Getting to grips with LNG shipping costs

The LNG shipping market is characterised by unusual terms such as ‘demurrage’, ‘ballast’ and ‘bunkering’.  It features interesting conventions such as ‘canal transit costs’ and is impacted by the very real threat of modern day piracy.

While all of this is interesting trivia, these factors all play a role in determining the cost of moving gas between locations. The market for LNG vessels is a different animal to the more homogenous traded markets for delivered gas.  The costs of shipping gas are determined by very physical considerations around logistics and constraints.

LNG shipping costs have an important influence on global gas flows and pricing dynamics. LNG shipping costs are a key driver of:

  1. The value that can be generated from moving gas between different locations
  2. The level of price spreads between regions across the global gas market

Shipping costs have played a particularly important role over the last two years in determining the cargo diversion decisions to higher priced markets, as global prices have diverged post Fukushima.  They are also a key consideration in understanding to what extent global prices may converge in the future.

In this article we provide an overview of the build up of LNG shipping costs and their influence on gas flows and pricing.  We will then follow up with an assessment of global LNG shipping supply and demand dynamics and the implications of these on shipping costs.

Shipping cost components

The key components that make up the cost of shipping LNG are as follows:

Chartering fee: This is the payment for securing access to shipping capacity by chartering a vessel.  There are broadly three ways to secure access to shipping capacity: (1) own vessel capacity (2) time charter and (3) single voyage or spot charter.   Spot charter rates are generally higher and certainly more volatile than longer term time charter rates.  We will look in more detail at the drivers and evolution of charter rates in an article to follow.

Brokerage: Vessel charters are typically arranged through specialist brokers and attract a 1-2% fee.

Fuel consumption: The voyage fuel or ‘bunker’ consumption is directly proportional to the distance and speed of the vessel.  This is typically the second largest cost component after the chartering cost.   The added complication for LNG vessels is the different propulsion mechanisms and fuel burn options.  Most LNG vessels can burn fuel oil, boil-off gas or a blend of both in their boilers.  As a result the calculation of fuel cost is closely tied to that of boil-off gas.  Natural boil-off occurs at a rate of approximately 0.15% of inventory per day and at times boil off is forced above this level to further reduce the fuel oil requirements.  Some modern LNG vessels also have the ability to re-liquefy boil-off gas, keeping the cargo whole (and allowing the use of more efficient diesel engines).  Calculation of the direct fuel consumption is fairly straightforward but the opportunity cost of LNG boil-off is also an important consideration.

Port costs:  The components and level of the costs of loading and unloading at ports can vary widely depending on location.  For example, ports in less stable regions can levy large security charges associated with ensuring the safety of the vessel.

Canal costs: Transit costs have to be paid for using the cross-continental Suez and Panama canals.  Only a small fraction of the current LNG tanker fleet can squeeze through the Panama canal making the Suez is the most common canal transit.  Suez canal transit costs are a complex function of vessel dimensions and cargo (laden voyages being more expensive) and LNG vessels are entitled to a 35% discount after which the costs are in the region of USD 300-500k per transit.  The Panama canal widening project, due for completion in 2015, will allow up to 80% of LNG vessels to make the transit.  This will reduce the distance from 16,000 to 9,000 miles from the US gulf coast to premium Asian markets.  The impact on shipping costs to Asia is less clear as the tariffs have yet to be published.  However, any reduction will increase the competitiveness and influence of Henry Hub priced US Exports on Asian pricing.

Insurance costs:  Insurance is required for the vessel, cargo and to cover demurrage (liabilities for cargo loading and discharge overruns).

In order to get an understanding of how these components combine to determine the overall cost of an LNG voyage, it is helpful to consider an example.  Chart 1 shows the shipping cost build up of a spot charter voyage from Nigeria to Japan.

Chart 1: Shipping cost from Bonny Island Nigeria to Sakai Japan

Shipping Costs

Shipping cost impact on diversion economics & regional price spreads

The calculation of an appropriate shipping cost between two locations depends on how the cost is going to be used.  Calculating the shipping cost behind cargo diversion economics is easier than calculating the shipping costs that influence inter-regional price spreads.

Diversion economics

The diversion economics for a cargo owner are based on a set of known parameters.  The diversion decision is focused on the cost difference between sending a cargo to Location A (e.g. Japan) as opposed to its original destination, Location B (e.g. the UK).  The relevant shipping cost for the diversion decision is the true incremental cost of Location A over Location B.

The incremental cost to a cargo owner is likely to depend in part on prevailing costs in the shipping market, e.g. the spot charter rate if incremental shipping capacity is required.  But it may also depend on considerations within the cargo owner’s portfolio.  Most importantly any sunk costs (e.g. associated with shipping capacity or port access) are not relevant for calculating incremental shipping costs.

Regional price spreads

Calculating the influence of shipping costs on regional price spreads is a more difficult problem.  Take the shipping costs between Europe and Asia as an example.  If Asian LNG spot prices fall , they typically find support 2-4 $/mmbtu above European hub prices (e.g. summer 2012).  The logic here is that at these price levels, cargo diversion opportunities from Europe to Asia are curtailed.  In other words the return from selling LNG into Asia starts to fall below the cost of diverting gas from Europe (determined primarily by shipping cost).

But understanding the level of shipping costs behind this Asian vs European price differential is not as straightforward as calculating a ‘point to point’ incremental shipping cost.  Diversion decisions differ depending on supply contract and portfolio considerations.  For example, the flow of European cargo reloads tends to be the most expensive source of diverted LNG to Asia and so the first to be curtailed as spot prices fall.  As prices fall further it impacts the diversion economics of producers in the Atlantic Basin (e.g. Trinidad, Nigeria) and eventually producers in the Middle East such as Qatar (which is more or less equidistant from Europe and Asia).

Diversion decisions also differ across the portfolios of LNG market participants given different incremental shipping costs.  Fuel, port and canal costs are generally a direct function of voyage and destination.  But the treatment of charter costs and the cost of the ballast (unladen) or return journey is less clear.

If the cargo owner uses existing portfolio shipping capacity to divert a cargo to Asia, then some of the charter costs may be unavoidable (or sunk) given long term charter conditions.  This may act to reduce the incremental cost of shipping gas relative to that implied by spot charter rates.

On the other hand, if using long term chartered capacity means making an unladen (empty) voyage back from a cargo delivery to Asia, this may significantly increase the incremental shipping cost associated with diverting the cargo.  Given what is currently a fairly consistent one-way flow of LNG from the Atlantic Basin to Asia, accounting for the burden of unladen return voyage costs is a key factor driving incremental shipping costs.  This burden is often one of the key terms for negotiation in charter contracts.

Making sense of shipping costs

There is no hard and fast rule or formula for the shipping costs between two locations.  But a shipping cost calculation tool is useful piece of kit for estimating shipping costs as well as understanding the dynamics behind changes in costs.  Building up an estimate around current spot charter rates typically gives the best and most transparent benchmark for shipping costs, in the absence of any more specific information on portfolio factors driving costs.

The LNG market is evolving in response to the substantial regional price differentials in a post-Fukushima world.  Contract diversion flexibility is increasing, new and more flexible shipping capacity is being commissioned and trading in spot cargoes continues to expand.  As the decade progresses, the current price premiums over shipping costs will likely be eroded, with regional prices re-converging.  As this happens shipping costs will increasingly become the primary driver of regional price spreads.