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Gas Advisory
Issue #81 17 August 2016

Methodology: LNG Supplies for Latin America—Part 1, the Decision Matrix

Highlights:
 FGE has developed a methodology for assessing LNG supplies into various markets including Latin America.
 The model incorporates market and shipping data and allows for risk tolerances.
 Back testing of FGE's methodology shows 83% of model accuracy for US cargoes to date.

1. Complexity of LNG Supplies for Latin America

In our previous Gas Advisory, “Methodology: Finding a Home for US LNG,” we provided a methodology for
deciding where, Asia or Europe, and when US LNG supplies may find a home.

FGE has extended its methodology to include multiple global supply and demand basins. The interconnected
nature of global LNG supply and demand, as well as the changing nature of LNG fleets, adds a considerable
amount of complexity. To simplify its presentation and demonstrate the model in this article, we restrict and
apply our methodology to Latin America.

Applying our methodology to Latin America adds a few complications to the mix, because there exists a diverse
set of factors affecting LNG supply and demand in Latin America, including:

1. LNG price discovery into Latin America is opaque.

a. Latin America does not have a well-established gas hub.
b. Only a few long-term LNG supply contracts into Latin America exist.
2. LNG supply patterns into Latin America are complex.
a. There are demand pulls from diverse regions such as Europe, Middle East and Asia.
b. There are supply pushes from the US, Atlantic and Asia Pacific basins.
3. LNG infrastructure and markets in Latin America are still developing.
a. There exists about 44 mmt of LNG regasification for, including the Caribbean, a population of
about 640 million.
b. Regional and cross national gas pipelines are few and poorly interconnected.
4. LNG demand is non-homogenously affected by different factors across the region.
a. Precipitation levels in Brazil.
b. Temperatures in Argentina.
c. US pipeline gas into Mexico.
d. LNG from Chile and Trinidad and Tobago.
5. The interaction of the above factors causes larger uncertainty in estimating supply, demand and prices
for Latin American LNG.
a. The risk factors are complex and interconnected.

In this article we solely focus on which market offers the best price for US LNG based on our scenario matrix
methodology, elaborated in “Methodology: Finding a Home for US LNG.”

As mentioned in our previous Gas Advisory, we only consider the marginal costs of US LNG (no fixed
liquefaction costs). Moreover, there are non-price related factors that may affect the flow of LNG out of the US,
which we are not considering in this analysis.
FGE Gas Advisory - 17 August 2016 2
2. FGE’s Methodology
Our methodology consists of the following steps:

 Provide estimates for shipping costs between USGC, Europe, Asia and Latin America.
 Establish netback prices from Africa and Asia into Latin America.
 Determine whether US LNG can compete with LNG cargoes pulled from Europe or Asia.
 Decide which market will offer the best price for US LNG.
 Incorporate risk bands due to opacity of Latin American LNG.
 Back test the model on the recent shipment data for US LNG.

In the following we detail each of these steps.

Our Assumptions
For illustration purposes we have made a few simplifying assumptions regarding the marginal cost structure of
US LNG and transportation costs between various regions. We have also excluded the Middle East, a key
potential swing supplier.

We should note that transportation costs are used to estimate the cost of delivering LNG into a region. In
addition, they are used to deduce netback prices of LNG from one region, say Africa, to another one, i.e., Latin
America.

For NBP, we have included regasification charges because regasification terminals in the UK are well contracted
and LNG players who intend to supply into the UK will need to contract and pay for regasification.

Figure 1: Transportation Costs

Transport (US$/mmBtu)
EU Asia1 LatAm2
US → 0.58 1.23 0.72
Africa3→ 0.44 - 0.46
4
Australia → - 0.39 0.77
1: US Asia transport charge assumes passage through Panama Canal to Northeast Asia.
2: LatAm = Bahia Blanca, Argentina. 3: Africa = Nigeria.
4: Australia  LatAm charges assume voyage from west coast Australia to Bahia Blanca via Cape of Good Hope.
- Grey colored areas indicate shipping routes that are not used in the calculations directly.

