LNG Markets

1
LNG Markets Price VolatilityJean-Pierre
MateilleGeneral Manager, Gas Power
TradingTotal Gas PowerLNG14 Conference,
Doha, March 22nd, 2004
2
LNG Markets and Price Volatility

• Price determination in gas markets
• The portfolio approach
• Management of price risks
• Concluding remarks

3
LNG Markets and Price Volatility

• Price determination in gas markets
• The portfolio approach
• Management of price risks
• Concluding remarks

4
Price determination

• LNG markets are not isolated LNG prices depend
  ultimately on regional gas markets
• Long-term gas price drivers
• marginal cost of supplying markets
• pattern of demand growth generation, domestic,
  GDP
• government policies conservation, supply
  security...
• Short-term gas price drivers
• day-to-day uncertainty on local supply/demand
  balance gas production transportation,
  weather, power generation
• availability of tools storage, flexibility,
  fuel switching,...
• positioning of each market participant

5

Price determination over time (US market)

• weather / temperature
• competing fuels / markets
• storage / interconnections
• industry confidence

6
Price formation in UK gas market

• The National Transmission System (NTS) and the
  National Balancing Point (NBP)
• any licensed shipper can buy and sell gas in the
  high pressure network (NTS) under the Network
  Code
• within the NTS, natural gas is exchanged at a
  virtual trading hub (NBP)
• capacity must be booked or purchased through
  auctions to enter into and exit from the NBP
• NBP price is the immediately negotiable value for
  a given delivery period (day-, week-,
  month-ahead)
• Most UK gas is traded at fixed price at the NBP

7
UK National Transmission System (NTS) and
National Balancing Point (NBP)
8
Recent price developments in the UK

• Spot UK gas prices remain high and above 2001
  highs
• Gas Year 2004 is assessed at 24.6 p/th (12.5
  /MWH 4.5 /MMBTU)
• How do spot gas prices compare with long term
  contract prices ?

9
Price formation in Continental Europe

• Over 90 of continental demand is imported from
  Russia, Algeria and Norway
• long-term natural gas compete with LNG imports
• crude oil and oil products indexation interact
  with spot gas
• emergence of continental spot trading hubs
  (Zeebrugge)
• Dynamic linkage UK / Europe (Interconnector)
• Growing distortion between
• long-term horizon of supplies, and
• short-term horizon of demand most customers
  make competitive supply tenders every year
• Market players must constantly balance portfolio

10
How do spot prices compare with LT contract
prices ?

• Continental European gas prices remain oil driven
• Spot prices are influenced by short term
  supply/demand distortions (UK switch to import)
• Contrary to recent history todays spot prices
  (NBP or ZHUB) are above Long Term oil indexed
  contract prices
• LNG supply contracts must compete in this market

11
LNG Markets and Price Volatility

• Price determination in gas markets
• The portfolio approach
• Management of price risks
• Concluding remarks

12
The global market

• LNG is the only physical link between world gas
  markets
• LNG participates in the global equilibrium of gas
  prices
• direct influence is however difficult to
  demonstrate
• conversely flows of LNG are directly influenced
  by variations in regional gas prices, leading to
  arbitrage opportunities
• Aspiring leading market players will need to
• balance the right mix of gas and LNG supplies
• secure access to logistics assets (regas
  terminals, pipes, ships)
• access end-user markets
• be active in most gas and LNG markets
• develop sophisticated risk management expertise
  (hedging)

13
Integrated Oil Companies as LNG buyers

• IOCs have been traditional players in upstream
  markets and LNG liquefaction
• IOCs are becoming purchasers of LNG
• leverage their gas reserves and allow for faster
  launch of upstream project by securing outlets
• IOCs are developing a strong marketing base, with
  direct access to end-user markets
• credit worthiness
• expertise in technical, commercial and financial
  matters, as well as risk management (Oil, Gas,
  Power, FOREX)

14
Why developing a portfolio ?

• In todays complex environment, back-to-back
  deals will become exceptional
• Market players hold a set of purchase and sale
  commitments that cannot fully match
• Portfolio
• manage sum of purchase and sale commitments, and
  adjust base load and swing supplies to demand
• manage time horizon discrepancies
• aggregate risks using a unique rule book
• take advantage of correlations between price
  formulas
• minimize cost of commercial operations and
  logistics

15
How TOTAL portfolio aggregates flows risks in
Europe

• LNG is a long term business (15 yrs )
• Trading is perceived as a short term activity (1
  day )
• Retail Marketing are medium term businesses (1
  yr )
• Portfolio management conciliates these different
  time horizons

16
TOTAL European Gas Marketing Assets
Leading supplier to IC market
UK 6.7 BCM 20 IC
As of 2004, TOTAL end-user European demand
amounts to 17 BCM/y
NWE 1 BCM
Cross-border pipeline project
FRANCE 8 BCM 17 market share
SPAIN 1.3 BCM 6 market share
1/3 Equity in FOS 2 terminal
4th marketer in Spain
17
The Gas LNG portfolio of TOTAL in the Atlantic
basin
The building blocks of a worldwide portfolio are
progressively put in place
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LNG Markets and Price Volatility

• Price determination in gas markets
• The portfolio approach
• Management of price risks
• Concluding remarks

19
The best hedge ? The right formula !

• A right price formula initially
• LNG price formula must be representative of the
  fair value of gas in the target market
• versus alternative competing supplies (gas or
  LNG)
• A right price formula during contracts life
• long term take-or-pay and price reviews are
  linked
• price review mechanism is of utmost importance to
  guarantee that the contract will remain balanced
• LNG price formula must remain representative of
  gas prices

20
The representation of risks

• Mark-to-market
• flows risks are recorded when commitment is
  taken
• exposure can then be evaluated and categorized
  against set of references, driven by market
  standards
• contracts are said to be marked to the market
• examples of such references Henry Hub in the US,
  NBP in the UK, oil-indexed prices in Continental
  Europe
• At portfolio level, mark-to-market exposure of
  all contracts, LNG as well as pipeline gas, can
  be aggregated
• identification of overall risk
• implementation of appropriate hedging strategy

21
Risk management in LNG markets

• Risk management over long-term horizon
• the right formula
• price review mechanism
• Risk management over mid-term horizon
• adequation between expected import flow and
  market
• market risks are evaluated when the annual
  delivery programme is known
• buyer can decide to take hedging and corrective
  action for exchange rates, oil vs. gas, crude vs.
  products
• Risk-management over short-term horizon
• day-to-day adjustment to schedules and actual
  physical flows

22
LNG competition (LNG vs. LT gas - FRANCE Zone
North)
23
LNG Markets and Price Volatility

• Price determination in gas markets
• The portfolio approach
• Management of price risks
• Concluding remarks

24
Concluding remarks

• LNG markets have achieved a maturity comparable
  to gas markets in North West Europe and North
  America
• For IOCs acting as buyers, LNG purchases are now
  an integral part of their global gas portfolio
  supplying their marketing affiliates
• Mastering the technicalities of markets is a key
  part of the commercial expertise required to be a
  successful player in LNG markets