+ Exploring shipping inefficiencies in global LNG trade patterns - - PowerPoint PPT Presentation

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Exploring shipping inefficiencies in global LNG trade patterns

Anastasia V . Shcherbakova Andrew N. Kleit Bagas Dhanurendra

+Industry overview

n During the first decade of 21st century, global trade of natural

gas trade by sea doubled in volume

n New players entered the industry n More tankers were delivered to market n By 2012, LNG accounted for 9% of global natural gas trade,

with 1/3 of that traded on spot

+Some curious observations

n Usually markets become more “efficient” as they grow, attract

entry, and become more liquid

n Yet, regional spreads in natural gas prices persist despite

growth in global trade

n In addition, we observe curious shipping patterns: fully-

laden LNG tankers crossing one another’s path

+Observed LNG Shipping Routes

+Why Not This?

+

n This suggests that shipping agents may not be optimizing the

routes which their vessels take

n We ask, “why?”

+Why focus on shipping efficiency?

1.

Shipping makes up a significant share of LNG supply chain costs

n Shipping costs account for almost 1/3 of total cost along the LNG

supply chain, including capital expenditures; optimizing route selection, etc. could reduce total cost by as much as 15% (Jensen 2004)

2.

Transaction costs can prevent optimal outcomes

n

LNG trade is subject to long-term contracts; transportation component included in contract negotiations; presence of high transaction costs may inhibit optimizing behavior

+ Some particularities of LNG shipping

n For most marine vessels, charter rate is most important

component of total transportation cost

n LNG tankers face two additional important cost components:

1.

Loss of cargo (gas boil off; propulsion)

2.

Absence of triangulation opportunities

+Classic triangular trade

Source: http://gprmcglashan.weebly.com/slavery.html

+ Some particularities of LNG shipping

n Design of LNG tankers is highly specialized; can’t transport

anything else on board, so much return in ballast (empty)

n Crude oil tankers are also non-trianguable, but they are

much less expensive to construct and operate than LNG vessels, so cost minimization takes on greater importance for LNG shippers

+Existing literature

n General transportation economics studies

n Alfred Weber’s least cost theory (Theory of the Location of

Industries, 1929).

n Optimal site minimizes labor & transport costs, benefits from

agglomeration economics.

n In our case, labor costs dictated by local labor markets, don’t

change over the short term; agglomeration irrelevant since location of gas deposits is predetermined; so optimal site is a function of ability to chart shortest transportation route between buyer and seller.

n So observed shipping patterns would not be considered

“efficient” by Weber

+Existing literature

n LNG supply chain optimization studies

n LNG producers aim to maximize profits by optimizing operations

along entire supply chain, not just within transportation (facilitate inventory management and timely contract fulfillment) -- Fodstad et al. (2010); Halvorsen-Weare & Fagerholt (2013) and Stanivuk et

• al. (2013)

n So extending voyage durations (longer voyages or idling tankers

• utside ports) may result in an increase in profits, so long as

incremental shipping cost is more than offset by gains in LNG price ultimately obtained at destination

+Existing literature

n LNG supply chain optimization studies

n Makes sense from single LNG supplier perspective; observed

shipping patterns would be considered “efficient”

n But consider industry equilibrium conditions: n Assuming that all shippers have identical access to information,

pursue same objective (profit maximization or cost minimization), all parties would independently embark on a voyage to the highest-priced customer.

n Closest tankers would arrive first, satisfying a portion of

demand for which the customer has highest WTP.

n By the time the more distant vessels arrive, customer’s offer

price would have fallen, likely making the higher cost of the extended trip unjustified.

+Existing literature

n In equilibrium, as all ships sail to more distant but more

lucrative locations, prices at these destinations fall and rise elsewhere, redirecting the optimal flow of ships from distant locations to more proximate ones.

n So the supply chain literature argument that may be perfectly

valid for shipping strategy of an individual firm is flawed because it ignores behavior of competitors.

n Supply chain perspective also focuses on shipments

arranged under long-term contracts and takes existing contract structures as given. Further increases in efficiency

• f shipping routes and reductions in costs may be attainable

through bilateral contract swaps.

+

n Here, we are not asking what is optimal (yet). We are

interested in why we observe deviations from optimal.

n Here’s how:

+

Qatar:

• Rich in natural gas
• Strategically located between east and west
• Accounts for about 1/3 of global LNG trade

+

Nigeria:

• Rich in natural gas
• Second largest LNG exporter in the world
• Less well positioned

+ 51.53o E – the longitude of efficiency

+ 51.53o E – the longitude of efficiency

+ 51.53o E – the longitude of efficiency

+

n With Qatar designated at the global balance between

Europe and Asia, no efficient shipment should cross the line

• f efficient longitude.

n All shipments are evaluated on the bases of whether or not

they cross this line

n Shipments that do are inefficient (better to get your gas from

Qatar)

+Rational hypotheses

n What rational factors can lead to the observed tanker

movements?

n Tightening of markets (peaking demand) (+) n High demand regions command high market prices, make

attractive destinations for LNG supplies. Sending an LNG shipment to a consumer with a higher willingness to pay for gas is a rational economic response to market changes. So we expect to see an increase in crossings of the 51st parallel during seasonal demand peaks.

