(72e) Strategic Model of LNG Arbitrage: Analysis of LNG Trade in Atlantic Basin

With the increase in oil and gas prices over the last decade, the role of LNG in natural gas markets has become more prominent. According to the BP Statistical Review of World Energy (2003-2008), the total world LNG trade has increased by more than 40% over the last five years, with an average growth rate about 7%. Imports of North America have risen by about 50%from 2002 to 2007. This dynamics attracts growing attention to the LNG markets.

Historically, LNG contracts have been signed for 20-25 years and had destination clauses. Over the last decade the structure of the LNG markets has transformed. Most of the new contracts have a much shortened duration of 10-12 year. Destination clauses have not been completely remove, but relaxed allowing buyers to redirect their ships to extract a higher rent, which is to be shared with the seller. As the world market was growing a spot markets emerged. Now exporters sell LNG without contracts competing on spot markets directly.

The study, based on a comprehensive analytical model of the LNG market, aims to answer the following questions:

? How will LNG trade develop: will the LNG market continue to grow?

? Will the relation between markets get stronger and prices converge? If so, could it lead to decoupling of NG prices in general and LNG in particular, from crude oil/oil product prices?

? Will the arbitrage continue to exist? If yes, in what scale?

Preliminary Conclusions

Based on our analytical model, we have shown that it is beneficial for an LNG importer as well as an exporter to enter long-term contracts, if other market players do so. The intuition behind this result is similar to one in Allaz & Villa (1992). We have derived the shadow price of LNG export capacities. Based on its value we calculate: how much LNG-exporting countries should invest to benefit from the LNG spot trade; how much LNG-importers are willing to pay for have flexible destination clauses and hence, be able to resell LNG; and how much LNG importers should invest in regasification facilities given the expected market conditions. Our results allow to explain observed price dispersion in the Atlantic Basin. Moreover, we show that given the capacity constraints (and/or high capacity costs) and information asymmetry the price difference may continue to exist even if the market is global (central). Though the exact figures are subject to change with respect to willingness to pay in different countries as well as marginal costs of supply and capacities, the overall incentives and effects obtained are robust.

References Cited

1 Friedmand, Daniel, ?A simple testable model of double auction markets?, Journal of Economic Behavior and Organization 15 (1991), pp. 47-70

2 Hubert, Franz; Ikonnikova, Svetlana, ?Investment Options and Bargaining Power in the Eurasian Supply Chain for Natural Gas?, 2005 North American Winter Meeting of the Econometric Society, Philadelphia, PA

3 Allaz, B., J.- Vila, L., ?Cournot competition, forward markets and efficiency?, Journal of Economic Theory 59, pp.1-16.