liquefied natural gas, or "LNG" as it is more popularly known, is simply natural gas that has been cooled to

approximately --161 Celsius to its liquid state through a special cooling process. Natural gas is about 90%
methane and, when it is cooled to below 161 Celsius, it concentrates into liquid but maintains atmospheric
pressure, meaning it is not under pressure. During the refrigeration process, heavier particles like oxygen,
carbon dioxide, and sulfur compounds are drawn off. Water and natural gas liquids (NGLs), which are
hydrocarbons such as propane, ethane, and butane, are also removed as they freeze when the gas is
chilled. The resulting LNG weighs less than 50% of water. It is colorless, odorless, non-corrosive, and non-
toxic. One ton of LNG equals 48.7 MMcf of regular natural gas.( n1) LNG is stored as a "boiling cryogen," a
very cold liquid at its boiling point. LNG is lighter than air when it is vaporized and, since it remains a liquid at
atmospheric pressure, it does not require pressure containers for storage or transportation.
The LNG industry grew in response to the difficulty producers faced in delivering natural gas from the large
gas fields discovered in the 1960s and 1970s in Africa, the Middle East, and Southeast Asia to the major
developed markets for natural gas that were in United States, Europe, Japan, and Korea. The common
mode of delivering natural gas is through pipelines, but pipelines are not feasible for delivering natural gas
over such vast distances. This is because natural gas, in its normal state, takes up a lot of room and is
uneconomical to transport over long distances. LNG, however, is 600 times smaller in volume and can be
transported long distances by tankers. LNG gave the natural gas producers and suppliers an alternative to
tap into markets that once were out of reach because of transportation limitations.
The role of LNG in developing the international natural gas markets is clear when one considers that in
2002, the gas-producing areas (where liquefaction facilities have been established for converting gas into
LNG) were in the Middle East (Qatar, Oman, Abu Dhabi), Trinidad (in the Caribbean Sea), Southeast Asia
(Indonesia, Malaysia, Philippines), Africa (Egypt, Algeria, Libya, Nigeria) and Australia. Russia, Iran,
Venezuela, and Norway are considering exporting natural gas by developing liquefaction facilities. As
mentioned above, the developed markets for LNG/natural gas consumption are in the United States, Japan,
Korea, and Europe. India and China are considered to be the emerging Asian LNG markets.
A December 2001 report by the United States Department of Energy suggests that 10 countries (Russia,
Iran, Qatar, Saudi Arabia, United Arab Emirates, United States, Algeria, Venezuela, Nigeria, and Iraq) hold
77% of the world's natural gas reserves, with Russia, Iran, and Qatar accounting for more than 55%.( n2)
Because LNG must be kept very cold to remain a liquid, the liquefaction process, the storage at the point of
shipment, the tanks in the LNG tankers, the LNG receiving facility, and LNG storage tanks at the receiving
facility are all technology-intensive facilities. The LNG receiving facility also has a LNG regasifying facility
that converts the liquefied LNG into pipeline-quality natural gas.
LNG/natural gas is used as a fuel mainly by power plants and as a feedstock fuel for the fertilizer industry
and certain heavy industries such as steel. LNG projects require such base customers in the power sector,
fertilizer sector, or heavy industries to be viable.
In light of the high costs and dedicated, highly specialized infrastructure required for production, storage,
transportation, delivery, and regasification, LNG traditionally has been considered a "niche" fuel meant
essentially for highly creditworthy gas markets. The sale and purchase of LNG always has been considered
to be governed by somewhat strict and uniform rules. This article seeks to present certain recent
developments and the changes they have triggered in the sale and purchase of LNG.
THE LNG CHAIN
LNG, unlike other energy sources such as oil and coal, does not have a developed spot market. The spot
market in LNG is very limited and only relatively small volumes are transacted in such deals. The absence of
a developed spot market prevents investment in any part of the LNG process that lacks the security of
assured consumers or "base customers." This has resulted in a concept that is unique to the LNG industry,
namely "the LNG chain."
