TRENDS AND DEVELOPMENTS IN

LNG MARKETS & MARKETING:

Adjusting Contracts to Fit a Shifting Market
Daniel R. Rogers
Partner
King & Spalding LLP
Houston

© King & Spalding 2017

© King & Spalding 2017 2
 Representative LNG Clients

© King & Spalding 2017 3

Agenda
• Today’s LNG market
• What do today’s LNG Buyers
want?
• Trends in LNG marketing &
impacts on contracting
• The changing LNG SPA
© King & Spalding 2017 4
Recent LNG market headlines

© King & Spalding 2017 5

Recent LNG market headlines (cont’d)

© King & Spalding 2017 6

Recent LNG market headlines (cont’d)

© King & Spalding 2017 7

Shifting tides?
• While today’s buyer’s market condition is a
product of the present “supply overhang”,
many analysts project that LNG supply and
demand will come back into balance
sometime between 2021-2023
• In the meantime, pricing shifts in the relevant
oil and natural gas market price indexes may
begin to change the market dynamic
somewhat on a bit earlier timeline
© King & Spalding 2017 8
Historical U.S. natural gas pricing

© King & Spalding 2017 9

Historical U.S. shale gas production

© King & Spalding 2017 10

Near-term gas price forecasts (EIA)

Source: Market Realist

© King & Spalding 2017 11

Long-term gas price forecasts

© King & Spalding 2017 12

Oil price projections (cont’d)

© King & Spalding 2017 13

Oil price projections (cont’d)

© King & Spalding 2017 14

Oil price projections

© King & Spalding 2017 15

Market impact conclusions
• Regardless of whether oil prices remain flat or gradually
escalate from US$55/bbl to US$80/bbl over the next 10+
years,
– it seems plausible that U.S. Henry Hub pricing is likely to
continue to rise, and
– a US$4.00-5.00/mmBtu HH pricing level is possible in
the near-term
• Higher HH prices will begin to erode some of the “pricing
advantage” that theoretical U.S.-origin LNG supplies would
have enjoyed over the past few years
– Asian buyers that were dead-set on moving to HH
pricing 5 years ago will continue to re-think their pricing
strategies
© King & Spalding 2017 16
Market impact conclusions (cont’d)
• Even though we may be moving toward more global LNG
supply-demand balance over the next 5 years (with
corresponding LNG price increases), many North American
export projects still may not be seen as being as competitive
as they were viewed 3-4 years ago
• U.S. HH feed gas cost increases may offset or even exceed
the significant liquefaction cost improvements that we may
see with some of the new liquefaction technologies and
improved construction methods
• The “next wave” of North American LNG producers will need
to significantly bring down the cost of liquefaction in order
to maintain a competitive foothold in the global marketplace

© King & Spalding 2017 17

 What do today’s LNG
Buyers want from Sellers?

© King & Spalding 2017

1. Many buyers want shorter-term contracts
• Recent McKinsey & Company survey of LNG buyers &
industry experts:
– Significant shift towards shorter term sales
contracts
• Average length of a term contract signed in 2015
was just 8 years, compared to 15 years in 2008.
– Trend is likely to continue
• McKinsey survey suggests that more than half of
LNG buyers expect their next LNG term contract
to be a 5-9 year deal
© King & Spalding 2017 19
2. Many buyers are not interested in contract renewals
– McKinsey survey also found a reduced
likelihood that buyers will renew their
existing term contracts
• 2/3 of buyers with existing contracts
reported that the chances of renewing
those contracts were either
‘somewhat unlikely’ or just ‘possible’.
• The most significant reason for this
was that the supplier was not felt to
be price competitive (38 out of a
possible 100 points)
• Supplier under-performance and
inability to guarantee future volumes Source: McKinsey & Company (Energy
were also important, (accounting for Insights, January 2017)

nearly 27 out of a possible 100 points.)

