There are key questions which businesses can ask in order to carry out an initial assessment of their position and readiness to face a transformed market, focusing on six accelerators to make possible the transformation they will require.
LNG businesses need to rethink their commercial strategy and whether their internal ways of working, cost structures and capabilities are aligned to servicing the changing markets. This means questioning the choices which businesses make, ranging from the formulation of their commercial strategy to the functioning of day-to-day operations. LNG businesses can assess their readiness, and accelerate their transformation in this fast-changing market, by asking themselves a set of questions about their business model, market and customers; their operating model, processes, technology, structure, people and culture; and their measurement and incentives. We see six accelerators essential to consider for such a transformation.
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Considerations for suppliers
Understand LNG demand holistically: Compare the attractiveness of different end-user geographies, including large, but mature markets, big markets with potential for growth and emerging niches. On a global scale, strategic choices by gas exporters shifting from one market to another (for instance Russia’s changing pipeline focus from Europe to China) can open up LNG supply opportunities.
Create demand: Access niches and new markets and create new import points by investing in or facilitating regasification terminals and connections. Joint ventures could be considered to create demand (for example, on gas-fired power plants in existing coal-using markets or on LNG shipping). Singapore’s ambitions in LNG bunkering point to a way ahead that may be linked to China and India for both sea and ground transport.
Considerations for buyers
Create buyer alliances: Reduce duplication of redundant demand and strengthen negotiating positions. JERA may point the way to future buyer alliances, for instance as proposed between Chubu Electric of Japan and GAIL of India, between Tokyo Gas and Korea Gas, and the March 2017 MOU between JERA itself, CNOOC and KOGAS. Potential issues such as minority interests, competition law and response of LNG suppliers would need to be taken into account.
Diversify portfolio: Reloading (the practice of reloading an already discharged LNG cargo back onto a vessel for export) is an option, given more flexible LNG markets, but exposes the reseller to the risk of mismatches between long-term and spot prices.
Build a more diversified portfolio of contracts with different suppliers, periods and pricing bases, and extend portfolio management via intermediary trading companies and financial hedging mechanisms.
Delivering value to end-users is taking on much more importance. This includes utilizing a portfolio approach that includes trading in the market instead of using one's own capacity.
Today, many businesses are set up on the assumption of individual point-to-point sales based on assets in source regions built off legacy contracts. This has led to considerable latent exposure under liberalized markets and changing electricity generation requirements, creating a need to rebalance volumes around spot/short-term contracts.
With growth in options such as spot sales and financial derivatives and rapidly shifting pricing and buyer expectations toward optionality, reinforced by removal of destination clauses, the opportunity is to offer portfolio management through the central management of product flows and delivery, in a way that can create greater value for businesses.
Creating stronger central management
Players will need to optimize not on individual assets or contracts but from a portfolio perspective, which will need to bring stronger central portfolio management across the value chain.
Building trading capabilities linked to supply chain
As buyers seek to diversify their portfolios, there are increased spot and short-term market volumes.
Testing the portfolio resilience against various supply, demand and price scenarios
Players will need to bring together 'the basics' to understand the likelihood, materiality, velocity and interplay of factors. Insight to manage and mitigate risk is required.
Questions to be answered (and capabilities developed to answer them):
With tightening margins, increased spot sales and short to medium-term contracts, we foresee increased tension between suppliers and buyers. Both will need to reassess their in-house capabilities for such negotiations. KPMG work on some of the highest-profile contract renegotiations have highlighted key strategies and bargaining positions, and that neither buyers or suppliers can afford to be complacent or singular.
Considerations for suppliers
Segment markets by price-sensitivity and pricing basis: Some markets have gas-on-gas competition, some feature competition against oil-indexed pipeline gas, and in others, LNG competes against coal for bulk demand. Demand and price are further complicated by policies that distort pure economics. To understand demand intelligently, it should be measured against the right LNG price basis and policy mechanisms.
Understand buyers' business strategies: Align with marketing and business strategies that will differ between a traditional large LNG project looking to secure anchor customers; a Henry Hub-based tolling project in the USA; a small floating LNG project; and a portfolio player or trader with many sources and destinations. These different business models need to match with the choice of pricing bases and contract durations and the access to physical infrastructure such as tankers and regasification terminals.
Considerations for buyers
Understand bargaining positions: The current market provides buyers an upper hand. Long-term buyers need to balance the desirable objectives of portfolio diversification and supply including jurisdictional, commercial models, terms and investment along the value chain; matching LNG pricing basis with their downstream customers; and flexibility.
Balance contract portfolio: Shorter terms reduce the risk of over-committing to purchases with uncertain demand. Reloading is an option, given more flexible LNG markets, but exposes the reseller to the risk of mismatches between long-term and spot prices. A bundle of contracts with different suppliers, periods and pricing bases can help, as can a greater role for intermediary trading companies who can manage demand risk across their portfolio.
Plan for a shorter/balanced market: Buyers are at risk of getting complacent, expecting an extended period of oversupply. Over the course of the last six months, the LNG supply demand outlook has changed to a more balanced view over the long-term, prompting a need for buyers to have better forecasting capabilities.
Realizing project cost and cost improvement opportunities is challenging in complex LNG environments. The experience of the LNG sector of mega projects with mega cost overruns and delays reinforces the imperative for players to refocus on improving project development, including exercising the supply chain, reducing complexity and adopting a commercial mindset to improve capital efficiency and capital costs.
The cyclical nature of the LNG industry suggests an opportunity for fewer, higher-quality projects to be sanctioned — leveraging improved commercial value that includes revisiting contracting strategies and project execution structures.
A recurring theme in the LNG experience is that each LNG project creates unique stresses on the contracting approach and associated risk management driven by:
Below are areas of focus and opportunity to navigate the high-risk environment of LNG projects (all of which are obvious, but to date, elusive in realizing).
Project management and simplification
Key principles behind a robust contracting strategy should include:
Increased competition can be met by a relentless focus on asset performance. This means lower capex and opex as well as maximum possible throughput.
Most suppliers have an ongoing continuous improvement program, but these may fall short of addressing their needs in an increasingly competitive market. By answering three questions, companies can identify gaps and additional opportunities:
Using benchmarks from related industries — validated through work with LNG assets and using the rigor of our proven external investor lens approach — we typically see the following sources of value for asset operators:
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A significant majority of LNG producers operate under a JV agreement.
Realizing many of the opportunities highlighted earlier, both for execution of capital projects as well as operational efficiencies, require businesses to overcome suboptimal JV arrangements and operations.
This requires JV partners to act as active asset managers and owners instead of passive shareholders.
Where JV partners have played the role of active asset managers, businesses have been able to realize a set of improvements including cost rationalization and overall operating and development asset performance improvements, implemented new operating models keyed to sustaining improved performance, applied innovation to update process and practices to achieve better performance and attracted new investors based on improved performance.
Making material step changes requires JV engagement and improved JV Agreements to promote comprehensive cross-functional programs in major assets keyed on performance.
This requires companies to focus on:
Separation of ownership of infrastructure
Contract collaboration and service sharing