Why LNG Traders Need Modern CTRM/ETRM Software…
August 19, 2019
Energy markets are volatile. Political complications like Brexit, turmoil in the Middle East, and the trade war between the US and China are just a few examples of global events causing uncertainty in energy trading. LNG traders face unique challenges because LNG markets are still developing, with new buyers and sellers entering the market every year, and pricing is complicated.
Constantly Changing LNG Markets
In the early 2000s, roughly 10 countries exported LNG and 10 imported gas. Trade routes were simple and routine, with most LNG flowing within the Atlantic and Pacific basins or from the Middle East to the Pacific. By 2018, there were 19 LNG exporters and 37 LNG importers. While intra-regional trade continues to dominate LNG trade, new trade routes continue to be created.
The structure of the LNG contracts is evolving as well. Historically, 95% of gas was traded via long-term contracts, but today, the short-term market now accounts for almost one-third of LNG trade. Long term contracts are still being signed, in fact Mozambique LNG just signed 8 sales contracts ranging from 13 to 20 years, but short-term contracts are on the rise. It’s increasingly common to have flexible destination contracts as well. These flexible contracts are linked to HH, TTF or UK NBP, and JKM in SE Asia. They make market entry easier for trading companies, increasing interest in spot markets.
Global demand is growing, particularly in China and Japan; however, China has experienced the slowest quarterly growth rate since 1992, signifying a possible slowdown in Chinese demand. This slowing of demand could drive prices down. At the same time, the push to reduce carbon emissions is fuelling demand for cleaner burning fuel like LNG.
As more countries and companies invest in liquefaction, vessels and regasification, the market could reach over supply conditions. In 2017, the spot charter rate for 160,000 cm LNG carrier was nearly $90,000/day. In 2018, it was almost half that. On the other hand, the Strait of Hormuz is crucial for about 25 percent of world’s LNG, and spot prices could double if that route remains problematic and supplies are disrupted.
Tech Challenges in LNG Trading
LNG markets are volatile and complex, creating significant challenges for LNG commodity trading and risk management.
- Trade capture must include functionality to manage complex pricing formulas. 70% of gas pricing is indexed to oil, creating a complicated pricing system. LNG producers use net back to assess options, so they must assess the viability of trades based on oil price indices. They must track natural gas purchase price and oil-based indices as well as costs. Multiple commodity component pricing is challenging and takes a lot of time if you are using spreadsheets to manually aggregate and analyze data.
- Arbitrage identification is challenging with complex pricing models. Traders want to buy and sell spot, short-term and long-term contracts, and you need a trading system that can analyze pricing now, run simulations, and assess options to make the best choices. Unfortunately, LNG trading often involves a complete lack of transparency, delayed access to price information, and volatile pricing – a bad combination if you want to make effective trading decisions.
- Hedging exposure is limited. There are limited financial instruments, pricing is tied to alternative fuels, and VaR capabilities don’t have enough information to be meaningful. Assessing and mitigating price risk is difficult.
Vessel and voyage planning and scheduling are complicated. LNG requires liquification, transport – often across thousands of miles – and regasification. It’s complicated, full of risks – contractual flexibility, weather, pirates, hostile governments – and it requires careful management. Destination flexibility may drive profits, but it also increases risk. If you send a cargo from Location A destined for France to UK instead, for a positive margin, can the ship get back to Location A for the next scheduled cargo? If not, the penalties could outweigh the profit on the diverted vessel.
- Trade routes impact insurance costs as well. Today, operating in the Strait of Hormuz can increase insurance 20-fold.
- Risk management is challenging. The lack of pricing transparency combined with extreme pricing volatility and delayed, and incomplete price information makes traditional risk management tools ineffective.
The Need for Energy Trading and Risk Management Software (CTRM/ETRM)
LNG trading and risk management cannot be managed on spreadsheets or outdated systems that are not designed for complex pricing and constantly changing markets. LNG traders need a modern ETRM system that automatically captures trades with complex pricing and shifting locations, identifies opportunities and risks and facilitates decision making by aggregating and analyzing data – internal, external, real-time, historic, structured, and unstructured – from as many sources as necessary to provide the insight they need.
LNG traders need modern ETRM systems that can manage multi-location and flexible location contracts with complex pricing. They must be designed to build complex formulas easily and manage contracts with various price types – fixed, basis, index, formulas and more. They need to capture adjustments, fees and price across multiple currencies and manage price exposure in real time. And they must manage the complicated shipping dynamics of a product that requires liquification, transport – often across thousands of miles – and regasification.
All of which explains why we are seeing a spike in demand for ETRM systems for LNG traders – especially multi-commodity trading systems like Eka’s.
Colin Cooper is Eka’s vice president, EMEA. He is responsible for managing Eka’s expansion in the EMEA region, including increased adoption of Eka’s newest solution, Commodity Analytics Cloud.