The government faces criticism for expensive spot buying of LNG. Some commentators have compared spot price purchases with existing long-term contracts. If the objective is to make a fairer comparison, one must compare long-term contracts by the previous government and by the incumbents, and gauge potential savings – or lack thereof - accordingly.
Nevertheless, any delay in procurement of spot cargo, observed recently, is uncalled for. It appears that fear of accountability behemoth going into hyper drive – in response to primetime breaking news bleeding red - is perhaps making the decisionmakers unnecessarily cautious. This in turn is instigating a vicious cycle of delays and poorly timed actions, eventually leading to sup-optimal decision making.
The key is to lock in long-term contracts. Pakistan’s ongoing contract with Qatar Gas was made at 13.37 percent of brent for a 15-year period, in which price was locked for a 10-year period. The country is buying 5 cargos (3.75 million tonnes per annum or MTPA) per month with an option to buy three additional cargos every year. The new deal with Qatar which shall commence in November 2021, has been reached at 10.2 percent of brent with 2 cargos a month (1.5 MTPA) – with addition of 2 cargos per year. The number of cargos shall increase to 4 cargos per month (3 MTPA) in 2024. (For details, read ‘The sweet LNG deal’ published on 2nd March 2021).
In order to better understand the savings from each deal, one must first draw a comparison between long -term contracts during their respective timeframes before commenting on inefficiencies of spot buying, and its implication on power generation. In 2016, when Pakistan reached its first deal at 13.37 percent, cheapest deals in the international market were made at 12 percent. Assuming Pakistan’s deal was 1 percentage point above the average, the annual opportunity loss at $57 per barrel Brent, which was the average oil price during FY17-21, comes at $110 million. Thus, the opportunity loss over past five years was $550 million, and $1.1 billion (at past prices) till 2026.
The more recent deal has been made at 10.2 percent of Brent which was at market price – as the best deal with China was reached at 10.19 percent. Thus, no opportunity loss, as the government is getting the best possible price currently on offer in the global market. Currently, negotiations for long-term deals are taking place at 11 percent. The opportunity gain, at $69 per barrel Brent (average price over last six months) is $42 million per year for first two years and $85 million per year from 2024 – when the cargo numbers double. The overall theoretical benefit is $763 million over next ten years.
Assuming Brent at $70 for next five years – the opportunity loss on 2016 deal is $672 million during 2021-26 and gain of $344 million on 2021 deal during the same time. Net benefit for next five years is $1,016 million on 2021 deal versus 2016 deal – both of which have been made between Government of Pakistan and Qatar Gas. In the strictest possible sense of opportunity loss, that is an apples to apples comparison. The new deal saves over a billion dollar over the next five years versus the old one.
This clearly shows that the new deal is much better. But these numbers are opportunity gain and losses and are in hindsight. One should not see things through such a lens. Given the extremely volatility in the LNG spot market, even hindsight is not perfect. (For details read “LNG Spot: even hindsight is not 20/20”, published on 1st September 2021).
Having established this fact, the government buying spot at the last moments is not optimal. By delaying the decision, in a moving market, government is losing millions of dollars opportunity per cargo. But it is not fair to compare these to long term contracts. During 2017-21, there were 16 out of 44 months where spot cargos were expensive than long term while spot was cheaper rest of the time.
On that note, the spot cargo on average cost less over the past four years. On average, spot cargos were at 0.6 percent discount to long term (Qatar Gas) during Dec 2017 to Nov 2021. This implies that at $60 per Barrel brent (average of Dec17 to Aug 21), for 121 spot cargos, the government saved $139 million. Excluding the exceptionally high prices over the last few months, between Dec17 to Jun 21 average discount of spot to long term was 1.4 percent. For 100 spot cargos, the opportunity gains of buying spot were $268 million during Dec17 to Jun21. This implies that the country would have been better off if it had purchased LNG on spot instead of long-term throughout past four years.
However, price analysis of spot versus long-term conducted retrospectively will always lead to such skewed conclusions. But it must be driven home that no one can buy large volumes in spot market, and usually the world does higher quantum in medium to long term contracts versus spot or short-term. Hence Pakistan is no exception.
Moreover, it is not fully fair to compare the deals (in respective time frames) of 2016 and 2021 with the same supplier. In 2016, Pakistan was a new player which found it hard to get a deal at market competitive rates. Now in 2021, Pakistan is a sizeable player with 4-5 years of dealing with Qatar Gas. Thus, Pakistan’s negotiating position is much better in comparison.
Unfortunately, some commentators have frequently drummed up the charge that the country should have entered a swap deal with Trafigura in 2020 when the international prices nosedived. Apparently, a letter was written to swap Pakistan’s long term contracts at $3.7-4.7 price for 12-24 months contracts. That is easier said than done. Firstly, that process would have taken months and by that time market would have moved and the deal would not have been on the table. And at $40 per barrel Brent, government would have needed to post $1.5 billion margin requirement. Does the government have that kind of liquidity? Should government have gambled with such a high margin, given the long arm of NAB which has poked its nose in almost every commercial matter? There are host of other more pressing issues surrounding the LNG debate that need more focus and effort than the versus and long-term debate. But more on those later.
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