The LNG chain, simply stated, is the series of separate but interdependent activities which basically
includes:
producing gas from gas fields,
converting natural gas into LNG,
transporting LNG,
receiving, storing, and regasifying LNG, and
transporting natural gas obtained from the regasification of LNG to the final end consumer.
The broad activities of the LNG chain can be divided into 1) the upstream segment and 2) the downstream
segment:
1. Upstream Segment: The upstream segment is comprised of: a) development of the gas reserve to
enable stable and commercial production of natural gas from the reserve; b) transportation of natural
gas from the gas reserve to the liquefaction facilities; c) conversion of gas into LNG at the liquefaction
facility; d) the storage and loading of LNG into LNG tankers for transportation; and e) shipping of the
LNG by LNG tankers to the LNG purchaser.
2. Downstream Segment: The downstream activities are broadly comprised of: a) unloading LNG from the
LNG tanker; b) storage of LNG; c) regasification of LNG into natural gas; and d) transmission of natural
gas so produced to the end consumer.
DEVELOPMENT AND FINANCING OF LNG CHAIN
Although worldwide natural gas supplies for LNG facilities are abundant and can be produced inexpensively,
the development of the LNG chain, particularly the processing and transportation equipment, is capital
intensive and highly specialized, requiring hundreds of millions of dollars of investment for each new facility.
For each cubic foot of natural gas delivered to end users, less than 30% of the cost is for the commodity
itself. The balance reflects the costs of processing and transportation. LNG project costs can vary
significantly because of site-specific construction costs. LNG projects comprise several distinct elements,
each of which is necessary to implement a successful project:
Abundant Low-Cost and High-Quality Natural Gas Reserves. A successful LNG project must have enough
proven reserves of natural gas available to support liquefaction capacity for the life of the plant (20+ years).
The main characteristics of a gas reservoir that determine its suitability for sustaining an LNG project are: 1)
quantity of proven reserves, 2) sustained gas production, 3) quality of natural gas from the reserve, and 4)
transportation of gas from the reservoir to the liquefaction facility. The gas reservoir from which gas is
converted into LNG is critical for any LNG project. The proven reserve capable of commercial exploitation
must be large. The delivery of 1 million tons of LNG per annum for 20 years is equivalent to 1 Tcf( n3) of
natural gas. After taking into account the gas used and lost in the LNG chain and to maintain the production
of LNG at a specific level, a world-scale LNG project with a capacity of 6 to 8 mpta,( n4) requires a minimum
of around 10 Tcf of proven gas reserves.( n5) The gas reserves also should be of a nature that would
sustain gas production at a reliable level for the life of the LNG project, which is usually 20 years.
Because of the nature of the LNG chain, any interruptions in the gas supply leave the liquefaction facility, the
LNG tanker, the LNG receiving facility, and the end consumer without any LNG. Consequently, the nature of
the gas reserve is critical. The quality of the gas from that reserve is as important as the quantity of proven
reserves. The presence of impurities such as carbon or mercury in natural gas result in additional costs in
the liquefaction process. At the same time, associated liquids and condensates of heavier hydrocarbons
formed from natural gas during the LNG liquefaction process provide additional revenues to the liquefaction
facility and play an important role in the overall economics of the liquefaction facility. In addition, production
costs (including applicable production taxes levied by the host government) need to be low (typically, less
than $1 per thousand cubic feet, and preferably on the order of $0.50 per thousand cubic feet).( n6) Finally,
the costs of delivering gas to the liquefaction facility have to be low if the LNG project is to be commercially
viable.
The Liquefaction Facility, Including a Jetty and Loading Facilities for LNG Tankers. The liquefaction plant is
typically the most expensive element of a LNG project. The cost depends on a host of site-specific factors,
including the project's scale, with larger projects having lower unit costs. Operating costs are relatively
minor. Liquefaction is a very energy-intensive process, with typically about 8% to 9% of the plant's input
used as plant fuel. Liquefaction technology is a highly capital- and technology-intensive process. In the
process of liquefaction, the natural gas first is treated to remove any water, condensates, and contaminants
such as carbon dioxide, mercury, and hydrogen sulfide. It then is fed into a heat exchanger, where it is
liquefied by cooling to -161 Celsius. The liquefied gas is stored in tanks until it is loaded onto LNG tankers
for export. After the initial liquefaction, no further refrigeration normally is carried out. The LNG is, after the
initial liquefaction, stored at atmospheric pressure in insulated LNG tanks either at the liquefaction plant, in
the LNG tanker, or at the LNG receiving facility.
