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Financial Times: Oman LNG pact sets the tone for future deals

By Raphael Minder in Bangkok
Published: March 16 2008 17:46 | Last updated: March 16 2008 17:46

Last year Oman was due to sell the bulk of its liquefied natural gas production to Spain. In view of surging demand in Asia, however, it decided to ask its Spanish customers to forfeit the order and divert the shipment instead to higher-paying Asian bidders.

The Spanish companies – Union Fenosa and Gas Natural – agreed, and Oman then equally split the profit on the Asian sale with them.

“This really was a win-win situation,” says Adnan Rajab, vice-president at Oman LNG. “We are one of the pioneers of such diversions and we certainly want to have such flexibility in our contracts.”

Middle Eastern LNG producers have recently become masters at a game of arbitrage, helped by their geographic positioning, with comparable delivery times for cargoes bound for either the Atlantic or the Pacific basin.

Such diversions also confirm the emergence of an LNG spot-trading market in all but name, breaking with the traditional long-term purchasing contracts signed for periods of as much as 20 years.

Steven Miles, partner at Baker Botts, a US law firm, says that Oman-style “destination flexibility” is being introduced into almost every sales purchase agreement. And with some SPAs now reduced to less than a year, he says there is a “clear convergence of SPAs and spot agreements.”

There are potential benefits for both parties, Mr Miles argues. On the one hand, producers want to be able to play different regions against each other in a market where demand can shift rapidly – as witnessed last year when Japan had to import more gas after an earthquake damaged a nuclear power plant. On the other hand, Mr Miles says that “some buyers are trying to avoid committing long-term to what they see as a seller’s short-term or mid-term price bubble”.

For now, however, the bubble shows no signs of bursting, even if the price differential between Asia and the US has narrowed slightly.

Still, some Asian buyers are venting their anger at what they see as a breakdown in their traditional links with producers, which they hoped would protect them from sudden price hikes.

Yasuo Ryoki, representing Osaka Gas, suggested at a gas conference last week that Asian buyers should start a bulletin board to coordinate information about their purchases and avoid price manipulation by buyers. Jane Liao, an executive from CPC of Taiwan, says that “mutual trust and solid relationships between buyers and sellers seem to have gone with the wind”.

Taiwan’s import strategy also confirms a shift away from long-term contracts. This year, long-term contracts are likely to account for just over two-thirds of its imports, compared with almost 90 per cent in 2005. “We have now imported spot cargoes from places such as Trinidad and Egypt,’’ says Ms Liao. “There is real change in the market.”

Future pricing of LNG hinges in large part on when delayed projects such as Gorgon, an Australian field owned Chevron and two partners, will come on line. Qatar’s plans to more than double LNG production should also ease shortages that have led to spiralling prices in the Asia-Pacific region, which accounts for about 60 per cent of LNG demand.

The growth of spot trading also depends on vessel availability. Industry executives estimate that four-fifths of the world LNG fleet are tied to long-term contracts, often in the hands of oil majors. Access to spare cargoes is therefore limited, despite attempts by the likes of Goldman Sachs, Merrill Lynch and Gazprom to develop LNG trading activities. “A handful of traders try to play with the big boys and get access to the cargoes but it really is almost impossible to get access without going through the oil majors,” according to Olga Vedernikova, a London-based LNG broker.

Accordingly, some executives from the majors play down the shift away from long-term deals. Jon Chadwick, a Shell executive, says that spot trading is likely to remain “at the fringes” because “reliability underpins the success of LNG”. John Gass, a Chevron executive, says: “Over time we believe that we’re going to see the evolution of a market price, but that’s some way off.”

The short-term market has nonetheless quadrupled in seven years, with about 520 cargoes being diverted last year compared with 92 in 2000, according to Ms Dedernikova.

The trend could accelerate as the global LNG fleet increases. While there are about 260 LNG vessels now at sea, the order books indicate that the fleet should reach 400 by 2011.

Copyright The Financial Times Limited 2008

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