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Explainer-Should Europe use more long term LNG contracts? -Breaking

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© Reuters. FILEPHOTO: A terminal for Adriatic liquefied gas (LNG), can be seen at Venice on October 20, 2009. REUTERS/Stefano Rellandini/File Photo

By Marwa Rashad

LONDON (Reuters – In the event that sanctions are imposed by the West on Russia for its invasion of Ukraine, the threat of disruptions in Europe’s gas supply has prompted a heated debate over the necessity for LNG (long-term liquefied) contracts.

A source claimed that the United States had asked Qatar and other important gas producers to send additional gas to Europe over recent weeks, in response to Russian disruptions.

Qatar and other major LNG producers say Europe needs to rely more heavily on long-term agreements for its energy.

Globally, approximately 70% of LNG trades are done through long-term contracts. In Europe however spot and short term contracts account for around 45%-50%.

WHAT ARE LONG-TERM CONTRACTS’ BENEFITS?

The term of long-term contracts is between 10 to 25 years.

Gas producers generally want to make long-term agreements for capital-intensive, capacity-expanding projects.

Qatar prefers long-term, generally oil-indexed contracts for revenue stability, Luke Cottell, EMEA LNG analytics lead at S&P Global (NYSE:) Platts, said.

The United States is one of many producers that require long-term contracts in order to finance their liquefaction plants. They typically sell some portion to traders and have the right to export the rest to Asia or Europe.

Cottell stated that prices could fall if a fresh wave of LNG supplies comes online in the 2025-2026 global markets. “While sellers now want spot exposure and buyers don’t want spot exposure, in five years’ time the situation might flip.”

WHAT IS EUROPEAN UNION’S POINT?

According to the European Commission, long-term agreements could prevent gas flows in Europe.

EU policymakers encouraged spot trading to counter the dominance of single players like Russia, which can lead to customers benefiting from lower prices in times when there is a shortage.

These customers are also not locked in to fossil fuel use for long periods of time. The EU is striving to reach net zero emission by 2050.

Felix Booth from Vortexa’s LNG division stated, “European Gas Market Liberalization has Delivered a Large Benefit to Consumers, With Lower-than-average Prices than Traditional Oil-Linked Contracts From Russia,”

Last year, the European Commission declared that long-term gas agreements should not extend beyond 2049. It should not prevent entry of low-carbon or renewable gases.

Spot trade, according to producer countries, has often exacerbated volatility in price, particularly given the tight supply environment following disruptions like the COVID-19 Pandemic or the economic recovery.

WHAT IS THE EFFECT OF ENERGY TRANSITION OVER THE MARKET

James Huckstepp, manager of gas analytics at S&P Global Platts, said the energy transition has raised concerns that gas demand will drop in the next five-to-10 years, when Europe is using more green energy, such as hydrogen.

Huckstepp indicated that although long-term oil-indexed contract have proven profitable in the last year, they could lose money for most of them over the next decade.

Who is making money?

The gas price increase last year brought many windfall profits.

Guy Broggi (an independent LNG consultant) stated that U.S. LNG was selling at a price of $6/MBtu and Europe would have to pay $30/MBtu.

Broggi stated that there were approximately 80 containers per month arriving from the United States. Each cargo made around $60 million of net profit.

What is the problem with DESTINATION CLAIMS?

Qatar, Indonesia, and Malaysia were among the Asian producers that used destination clauses to restrict gas delivery to specific markets and prevent it from being rerouted.

These clauses in Europe are unlawful and LNG can be sent to countries around the world despite EU rules.

Capra Energy Group’s managing director Tamir Druz stated that while long-term contracts were important, they did not allow for the same flexibility, diversification, and profit potential as spot-and-short-term agreements.

He said that removing destination clauses from the EU and Japan in recent years made long-term agreements more appealing.

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