A typical liquefaction facility is comprised of a series of processing units that treat and liquefy the gas into
LNG. Each complete series of such processing units is known as an LNG train. A liquefaction facility
consists of two or more LNG trains that can operate independently of each other. The largest LNG
liquefaction facility is the Bontang facility in Indonesia, which has eight LNG trains in operation. An LNG
liquefaction facility can be expanded through additional LNG trains.
There are only three main types of technology used in the liquefaction process. The first, which is most
widely used, originally was developed more than 25 years ago by Air Products and Chemicals Incorporated
(APCI) and is called the Multi-Component Refrigerant (MCR) process. The second process was developed
by Phillips and Bechtel and is referred to as the Phillips Optimized Cascade (POC) process. A third and
comparatively newer process, developed by Black & Veatch Pritchard, is called the Poly-Refrigerant
Integrated Cycle Operation (PRICO) process.( n7)
LNG Tankers. Each liquefaction facility requires several LNG tankers dedicated to shipping LNG from the
liquefaction facility to the receiving facility of the LNG purchaser. LNG tankers are among the most complex
and expensive merchant ships ever built because of their double hulls and special cryogenic lining. Each
new 135,000 cubic meter (three billion cubic foot) capacity tanker costs approximately $260 million.( n8) The
tanker's LNG cargo is kept cool by evaporating a fraction of the cargo ("boiling off") and burning it as boiler
fuel. Typically, 0.15% to 0.25% of the cargo is consumed per day, during which time the tanker travels about
480 nautical miles. Normally, a small amount of LNG is left in the ship's tanks to keep them cold for the next
voyage and so the tanker will not have to spend time cooling down at the loading port.
LNG tankers are the critical links in the LNG chain between the LNG seller and the LNG buyer. It is common
for the developers of an LNG liquefaction facility also to order the construction of LNG tankers to enable
them to offer LNG on a CIF basis (cost, insurance, and freight) as well. The fact that the majority of the LNG
tankers are dedicated to specific projects also has inhibited the growth of a spot market in LNG, because it
means that a short-term buyer may not always be able to procure the shipping required for using the LNG
purchased on a short-term basis.
LNG Regasification Plant. LNG can be unloaded only in a specialized terminal, which typically includes a
jetty and unloading facilities, LNG storage equal to at least a single tanker's cargo, regasification facilities,
and connections to pipelines. The cost of the regasification terminal varies with capacity, local construction
costs, and the amount and type of site-preparation costs. Regasification plant costs are typically
considerably lower than liquefaction plant costs. Regasification energy requirements consume a further
1.5% of the delivered LNG. The marginal cost of either utilizing excess capacity at an existing regasification
plant with excess capacity or expanding the capacity of an existing plant are far lower than the cost of
building a new greenfield facility.
Regasification is a much simpler process than liquefaction. The LNG is heated by using seawater in open-
rack vaporizers or by burning some of the gas in combustion vaporizers. Typically 2% to 3% of the gas is
used or lost in the regasification terminal. The capital cost of a regasification terminal varies widely
depending, in particular, on the amount of storage and the location. Regasification terminals can cost
between US$200 million for 3mpta of capacity to more than US$1 billion if the location costs are high and
additional storage has to be provided for strategic reasons.( n9)
The primary elements of the LNG receiving facility itself are berths for unloading the LNG tankers, storage
tanks to receive the ship's cargo, and vaporizers to regasify the LNG for distribution to market centers
through natural gas pipelines. Other elements include site improvements, roads, buildings, services, and
miscellaneous components including piping, controls, and utilities. The actual construction time averages
about three years, but obtaining approvals for construction can increase the time period by one to two years.
