Reed Smith In-depth

Key takeaways

  • The liquefied natural gas (LNG) market is in flux because of its rapid pace of growth, shifts in trading patterns and volatility in prices.
  • There has been a marked increase in short-term transactions and spot trading in LNG during recent years. ‘Aggregators’ or ‘portfolio players’ are playing an increasingly large role in the market.
  • LNG contract documentation is heavily influenced by the features of very long-term contracts imposed by LNG producers.
  • There is no industry wide standard documentation for LNG trading that works effectively for short term or spot trading.
  • Documentation is dominated by bilaterally negotiated master sale and purchase agreements (MSPAs), which include terms that deviate from ‘trading norms’ and in many respects from general principles and statutory provisions of English law.
  • In this paper we make the case for industry-wide standardisation of contracts for LNG trading.

Introduction – the evolution of LNG trading contracts

The LNG trading market is evolving rapidly. Over the last decade, it has been one of the fastest growing commodities markets. This process has been accelerated by the increased demand for LNG in Europe and Asia and in the wake of Russia’s invasion of Ukraine.

The LNG trading market is relatively new. Intermediaries, such as trading houses and other ‘portfolio players’ (or ‘aggregators’) only began filling the gap between producers and end-users during the course of the last two decades. Prior to that, most LNG production was committed to long-term supply agreements, often with terms spanning 20 to 25 years or more.1 The rapid growth of LNG trading has created changes in how LNG is bought and sold, with more volumes than ever being traded through spot sales or short-term contracts. Recent data suggests that, during each of the past two years, around 30 per cent of LNG cargoes were traded on a spot basis.2 With a number of long-term contracts approaching their end in the near term, the opportunity for further growth in ‘spot’ or ‘shorter term’ deals is significant.

Some of the world’s largest market participants have made strides towards the standardisation of LNG trading documentation, in a bid to promote a transition to a trading model more closely resembling other commodities markets such as oil and products trading.3 The aim has been to standardise and streamline transactions to reflect and promote greater market liquidity. However, standardisation has been slow. This can in part be attributed to the historical dominance of producers (and, to an extent, end-users) who have wielded considerable negotiating power over their counterparties and/or are reluctant to move away from their own preferred trading terms. Some commentators see real change in this dynamic on the horizon.4

Contractual documentation used for LNG trading meanwhile remains unique. It is subject to complexities that do not exist in other trades. LNG has yet to become aligned with other globally traded products such as oil, refined products, coal, metals or grains in terms of standardisation. It might be said that this is an inevitable result of the complexity of the production processes or the terms on which LNG has to be originated from producers. But the fact remains that the unique features of LNG trading agreements create impediments to the expansion of the LNG trading market, especially for new entrants. Arguably, they undermine liquidity and create inefficiency. Many traders believe that current contractual arrangements lack sufficient optionality and flexibility.