The rise of trading houses in the LNG world
January 2017 | Loukas Ziomas
The LNG market has evolved significantly in terms of both complexity and sophistication over the last 10 years. It has doubled in size and moved from a market dominated by long-term trade with strict destination clauses to one also strongly influenced by spot sales, tenders, and gas benchmark-linked trade, along with an increase in re-trades and destination swaps.
Exhibit 1: The LNG market has evolved significantly in terms of complexity and sophistication over the last ~10 years
Source: McKinsey Energy Insights
Within this market shift, new types of stakeholders have appeared and begun to flourish largely as intermediaries between resource holders and end users. These intermediaries include portfolio players, dedicated liquefiers, and, more recently, trading houses. Even though the arrival of trading houses in the LNG space had been long anticipated, the constrained market size and supply tightness of earlier years made it difficult for them to gain an appreciable foothold.
Exhibit 2: Underlying demand for LNG will struggle to keep pace with new capacity in the medium term
Source: Energy Insights’ Global Gas Model, BP Statistical Review of World Energy 2015
While some trading houses have managed to successfully enter the LNG market even in a constrained environment, their footprint has remained relatively small, accounting for ~ 3-5 % of the traded volume in 2015. The role of those established traders going forward, however, has the potential to increase remarkably as two big megatrends are expected to dominate the LNG world in the mid and long term:
- The market is expected to become long in the next 6-9 years (figure 3), catalyzing increased liquidity and the availability of volumes
- The majority of new LNG demand is expected to come from 17 recent and 15+ ‘’likely ‘’ emerging markets (figure 4). Trading houses have a unique value proposition based on 6 key areas covered below that makes them particularly well-placed to serve those markets.
Exhibit 3: Largest share of LNG growth is expected to come from ~17 recent and15+ likely emerging markets, primarily centered in Asia, LatAm, and ME
Source: McKinsey Energy Insights
What do trading houses bring to the table?
The unique value proposition of trading houses is based on the following key areas:
- Risk appetite: Trading houses have a significant, long, and strong presence, trading several products in most of the emerging and risky markets where LNG is gradually becoming more relevant. This allows them to feel more comfortable taking country and counterparty risk, while traditional suppliers partner with them or stay out. Typical examples are positions that traders took in Egypt, Argentina, and Mexico joining forces with large LNG suppliers. Furthermore, while the market remains long and becomes more liquid, the certainty of covering open exposure is increasing, allowing traders to take even more risky positions.
- Product bundling: Some traders have already experimented extensively and effectively in combining trading relationships on the basis of their wider product portfolio. Such product bundling allows traders to a) more creatively link LNG supply and pricing to oil substitutes for several downstream users around the world and b) leverage their extended positions in other products to receive payments on time even with less reliable counterparties.
- Aggregation of demand: Traders’ presence and product portfolio allow them to talk to counterparties of various importance and size. This, in turn, helps them to aggregate demand from several buyers and then pursue large volume deals at better prices. There are already examples of such behavior with small power and industrial users in South America where trading houses acted as brokers in aggregating demand and then managing the respective LNG supply.
- Shipping costs: Trading houses have very well developed in-house ship chartering departments in the main global shipping centers like London, Piraeus, and Singapore. They use this footprint to avoid locking themselves into long-term expensive time charters and take full advantage of the respective LNG carrier market conditions, chartering on a spot or short-term basis at lower rates. Given their large shipping portfolios spanning beyond LNG, they also have higher negotiating power and, as a result, they can strike better deals with ship-owners. Using that power, trading houses have introduced adjustment clauses which allow them to even renegotiate long-term time charters based on market conditions.
- LNG pricing: Traders are much more comfortable accommodating different pricing mechanisms based on the needs of each buyer, because they have extensive presence in the underlying markets, while being more willing to take more risk. For example, an extensive presence in the North American gas trading market makes them more comfortable with Henry Hub linkage. The same applies for agreements linked to crude, TTF, NBP, and JKM. Characteristic examples are deals with markets like Mexico that were done on JKM via traders, while many traditional LNG suppliers were not willing to accommodate such flexibility. Finally, trading houses tend to have a continuous and very close relationship with banking institutions, which in turn helps them to more easily and effectively hedge their positions.
- Volume optionality: Traditional upstream equity players in the LNG market tend to focus on selling existing volumes as base and, thus, are generally constrained by their existing supply base. Trading houses, on the other hand, tend to be agnostic to the source of their LNG volumes. Such a characteristic increases their flexibility and will potentially allow them to more effectively take advantage of the long market environment and optimize their supply. Finally, trading houses have been highly successful in the identification of advantaged assets and positions in other commodities. Being able to utilize such assets in the LNG space, which should ideally be placed close to or integrated with storage, will allow them to maximize their optionality.
What does the future hold for the role of trading houses?
It is fair to expect that the increasing presence of traders in the LNG space will have an impact on both LNG sellers and buyers. For traditional LNG sellers, the impact may be both negative and positive. On the one hand, it may mean more risk stemming from increased competition but, on the other, it may act as an opportunity for them to use a new platform that will allow them to access markets they would not consider otherwise. For LNG buyers, the impact is expected to be positive as it could increase their optionality in terms of LNG supply, while also providing them with more flexibility and negotiating power on the formation of contractual terms.
Looking into the future and taking into consideration that trading houses will also face constraints in the process of expanding their footprint as a) the typical trading model of ‘’store and leverage the contango’’ does not apply for LNG because of the significant boil-off losses and b) they don’t own production and cannot support asset-backed trading - which limits their ability to support long-term trades. Therefore, the LNG volume share that they will manage to grasp in the years to come remains highly uncertain.
What becomes increasingly certain however is that trading houses have a unique value proposition to not only become more relevant as the market is growing but also to become shapers of its growth by catalyzing the entry of new countries and buyers in the LNG world.
McKinsey’s Energy Insights provides a unique insight into the ways in which the behaviour of key players is changing. We bring unbiased access to a panel of 40+ LNG buyers and experts from 24 countries, with market insights covering more than 80% of the world’s LNG trade. When combined with our proprietary knowledge of LNG contracts and proven B2B marketing expertise—along with our market analytics and risk management skills—we are very well placed to support buyers and sellers in maximising trading value.
About the author
Loukas Ziomas is a specialist with Energy Insights in McKinsey's London office.