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.
Canadian crude output is rising, requiring new export routes. As traditional pathways face constraints, the U.S. Rockies—especially the Guernsey, WY hub—are emerging as key corridors for moving Canadian heavy crude to downstream markets, including the Gulf Coast.
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About the song
"Sultans of Swing" was written by Mark Knopfler and appears as the first song on side two of Dire Straits' debut album, Dire Straits. Knopfler wrote the song after witnessing a subpar jazz combo playing to no one at a deserted pub. After finishing their set, the singer announced: "Goodnight and thank you. We are the Sultans of Swing." The original version of the song was recorded as a demo at Pathway Studios in London in July 1977. BBC London started playing the demo in heavy rotation on the radio, leading to a deal for the band with Phonogram Records. They re-recorded the song at Basing Street Studios in London where they recorded their debut album, going for a more polished sound. After the label and band heard the new version, they decided it sounded too polished, so they went back to Pathway Studios in April 1978 and recorded a third version that had a more raw, live feel similar to the demo. This is the version that they chose to be on the album, and it was released as a single in May 1978. "Sultans of Swing" went to #4 on the Billboard Hot 100 Singles chart and primed the pump for Dire Straits’ debut album released four months later. Personnel on the record were: Mark Knopfler (lead vocals, lead and rhythm guitar), David Knopfler (rhythm guitar, backing vocals), John Illsley (bass, backing vocals), and Pick Withers (drums).
Dire Straits was recorded between February and April 1978 at Basing Street Studios and Pathway Studios in London, with Muff Winwood producing. It was released in October 1978, and went to #2 on the Billboard Top 200 Albums chart. It has been certified 2x Platinum by the Recording Industry Association of America. Two singles were released from the album.
Dire Straits was a British rock band formed in London in 1977 by Mark Knopfler, his brother David Knopfler, John Illsley, and Pick Withers. Drawing from a sound combining pub rock, country blues, and a heavy dose of J.J. Cale guitar stylings, the band has sold over 100 million records worldwide. They have released six studio albums, three live albums, three compilation albums, two EPs, and 23 singles. They have won three Brit Awards, four Grammy Awards, and two MTV Video Music Awards. The band was inducted into the Rock and Roll Hall of Fame in 2018. Twelve members have passed through the ranks of Dire Straits from their formation until their breakup in 1992. Mark Knopfler has continued on with a successful solo career. He has released nine studio albums, two compilation albums, two EPs, nine soundtrack albums, and 12 singles, and appeared on many albums as a guest guitarist. He continues to record and tour to this date.
Comments
Really good blog today. I have a question about the statement that "regas for delivery into Asia is typically accounted for as fuel loss". How a cost is accounted for is really just a classification question, but what isn't clear from that statement is whether the fuel or boil-off costs assumptions to Asia have been adjusted in the model to include that regasification fee. It would have a big impact on Figure 4 if an additional fifty cents or so in costs needed to be deducted to get to JKM Netback DES GOM.
Thanks again for a really good blog.