The large capital costs associated with each stage in an LNG project imply that projects can be undertaken
in general only by organizations with sufficiently large financial capacity. Under the traditional LNG project
structure, successful LNG projects require the cooperation of the host government (where the natural gas
resources are located), the entity that owns the natural gas rights (private or state), the government of the
consuming country, consuming organizations (national or private electric utilities, gas companies, etc.), and
a host of specialized organizations, including shipyards, financiers, tanker operators, construction
companies, and process technology licensors. Protracted negotiations are often needed to reach agreement
regarding the distribution of the costs, the benefits, and the considerable risks associated with the project.
No LNG project is likely to proceed unless the developers receive some assurance that they will be able to
earn an acceptable return on their investments. A successful LNG project requires a price that is low enough
to motivate consumers to use large volumes of natural gas, yet still high enough to persuade developers and
borrowers to build the project.
In light of the amount of debt required for development of the entire LNG chain, financing for each of the
segments is closely monitored in terms of timing and funding sources. The commercial and contractual
structure of the downstream regasification project should be such that it is able to support not only its own
financing but also financing of the upstream liquefaction plant and the LNG ships. Financing of each of the
other legs of the LNG chain is generally a condition precedent to draw-down of the loan facility for any leg of
the LNG chain.
In case of timing mismatch with respect to the construction period, the developers of the project starting
construction first need comfort from the sponsors of the other segments that their respective facilities will be
completed in time. The commercial framework for each component of the LNG chain from the "well head" to
the "burner tip" needs to be developed on a back-to-back basis with that of the other components.
Some of the major issues affecting project contracts across the LNG chain that need to be structured on a
back-to-back basis include conditions precedent, delivery dates, force majeure, liquidated damages, and
termination. Inter-creditor agreements among different lending groups providing for appropriate remedies in
case of various events of default also need to be put in place.
Integrated project documents and agreements provide the basis to formulate integrated financing
documents, including complex inter-creditor agreements. A payment security mechanism spelling out priority
of cash flows, acceptable to lenders to the upstream facilities, LNG ships, and regasification terminal needs
to be put in place.
A welcome but limited addition to the manner of financing LNG projects was introduced by the Ras Laffan
Project of Qatar, which in 1996 obtained financing of US$1.2 billion through an international bond issue.
However, at times when the international capital markets are hit by a slump, bonds have limited utility as a
source of LNG project financing.
EMERGING TRENDS IN LNG SALE AND PURCHASE
In light of the fact that the initial development of the LNG industry depended upon the development of a
large gas reserve and the construction of a suitable liquefaction facility, the LNG industry traditionally has
been a seller-driven market dominated by long-term LNG sale-and-purchase contracts that do not provide
any flexibility to the consumer and require dedicated LNG tankers and a strict framework governing the
shipping of LNG.
However, the future projections of the LNG international industry indicate a rapid increase in liquefaction and
shipping capacity that may lead to greater short-term LNG sales and could result in the shifting of the LNG
industry from being a seller-dominated one to being one that is equally controlled, if not driven by, the
buyers and end consumers of LNG.
According to a United States Department of Energy report,( n10) considerable expansion is planned for
existing LNG liquefaction facilities and at least 15 new LNG projects are under consideration. Iran has two
terminals in planning stages currently expected to become operational by 2005-2006; Venezuela has plans
to commence export of LNG by 2003; Oman, which commissioned two LNG terminals in 1997, is planning a
third one. Indonesia, Algeria, Malaysia, UAE--four of the top five LNG exporters (Oman being the fifth)--all
are planning increases in liquefaction facilities. Australia, which commenced LNG supply in 1989, is planning
expansion of its LNG facility. Egypt, Nigeria, and Libya as well are planning expansion of their LNG
facilities.( n11)
One factor contributing to the world growth in the LNG trade is the declining cost structure of all phases of
the supply chain, which has allowed the cost at which LNG becomes economical to fall within the year 2001
range of natural gas prices. With new suppliers coming on board, competition has forced cost-cutting
measures and price reductions. Liquefaction costs between 1996 and 2000 averaged $230 per ton,
compared with $560 per ton between 1986 and 1990. Between 1996 and 2000 the cost of a new tanker
dropped by approximately 30%. Construction costs for regasification terminals have seen similar decreases.
In addition to the numerous planned expansions and new facilities for liquefaction, the tanker fleet is
expanding. At the end of 2000, the worldwide fleet of LNG tankers stood at 127 ships.( n12)
Furthermore, the traditional trend of LNG tankers being dedicated to projects or LNG liquefaction facilities is
expected to change. It is reported that in 2002, 58 LNG tankers were on order at various shipyards around
the world, of which a record number of 21 were scheduled for delivery in the year 2004.( n13) It is also
estimated that, for the first time, as many as 40% of the LNG tankers on order are not dedicated to any
particular LNG project and some of those tankers have been ordered by oil and gas companies (such as
Shell) that intend to use them for LNG trading.( n14) This clearly indicates that a surplus of uncommitted
LNG tankers may develop that could lead to a promotion of short-term trading in LNG.
STRUCTURES AND DOCUMENTATION FOR UPSTREAM AND DOWNSTREAM LNG
PROJECTS Upstream LNG Project Structures
If the gas reservoir(s) and the liquefaction facility are under common ownership, the LNG project is referred
to as an "integrated project." Sometimes common interests in the upstream segment can speed the
implementation of such a project. At times, an integrated project also may be combined with ownership of
LNG tankers. The Ras Laffan LNG Project in Qatar is an example of an integrated project that does not
cover shipping. The LNG projects in Algeria, Alaska, and the Australian North West Shelf are examples of
integrated projects that cover shipping as well.
In a second general structure of LNG projects, the gas reservoirs and the LNG liquefaction facility are owned
by different entities. In such projects, more detailed project documents are required because the gas
producers and the LNG producers have different interests.
A third general structure of LNG projects is based on a "tolling arrangement," where the producer or owner
of the gas uses the liquefaction facility to produce LNG for a particular fee/toll for the LNG liquefaction
services. This structure enables greater flexibility in the marketing of the LNG, as each party with an interest
in the gas has the right to sell the LNG so produced in whatever way it wants.
Similarly, LNG tankers either can be owned or hired by the liquefaction facility, enabling the sale of LNG on
a CIF basis by the LNG seller, or they can be owned by a separate shipping company and provided to
specific LNG sellers for specific time periods.
Downstream LNG Project Structures
In the same manner as the upstream LNG projects, the downstream LNG projects can be generally divided
into categories where:
1. The LNG receiving facility and the transportation pipelines are owned by a consumer of the LNG or the
marketer of the LNG in the country of import.
2. The LNG receiving facility is owned by the LNG importer (which is not the end user of the gas) and the
gas transportation pipeline to the end users is owned by a separate entity.
3. The LNG receiving facility is owned and operated by a distinct and independent entity on a tolling and an
open-access basis to all LNG importers interested in using the facility. Those LNG importers arrange for
the pipeline transmission capacity to the ultimate consumer. In such a structure the LNG receiving
facility, the LNG importer, the gas transporters, and the ultimate consumers all could be separate
entities.
Documentation
The main documents involved vary based on the structure of an LNG project:
I. Upstream LNG Project Documents: An upstream LNG project, depending on its structure, could include,
in addition to the usual package of project documents and finance documents, the following documents:
a) Production sharing contract between the government and the developer(s) of the gas reservoir. This is
the license from the government of the "host" country, enabling an entity or an association of persons to
develop a gas field.
b) Joint operating agreement between the developer(s) of the gas reservoir
c) Gas sales agreement between the developers of the gas reservoir and the LNG producers
d) Gas processing agreement between the gas owners and the LNG liquefaction company (if the structure is
a tolling structure)
e) LNG sale and purchase agreement between the LNG seller(s) and the buyer (the LNG SPA)
II. Downstream LNG Project Documents: A downstream LNG project (for establishing an LNG receiving
facility and marketing of LNG in the country of import), depending on the structure of the project, could
include, in addition to the usual package of project and finance documents, the following documents:
a) Time charter party for hiring the services of the LNG tanker (between the shipping company and the LNG
buyer if LNG sale is on FOB [free on board] basis)
b) LNG tolling services agreement (if a tolling structure is adopted)
c) Gas sales agreement between LNG importer and ultimate consumers
d) Gas transmission agreement between gas shipper and gas seller to deliver gas to the ultimate buyer
LNG SALE AND PURCHASE AGREEMENTS Typical LNG SPAs
The LNG sale and purchase agreement is the core agreement for the financing of a typical upstream LNG
liquefaction facility. The LNG SPA is also the critical document for the LNG downstream project for
establishing the LNG receiving facility and the gas distribution network from the LNG receiving facility.
