For most arbitrage traders, market price volatility is a cherished friend. While this may be a well known observation, it is probably less obvious that inter-market correlation can be one of the arbitrage trader's worst enemies. This is equally applicable to LNG trading. The higher the correlation between two LNG markets, the less likely it is that the spread will move to a level that exceeds the freight costs involved in shipping a cargo between them, allowing traders to earn the difference.
The typical LNG marketing and trading portfolio will contain some of the simplest and some of the most complex derivative structures encountered in energy finance. Some of the more commonly found structures are physical forwards, basis spread options and best-of spread options, but longer-term transactions like SPAs will often contain an even wider array of embedded exotic features. In this post, we provide an example of one of the simpler derivative structures, and demonstrate how it is valued.
The BP-TEPCO LNG Deal
Tokyo Electric Power Co's (TEPCO) recently announced sale and purchase agreement (SPA) with BP Singapore for 1.2 million tons per annum (mtpa) of lean LNG over 17 years is just the latest in a string of long-term deals that Asian LNG consumers have signed for supplies originating from the US Gulf Coast. The BP-TEPCO deal is technically a 'portfolio contract' that gives BP the flexibility to source the LNG from anywhere. But given BP's large purchase position in the Freeport project, the TEPCO deal's linkage to Henry Hub spot prices, and the specification of low heating value (lean) LNG, it is a safe bet that much of the supply will originate from the US Gulf Coast.
The Japan OTC Exchange's (JOE) new LNG contract was officially launched today. It is technically being described as a "non-deliverable forward contract," and is starting off as a non-cleared, cash-settled, bilateral contract, but JOE expects that CME will be providing clearing in the near future. The launch of this contract is a positive development for global LNG trading and risk management, and once CME clearing kicks in, we expect a wider and larger group of participants to make use of it. The full details of the contract are presented below: