Protracted weakness in spot LNG market will test buyer-seller relationships in 2024

A prolonged period of low spot LNG prices is expected to see the market shift in favor of buyers and seep into broader aspects of the LNG business such as price reviews, contractual terms and long-term deal negotiations in 2024, according to industry experts.

Asian spot LNG prices have been under $10/MMBtu since the end of January and had dropped below $8/MMBtu in end February, on weak demand and mild winter, prompting changes in the short-term market such as preference for spot cargoes over oil-linked term supply and downward quantity tolerances, or DQTs, in delivery programs. Platts, part of S&P Global Commodity Insights, assessed the April JKM at $8.553/MMBtu March 12.

If LNG prices stay lower for longer, more material changes are expected in buyer-seller relationships that have always been a tug-of-war in volatile markets.

This was particularly true during extreme price movements such as the spot LNG price crash during the pandemic when buyers made force majeure claims to cancel cargo purchases, or the price spike during the Russia-Ukraine crisis when sellers pulled back on contracted supply. Both markets conditions resulted in LNG disputes and arbitrations.

"But what will be common between 2020 and this year [2024] is that oil-linked term SPAs [sales and purchase agreements] that are subject to price review will face downward pressure and some sellers will find it difficult to resist reductions in LNG prices, whether through negotiation or dispute resolution," Daniel Reinbott, partner at law firm Baker Botts, said.

Buyers are likely to be more confident during price reviews and may be less afraid of pushing matters into dispute resolution where a revised price cannot be mutually agreed, but this is more a function of pressure on term prices, rather than due to spot prices, Reinbott said.

There is no direct link between spot and term prices when it comes to price reviews, and price review provisions under term contracts almost always exclude spot prices, Reinbott said. "If spot prices do remain low for a period and this puts further pressure on negotiated and signed term prices, there will be an impact [indirect] on price reviews in the near future."

Long-term LNG contracts typically have clauses that allow price reviews within certain parameters and under specific market conditions. For instance, recent price reviews between South Korean importers and Asia-Pacific suppliers helped lower oil-linked price slopes in line with market levels.

DQT limitations

Sometimes, oil-linked tenders and term contracts allow buyers to reduce volume when spot LNG is cheaper, but it also depends on the buyer-seller relationship and a good relationship can enable easier cargo cancellation, a European LNG portfolio player said.

The trader said, in 2020 when JKM fell below $3/MMBtu, more than 20 US LNG cargoes were cancelled, and the market is wondering whether it might happen again in 2024. With JKM expected to hover around $10/MMBtu for 2024 and a flat price structure in the upcoming quarter, it is likely to be cheaper than long-term contracts and could further motivate spot procurement, the trader said.

Traders from Chinese national oil companies also said that importers in Asia may prefer spot procurement if JKM remains low and opt to postpone shipments to capitalize on the price difference.

But implementing this flexibility through DQTs may not be sufficient as DQT discussions are infrequent, and analyzing the price arbitrage and negotiating DQT terms with sellers is a time-consuming process, they said.

JKM prices must remain consistently below long-term prices for adjusting offtake or negotiating prices, and they are still hesitant to commit to long-term structural changes, traders added.

"Additionally, there is a perspective that the price structure for future months might follow a contango, potentially narrowing the price arbitrage between JKM and LTC prices. Hence, it is still early for buyers to consider changes for long-term contracts," another Chinese trader said.

Contractual challenges

Baker Botts' Reinbott, who specializes in LNG contracts, said sellers and buyers are already inquiring about the impact of low spot prices on existing contracts or new deals. This was despite LNG contracts maturing to reflect more flexibility, both in terms of quantities and destinations, and becoming increasingly transactional as term contract provisions mirror spot contracts.

The peaks and troughs in prices in the last three or four years have resulted in some conflicting reactions from sellers and buyers, Reinbott said.

During extreme market conditions, disputes arise when either LNG sellers fail to meet their commitments to deliver, which allows buyers to seek damages, or when buyers fail to accept delivery and have to meet take-or-pay obligations.

Some sellers are considering how to deal with buyers intentionally failing to take LNG cargoes at extremely low spot prices, with some now taking the position that they should not be required to undertake a mitigation sale or to maximize the proceeds of the mitigation sale, Reinbott said.

"On the other hand, buyers that saw sellers divert cargoes to the spot market have been trying to push up caps on seller liability where there is a willful failure to deliver," Reinbott said. "The outcome of these competing forces will depend on the time in the market when a contract is negotiated, which impacts the relative bargaining position of the parties."

Market participants also noted that in the absence of a pandemic or war, buyers may not be able to point to a clear event for a force majeure claim, especially if prices drop purely due to oversupply.

Reinbott said other consequences of low prices would be reduced investment in supply, delayed projects, reversal of demand destruction, coal displacement and more affordable climate mitigation.