LNG shipping keeps stepping on the gas
LNG market today
The natural gas supply and consumption are growing rapidly across the globe. Much of this increase in gas supply will be delivered to market as liquefied natural gas (LNG). The long-term outlook: by 2050, DNV GL estimates that global LNG production will increase from 250 million tonnes per year in 2016, to around 630 million tonnes per year. The short-term outlook: natural gas is on track to overtake oil as the primary energy source by 2025.
LNG’s environmental benefits and its versatility make it particularly attractive as a destination fuel for thermal power generation and cogeneration, in the industrial and commercial sectors. LNG is also favoured by the recent regulatory changes, and the general drive to reduce emissions in the marine and road transportation. In the shipping industry, the IMO decision to implement a global cap on sulphur emissions by 2020, and the IMO’s stricter Energy Efficiency Design Index (currently in draft form) for lower CO2 emissions, are opening new opportunities for LNG as a marine fuel (1).
Asia and beyond
In 2018, Asia was again the leading importing region with a 76% share of global LNG imports, up from 73% in 2017. Japan remained the leading importing country, with a 26.3% market share. As was the case in 2017, the global LNG import growth in 2018 was led by China and South Korea, the world’s second and third largest LNG importers. China’s policy of substituting coal by gas to reduce air pollution in major cities and to complement domestic gas production, meant that it consolidated its position as second largest LNG importer globally and increased LNG demand by +38.4% compared with 2017. Other emerging economies will also boost demand. India, which currently has four LNG receiving terminals, plans to build 11 more over the next seven years. New LNG importers have emerged in recent years, especially in Asia, including Indonesia, Malaysia, Pakistan, Singapore and Thailand, while Bangladesh, Myanmar, the Philippines and Vietnam are following suit. Even Australia – the world’s biggest exporter of LNG – is building import terminals to provide gas from its north-west fields to its major cities in the south and east. Import terminals are quicker and cheaper to build than a pipeline network across the breadth of the country, so imported LNG will be important to Australia’s long-term gas price management and security of supply. In Europe too, where the options for its long-term demand for gas is dependent on Russian pipeline gas or LNG shipments, geopolitical reasons are expected to tip the scale in favour of ship-based LNG, imports affording Berlin the much-needed leverage in its still asymmetrical energy relationship with Moscow. As for the exporting part, by 2022, the US and Australia are expected to overtake Qatar as the biggest LNG exporters. However, with the addition of four more liquefaction trains in Qatar, scheduled to be fully operational by 2024, Qatar will return to its leading position. Industry sources report that final investment decisions are taking longer than usual, but the current anticipated output means the LNG shipping markets should benefit until 2022.
LNG Shipping highlights
As of end 2018, the total LNG tanker fleet consisted of 563 vessels, including 470 with a size above 125,000 cubic meters, 44 vessels of less than 50,000 cubic meters, and 33 FSRUs. Total cargo capacity at the end of 2018 stood at 83.1 million cubic meters. In 2018, the average spot charter rate for a 160,000 cubic meters LNG carrier stood at $88,692/day (having reached as high as double that), compared to an average $46,058/day in 2017. A total of 57 vessels were delivered in 2018 while 77 units were ordered (against 19 orders placed in 2017). The LNG carrier orderbook consisted of 138 units at the end of 2018 (equating to 25% of the LNG carrier ﬂeet) with over 40 of these vessels scheduled for delivery in 2019.
Given that the 2019 LNG production growth is in the region of 33 million tonnes, the demand for shipping will only increase. Taking into account the new LNG carriers to hit the water in 2019, FLEX LNG notes that there is only 1.15 new ships per million tonne of new LNG, compared to the historic requirement for about 1.3 ships per million tonne of LNG, stretching the capacity of LNG carrier to about 750,000 tonnes per annum.
LNG Carriers (LNGCs) and the growing spot market
It is not surprising that during 2018 we saw an increased volume in the shipbuilding and increased activity in the chartering of LNGCs. Some owners or entrants didn’t order construction without a fixed charter in place. Others are more bullish in their strategy. The market caters for both models: 32% of the total LNG trade was transacted on spot or short term in 2018. In fact, the “true” spot volumes (i.e. LNG delivered within three months from the transaction date) reached 25% of total imports in 2018, compared with 20% in 2017. China, South Korea and Japan together absorbed 52% of all spot volumes (according to the International LNG Importers Group – GIIGNL).
LNGC – Shipbuilding
Most of the LNGC orders remain with Korean and Japanese shipyards, not least due to their synergies with globally leading suppliers of containment/tanks and propulsion systems. The average capacity of the majority of the recent LNGC orders are approximately 170,000cm, with some of them to be ice-classed for the Arctic routes.
While negotiating shipbuilding of LNGCs resembles that of its close relative, tankers, it also bears certain distinct features. The nature and composition of the cargo pose individual challenges, which need be finely regulated in the construction contract, to allow the newbuilt enter the market competitively, with the requisite technical attributes and within schedule.
