical deals, Centrica expects to maintain profitability. The U.S. contract’s flexibility along with multiple other deals in place creates optimization opportunities which can be monetized to offset the cost of buying the gas in the first place, he said.
“You have to be quite creative in terms of how you can effectively risk manage that through doing physical activity and creating physical homes for the cargoes,” Westby said. “We have entered some mid-term contracts and we will be selling the cargoes into multiple destinations.”
One such contract was a deal with Poland’s PGNiG, which is committing to U.S. LNG as the eastern European nation is moving to free itself from buying pipeline gas from Russia’s Gazprom PJSC, Europe’s dominant gas supplier.
In February, Centrica signed an innovative contract to buy the fuel from the Mozambique LNGproject jointly with Tokyo Gas, with which it also has a separate deal to swap cargoes. Centrica also teamed up with New Fortress Energy, which converted a number of oil markets in Jamaica into gas customers, providing the utility with a market for its LNG.
“With the Polish deal, with the Caribbean deal, and obviously our partnership with Tokyo Gas, we feel that we can add more value by working collaboratively with other companies that have complementary positions,” Westby said. “That is how we achieved a lot of our growth, is through this kind of collaboration.”
In the currently oversupplied market, Centrica isn’t shocked by lower prices. Traders watch spreads between regions, such as Asia and Europe, as well as price gaps in time to explore opportunities for floating storage and diversions, rather than an absolute price level, Westby said.
But even the best modelling can be upset because of unpredictable weather and unplanned outages at plants, he said. Also, lower LNG prices open up demand, and once nations switch to cleaner gas, that usage becomes permanent.
“The markets are probably looser now than they have been in the past,” Westby said. “That presents some challenges in terms of securing markets for product. Looser markets typically create liquidity — it is easier to trade and enter transactions. That will be something we will be looking to take advantage of.”