Sultans of Swing, Part 2 - LNG Shipping Costs, Netbacks, and the Decision to Cancel Cargoes

Global LNG demand has picked up, cancellations for U.S. cargoes have subsided, at least for now, and there’s upside to U.S. cargo activity once tropical storm-related disruptions are resolved. But positive netbacks year-round are no longer a foregone conclusion for U.S. offtakers. As global oversupply conditions persist, at least on a seasonal basis, and supply competition intensifies, the economic decision to lift U.S. cargoes will be much more nuanced than it was in previous years. What do the economics for cargoes this winter and beyond look like? Today, we put the LNG economics model to work to understand what’s in store for U.S. LNG in the coming months.

The international gas price rout this spring and summer had a cascading effect on the LNG market, from collapsed price spreads to extreme disruptions in cargo activity. One of the byproducts of the market upheaval has been that LNG players have had to adopt a more detailed, cost-conscious approach to their offtake decisions, including parsing the individual costs and potential netbacks at a more granular level. The focus of this blog series is to unpack the various components that make up the LNG economics model and see what the model tells us about cargo activity in the coming months, based on current prices and our model assumptions. (We’ll also be discussing the latest trends in U.S. LNG exports at our Virtual School of Energy on October 20-21. Click here for more information or to register.)

In Part 1 of this series, we defined the main economic drivers that shippers consider when making the decision to lift or cancel cargoes. To briefly recap, costs for contracted shipments fall into two main buckets: fixed costs, which offtakers pay whether they take a contracted cargo or not, and variable costs, which offtakers incur only when they produce LNG and lift a cargo.

Fixed costs include the fee for the liquefaction capacity itself that offtakers agree, at the outset, to pay for the term of the sales and purchase agreement (SPA). If the offtaker holds long-term time charters for LNG vessels that are also take-or-pay, then that would also be considered a fixed cost. Given that these fees are on a use-or-pay basis, offtakers are incentivized to produce and sell the LNG, but not if it means incurring more costs that can’t be recouped. Thus, the real-time market decision of whether to lift cargoes really comes down to the variable cost economics of delivering the cargo to market. If offtakers’ netback — the price at delivery minus the variable costs — is positive, they would opt to move the cargo and recoup some (or all, if they’re lucky) of their fixed costs; if the netback is negative, that’s a losing proposition, and offtakers would be better off canceling the cargo, paying their fixed costs, and potentially covering any delivery obligations with lower-cost cargoes in the spot market. When international destination prices are well above U.S. prices and netbacks high, the decision is simple. But, understandably, when netback margins are thin, there’s heightened attention to the individual costs that can make the difference between a profitable or unprofitable cargo.

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