Figure 2: Henry Hub Marginal Costs

ǂ Variable costs including cost of commodity and shrinkage.

Figure 3: Regasification Costs

Regas (US$/mmBtu)Ɨ
NBP Asia LNG LatAm LNG
Regas 0.3 0 0

Ɨ Regas tariff is subtracted from NBP to arrive at price of LNG at the UK.
FGE Gas Advisory - 17 August 2016 3

LNG Price Discovery in Latin America

Since Latin America lacks an active gas hub, we use netback pricing to arrive at a DES Latin America LNG price.

For Latin America to receive LNG supplies, it has to offer high enough a price to either attract LNG cargoes from
the Atlantic Basin destined into Europe or pull Asia destined LNG into Latin America.

Moreover, such cargoes will then need to compete with US LNG, which also has the option of going to
alternative markets of Asia or Europe, depending on which market offers the best price.

This process is explained in the following steps:

1) Find Africa’s LNG Netback into Latin America.

a. We assume Nigerian LNG sets the marginal price of NBP.
b. Hence, we netback NBP into Latin America by subtracting Africa  Europe transport costs and
then adding Africa  LatAm costs.

2) Find Asia’s Netback into Latin America.

a. Asia could also be a source of LNG supply for Latin America, if prices make sense. This may
appear counterintuitive, but in fact we can show an Asia LNG supply overhang over the 2018-
2019 period.
b. Hence, netback Australian LNG into Latin America by using shipping costs, in the same manner
as above.

3) Decide Africa or Asia as Supply Source for Latin America.

a. The market that offers the cheapest supply will set the price.

Figure 4: Africa or Asia into Latin America?

9.5 Africa Africa Africa Africa Africa Africa Africa Africa Africa Africa
9 Africa Africa Africa Africa Africa Africa Africa Africa Africa Africa
8.5 Africa Africa Africa Africa Africa Africa Africa Africa Africa Africa
8 Africa Africa Africa Africa Africa Africa Africa Africa Africa Asia
Asia LNG (US$/mmBtu)

7.5 Africa Africa Africa Africa Africa Africa Africa Africa Asia Asia
7 Africa Africa Africa Africa Africa Africa Africa Asia Asia Asia
6.5 Africa Africa Africa Africa Africa Africa Asia Asia Asia Asia
6 Africa Africa Africa Africa Africa Asia Asia Asia Asia Asia
5.5 Africa Africa Africa Africa Asia Asia Asia Asia Asia Asia
5 Africa Africa Africa Asia Asia Asia Asia Asia Asia Asia
4.5 Africa Africa Asia Asia Asia Asia Asia Asia Asia Asia
4 Africa Asia Asia Asia Asia Asia Asia Asia Asia Asia
3.5 Asia Asia Asia Asia Asia Asia Asia Asia Asia Asia
4 4.5 5 5.5 6 6.5 7 7.5 8 8.5
NBP (US$/mmBtu)
Supply Source: Asia Africa

Destination of US LNG
To arrive at a scenario matrix that explains the destination of US LNG under a variety of scenarios, we need to
answer the following question:

1) Can US LNG be delivered into Latin America such that it can compete with the netback LNG prices from
Europe and Asia?
2) If yes, would US LNG have a better choice of going to Asia or Europe rather than Latin America?
3) What are the maximum Henry Hub prices that such strategies are valid?
FGE Gas Advisory - 17 August 2016 4
In general there will be three distinct regions that may offer the best home for US LNG. For example, when NBP
is US$4.5/mmBtu and Asian LNG prices are US$5.0/mmBtu, Latin America offers the best price for US LNG, as
long as Henry Hub Prices are below US$3.31/mmBtu.

The following table summarizes the results. It also demonstrates that the decisions regions are distinct, i.e.,
Asia, Europe or Latin America, and there are no regions that Asia or Europe overlap with Latin America. We
return to this point shortly.