© King & Spalding 2017 20

 3. Long-term buyers want very low pricing
• Today’s spot LNG prices are lower than many Buyers’ long-term
contract prices
– Some Buyers seem to be happy buying additional quantities on the spot
market rather than committing to longer-term contracts
• Buyers now have actual “gas-on-gas” pricing competition with
the introduction of significant US HH-indexed supplies
• With oil prices in the US$50+/bbl range (Brent), traditional oil-
linked Asian contract prices are very competitive with present
US HH-linked supply pricing
• Some Buyers are now pushing down “slopes” in oil-linked pricing
formulas
• Today’s low LNG and gas prices and gas-on-gas competition
may further open the door to new emerging market Buyers

© King & Spalding 2017 21

Oil-indexed LNG Pricing
• Typical Asian market LNG contract price formula:
CP (in US$/mmBtu) = [0.1485 x JCC (in US$/bbl)] + ß

JCC / Brent oil price slope @ oil = US$50 / bbl @ oil = US$100 / bbl

0.1485 x JCC US$ 7.425 / mmBtu US$ 14.85 / mmBtu

[Traditional Asian oil-indexed
pricing slope]
0.1335 x Brent US$ 6.675 / mmBtu US$ 13.35 / mmBtu
[QatarGas – Pakistan State Oil
Company Limited slope]
0.1267 x Brent US$ 6.335 / mmBtu US$ 12.67 / mmBtu
[RasGas – Petronet LNG
Limited slope]

© King & Spalding 2017 22

 Further downward pressure on oil price index slopes
• Latest 15 year term
Pakistan supply tender:
– Eni – 12.29% x Brent
– Shell – 12.599% x Brent
– Gunvor – 12.7% x Brent
– Petronas – 12.9% x Brent
– Trafigura – 13.3699% x
Brent
© King & Spalding 2017
• Latest 5 year term
Pakistan supply tender:
– Gunvor – 11.6247% x Brent
– Eni – 12.29% x Brent
– Shell – 12.3% x Brent
– Engie - 12.39% x Brent
– Gazprom - 12.4700% x Brent
– Trafigura - 12.4874% x Brent
– CNOOC - 12.8280% x Brent
– Petronas - 12.900% x Brent
– Gas Natural – 13.29% x Brent
– Glencore – 14.4865% x Brent
23
U.S. HH-indexed LNG pricing
• Representative U.S. Gulf Coast (FOB) pricing :
– Brownfield (conversion) facility:
• 115% x HH + US$2.25-3.00
– Greenfield facility:
• 115% x HH + US$3.50
• At today’s HH price of US$3.26/mmBtu, this
equates to an FOB LNG price of US$6.00-6.75
per mmBtu

24
Detailed oil-indexed pricing analysis

© King & Spalding 2017 25

Detailed HH-indexed pricing analysis

© King & Spalding 2017 26

4. Buyers want more quantity flexibility
• Upward Quantity Tolerance (UQT)
– Typical limits
– Timing of exercise
• Downward Quantity Tolerance (DQT)
– Typical limits
– Timing of exercise
• Cargo cancellation rights
• Back-end “ramp-down” rights
• Call option structure
© King & Spalding 2017 27
Composite quantity flexibility

© King & Spalding 2017 28

5. Buyers want more cargo destination flexibility
• Destination restrictions
– Historical rationale for destination restrictions
– European Commission competition laws
– Easing of destination restrictions
• Today’s market:
– Destination flexibility in DAT deals – geographic area limits,
“same or shorter distance” limits or unlimited range?
– Vessel-terminal compatibility issues (in DAT deals)
– Incremental shipping costs (in DAT deals)
– Which party may request (in DAT deals)?
– Economic “upside” sharing (in both FOB and DAT deals)
– Timing for request (in both FOB and DAT deals)
© King & Spalding 2017 29
6. Some buyers want seasonal delivery schedules

• Typical contract language:

– LNG to be made available for delivery from Seller to Buyer
“shall be at rates and intervals and in quantities reasonably
equal and ratable throughout each Contract Year . . .”
(emphasis added)
• Today’s market:
– Requests for a disproportionate quantity of the AACQ to be
delivered in a defined 3-5 month season (typically winter)
– Issue: since a Seller-producer will produce LNG on a
reasonably ratable basis throughout the year, seasonal
deliveries put significant strains on its ability to market all of
its production on a long-term basis

© King & Spalding 2017 30

7. Buyers want more expansive FM protection
• Many traditional LNG SPAs do not explicitly
extend FM protection to the Buyer for facilities
and customers downstream of the LNG
receiving terminal
• Today’s market: some Buyers are pressing for
explicit FM coverage for various downstream
pipeline, power generation and industrial
facilities in the Buyer’s end-market
• Issue: this exposes the Seller to risks that are
well outside its ability to understand or mitigate
© King & Spalding 2017 31
Trends in LNG marketing and
contracting:
Emergence and impact of portfolio
marketing and LNG commodities trading