In light of the high capital investment required for the establishment of liquefaction facilities, LNG SPAs
formulate detailed frameworks to govern each aspect of the sale and purchase of LNG including
arrangements that govern shipping, loading, and unloading of the LNG.
The commercial aim of the LNG SPA traditionally has been to establish the buyer's long-term commitment to
purchase and off-take the LNG produced at the liquefaction facility. The main issues covered by a typical
LNG SPA generally include: a) sale and purchase of a specific quantity of LNG of a specific quality, b) take-
or-pay framework, c) pricing, and d) shipping.
a) Sale and Purchase of LNG: This is the critical commercial content of the LNG SPA. The LNG SPA
seeks to provide for a long-term commitment from the buyer to purchase a specific quantity of LNG and the
buyer seeks to be assured of LNG availability in the agreed quantity and quality.
The LNG SPA generally specifies an annual quantity of LNG that the buyer undertakes to purchase and take
delivery of or pay for if not taken. The annual quantity of LNG contracted for is generally broken down into a
specific number of LNG tanker full-cargo loadings so a clear annual delivery program for the LNG can be
formulated and agreed upon.
Traditionally, LNG SPAs provide for only a limited and temporary flexibility to the buyer to reduce the
quantities of LNG it is required to take in a year. The flexibility generally is limited to a specific reduction in a
given year and that reduction is temporary. The buyer is generally obligated to make good the gas it does
not take in one year over the term of the SPA. Furthermore, in exercising the flexibility to reduce its off-take
in a particular year, a buyer also generally is mandated to act no less favorably to other LNG suppliers it
may have.
b) Take or Pay: In light of the high capital investment needed in establishing liquefaction facilities as well as
procuring and distributing natural gas, the LNG as well as the natural gas industry traditionally have imposed
take-or-pay obligations on the buyer in relation to a specific volume of LNG/natural gas.
Simply stated, a take-or-pay obligation is a buyer's undertaking to pay for a specific volume of gas even if it
does not actually take that volume. A take-or-pay provision provides a minimum guaranteed off-take by the
buyer. It guarantees the seller a specific amount of return on the sale of LNG/gas. It is a form of security for
off-take of LNG/gas. It is a critical commercial agreement contained within an LNG SPA. The take-or-pay
provision generally is an integral part of the consideration for the seller undertaking to deliver the LNG/gas to
the buyer.
A take-or-pay provision generally functions as follows:
i) Take-or-pay liability is triggered when the quantity of LNG taken and purchased by the buyer falls below a
specific threshold level
ii) The annual quantity of LNG the buyer has agreed take is the base figure used to calculate the take-or-pay
liability. To the annual quantity certain volumes of gas are required to be added or deducted based on the
terms agreed to under the SPA for various circumstances. Such adjustment to the annual quantity is
necessary to accurately determine the overall quantity of LNG that the buyer has agreed take annually. This
is because provisions of the SPA may reduce the quantity of gas or increase the quantity of gas agreed to
be taken by buyer based on various circumstances.
iii) The take-or-pay liability generally is determined as the liability to pay the price for a specific percentage of
the total adjusted annual quantity of LNG agreed to be taken by the buyer.
The take-or-pay provisions of an LNG SPA provide that if the buyer has made payments pursuant to its
take-or-pay liability, then it becomes entitled to take without any further charge, in any subsequent year
during the term of the SPA, such volume of gas that can be procured, under the terms of the SPA, for the
amount so paid under its take-or-pay liability.