Figure 5: US LNG Decision Matrix

9.5 7.19 7.19 7.19 7.19 7.19 7.19 7.19 7.19 7.19 7.19
9 6.76 6.76 6.76 6.76 6.76 6.76 6.76 6.76 6.76 6.79
8.5 6.32 6.32 6.32 6.32 6.32 6.32 6.32 6.32 6.35 6.79
Asia LNG (US$/mmBtu)

8 5.89 5.89 5.89 5.89 5.89 5.89 5.89 5.92 6.35 6.66
7.5 5.45 5.45 5.45 5.45 5.45 5.45 5.48 5.92 6.22 6.63
7 5.02 5.02 5.02 5.02 5.02 5.05 5.48 5.79 6.19 6.63
6.5 4.58 4.58 4.58 4.58 4.61 5.05 5.35 5.76 6.19 6.63
6 4.15 4.15 4.15 4.18 4.61 4.92 5.32 5.76 6.19 6.63
5.5 3.71 3.71 3.74 4.18 4.48 4.89 5.32 5.76 6.19 6.63
5 3.28 3.31 3.74 4.05 4.45 4.89 5.32 5.76 6.19 6.63
4.5 2.87 3.31 3.61 4.02 4.45 4.89 5.32 5.76 6.19 6.63
4 2.87 3.18 3.58 4.02 4.45 4.89 5.32 5.76 6.19 6.63
3.5 2.74 3.15 3.58 4.02 4.45 4.89 5.32 5.76 6.19 6.63
4 4.5 5 5.5 6 6.5 7 7.5 8 8.5
NBP (US$/mmBtu)
Destination: Asia EU LatAm
Values: Maximum Henry Hub price (US$/mmBtu) for the designated destination.

EU = Europe, LatAm = Latin America

Risks and Sensitivities

From our previous article we know that the boundaries between decision regions can be sensitive, in the sense
that slight changes in the input estimates may change the outcome.

Moreover, as explained above, there are plenty of uncertainties around LNG supplies, demand and prices for
Latin America. There are also uncertainties around shipping costs and availability. Therefore, it is warranted to
perform a sensitivity analysis.

For example, when NBP is US$4.5/mmBtu and Asian LNG prices are US$5.0/mmBtu, a risk sensitivity of
US$0.1/mmBtu will result in either Latin America or Asia offering the best prices for US LNG. The
US$0.1/mmBtu represents the uncertainties due to potential price fluctuations and shipping costs.

Figure 6: Decision Matrix With Sensitivity Analysis

9.5 7.19 7.19 7.19 7.19 7.19 7.19 7.19 7.19 7.19 7.19
9 6.76 6.76 6.76 6.76 6.76 6.76 6.76 6.76 6.76 6.79
8.5 6.32 6.32 6.32 6.32 6.32 6.32 6.32 6.32 6.35 6.79
Asia LNG (US$/mmBtu)

8 5.89 5.89 5.89 5.89 5.89 5.89 5.89 5.92 6.35 6.66
7.5 5.45 5.45 5.45 5.45 5.45 5.45 5.48 5.92 6.22 6.63
7 5.02 5.02 5.02 5.02 5.02 5.05 5.48 5.79 6.19 6.63
6.5 4.58 4.58 4.58 4.58 4.61 5.05 5.35 5.76 6.19 6.63
6 4.15 4.15 4.15 4.18 4.61 4.92 5.32 5.76 6.19 6.63
5.5 3.71 3.71 3.74 4.18 4.48 4.89 5.32 5.76 6.19 6.63
5 3.28 3.31 3.74 4.05 4.45 4.89 5.32 5.76 6.19 6.63
4.5 2.87 3.31 3.61 4.02 4.45 4.89 5.32 5.76 6.19 6.63
4 2.87 3.18 3.58 4.02 4.45 4.89 5.32 5.76 6.19 6.63
3.5 2.74 3.15 3.58 4.02 4.45 4.89 5.32 5.76 6.19 6.63
4 4.5 5 5.5 6 6.5 7 7.5 8 8.5
NBP (US$/mmBtu)
Destination: Asia EU LatAm LatAm & EU LatAm & Asia LatAm & Asia & EU
Values: Maximum Henry Hub price (US$/mmBtu) for the designated destination.

