(454e) Optimal LNG Contract Selection Using Mixed Integer Linear Programming
AIChE Annual Meeting
Wednesday, November 11, 2009 - 4:55pm to 5:20pm
Natural gas is one of the most favorable natural fuel resources. However, due to gaseous status of this fuel, transportation to the demand market encounters limitations. As such, natural gas market has not fully developed and gas is not yet a globally traded commodity. Natural gas trade for long time was through pipeline between limited supply countries and their neighbors. The LNG transport, as an alternative to pipeline, started in 1960s mainly as a result of serious energy demand in countries remote from energy resources (e.g., Japan) that pipeline was either technologically impossible or economically infeasible. LNG is an alternative to crude oil that can be shipped to these countries using dedicated LNG carriers.
The trade of LNG is carried out by signing a sale and purchase agreement (SPA) between a supplier and buyer for a fixed duration which stipulates certain terms, conditions and commitments. Traditional contracts were long-term (20-25 years) and rigid. One advantage of such contracts was supply security for buyer. However in return, almost all of the contracts had take-or-pay (TOP) clause that was shifting the surplus volume risk to the buyer. Moreover, the contracts were mainly DES with destination clauses that were preventing the buyer to resell the cargos. All of these clauses were making contracts very rigid although more secure. In the recent contracts, however, significant changes have been noticed such as the medium-term or short-term (spot market) contracts or shifting the shipping term from DES to FOB. There are some other terms in new contracts that increase the flexibility to the benefit of buyer. The main reasons for such changes might be:
Emergence of new buyers and Supplier: Traditionally, the LNG suppliers and buyers were a handful of countries resulting in an uncompetitive market. In the recent years, however, a group of new suppliers and destination countries have emerged in LNG market. Moreover, local gas market liberalization in some countries has changed the monopoly market (i.e. only government or major corporations) to an oligopoly market motivating many small companies (e.g. power generators) to become LNG customers. It is predicted that from one aspect the new suppliers are going to balance the supply-demand to the benefit of buyers by bringing greater volume of LNG and from other aspect the new buyers with variable demands will increase the competitiveness and will add dynamicity to market.
Low cost and high capacity LNG value chain: The so called ?LNG value chain? contains four components comprising exploration/production, liquefaction, shipping and storage/regasification. Such a chain requires a huge investment (a few billion dollars). Therefore, one way to minimize the investment risk and increase the project finance opportunities has been to obtain long-term supply contracts with TOP clauses that oblige the buyer to pay for the contracted amount of gas even if at the due-date they do not need. However, in the last few years development of new high capacity liquefaction trains as well as high capacity LNG carries with lower cost has mitigated the dependency of suppliers to long-term contracts.
In brief, although LNG market is not still well developed, combination of recent increase in energy price, rise in gas demand, emergence of new suppliers with big gas reserves and more importantly development of low cost and high capacity LNG value chain has stimulated global LNG trade. The LNG contracts are thus becoming various in price formulations, reliability, flexibility, duration, lead time, quality, capacity, commitment, discount, terms and conditions, etc. Thus, finding an optimum balance among these factors and selecting the right combination of contracts with the right suppliers is becoming a complex problem. The most critical decision variable is LNG price formula. As discussed, natural gas prices are not globally fixed and vary substantially from region to region. The pricing structure that has been widely used is a linear function of crude oil (PLNG = A . Pcrude +B) with diverse value of multiplier and constant, A and B. The emergence of new buyers and suppliers, from different parts of the world, has resulted in the introduction of new price formulations. There are lots of negotiations between buyers and suppliers to reduce the dependency of price to crude oil price in order to decrease the price volatility. For this reason, there have been lots of efforts from buyers' side to introduce new formulas such as those being a function of fuel oil or coal prices. Such formulas have proved to decrease the price volatility although being challenged to lose their relation with market reality. Recently some new intelligent formulas including S-curve have been practiced. These price formulas are different above and below (ceiling and floor) a certain oil price, to dampen the impact of high oil prices for buyer benefit and low oil prices for the seller advantage. Therefore, selection of the right supplier with right formula is becoming seriously a complex problem. It should be noted that one specific supplier may introduce different formulations for flexibility in buyer's decision-making. The supplier may even provide some discount if the contract capacity is above a certain range. The other decision variable is the length of contract. The Contracts can be traditional long-term or new-born medium-term or short-term (Spot market). The long-term contracts have been relatively inflexible both in price and volume especially because of TOP clause. However, they have the advantage of supply security for a long period of time. Therefore, the buyers may decide to choose combination of contracts with different periods to increase their flexibility. Another decision variable is shipping terms. Most of traditional contracts used to practice DES, but with increase in the number of low cost and high capacity LNG carriers it might be more profitable for buyer to choose FOB contract and invest in their own LNG carrier fleet or sign a charter agreement with independent carriers. The other advantage of such contract is the opportunity for buyers to resell their cargo at the loading terminal if they have surplus volume, while for DES contracts, destination is not changeable.
In this paper, for the first time, we address the contract selection problem from the perspective of a LNG buyer company. Our objective has been to develop a decision support algorithm that helps the buyer analyze different types of contracts and select one or more best contracts, their starts, lengths, and purchase quantities in an integrated manner that addresses various aspects such as contract lengths, demands, prices, discounts, logistics costs, contract commitments, etc. For achieving this goal we have developed a mixed integer linear programming with minimum total LNG purchase cost as the decision criterion.
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