Build an LNG resource pool to empower the development of the industrial chain

Core Reading

In the context of the global low-carbon transition, the demand for natural gas continues to grow. Countries pay more attention to the diversification and safety of LNG imports, and major energy companies have also increased investment in the LNG industry chain and paid attention to the expansion and optimization of LNG resource pools. Chinese oil and gas companies can refer to the rich experience of international oil companies in the construction of LNG resource pools, further optimize the structure of resource pools, improve the economics of resource pools, and achieve steady expansion of resource pool scale and coordinated development of all links in the industrial chain.

LNG resource pool

LNG resource pool refers to the LNG resources obtained by LNG portfolio suppliers from multiple LNG resource suppliers around the world, including equity gas resources directly from upstream projects, as well as LNG resources obtained through long-term, short- and medium-term contracts and even spot procurement, for resale to different buyer users.

LNG portfolio providers often also own assets elsewhere in the LNG value chain, including shipping and regasification facilities. The LNG resource pool is a key component of the LNG industry chain, and a complete LNG industry chain will help to realize the expansion and further optimization of the LNG resource pool, which in turn will promote the further development and improvement of the LNG industry chain.

LNG industry chain

The LNG industry chain includes the exploration and development of upstream gas fields, natural gas processing, pipeline transportation, construction and operation of liquefaction stations, natural gas processing, liquefaction and storage, LNG maritime transportation, construction and operation of LNG terminals, LNG regasification, and transportation of natural gas to the final consumer market through pipelines.

IOCs have extensive experience in the construction of LNG resource pools

In the context of the global low-carbon transition, natural gas demand will continue to grow. Geopolitical tensions have plunged the international natural gas market into turmoil, and LNG prices have risen sharply due to Europe's sharp reduction in pipeline gas imports and global panic buying. Countries pay more attention to the diversification and safety of LNG imports, and major energy companies have increased their attention and investment in the LNG industry chain, striving to build a stable, diversified, complete and safe LNG industry chain.

Building a reasonable LNG resource pool structure can effectively improve business competitiveness and the ability to deal with risks. In terms of contract types, geographical distribution, destination flexibility, pricing methods, etc., international oil companies represented by Shell, TotalEnergies and BP provide examples for Chinese oil companies to refer to.

There are multiple types of contracts

The types of contracts contracted by international oil companies such as Shell include gas purchase agreements and liquefaction service agreements signed with upstream natural gas development projects, LNG purchase agreements signed with LNG projects and third parties, LNG sales agreements, etc. The LNG resources in the contract are both equity LNG and trade LNG.

For example, nearly 80% of Shell's resources come from liquefaction terminals in which it has a stake, and there are many equity LNG resources, compared with more than 20% of resources from third parties in 2021. In terms of the proportion of resources acquired by the liquefaction terminal with equity in the total resources, Shell is the highest among the three international oil companies, followed by bp and TotalEnergies. From the perspective of contract types, Shell embodies diversification and balance, which is conducive to risk diversification and optimal allocation of global resources.

The proportion of equity LNG of China's three major oil companies is lower than that of the three international oil companies, and the contract type is relatively simple, mainly LNG purchase agreements, with little equity LNG, and basically no long-term LNG sales agreements. This is related to the fact that China's three major oil companies entered the international oil and gas market late, developed and invested less in LNG liquefaction terminals, and mainly acted as LNG buyers.

Balanced geographical distribution

The geographical distribution of Shell's LNG resource pool reflects two characteristics: first, diversification, with resources distributed in the three basins; The second is equilibrium, which is reflected both between basins and among resource countries. Diversification and equalization facilitate risk diversification, and this structure is mainly due to the ownership of equity capacity in multiple liquefaction terminals. TotalEnergies' resource pool is dominated by the Middle East and the Atlantic-Mediterranean, with multiple countries of origin. The BP resource pool is dominated by the Atlantic-Mediterranean, with two-thirds of the resources coming from Trinidad and Tobago and the United States.

At present, Australia and Qatar are the main sources of China's petrochemical resource pool. PetroChina's main sources of resources include Qatar, Australia, and portfolio suppliers, with a relatively balanced proportion. CNOOC's resource pool accounts for a large proportion of resources from portfolio suppliers, as well as resources from Australia, Malaysia and other countries. Comparing the diversification and equalization of the source countries of long-term contracts by different companies in 2030, China's three major oil companies are generally at a disadvantage.

Resource destinations are flexible

Since the role of the three international oil companies as a portfolio supplier is to buy and sell, mainly engaged in global LNG trading, both as a buyer and a seller, to obtain resources from liquefaction terminals around the world and resell them globally, to make profits by establishing diversified resource sources and sales channels, and optimizing the flow of resources, so almost all resource destinations are relatively flexible.

China's three major oil companies import LNG mainly to meet domestic demand, and at the same time, in order to avoid buyers arbitrage between different markets and damage their interests, most of the sellers require the transaction method to be delivered at the destination, so the resource destination is mostly a fixed location, and the long-term LNG contract resources are basically supplied domestically, and only a few are resold in the international market.