Indicatively, one of the most known challenges in LNG transport is the boil-off and the rate at which it occurs (i.e. the rate at which gas components of the LNG evaporate during transit due to heat ingress). Boil-off poses a number of challenges, not perhaps so much to safety any more, but certainly to the quality of the LNG composition (e.g. methane and nitrogen boil/evaporate at lower temperatures than ethane or propane). Depending on the type of the propulsion system chosen for the LNGC, boil-off gas can be utilized as fuel, reliquefied or burned in a gasification unit. The modern propulsion systems include dual-fuel diesel-electric (DFDE), tri-fuel diesel-electric, and the MAN’s mechanically operated, electronically controlled, gas-injection (ME-GI) engines.
In the shipbuilding contract, the BOR guaranteed levels, need be agreed between the parties, and be in accordance with the guidelines of the tank designer. What is often neglected is express provisions as to the requisite period or voyages, within which final and reliable determination of the BOR can be made. Given that the guaranteed BOR level has a bearing on the liquidated damages available to the buyer, as well as the builder’s warranty of quality (not to mention the charter arrangements or options following delivery), the method of BOR determination need be carefully crafted to ensure that buyer’s rights do not lapse until such time as is required to determine actual BOR.
The design and technology of tanks and membrane containment systems has long been dominated by the French Gaztransport & Technigaz (GTT), now with its latest Mark V series, arguably the lowest BOR in the market. One of its competitors is Korea’s KC-1 tanks. The KC-1 tank system is being developed by KC LNG Tech, a joint venture between Korea Gas Corp and three Korean shipbuilders HHI (Hyundai), SHI (Samsung), and DSME (Daewoo). With a large number of the LNGCs built in Korea, and with the named builders holding together almost 70% of the market share, the KC-1 could save the builders considerable amounts in royalty fees, a saving the buyers may try to negotiate to their benefit too.
It is worth noting that with all the advances in the containment and propulsion systems, owners of less competitive LNGCs may potentially start looking at converting some of their existing tankers into FSRUs.
LNGC – Chartering
LNGCs were historically financed by project finance structures, linked to specific projects and long-term offtake and sale and purchase arrangements, with the charters also on long term and with fixed destinations. But this space is changed, especially by those shipowners, private or listed, that are able to raise the financing required for LNGC construction, and can take advantage of the short-term and spot opportunities heralded by the recent LNG market developments. LNGCs with multi-fuel propulsion (e.g. TFDE/DFDE or ME-GI) remain best positioned for most of the spot trade.
Aside the charterers’ own forms of charter contracts of affreightment (COAs), there are certain standard form charters for LNG carriage that are widely used in the LNG transportation.
Notably, the ShellLNGTime1 (2005) form, hosted by Bimco, and largely based on the tested and tried ShellTime4 (2003) form, has been used for long-term time charters, but provides a good start also for short-term charters, or single trip charters. Despite having been issued before the arrival of DFDE engines, its provisions (2) for the plant’s boilers and use of boil-off gas as fuel can cater for DFDE/TFDE engines, with some adaptions. Whilst it is considered a charterer-friendly form, it is more balanced than the charterer-own templates found in the market.
In 2016, Bimco and the International LNG Importers Group (GIIGNL) issued a joint form of LNG voyage charter, to allow greater flexibility and meet the needs of LNG owners and charterers. Its recent arrival enabled it to align its provisions with advances in LNG carriage, including boil-off caps, fuel options and risk allocation for boil-off (forced or natural), laytime and demurrage, and BOR warranties. This form goes far enough to provide owners and charterers considerable commercial flexibility that befits the development of the emerging LNG spot market.
The customary and distinct features between time and voyage charters are present in the LNG charters too. As an example, under a time charter, the weather risk rests largely with the charterer (except certain carve-outs for extreme weather or swell height, as under the ShellLNGTime1). Also, a time charter rarely entails a “substitute vessel” obligation on owners. Even where voyage charters or COAs do permit a substitute vessel, careful drafting is required for both parties, with detailed agreement for adequate time and cost allocation for testings and approvals regarding compatibility for the ship-shore or ship-to-ship interfaces of the vessel, and compliance with the relevant safety and communications.
With the continuously increasing number of LNG exporters and of importers in emerging markets, and the improved technology in LNG transportation, the global trend for LNG as cleaner source of energy is confirmed year on year, and is expected to continue for decades. The growing LNG shipping fleet has introduced a new dynamic and competition within LNG transportation, shifting from the dominating long-term fixtures to a good deal of short-term and trip-time charters. However, the growth is also dependent on the LNG mega projects materialising, and the financing of such projects requires long-term contracts. In May 2019, China, who is forecasted to be the leading importer by 2025, announced that it will raise the duty on imports of US LNG to 25% from the previous level of 10% in retaliation to the US increasing its tariffs on $200 billion worth of Chinese goods. Such trade war might have an effect on the forecasted growth, but it is more likely that the market forces will equalise such disruptions, so that those within, or embarking into, the LNG shipping have every right to be optimistic; and every reason to remain alert: as every time the market moves, contracting parties hope their lawyers were prescient enough.
At Simonsen Vogt Wiig, we regularly negotiate and undertake detailed analysis of contracts in LNG shipping contracts (financing, shipbuilding and chartering) for our clients. Should you have a particular interest in these matters, please contact Yannis Litinas (firstname.lastname@example.org).
(1) Market reports indicate that 124 LNG-burning ships are currently in operation, with 136 more on order and another 111 capable of burning LNG. Bunkering with LNG is now possible at major bunkering ports worldwide
(2) Ref. Appendix C of the ShellLNGTime1