An Economic and Legal Overview of the transition to the LNG Spot Market

Chartering, Legal, LNG, Maritime Education and Training — By on February 21, 2016 at 7:35 PM
Ioannis (Yanni) Mavrokefalos, Chartering broker

Ioannis (Yanni) Mavrokefalos, Chartering broker

An Economic and Legal Overview of the transition to the LNG Spot Market, is an abstract from Ioannis (Yanni) Mavrokefalos’ *thesis:

Will additional cargo capacity by shipowners, additional regasification volume due to the Floating Storage and Regasification Units (FSRU) and growth of the LNG supply contribute to the augmentation of the spot market?

Although the LNG carrier (LNGC) orders hit a peak in the previous three years and someone would expect that investors and shipowners lessened the ordering of new ones, their sentiment about a further increase of the demand and the creation of new export LNG projects and plants creates bigger expectations.

North America is expected to become a major LNG supplier. Australia, within the market of Oceania, is expected to become the world’s largest LNG exporter within four years. The gas boom will lead to an increase of 70% in years 2015-2016 and to a moreover 42% in 2018.

Moreover, during the last years, a new technological development, the so-called Floating and Regasification Unit (FSRU hereinafter) made its appearance. The flexibility offered to the market, gives buyers and marketers the opportunity to buy LNG certainly in lower prices, increasing the need for spot cargo. These floating units offer flexibility and agility as they are intended to be loaded with LNG cargoes from other carriers, store it, regasify and pump the gas into the consumption part of the LNG supply chain.

The rapid expansionof the global LNG market is a reality.  The volume of global liquefaction capacity will double over the next decade and therefore the spot market will boost, due to the forthcoming augmentation of the LNG volume produced.

In economics, Jean-Baptiste Say’s in Say’s Law or the Law of Markets, introduced in 1803 through his work called “A Treatise on Political Economy (Traité d’économie politique)”, states that additional supply creates additional demand.

The percentage of LNG transported under spot contracts is ~ 28% in 2015, while back in 2000 it was ~6%. The gas boom will lead to an increase of 70% in years 2015-2016 and to a moreover 42% in 2018.

” Are the existing charter-party forms sufficient? Is there a necessity for the creation of a new charter-party form?”

A factor influencing the sea carriage of LNG is the commitment or not of the new vessels to long term contracts. Although uncertain to assume whether these new vessels will be finally used to cover the SPA agreements (long term contracts) or whether they will serve the needs of the spot LNG market, a risk-aversive charterer i.e. the exporters will definitely decide to charter vessels in the spot market in order to avoid undertaking operational risks. We should not forget the 1973 oil crisis which led to such an uncertainty over future gas export prices that the so far projects were abandoned and the demand for LNG transport remained stable for the next three decades.

The LNG chartering procedures are influenced by the number and composition of the LNGC fleet. As the International Gas Union outlines, the unstoppable ordering of new vessels marked 2015 as the year of a new cycle of the oversupply of LNG tonnage.

Most LNG carriers function with time charters and the market is predominated by long-term contracts. “ShellLNGTime1» time charter-party fits well into to this market environment. Nevertheless, parties tend to amend and use it in voyage charters, since their frequency has been increasing rapidly in the last decade. To cover this need, GIIGNL, the International Group of LNG Importers, launched an LNG voyage charter form in May 2012, the GIIGNL “VCP, ” in order to facilitate spot chartering and ensure quicker drafting procedures.

“ShellLNGTime1” and   GIIGNL “VCP” forms have served their purpose efficiently, but the omissions found in them are a sound reason for their substitution by a new one, more charterer-friendly. Although recently drafted, both forms seem to present a number of issues that have to be revised and changed. Such issues are the omissions regarding boil-off, LNG price, port safety and compatibility, maritime security, piracy, and eventually demurrage and laytime clauses.

Future Challenges and Trends

BIMCO along with GIIGNL, took action and composed a working group which will draft a new more flexible form in order to give counterparties more options to hedge risks and reduce costs. This form will be the so-called LNGVOY and the issues to be regulated in it are mainly the clauses of heel and boil-off.

A solution which will hopefully be achieved via the clauses of the new LNGVOY, is that the vessel will make use of the boil-off as bunker for free during the voyage, but up to a predetermined limit. In case of delays, the fuel loss arising, will be shared by the counterparties. According to BIMCO, under the LNGVOY, the risk will be with the owners except for the case where the delay is caused by charterers’ fault or by any other unexpected incident such as piracy or seizure of the vessel.

ShellLNGTime1 although a time charter-party, has always been very widespread for both short and long-term LNG chartering, and still remains. Nonetheless, ShellLNGTime1 lacks in a piracy clause. Maritime security constitutes nowadays a core subject to the shipping industry and thus the drafting committees have to revise the standard charter-party forms as per their security clauses. On the other hand, the GIIGNL VCP was created in order to meet the gaps and the omissions that the hitherto forms used to have concerning the LNG provisions. Although the effectiveness and the profitability of this form regarding the former provisions was obvious, clauses like those of demurrage and laytime could have been more beneficial for the charterers instead of owners.

An increase in the liquidity of spot market could motivate additional spot market activity in market equilibrium. Simultaneously, the surplus created by trading in long-term contracting would decline, thereby reducing the liquidity of the long-term bilateral contract market. These changes could make developers of new projects more content to leave more of their capacity exposed to spot market trading. More spot and short-term trading LNG contracts may reinforce the increase in spot market liquidity and LNGVOY seems to be the vehicle to the attainment of this enterprise.

*MSc in Marine Policy, BA in Economic Science.

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