The pricing method is conducive to risk diversification

In terms of LNG resource pricing, the long-term contract resources owned by Shell and BP are more diversified, in addition to the linked oil and gas price, there are also equity extraction, hybrid pricing, netback pricing, etc., among which the proportion between Shell's different pricing methods is more balanced, which is conducive to risk diversification and risk hedging between different pricing methods.

In the early stage of development, China's three major oil companies were mainly linked to oil prices in long-term contracts, and only a small part of CNOOC's resources from portfolio suppliers were mixed with oil prices and Henry Center natural gas prices in the United States. In recent years, with the introduction of U.S. resources, the number of pricing methods linked to gas prices such as the natural gas price at the Henry Center in the U.S. has increased. However, on the whole, it is still relatively simple, and it is greatly affected by oil price fluctuations.

There is still great potential for the construction of LNG resource pools for Chinese oil and gas enterprises

Compared with the overall scale and industrial chain layout of international oil companies, the construction of LNG resource pools of Chinese oil and gas enterprises has great development potential.

The three major international oil companies, Shell, Total and BP, have relatively large-scale asset layouts in all aspects, which is related to their role as resource suppliers and traders in the market, and is also inseparable from their deep participation in the exploration and development of global oil and gas resources in the past few decades. The three major international oil companies started from natural gas extraction, and in order to monetize the natural gas reserves of resource countries, they extended from oil and gas field development to LNG production and export; Provide raw gas for a number of liquefaction projects, put into operation liquefaction terminals built with equity participation in many countries, and obtain equity production capacity; Build a global LNG resource pool and carry out global sales, expand regasification capacity, and direct resources to more profitable markets; Develop new downstream demand, develop marine LNG, etc. The industrial chain runs through from top to bottom, and all links develop hand in hand, forming a perfect industrial chain layout covering all links of the industrial chain.

As LNG buyers, Japanese and South Korean companies have huge assets in LNG purchase agreements and LNG regasification terminals. However, there are two differences with China's three major oil companies: first, because Japanese companies have been involved in the development of global LNG liquefaction terminals since the last century, the asset scale in this link is relatively high; Second, Japan's LNG market has developed to a mature stage, and enterprises will sell some resources to other small enterprises in the form of long-term contracts according to their own needs, so as to optimize the existing LNG resource pool.

In contrast, China's three major oil companies started their LNG business late, with assets concentrated in LNG purchase agreements and regasification terminals. Entering from the middle and lower reaches, focusing on the development of the middle and lower reaches, through the introduction of long-term LNG contracts, the construction of domestic receiving stations, the acquisition of a small amount of liquefaction terminal equity, there is also a partial layout in natural gas power generation, city gas and other terminal fields, but the extension to the upstream of the industrial chain is limited.

Compared with international oil companies, China's three major oil companies need to optimize the overall size of the LNG resource pool, the layout of the industrial chain and the ability to withstand market fluctuations. Compared with Japanese and South Korean companies, Chinese companies are still basically only buyers of LNG resources. While purchasing long-term contract resources, Japanese and South Korean enterprises have also participated in many small equity investments in liquefaction terminals, and sold resources on a small scale in the form of long-term contracts, achieving the purpose of optimizing resource allocation.

The economics of LNG resource pools of Chinese oil and gas enterprises need to be improved

In terms of resource pool economics, compared with international oil companies, Chinese oil and gas companies still lack sufficient upstream terminal rights and interests, and need to further grasp the timing of long-term contract signing.

Under the scenario of a Brent crude oil price of $70 per barrel and a WACC (weighted average cost of capital) equal to 8%, the break-even points of the liquefaction terminal projects owned by Shell, Total and bp show that the comprehensive break-even points of the three companies are below $6.5/MMBtu, and even if they are sold at a slope of 10% pegged to oil prices, there is still considerable profit margin.

For most of 2010 to the present, the long-term contract slope in the market has been above 10%, reaching a peak of nearly 15%. Therefore, the three international oil companies have obtained a large amount of LNG resources at cost price due to the large-scale LNG liquefaction terminal equity in the resource pool, and the economics of the LNG resource pool have a strong advantage. In contrast, Chinese oil and gas companies have less equity in LNG liquefaction terminals, so the advantage in this regard is not obvious.

In the same year, the slope of the oil price peg in long-term contracts signed by different companies was about the same. By comparing the slope of contracts obtained by different companies and the timing of the contract, it is found that the average slope of the long-term contract linked to oil price is positively correlated with the average annual average price of the spot contract in Northeast Asia, and the slope of the long-term contract signed in the low spot price period is relatively low. That is, the buyer has more bargaining power in the negotiation of long-term contracts.

The low-price spot stage is often a favorable period for long-term contract negotiations, and the slightly insufficient contract volume captured by Chinese oil and gas companies will indirectly lead to the lack of economics in the long-term contract resource pool of Chinese oil and gas companies. Acquiring equity in liquefaction terminal projects and seizing the timing of long-term contract signing will help further improve the economics of the resource pool of Chinese oil and gas enterprises.

