What it means
Natural gas is mostly methane. By cooling it to about minus 162 degrees Celsius at a liquefaction plant, producers turn it into LNG that can be stored in insulated tanks and loaded onto special ships.
At the destination, the liquid is warmed back into gas at a regasification terminal and fed into the local pipeline network. LNG matters commercially because it turns a regional commodity into a global one.
Before LNG, gas prices were largely set within regions linked by pipelines. With LNG, a cargo can be sent to whichever buyer pays the most, which links prices in different parts of the world and creates trading opportunities.
Contracts for LNG are often long-term, typically running for many years, with prices linked to oil or to a gas price index. Buyers also use spot cargoes, which are sold for near-immediate delivery at the market price, to cover short-term needs.
Many sellers sign take-or-pay contracts, under which the buyer pays for a minimum volume whether or not it takes the gas. The cost chain has four links: producing the gas, liquefying it, shipping it and regasifying it.
Each adds cost, so LNG usually competes best over long distances where building a pipeline is impractical. Shipping costs vary with distance, vessel availability and fuel prices.
For finance professionals, LNG is an example of a capital-intensive industry with long project timelines, large upfront spending and revenue tied to commodity prices. Analysts look at contract terms, the cost of each link in the chain and the exposure to price swings when judging whether a project or a company is attractive.
Another practical point is that LNG carries safety and environmental costs. The fuel is stored at very low temperatures, terminals need strict controls, and buyers increasingly ask about emissions across the supply chain, which can influence contract terms and financing.
In practice
Real-world examples.
Example
A power utility in a country with no domestic gas signs a 15-year contract to buy LNG. The finance team budgets fuel costs using the contract price formula, and holds a hedge for the share of the price linked to oil. Each quarter the team reports to the board how much of the expected fuel bill is fixed.
Example
A trading company buys a cargo from one region and sells it into another where prices are higher. It books the margin as trading profit after paying for shipping and port fees. If the price gap closes while the ship is at sea, the trade can lose money, so the company hedges part of the exposure.
Example
An industrial manufacturer buys LNG by truck to fuel its plant in a region with no gas pipeline. The company compares the delivered cost with the cost of oil-based fuels each quarter. It switches fuel when the gap is wide enough to repay the cost of the conversion equipment.
Formula
Calculation
Delivered cost per MMBtu = gas cost + liquefaction fee + shipping cost + regasification fee. Cargo value = delivered cost x volume.
Suppose gas costs $4.00 per MMBtu (a unit of energy), liquefaction is $2.50, shipping is $1.50 and regasification is $0.50. Delivered cost = 4.00 + 2.50 + 1.50 + 0.50 = $8.50 per MMBtu. A cargo of 3,000,000 MMBtu is then worth, at cost, 8.50 x 3,000,000 = $25,500,000.Case study
Seen in the real world.
Harbourgate Power is an illustrative, fictional utility that planned to replace an old coal plant with a gas-fired one but had no pipeline access. Its finance team compared a pipeline spur costing $600,000,000 with a floating import terminal costing $250,000,000 plus ongoing LNG supply costs.
The terminal looked cheaper upfront, but the fuel bill would depend on LNG prices, which can swing sharply. The team modelled three price scenarios and found that, in the high-price case, the pipeline would have been cheaper over 20 years.
In this illustrative case the board chose the terminal anyway, because it could be built faster and allowed the company to retire the coal plant two years earlier. It also signed a ten-year supply contract with a price cap to limit the downside. The finance team agreed to review the choice after five years, when real fuel costs would be known.
Watch out
Common mistakes.
- Comparing LNG with pipeline gas on the wellhead price alone, when liquefaction, shipping and regasification can double the cost.
- Assuming spot prices are stable, when LNG prices can move sharply with weather, supply disruptions and demand.
- Ignoring contract terms, since take-or-pay clauses can force a buyer to pay for gas it does not need.
Questions
People also ask.
How much smaller is LNG than natural gas?
Roughly 600 times smaller by volume, which is why it can be shipped economically.
Is LNG a different fuel?
No, it is the same natural gas in liquid form, and it is turned back into gas before use.
What is a regasification terminal?
It is a facility that receives LNG from ships, warms it back into gas and feeds it into the local pipeline system.
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