+Rational hypotheses

n What rational factors can lead to the observed tanker

movements?

n Scale economies (larger-capacity vessels) (+) n More gas on board à lower per-unit port fees, loading/

unloading fees, financing charges, etc. So employing high- capacity vessels would make longer distance voyages more economic.

+Rational hypotheses

n What rational factors can lead to the observed tanker

movements?

n Safety considerations (age of vessels) (+/-) n Older ships may require more maintenance and so make fewer

long journeys. However, many older LNG tankers undergo equipment upgrades and refurbishing, and are no less safe than new tankers. Net effect on shipping distance is unclear a priori.

+Rational hypotheses

n What rational factors can lead to the observed tanker

movements?

n Sailing speed (+/-) n The faster a tanker sails, the less cargo is lost to boil off, but the

more fuel is burned in propulsion. Net effect on propensity to embark on long journeys a priori unclear.

+Rational hypotheses

n What rational factors can lead to the observed tanker

movements?

n Spot market trades (+) n Spot shipments are more common when natural gas markets are

tight (used to make up unanticipated demand spikes, not replace existing contracted supplies). This also implies that, on average, buyers have a higher willingness to pay for spot cargoes, which should encourage shippers to sail longer distances to deliver flexible volumes, resulting in longer sailing distances for spot cargoes, as compared to contract volumes.

+Rational hypotheses

n What rational factors can lead to the observed tanker

movements?

n Spot shipping costs (+) n As cargo shipping costs decline, longer distance shipments

become more affordable and more “inefficient” routes may be

• bserved. Long term shipping costs are usually locked in to a

contract and don’t vary much, but spot shipping costs will reflect cost of shipping and market conditions, such as demand for and availability of tankers.

+Rational hypotheses

n What rational factors can lead to the observed tanker

movements?

n Organizational structure of shipper (-) n Vertically integrated firms tend to be state-controlled

enterprises with high bureaucratic inertia and low incentives for innovation and optimization.

n But they are likely to be better positioned to reduce transaction

costs, improve information sharing and coordination across industry segments, and optimize their customer portfolio in a way that minimizes the long run costs of doing business.

+Empirical specification

n Probit model

Pr(inefficient routeit =1| Xit) = Φ(β0 + β1 × I(peak seasoni)+ +β2vessel capacityi + β3vessel ageit + +β4−5shipping costsit + β6vessel speedi + β7 × I(spot cargoi)+ β8−9 × I(vertical integrationi))

+Data sources

n ICIS Heren Global LNG Markets

n Weekly tanker GPS data n Spot charter rates

n Tim Colton’s shipbuilding database

n Technical specifications of tankers

n The Baltic Exchange

n Baltic Dry Index (BDI): proxy for spot shipping costs

n Vessel operator websites

n Shipper’s organizational structure

+Summary statistics

Table 1: Summary statistics for 374 unique vessels operated by 112 unique shipping entities, includes both direct and transiting routes.

+Empirical results

LNG tankers are more likely to cross efficient longitude during peak demand seasons, when charter rates are higher, and if carrying a spot cargo (all signals that markets are tightening).

+Empirical results

LNG tankers are less likely to cross efficient longitude when spot shipping costs are higher and if they are operated by partly vertically integrated companies.

+Empirical results

Older vessels are less likely to embark on inefficient voyages. Scale economies (tanker capacity) do not appear to play a role (and may be associated with shorter voyages).

+Empirical results

Results on vessel speed are mixed: tankers sailing faster are associated with inefficient routes if all shipments are considered, but with efficient routes if only direct shipments are considered. Time constraint (delivery deadline, selection)?

+Empirical results

n Results largely confirm out rational hypotheses, meaning that

deviations from optimal shipping routes are driven by economic considerations.

n So “inefficient” is not the correct term.

+What next?

n Still, can we do better? n Possibly. Consider a set of potential contract swaps:

n To return to previous example, Nigeria and Australia could swap

their delivery obligations as follows: Nigerian cargoes go to Spain, Australian cargoes go to Japan (at least for the lower of the two contract volumes).

n Both sellers still receive their contracted price, so lack of

transparency in the price setting mechanism of long-term LNG contracts is not an issue.

n This could also appeal to risk averse buyers (in Asia) – preserve

diversity of supply portfolio at a lower cost. May eventually reduce contract prices (or not).

+Thank you for your attention

and comments

Anastasia.Shcherbakova@UTDallas.edu