EU = Europe, LatAm = Latin America

Back Testing
To gauge the usefulness of a methodology, it is a good idea to back test the model on historical data and check
if the model’s predictions are in line with the market.

To do so, we record historical Henry Hub, NBP and Asian spot LNG prices and also analyze destinations of US
LNG over the same period. We consider the February to May 2016 period for historical prices. Shipping data for
US LNG over the same period are obtained from the Energy Information Administration (EIA).
FGE Gas Advisory - 17 August 2016 5

Figure 7: Monthly Average of Historical Prices

5
US$/mmBtu

0
Feb-16 Mar-16 Apr-16 May-16

Henry Hub NBP Asia Spot

Source: MarketView & Reuters

Figure 8: US LNG Exports by Destination, February to June 2016

5
No. of Cargoes

0
South America Asia Middle East Europe
Source: EIA, based on assuming 0.065 mmt of LNG per ship

Before back testing the model we should pay attention to a few important points.

 Historical shipping rates may be different from our current assumptions.

 Market participants base their decisions on their perception of the prices in the future (ex-ante) whereas
we are back testing based on already settled prices (ex-post).
 There may be factors other than pure price differentials that may affect a marketer’s decision on where to
ship US LNG.

To overcome such discrepancies we measure the risk in terms of “price resolution” in a marketer’s decision.
This represents the fact that, starting in February 2016 the marketer may not have a perfect view of the market
conditions, in this case US$0.55/mmBtu. However, as time goes on and the marketer gains experience it can
narrow down market uncertainties and will need a narrower price resolution to make decisions. Price
resolution drops from US$0.55/mmBtu in February 2016 to US$0.35/mmBtu in March 2016. By April 2016 it
has stabilized around US$0.2/mmBtu. In fact, this is the same risk sensitivity of our previous example where we
used US$0.1/mmBtu.

Our back testing shows a good match between our model and the market. In fact, out of the twelve outcomes
(four months of shipping data to three markets of Asia, Europe and Latin America), our model only misses two
FGE Gas Advisory - 17 August 2016 6
instances. These two instances are shipping to Europe in Feb-2016 and shipping to Asia in May-2016.
Otherwise, the outcomes match. This will give our model about 83% of accuracy.

Figure 9: Back Testing

Market Prices US LNG By Destination (EIA) Decision Matrix Methodology

Henry Hub NBP Asia Spot LatAm Asia EU MidEast LatAm Asia EU Risk
Feb-16 1.96 4.16 5.21 100% 0% 0% 0%  -  0.55
Mar-16 1.70 4.07 4.46 34% 30% 36% 0%    0.35
Apr-16 1.90 4.01 4.33 63% 0% 0% 37%  -  0.2
May-16 1.92 4.28 4.64 63% 0% 37% 0%    0.2

 = Ship LNG to this destination

Don't ship LNG to this destination
Note: Cargoes sent to the Middle East are considered to be Europe. Based on the assumption that the original cargo to the Middle East would be priced off the alternative
European NBP market.

3. FGE’s Recommendations
As our Latin America discussion has shown, the decision-making process for finding a home for LNG cargoes is a
complex process. In a real world situation things are even more complicated because,

 As more supply and demand basins are added, the complexity of the situation grows exponentially.
 Moreover, the current oversupplied market exasperates the situation as cargoes may quickly become
“stranded” and regional prices can shift quickly.
 Therefore, it is important for LNG buyers and suppliers to develop sound methodologies that can assist
them in optimizing their decisions.
 Our back testing example shows, such methodologies need to be augmented by risk measurement and
risk management capabilities.

FGE’s current methodology is straight forward and yet offers such capabilities.

© 2016 FGE
For queries, please e-mail to FGE@fgenergy.com
The dissemination, distribution, or copying by any means whatsoever without FGE’s prior written consent is strictly prohibited.
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