China's oil and gas companies should take multiple measures to achieve coordinated development of all links in the LNG industry chain

Compared with portfolio investors such as Shell, TotalEnergies and bp, Chinese oil and gas companies still have a gap in the construction of LNG resource pools, and should refer to the rich experience of international oil companies to further optimize the structure of resource pools, improve the economics of resource pools, and achieve steady expansion of resource pool scale and coordinated development of all links in the industrial chain.

Realize the coordinated development of all links in the industrial chain

In addition to investing in development projects to build its own LNG assets, it can also optimize the allocation of assets through mergers and acquisitions, equity cooperation and other capital operation means, focusing on low-cost natural gas resources and assets that can give full play to the synergistic advantages of the company's industrial chain. For some high-quality projects, it may also be necessary to exchange some downstream resources in the domestic market.

The second is to expand the "intermediate", including increasing the scale of purchase agreements, which needs to consider not only domestic natural gas consumption, the scale of natural gas business operations, the proportion of domestic gas, the proportion of imported LNG medium and long-term contracts and spots, but also whether to further expand the scale to meet the needs of other overseas markets in addition to the domestic market LNG demand.

When the scale of the resource pool is insufficient, the signing of the sales agreement can be used as a means to optimize the allocation of resources on a small scale, and when the scale of the resource pool is greater than the scale of domestic demand, it can be used as a way of operation to earn the difference between the purchase agreement and the sales agreement. The expansion of capacity needs to take into account the capacity needs of FOB resources and the capacity needs to carry out international LNG trade. The expansion of terminal capacity needs to consider the scale of LNG imports, determine whether it is necessary to expand the scale of domestic terminals, and whether to enter the overseas LNG market and invest in or lease overseas LNG terminals. The development of downstream demand includes the development of gas demand for power generation that is matched with LNG terminals. Marine LNG is the growth point of LNG demand in the future, and the opportunities and challenges of entering can be considered to be evaluated.

Take multiple measures to achieve the steady expansion of the scale of the resource pool

The first is to pursue steady development under long-termism, which will bring greater risk exposure in a relatively short period of time, whether the scale does not grow or the growth is too fast. In the long run, only by maintaining the steady expansion of the scale can we go through multiple cycles of the LNG market and obtain the most stable income.

Second, internal and external factors comprehensively determine the absolute size of the resource pool. It depends on the target market and the market share pursued, which is as relevant as the company's strategy and the judgment of the target market.

The third is to expand the scale of the rights and interests of the liquefaction terminal, and try to obtain the rights and interests of the liquefaction terminal through acquisition, investment, cooperation, etc. The liquefaction terminal equity will greatly facilitate the expansion of the resource pool.

Fourth, we should enrich the ways of scale expansion, not only limited to signing purchase agreements, but also following the example of the three major international oil companies to find opportunities for mergers and acquisitions.

Fifth, the three major international oil companies will choose to enter new projects and exit existing projects, and the flexible entry and exit mechanism is a necessary means to optimize the resource pool.

The resource pool structure is further optimized

First, we will continue to optimize the resource structure and improve the degree of diversification and balance in terms of the geographical distribution of participating projects, the equity production capacity of liquefaction terminals, the source and scale of LNG resources, the pricing method, and the mode of transportation.

The second is to expand the scale of the liquefaction terminal equity, and obtain more resources with price competitiveness with the help of shareholders.

The third is to reduce the volatility of the proportion of spot, when it comes to the growth rhythm of long-term contracts, it is necessary to consider the overall scale of operation and the coordination of spot volume, and it is necessary to keep the ratio of long-term contract volume to spot volume relatively stable within a range. Evaluate gains and losses over a period of 10 years or more, focus on stability, prevent volatility risks, and adopt a robust and flexible procurement strategy.

Improve the economics of resource pools in an efficient way

The first is to obtain equity in an economically viable liquefaction terminal project. When the long-term contract price is high, the revenue of the liquefaction terminal project can be relied on to improve the revenue of the whole industry chain; When the long-term contract price is low, you can rely on the downstream revenue to improve the revenue of the whole industry chain. Improve technical capabilities and resource reserves in this field, and actively seek cooperation with international companies.

Second, the signing of long-term contracts is based on long-term stable development, reducing the interference of the current spot market on forward judgment, strengthening trend research and judgment, and taking appropriate reverse measures to avoid falling into cyclical passivity. Considering the cyclical nature of the LNG market, if we can take appropriate reverse measures on the basis of long-term trend research and judgment and market dynamics, such as replenishing a part of long-term contracts in a timely manner during the period of low spot prices and being more prudent in signing long-term contracts during the period of high spot prices, it will help to enhance the initiative in negotiations and improve the efficiency of long-term contracts.

Source of this article | Sinopec News

The author of this article | Qingyun Zhang (International Cooperation Department, Sinopec), Danxu Wang, Xiaoxiao Liu, Xinyi Kong (Sinopec Economic and Technical Research Institute)