LNG SHIPPING: A DESCRIPTIVE ANALYSIS

At present, throughout the world LNG investments are abounding. In particular, the US and the EU are trying to facilitate their security of natural gas supply. For this reason, LNG enables importers to extend their gas suppliers’ portfolio, considering that some producing countries can be reached only via sea transport. LNG will thus increase importers’ choice; at the same time it can widen the group of exporting countries and enhance the construction of a global gas market. In the LNG value chain one can identify three elements: liquefaction, shipping and regasification. While the first and the last element of the value chain have been deeply studied, too little attention has been paid to shipping. Nevertheless, the number of operative ships will be one of the key variables for the increase of an effective spot market and, consequently, for a greater market liquidity. The goal of this paper is thus clear: will LNG shipping be able to sustain a liquid market? The findings are not straightforward. In fact, while on the one hand shipping is not likely to represent a bottleneck in the foreseeable future, at least for what concerns transport capacity, on the other hand most of the ships are bound to long-term contracts and this can be detrimental to competition. Moreover, shipping is often part of vertical integrated projects. Thus, authors cannot hypothesize that in the short term spot sales will grow, as it happened with oil tankers. Introduction: the increasing demand for LNG In these last few years one of the main concerns of both the EU and the US has been that of facilitating the safeguard of raw materials’ security of supply, especially that of natural gas. Notably, the European Council has identified a list of instruments to strengthen its security of supply: as for natural gas, the LNG chain has been recognized as the most secure means of transportation (Directive 67/04, concerning the “Measures to safeguard security of natural gas supply”). Liquefied natural gas (LNG) is natural gas that has been cooled to the point that it condenses to a liquid, which occurs at a temperature of approximately -256° F (-161° C) and at atmospheric pressure. Liquefaction reduces the volume by approximately 600 times, thus making it more economical to transport between continents in specially designed ocean vessels, whereas traditional pipeline transportation systems would be less economically attractive and could be technically or politically infeasible. Thus, LNG technology makes natural gas available throughout the world. To make LNG available, energy companies must invest in a number of different operations that are highly linked and dependent upon one another. The major stages of the LNG value chain consist of the following: • Liquefaction, to convert natural gas into a liquid state so that it can be transported in ships; • Shipping the LNG in special purpose vessels; • Regasification, to convert the LNG stored in specially made storage tanks, from the liquefied phase to the gaseous phase, ready to be moved to the final destination through the natural gas pipeline system. Indeed, import through LNG chain does not imply an indissoluble physical tie between producer and buyer, contrary to what happens with pipelines (Chernyavs’ka e Dorigoni, 2002). In other words, the investment in a pipeline is very specific: according to Williamson (1985), the greater is the switching cost for an alternative use of any asset; the greater is its specificity. As for pipelines, their degree of specificity is maximum (the “site specificity” kind). Given this specificity, the counterparts recognize as vital the continuity of their contractual relation. That is why any such agreement will guarantee strong safeguards to each party, which would be unnecessary for more common neoclassic (nonspecific) transactions. For the natural gas market, these safeguards take the form of longterm agreements with minimum off-take requirements (take or pay clauses), designed to preserve counterparts from ex-post contractual opportunism (hold-up problem), that is really likely in these circumstances. Such contracts definitely contribute to the “cartelization” of the market, hindering competition. As said before, the LNG chain presents a much lower degree of specificity: in fact, even though the construction of a regasification plant is generally tied to the stipulation of a long-term agreement (with take or pay clause), once the contract is expired and the investment is sunk, the importer may satisfy his gas supply needs on the basis of his relative gains. Moreover, LNG costs have significantly decreased over time, thanks to the technological innovation (Oil&Gas Journal 2006); at the same time, it is getting increasingly common that part of regasification plant capacity is made available for spot transactions (in some countries this is a regulatory requirement, CEER, 2006). As far as LNG import contractual practices are concerned, significant changes have started to take place in the last few years, both in terms of agreements’ length – average duration has significantly decreased – and in terms of price indexation – in the most developed markets LNG price is tied to gas spot price (IEA, 2006). As for LNG costs, it is important to stress that some recent studies (such as IEFE, 2008) have demonstrated that from early 2007 there has been a clear reversal of trend. The main drivers for this turning point are the increase in raw materials costs and the oligopoly conditions that characterize the terminal construction industry, whose main players are already booked for the next three to four years. Nevertheless, this increase in costs concerns also pipeline costs, leaving the relative competitiveness unchanged. Another advantage given by LNG is that liquefied gas enables importers to widen their suppliers’ portfolio, considering that some producing countries (i.e. stranded gas) can be reached only via sea. A wider supply portfolio mixed with an increased integration of final markets, given by the possibility of redirecting cargoes depending on single countries’ supply-demand balance, would contribute decisively both to the security of supply and to the enhancement of competition (IEA, 2004). It is noteworthy to specify, though, that when referring to positive effects of LNG on competition, the authors mean competition between importers and only to a lesser extent between producers: in fact, upstream competition is not likely to occur, given the chronic deficit of liquefaction capacity (IEFE, 2008). Anyway, even if a bigger recourse to LNG would cause an increase in supply prices, this would be more than offset by sharp reductions in final prices, as shown in Graziano et al. (2008). When considering the possible advantages of LNG over pipeline transportation, it should be stressed that import via tanker is competitive for medium and long distances (the majority of experts indicate a critical threshold of 4,000-5,000 km, IEFE 2008). Anyway, given the current progressive depletion of both European and North American gas fields, it will be necessary to search for farther gas fields, so that pipeline and LNG costs will be increasingly closer. So far, the LNG stage that has received too little attention is shipping. Being the link between the producing/exporting country and the importing one, and having been subject to major changes in the last few years, it is particularly interesting to analyze it singularly, in order to understand how it is linked to the other two stages of the chain. In particular, it is important to comprehend the evolutionary trajectory this segment may take in the future: the number of operative ships will be one of the key variables for the growth of the spot market and, consequently, for greater market liquidity. The paper is organized as follows: in the first section LNG market will be introduced, with particular reference to the evolution of regasification and export capacity; section 2 and 3 will be dedicated to an analysis of shipping, both in current and in perspective terms. Then, in section 4 the proprietary and contractual situation will be addressed; section 5, finally, will present some concluding remarks.