Off-take commitments, similar to the take-or-pay obligations, are common in the electricity industry, the
mineral refining industry, as well as the shipping industry.
c) Pricing Is a Key Commercial Issue for Both the Seller and the Buyer: The parties generally agree to
a base price for the LNG and a formula to determine how the price will be varied over the term of the
contract. The price clause also generally provides for renegotiation of the price at regular intervals or in the
event certain circumstances occur.
The index for the base price under the SPA is generally the crude oil price. The parties agree to a specific
reference indicator of crude oil price to which the LNG price is indexed. In Asian SPAs, LNG prices generally
have been indexed to the Japanese Crude Cocktail (JCC), as Japan was the first bulk consumer for LNG
and still remains the largest and most important LNG consumer. JCC represents the weighted average
delivered price of the top 20 crudes by volume imported into Japan.
In exceptional cases, where the LNG is being produced for a very strong gas market (such as the United
States), a mechanism known as "netback" pricing also can be formulated. Under that structure, the LNG
price to be paid by the buyer to the seller is determined, either completely or to a certain extent, by the
proceeds received by the buyer from the sale of LNG itself or of natural gas derived from the regasification
of the LNG. In netback pricing, price adjustments also can be triggered to ensure that the LNG from the
particular project remains competitive with respect to LNG from other projects. Netback pricing would
indicate that the LNG producer has complete faith in the creditworthiness and reliability of the particular gas
market and that its priority is to ensure that the LNG it produces retains a substantial share of that gas
market.
The LNG price also depends upon whether the sale is FOB or CIE
d) Shipping of LNG: A typical LNG SPA provides a detailed framework governing the transportation of
LNG. The main issues covered by the transportation provisions of an LNG SPA include:
i) Responsibility for Transportation: If LNG is sold on a CIF basis, the LNG seller arranges for the
transportation; if LNG is sold on an FOB basis, the buyer arranges for the transportation.
ii) Points of Transportation Clearly Identified: The loading port where the LNG shall be loaded onto the LNG
tanker and the delivery point where the LNG shall be unloaded from the LNG tanker are clearly identified in
an LNG SPA.
iii) LNG Tanker(s): The technical specifications of LNG tankers are clearly specified in the LNG SPA. This is
important to ensure the LNG tanker is capable of taking the agreed volume of LNG in the agreed number of
trips as well as to ensure the tanker meets the specifications allowed at the loading port as well as the
unloading port. The LNG SPA specifies the party whose obligation it is to provide, maintain, repair, and
operate or cause to be provided, maintained, repaired, and operated, the required LNG tanker.
iv) Loading Port and Loading Port Obligations: The SPA provides a detailed technical specification of the
loading port and the obligations of the buyer and the LNG tanker while approaching and using the loading
port. The SPA provides the seller's corresponding obligations to ensure loading of the LNG tanker within a
specific time frame and consequences of any delay caused by either the buyer/LNG tanker or the seller in
the loading of the LNG tanker. The SPA seeks to define appropriate obligations of the parties to ensure
adequate coordination among those parties and efficient loading and despatch of the LNG tanker.
The shipping provisions are considered crucial as the efficiency in the shipping operations ensure the ability
of the seller to deliver and of the buyer to take delivery of the agreed annual contract quantity of LNG under
the SPA.
EMERGING TRENDS AND POTENTIAL IMPACT ON LNG SPAs
The emerging trends in the LNG market discussed earlier in this article clearly indicate that the LNG industry
may soon swing from being seller-dominated to being more balanced between the buyer and seller. This is
expected to have an impact on the terms and conditions of traditional LNG SPAs.
In addition to a projected increase in international LNG production, LNG will face greater competition from
piped natural gas in certain markets as well as certain emerging LNG markets.
It should be noted that the base consumers for LNG are essentially power stations and, to a certain extent,
fertilizer units and other heavy industries, for which LNG faces competition from existing sources of energy,
particularly coal.
In spite of the projected increase in LNG production and competition, the development of a viable spot
market in LNG is far in the future. Although there is an increasing incidence of LNG procurement on what
resembles a spot basis, these transactions are neither large nor frequent.
However, buyers appear to be able to negotiate more flexible contractual terms from the LNG producers.
