COVID-19 to permanently change Asia's LNG contracting landscape: academic

Singapore — LNG market disruptions caused by COVID-19 this year are expected to result in some permanent changes in the structure of sale and purchase agreements between buyers and sellers, to account for similar eventualities in the future, Agnieszka Ason, Visiting Research Fellow at the Oxford Institute for Energy Studies, said at the S&P Global Platts LNG & Hydrogen Conference.

The changes will be part of the new generations of SPAs being signed in the midst of a rapidly transforming LNG market place that is seeing the emergence of a viable spot and short-term market and the commoditization of LNG.

Key changes to LNG contracting will include a more widespread adoption of cargo cancellation clauses that was previously limited to US LNG contracts, and the ability to reopen contract terms for renegotiations in order to facilitate the signing of more long-term SPAs, Ason said on Oct. 27 at the conference, held as part of the Singapore International Energy Week 2020.

In the context of market disruptions, the past few months have seen notices of force majeure, requests for cargo diversions, delays, cargo cancelations and deferrals in response to the pandemic, which exposed the weaknesses of current contracting mechanisms, she said.

"On the basis of the lessons learned it is likely that in future contract negotiations, more attention and more scrutiny will be afforded to operational terms that allow for adjustments, in response specifically in the context of market disruptions," Ason said.

"COVID 19 will have an impact on the Asia LNG SPA. Potentially, it will be a significant and lasting impact," Ason said.

INTER-REGIONAL LESSONS

Earlier this year, when the initial waves of COVID-19 triggered lockdowns in China and India, a sudden double digit percentage decline in natural gas demand forced key buyers like China's largest LNG importer, CNOOC and India's Petronet LNG to invoke force majeure on cargoes, which were not accepted by most suppliers.

In the following months, spot LNG prices were stuck under $3/MMBtu and even fell below $2/MMBtu in mid-summer, triggering a supply response from US LNG producers that saw dozens of LNG cargo cancellations until the fall season.

"Cancelation rights which are enshrined in cancelation clauses typically, or regionally, belong to US LNG contracts.

They are, however, feasible in some other contexts, and I would say it is likely that we will see an increased interest and potentially an increased execution and implementation of cancelation options in other contexts in the future," Ason said.

She said Asian LNG buyers will increasingly emulate European market mechanisms and there will be an increasing amount of cross-basin influence between the Atlantic and Pacific in the evolution of LNG SPAs.

For example, Asian price review clauses have traditionally allowed for price reviews at narrowly defined time intervals like every five or 10 years, but increasingly they will be triggered by the notion of "change of circumstances" -- well-known in European price reviews but only now being injected into Asian contracts, she said.

RIGID LONG-TERM CONTRACTS

COVID-19 has also exacerbated the oversupply problem in the LNG market due to which few long-term contracts have been signed this year, making it difficult for upstream and export projects to reach a final investment decision.

For instance, 2019 was a year of record FIDs with 71 million mt of new liquefaction capacity being sanctioned, and as Doug Wharton, VP Origination, Asia, Cheniere Energy pointed out -- 2020 was expected to touch 100 million mt before COVID-19 hit and no FIDs have materialized so far this year.

Ason said the rigidity of long-term contracts that do not allow contracts to be reopened, for both price and non-price renegotiations, is likely to be one of the key reasons why some market participants are unwilling to commit to a long term contract.

"Adjustments to non-price terms are typically attempted and sometimes secured in price reviews. In extreme cases they can only be obtained if they are forced by the threat of contract termination," she said.

She said in an environment where long term contracts are likely to lose out to short term alternatives in a highly competitive market, more flexibility in allowing renegotiations will help sellers get more buyers on the SPA table.

"In order to secure long term contracts .... and in order to reverse the general tendency towards shorter and smaller deals, an alternative will be to inject this contract reopening mechanism, allowing for a comprehensive contract adjustment that is so far largely missing in the context of long term contracts," Ason said.