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Fitch sees rising price risk for LNG sellers in evolving global market

As the global trade of LNG transitions into a fully liquid commodity market, a changing landscape of LNG buyers and sellers has increased competition among LNG export developers and created new project financing challenges, according to a report from Fitch Solutions Macro Research.

LNG sellers are expected to face rising price risk as a glutted global gas market and a crowded field of LNG export hopefuls skew contract terms and pricing structures in favor of LNG buyers, who increasingly prize shorter-term and more flexible contracts, according to an Aug. 27 report by the research firm, an affiliate of Fitch Ratings. Demand growth is also shifting to emerging markets, where buyers often have different needs and are less creditworthy than the counterparties export developers have traditionally sought.

Those trends have important implications for project financing and development, including the potential of higher financing costs and limited access to traditional project finance vehicles for some companies, Fitch Solutions analysts said. The analysts said the price risk is exacerbated by the near-term market oversupply that emerged amid the ramp-up of new LNG facilities, which is especially pronounced in the U.S.

"The rapid growth in liquefaction capacity is depressing spot LNG prices, and this is likely to last for the next several years as demand growth ... catches up," Fitch Solutions analysts said. "This combined with the large number of liquefaction plants seeking [final investment decisions] has created a buyer's market ... Pricing formulae negotiated during periods of low prices tend to be more favorable to the buyer (and vice versa), and this depresses the cost of the contract LNG even as prices rise. Lower LNG prices pressure project economics and have a bearing on the cost and availability of project financing."

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U.S. developers seeking to commercialize projects continue to experiment with different pricing and contract structures to compete for buyers in world markets.

But shifting customer demand also creates challenges that could see LNG developers struggle to secure sufficient long-term off-take to underpin their projects, Fitch Solutions said.

Most North American LNG developers have planned to finance projects with a mix of debt and equity, and many have looked to project-level financing to provide the majority of funding for the multibillion-dollar export facilities. That has usually meant securing long-term contracts with creditworthy buyers to satisfy lenders who want to see guaranteed cash flows over decades.

In a traditional environment when deals used to underpin projects were marked by fixed end-to-end trading with a relatively small pool of buyers and sellers, the major buyers were primarily state-owned gas and power utilities in developed Asian markets. But the market is evolving past that, Fitch Solutions said.

Fitch Solutions attributed much of the shift in buyer preference to the demand swing toward buyers in emerging markets. Those buyers often face relatively uncertain demand outlooks and are less creditworthy, limiting their desire and ability to commit to long-term sales and purchase agreements. But the analysts said traditional buyers such as major utilities in Japan and South Korea have demonstrated similar preferences as they too face less secure demand outlooks.

The vast majority of LNG buyers remain investment-grade entities, but the credit quality of LNG buyers has also migrated downward over the last decade, adding to the project financing challenge, Fitch Solutions said. The creditworthiness of offtakers has played an important role in gauging the credit risk of a project, and lower credit ratings contribute to higher financing costs. Sub-investment-grade buyers are also taking on a larger share of offtake from projects, adding a higher degree of risk, but guarantees from domestic governments and multilateral institutions can help mitigate those risks.

Long-term price risk is further complicated by price renegotiations involving Asian buyers, which were once rare but are now increasing due to a variety of factors, Fitch Solutions said. The research firm expected price reopener clauses in contracts to become increasingly sophisticated.

"While this is positive for the health of the market overall, it raises a new source of long-term price risk for sellers, given that the way in which LNG is priced could fundamentally change over the life of the contract," Fitch Solutions analysts said. "Projects will need to be resilient in lower price environments, when price reopeners will most likely be triggered by the buyers. As a result, individual plant economics will increasingly become the deciding factor for investment."