The main terms of an LNG SPA that might be made more flexible include:
i) Contract Duration could be reduced to a medium term (5-10 years) rather than the traditional long term
(20-25 years).
ii) Price Review Clauses could be added to provide for re-opening of price negotiations every few years.
iii) Shipping Arrangements could be made more flexible. As stated earlier, a number of LNG tankers
currently under construction are not dedicated to any particular projects. This could change the usual trend
of dedicating LNG ships to specific projects and enable short-term LNG transactions. Furthermore, the buyer
could have greater flexibility in the destination of the LNG and that destination may not be strictly specified in
the SPA.
iv) Flexibility in Off-Take Obligations: If there is an increase in short-term LNG trading, buyers can be
provided with greater flexibility in their off-take obligations.
v) Flexibility in Take-or-Pay Obligations: If there is an increase in short-term LNG trading, contracts may
provide greater flexibility in take-or-pay obligations. This could be reflected in a lower percentage of take-or-
pay obligations or in greater limitations in the triggering of such obligations.
vi) Beneficial Pricing Mechanism: LNG producers will have to adapt to the growing competition not only
among LNG producers but also between LNG and other sources of energy such as piped natural gas, oil,
and coal. LNG producers would have to realize that greater consumption of LNG can be supported only if
the interests of the ultimate consumer, namely power utilities or other heavy industries, also is taken into
consideration and LNG is packaged as a more viable fuel for such consumers. The indexing of LNG to JCC
or other crude indices would have to be re-evaluated. Japanese importers originally agreed to index LNG
prices to JCC to promote the development of LNG facilities and secure assured production and supply of
LNG into Japan. With the rapidly evolving scenario, JCC or indexation to crude oil prices as an index or
basis for LNG may no longer be relevant or acceptable. It is possible that for determining LNG prices and
ensuring that they remain competitive, the prices of commodities such as coal and electricity also may have
to be taken into consideration.
Even in evolving gas markets, netback pricing could be considered to ensure one or two base-load
consumers for the LNG.
vii) Development of LNG Cargo Swaps: With the development of some short-term trading market for LNG it
would be beneficial to the seller as well as the buyer to allow for a buyer to have the flexibility to nominate a
third party to procure a LNG cargo load that originally was not that buyer's obligation.
Editor's Note
Piyush Joshi, an Indian lawyer, is Deputy Legal Counsel, British Gas India, New Delhi and the author of the
book Law Relating to Infrastructure Projects, Butterworths India, 2001.
ENDNOTES
(n1) See, http://www.platts.com/features/LNG. MMcf stands for Million cubic feet.
(n2) "U.S. Natural Gas Markets: Mid Term Prospects for Natural Gas Supply," Energy Information
Administration, Department of Energy, December 2001.
(n3) Tcf stands for trillion standard cubic feet.
(n4) mpta stands for million tons per annum.
(n5) Andy Flower and Richard King, "LNG Today: The Promise and the Pitfalls," Energy Publishing Network,
U.K., 2002.
(n6) See, "U.S. Natural Gas Markets: Mid Term Prospects for Natural Gas Supply," Energy Information
Administration, Department of Energy, December 2001.
(n7) Andy Flower and Richard King, "LNG Today: The Promise and the Pitfalls," Energy Publishing Network,
U.K., 2002.
(n8) "U.S. Natural Gas Markets: Mid Term Prospects for Natural Gas Supply," Energy Information
Administration, Department of Energy, December 2001.
(n9) Id.
(n10) "U.S. Natural Gas Markets: Mid Term Prospects for Natural Gas Supply," Energy Information
Administration, Department of Energy, December 2001.
(n11) Id.
(n12) Id.
(n13) Andy Flower and Richard King, "LNG Today: The Promise and the Pitfalls," Energy Publishing
Network, U.K., 2002.
(n14) Id.
To order reprints of this article, please contact Ajani Malik at amalik@iijournals.com or 212-224-3205.
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By Piyush Joshi
Piyush Joshi is Deputy Legal Counsel, British Gas India. piyushjoshimail@yahoo.com