De Gaulle Fleurance & Associés release today the first standard terms and conditions for the sale and purchase of LNG. These LNG general terms and conditions, known as the "LNG GTCs 2018" offer a more efficient way to trade LNG on the spot and short term markets. The LNG GTCs 2018 will be able to debottleneck the cumbersome contracting process used today in the LNG spot trade. Market access will be less costly for new entrants, liquidity and tradability improved, and legal risk management streamlined. Moreover, the LNG GTCs 2018 set a standard for online LNG trading platforms and OTC derivatives.
"General terms and conditions are already widely used for spot transactions across the oil and gas industry, including for crude oil, LPG and pipeline gas" says Ruchdi Maalouf, chair of oil and gas at De Gaulle Fleurance & Associés, and the author of the LNG GTCs 2018. Historically, LNG has been slower to commoditise than other segments of the oil and gas industry. Spot contracting reflects this evolution. Short term sales evolved from fully termed LNG sale contracts to a dual structure with a framework agreement, the “master sale agreement” (“MSAs”) containing the bulk of the sale terms, and a short special form, the “confirmation notice”, which includes the specifics of a particular deal (price, time of delivery, quantity, etc.). Over the past 20 years, MSAs emerged and converged. Their continued use is no longer justified and represents a significant hurdle to the commoditisation of LNG markets. MSAs are essentially general terms and conditions of LNG trade agreed between two parties only. Each trading party on the spot and short term LNG markets need to enter an MSA with each counterparty. As the market grows, the number of MSAs required for the market to be efficient grows exponentially. "Today, terms and conditions in MSAs have converged and can be standardised" says Ruchdi Maalouf. "Having reviewed close to 50 MSAs in the past 8 years, the trend is clear. Leaving aside legal technicalities, commercial terms now have a 95%-98% convergence. The main divergence is the ratio of the liability cap when a seller fails to deliver or a buyer fails to take delivery. That issue does not belong in the MSA anyway, and the LNG GTCs 2018, make it a provision to be agreed in the confirmation notice. GTCs are the natural evolution for the industry, and a seamless evolution. Moving from MSAs to GTCs will require minimal adjustments to the trading desks, but they will improve legal risk management which is very complex at the moment with so many MSAs around". On why the time is right for the LNG GTCs 2018,
Ruchdi Maalouf adds “the early LNG market consisted mainly of bilateral buyer-seller relations revolving around a handful of long term contracts. MSAs reflect that. Over time, portfolio sales developed, LNG traders appeared and uncommitted LNG volumes grew steadily. The LNG industry is no longer characterised by bilateral relations. MSAs have become archaic and stand in the way of a commoditisation of LNG”. Background
- The LNG industry started in the 1960s with a few long term projects involving a small number of producers and importers. As new projects, producers and importers joined the club, a modest short term trade grew at the margins (less than 1% before the 1990s, 5% in 1998).
- Today, the short term market is well supplied (37% of the global LNG trade) but the contracting still reflects the evolution from a market that was not commoditised and where bilateral relations dominated.
- LNG is traded on the short term markets through a peculiar instrument called a “Master LNG sale and purchase agreement” or MSA. An MSA is a contract between two companies which is signed as a precondition to trade LNG. It is not an LNG trading agreement.
- MSAs are intended to simplify future trade by agreeing in advance boilerplates and certain commercial terms such as force majeure and liability for failure to deliver or take.
- However, instead of simplifying the trade, they lock the market in a constellation of bilateral relations outside of which it is virtually impossible to access the short term LNG market.
- An alternative exists: instead of each company signing an MSA with each company, the industry can have a set of general terms and conditions relevant to all trades that can be incorporated in all trading contracts (and tweaked through those trading contracts when necessary). “General terms and conditions” are the method of choice for crude oil, oil products and LPG.
- In summary, MSAs and GTCs contain substantially the same terms. MSAs are a contract negotiated between 2 parties and signed, whereas GTCs are standalone terms that do not need to be negotiated or signed before incorporation in the trading instrument. In both cases, all LNG sales are done through special trading contracts, the confirmation notices (both for MSAs and GTCs) which incorporate by reference the relevant MSA or the GTCs.
- For a new entrant, a significant investment is required in time and legal fees to establish market standing, even before trading the first cargo. This is because a new entrant needs to sign MSAs with a large number of counterparties before trading operations can start.
- The requirement to enter many MSAs in order to be able to trade is no longer justified. The market has matured and over time, the terms in the MSAs have converged.
- Using one set of terms, such as the LNG GTCs 2018, would lift the access barrier that MSAs are maintaining and allow more parties, and smaller ones, to access the LNG short term market without additional delay.
Improving liquidity and tradability
- Using standard terms for trading LNG would also make LNG cargoes more tradable as they could change hands on the same terms easily, which is not the case today.
- At the moment, when a cargo sold by party A to party B is sold on to party C, a different set of terms apply to each transaction. MSAs make each new transaction relating to a specific cargo increasingly lengthy and difficult. Alternatively, the LNG GTCs 2018 are a single set of terms that can apply to all subsequent sales of a cargo instead of several different MSAs.
- By making it easier to sell and resell a specific cargo, and by opening the market access to new entrants, both liquidity and tradability are improved. Increased tradability also contributes towards achieving the churn ratios necessary for an LNG hub and an LNG spot price to develop.
Streamlining risk management
- When a cargo is traded by more than 2 parties (the initial buyer sells it on to a new buyer for example), additional MSAs enter into play. Due to the length and complexities of MSAs, matching terms between several MSAs is a costly, difficult and risky exercise in risk management for trading teams and legal teams.
- By applying one set of terms such as the LNG GTCs 2018, much of the risk of mismatch between MSAs legal terms is eliminated.
Standard terms for online trading and OTC derivatives
- The LNG industry has recently seen a number of initiatives to develop LNG trades via online platforms. All these initiatives require the interested parties to conclude or have an MSA off line.
- GTCs such as the LNG GTCs 2018 would eliminate that requirement and reduce offline requirements.
The same applies to derivative products. For ISDAs to be used to develop LNG derivatives (over the counter LNG futures for example), standard reference terms are necessary. These could be provided by the LNG GTCs 2018
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