Lower LNG prices: Are long-term contracts in trouble?

Lower LNG prices: Are long-term contracts in trouble?

India’s latest victory with Qatar over gas offtake penalty is more than just an effect of good times. The good times had, in fact, started ringing in when the price of LNGfell to $6.80 per mmbtu by over 50% in the last one year. 

Gas plants and fertilizer units which were earlier rendered uneconomical due to the high price of gas, are now cranking upIndian Oil too, said that it plans to cut down dependence on coal and oil and is expanding its natural gas business. 

India is at the gaining end of the commodity price cycle, Qatar is the other end of the see-saw. The world’s largest gas producer recently waived a $1 billion penalty that they had slapped on India’s PetronetLNG for offtaking lesser LNG than contracted. Petronet chose to supplant costlier long-term gas with that of cheaper spot LNG, and contractually it had called for a penalty of $1 billion.

Offtakers of LNG that base their demand on continuous supply are always eager to sign long-term contracts. Since gas cannot be stored, producers too offer discounts for those who would want to sign such contracts. They include take-or-pay clauses which ensure that it is purchased, at least on paper. 

Yet, the mechanism is not simple and effective. Many coal producers have long since complained that it is very common amongst buyers to renege on contracts when prices fall. Unfortunately, this behaviour seems to be spreading to that of gas buyers too. The reason; lowered prices are too enticing to remain contractually bound.

Apart from waiving off the heavy penalty, Qatar has also agreed to re-negotiate the contract making a win-win for both. This decision is not just an indication of producers bowing to lower commodity price wave. Naturally, the power dynamics shifts from producers to buyers depending on the environment. However, this time around, it is more than that. There are other long-term changes in the gas industry that are making producers take the backfoot. 

Asian buyers have been depending exclusively on Qatar for their gas supplies, for years. The reason being the shale gas boom in the US. Apart from the abundance in which this new source of gas has brought, shale gas can be recovered at a cheaper price, bringing down the net price to around $2 per mmbtu. 

Many Asian buyers have started protesting the difference in prices between the gas sold in the Atlantic and the Asia-Pacific. The possible export of gas from US is still years away, but the effect is starting to build up. In the last few years, many large Asian buyers are either delaying the signing of long-term contracts that bind them for 25 years or ten years. They would prefer to wait and watch. 

This problem is only multiplied by the current long spell of low crude prices. It is time to face the truth. 


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