The riddle of RLNG

RLNG is a hot topic. Enough has been discussed in the media. Some pertinent questions are raised; but some key points are missed. The overall gist is right; but some arguments are construed on factual inaccuracies and conjectures. The discussions are way too simplified. International spot prices and long term contracts are being confused. Then long term contract performance issueslike credit guarantee and other risks associated with a market like Pakistan are not touched upon.

The basic difference between RLNG and oil is that latter is first produced and then sold; while the former is first being sold then produced- this is a key requirement of project financing the multibillion dollar LNG liquefaction facilities. There is no way to physically store RLNG over long periods of time without compromising quality and flaring the gas. Physical forward contracts in RLNG are not a norm as all LNG contracts are sold under confidentiality agreements with varying contractual arrangements. Forward LNG contracts are bought either on medium term contracts or long-term contracts- but a standard physical market (like in the case of oil) is not available- Contracts are thus negotiated on a case to case basis.

Most of the LNG (around 90%) globally is sold through bilateral negotiations, 70-80 percent of the world's LNG is sold on a long-term basis (such as Pakistan's contract with Qatar) and rest operates on spot (a majority of the spot is diverted from existing long term contracts as LNG is sold before being produced).

Major resource holder (or large Suppliers) generally shy away from operating on the spot market (tenders) in Pakistan as there is a thick layer of bureaucratic red tape in the procurement process. The role is assumed by traders, and they charge premium, as they have to bid and wait for approvals. The spot prices are computed on the slope to Brent oil, and there is a premium for it. Traditionally spot cargos are sold on a fixed price basis- selling on oil increases an index exposure and therefore reflected in a premium price. It is fair to say that Pakistan is amongst the highest priced spot LNG market due to these issues.

Some say that there are traders' lobbies at the buying time. There are 4-5 traders operating in Pakistan. These traders mostly operate in a very few economies including Brazil, Egypt and Argentina. The four countries are known for corruption and inefficiencies, and these traders perhaps capitalize on these. A right question to ask is why these traders are influencing market decisions, and why Pakistan is not attracting the major suppliers (11 players control 70% of world's LNG supply).

The first step to take is to bring down the inefficiencies in the RLNG market. The government is inefficient. Hence, the role of the government needs to be minimized. The burning question in the media last two weeks was why the LNG forward contracts are not being done during June-Aug for Nov-Jan when LNG spot prices were low. It is a right question; but the quantum of losses is grossly overstated.

Someone said that in summer of 2020, three long-term contracts are being signed in the world; why couldn't Pakistan do the same? This is comparing apples with oranges. These contracts are for long term with all 3 starting in 2022 onwards and are for 10years plus; while Pakistan's best bet was to book 6-8 cargos for this winter. The apple to apple comparison could have been to see what South Korea did this summer. They made a side deal with their long-term suppliers to import 10 plus cargos for Nov-Dec at 13 percent slope at the time when spot market was at 9 percent. The Koreans did not go to the open market as such a purchase spikes up prices.

Koreans got rates for winters. So it's not possible to get summer rates for winters, irrespective of the time of buying. But the rate today is around 15.5 percent. Pakistan could have saved around 2 percent margin, if the winters stocks were secured in the summer. That is an opportunity loss in retrospect - hindsight is always perfect.

The question is why did the government not book forward contracts in the bearish spell? The government can say that at that time no one was expecting market to be this bullish in winter. Suppose you are in government, and you ask for permission to book supply at 13 percent slope for December when the spot is at 9 percent in September. The day this proposal rolled, the whole media would have been in frenzy about mulling this expensive option. Not to forget NAB fear. Here when straight deals are not being signed; who would dare take this risk? The question needs to be asked why RLNG buying/selling is confined to the government.

The other reason government given for delaying buying is the lack of clarity on assessment of demand. The whole process of demand is full of red tape. An RLNG cargo is booked once demand is generated by gas distribution companies, and they generate demand, when power division (or other consumers) asks for it.

PLL was asking for raising demand in summer; but power division was silent. The demand is based on the merit order, and it keeps on changing. No one wants to take risk. Then there are PPRA rules. There is a process of advertisement and bid opening and deciding before the decision is to be made. This takes a good 40 days.

Markets move in five weeks. The decision to be taken on day zero would be applicable at day 40, and cargo to come at day 70. Traders know this and they have to comply with the bid they offer. There is a gap between the submitting bid and awarding contract. The pricing risk is with the trader. He charges premium for it. If the job is left to the private sector, the awarding decision can be taken in 2 hours, and it will take 2-4 weeks for cargo to reach.

Then the merit order can change between the time of advertising and contract awarding. The government officers are risk averse and they tend to remain indecisive. Then the decision makers are not competent. They don't know the market dynamics. The cost is paid by the exchequer. The government paid higher costs in 2015, 2016, 2018 and 2020. The frustration is being shared by current minister as well as by those who were in power in 2015 and 2016. In other years - such as 2019, the spot prices were not high in winters. Hence, the issue was not hyped in the media.

Another important question is the existing capacity to handle RLNG and its 'take or pay' contracts. Government is paying terminal charges on take or pay basis for 1,200 mmcfd. The long-term 'take or pay' contracts of RLNG are for 800 mmcfd where 8 cargos of long term contracts are to be supplied per month. In Europe, 25 percent of terminal capacity is reserved by law for storage and gas network supply chain disruptions - this margin does not exist in Pakistan.

In Pakistan, the capacity risk multiplies whenever spot cargo is being imported. No one is asking about this risk and the fragility of the value chain that can trigger LNG liquidated damages far greater than the capacity payments to the terminal. Nobody is asking why private sector third terminal approvals (on take and pay basis) are delayed. Nobody is asking if the existing two terminals are expanding their storage or throughput only? A well-thought out gas development strategy is missing - the firefighting is taking us nowhere.

If things go as per plan of the government, by Jan 22, the RLNG handling capacity would increase from existing 1,200 mmcfd to over 2,000mmcfd. The next question is whether there is enough demand for RLNG. Are buyers willing to pay international prices for the LNG? If the private sector brings cheap RLNG, who will be using government contracted RLNG? Will this not create a RLNG circular debt? Well, this is a subject in itself.

Copyright Business Recorder, 2020