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The pitfall of long-term contracts for LNG

  • January 28, 2021
  • , Nikkei , p. 2
  • JMH Translation

Due to the record cold weather this winter, demand for electricity skyrocketed. There has been a shortage of supplies of Liquified Natural Gas (LNG) to fuel thermal power generation, which in turn pushed up the LNG spot price to the highest level in history. There are multiple causes that led to this situation, one of them being the long-term contract system designed to ensure the stable supply of LNG.


A large portion of Japan’s LNG purchase agreements is in the form of long-term contracts. Only a little over 10% of the LNG was purchased by Japan on the spot market in 2019. On global average, 30% of LNG contracts are made at spot prices. Japan’s inclination for long-term contracts could be helpful in securing stable supplies. However, sudden changes in temperature such as extreme heat and severe cold cause wide fluctuations in demand for LNG.


Furthermore, there is no stockpile system for LNG, whose long-term storage is difficult, making it inevitable to rely on private stockpiles for extra supplies, which satisfy about 2 weeks’ worth of demand for LNG in normal times.


LNG spot prices in Asia stayed low until last year, due to an increase in supply from the U.S. and other new sources. The novel coronavirus pandemic added a blow to the LNG market, pushing prices even lower.


Japan’s long-term contract price for LNG is often linked to the import price of crude oil. Until the LNG spot price rose toward the end of the last year, the long-term contract price had greatly exceeded the spot price.


Because stockpiling a considerable amount is not possible, importing under long-term contracts more LNG  than the amount used domestically would force the importer to sell the excess LNG on the spot market at a significant loss. In addition, many expected the economy to slow down in the pandemic, bringing down consumption of electricity to a lower level than normal. Japan under bought LNG.


Japan’s LNG imports in May last year were down by 18% compared with the same period in the previous year and down by 4% in November. When demand suddenly grew in December (13%), supply couldn’t catch up. In January 2021, the LNG spot price in the Asian market increased 15-fold from last April.


China’s emergence as a major LNG importer is playing a role as well.


As part of its environmental policy, China is rapidly increasing its imports of LNG. As Japan’s imports lag, China’s annual LNG imports are expected to exceed Japan’s next year.


Hiroshi Shirakawa at Japan Oil, Gas and Metals National Corporation (JOGMEC) points to an immature LNG market as the cause of Japan’s problem. As of 2019, only one third of LNG was traded on the spot market in the world, less than 1/30 of oil traded in the spot market in monetary value. In order to prevent a repeat of the current severe shortage, “the LNG market must be developed to enable hedging risks associated with price fluctuations,” Shirakawa stressed.


Specialized ships for transporting LNG further complicate the issue. According to Nippon Yusen, most of the world’s 570 large LNG ships operate under mid-to-long-term contracts, and only 20 vessels are available on short notice.


Furthermore, the recent “congestion” at the Panama Canal adds to the problem. While production of LNG has increased significantly in the Gulf of Mexico, only 2 LNG vessels are allowed passage through the canal per day. “If it hasn’t booked a passage, a ship has to wait for about a week to ten days for its turn to go through the canal,” according to Nippon Yusen.


From now to 2030, the Atlantic region, centered on the U.S., is expected to be the site of increased production of LNG. While it will help Japan ease its dependence on the Middle East for fuel, transporting LNG from the Gulf of Mexico could pose a tricky problem. Japan should learn from the mistakes of this winter, as the country needs to rely on LNG to generate electricity, at least for the time being. (Abridged)

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