© King & Spalding 2017

 Portfolio Marketers
• Who are they?
– LNG trading companies linked to their upstream LNG
producing affiliates
– Shell Marketing & Trading, BP Gas Marketing Ltd., Total Gas
Marketing, Cheniere Marketing, Petronas LNG Limited, etc.
• What do they do?
– Take/purchase equity LNG from one or more upstream LNG
producer affiliates
– Will also buy LNG from other producers
• Spot and term
• Typically FOB (loading port) delivery terms
– On-sell LNG to third-party buyers on a spot & long-term
basis, typically on DAT delivery terms
© King & Spalding 2017 33
Commodities traders
• Who are they?
– Pure commodities trading entities: no affiliated upstream
LNG production
– Gunvor, Trafigura, Vitol, Glencore, Mercuria, etc.
• What do they do?
– Purchase LNG supplies from multiple non-affiliated LNG
producers/sellers
• Spot and term
• Typically purchased on FOB (loading port) delivery terms
– On-sell LNG to third-party buyers on a spot & long-term
basis, typically on DAT delivery terms

© King & Spalding 2017 34

Portfolio marketers & commodities traders

• What is the impact on the LNG SPA?

– No fixed upstream facilities or dedicated reserves for supply
– Buyer must focus on financial credit & experience of Seller
• No dedicated plant facility & reserves supporting contract
• Seller typically has a large number of customer relationships to
manage
• ADP will typically identify plant and vessels, but may vary from cargo
to cargo
– Better ability of Seller to mitigate supply interruptions
– Seller might better accommodate Buyer’s seasonality
requests
– Need for closer monitoring of credit & performance risks
© King & Spalding 2017 35
 Portfolio marketers & commodities traders
• What is the impact on the LNG SPA? (continued)
– Cargo-by-cargo seller shortfall / buyer deficiency regime
• Differs significantly from traditional take-or-pay (TOP)
• Parties’ delivery & receipt obligations are measured on a
“real-time” basis
– Buyer’s and Seller’s performance failures are settled as
and when they occur, instead of accumulating into
year-end TOP invoice or Seller Shortfall invoice
– Buyer typically pays in full for missed cargo and
receives a credit from Seller’s re-sale proceeds
» increased focus on Seller’s mitigation re-sale obligations &
transparency of re-sale pricing
– Potentially lower payment security needed from Buyer
© King & Spalding 2017 36
Portfolio marketers & commodities traders
• What is the impact on the LNG SPA? (continued)
– FM risks and handling are very different
• Typically a more cargo-by-cargo approach, with
main focus on loading terminal and ship named
in the ADP/90 Day Schedule
• Issue re whether events affecting upstream gas
reserves or delivery pipelines should be covered
• Complicated issues flowing from allocation /
spreading of FM risks across multiple supply
sources in any single Contract Year

© King & Spalding 2017 37

Portfolio marketers & commodities traders
• What is the impact on the LNG SPA? (continued)
– Greater shipping & cargo size flexibility
• Need to address potential for Seller’s “out of
fleet” supply and delivery opportunities
• Puts more pressure on Buyer’s inventory
management
– Potentially greater scheduling flexibility
• Potential for Buyer cargo diversions and
cancellations within the 90 Day Schedule
– Potentially broader GHV specification range from
multiple supply sources
© King & Spalding 2017 38
 QUESTIONS?

© King & Spalding 2017

 Chambers Quotes on K&S LNG Team:
• “They have a very specialised knowledge that most firms don't have, particularly on LNG
projects.” Chambers Global 2016

• “They are very creative and willing to chat through unique and challenging circumstances
without preconceived notions of how to solve issues.” Chambers USA 2016

• “Considering the many millions of dollars that we save our company with their help, their
value far exceeds the money that we pay for them.” Chambers USA 2015

• “Very hands-on and incredibly responsive, they assign the right people at the right value level
for what needs to be done. They are fast and give the right advice.” Chambers USA 2015

• “Respected project finance group that focuses on advising sponsor clients on the
development and financing of oil and gas infrastructure.” Chambers USA 2015

• “Exceptional expertise in LNG matters and frequently sought out to play a leading role on
some of the largest mandates worldwide.” Chambers Global 2015

• “They are very strong in LNG.” Chambers Global 2015

© King & Spalding 2017 40

© King & Spalding 2017 41