Commodity traders accelerate industry growth with LNG investments

LONDON (Bloomberg) -- With margins narrowing in the crude oil business, some of the world’s biggest commodity trading houses are helping to reshape the energy industry with a drive into liquefied natural gas.

Gunvor Group Ltd., Trafigura Group Pte. Ltd. and Vitol SA have moved a step beyond trading LNG, investing in ships and terminals handling the fuel. That’s accelerating the growth of the industry, moving more gas that traditionally has flowed through pipelines onto ocean-going tankers chilled to minus 162 degrees Celsius (minus 260 degrees Fahrenheit).

Those houses in the 1970s broke away from Big Oil’s long-term contracts and created a market where cargoes change hands in the blink of an eye. Now they’re turning their attention to LNG, where spot trading is rapidly expanding. The result is handing utilities from Centrica Plc to RWE AG more flexibility to buy gas, encouraging them to make the leap away from more polluting coal.

“It looks like a much younger crude oil market,’’ Russell Hardy, CEO of Vitol, said in an interview in Lausanne, Switzerland. “It is an area that can grow and that is a positive for us.’’

The top three commodity trading houses active in LNG have more than doubled their delivered volumes over the past two years and took almost 9% of the global trade in 2018, according to data compiled by Bloomberg. Royal Dutch Shell Plc remains the industry leader with 22% and stakes in LNG plants and import terminals.

Other traders such as Glencore Plc and Koch Supply & Trading LP also are building expertise or looking to expand in LNG. Most trading houses set up their desks earlier this decade, while Vitol started back in 2005.

There’s now at least 800 people working in LNG trading and sales, no more than 150 or so a decade ago, according to Connexus Search, which has hired for leading trading houses, producers, developers and utilities. Many companies have three to six traders each in Europe and one or two in Singapore.

“Five to 10 years ago, it was really immature,” said Alex Lee, managing director of Connexus. “Now we see LNG become a much more of a traded commodity, like oil, like metals, as the market becomes more liquid.”

Slower growth in the oil trading business is pushing the trading houses into gas. The biggest energy commodity traders now trade twice or even triple the amount of oil they did a decade ago, but their earnings have remained largely flat as the margin per barrel narrowed.

The oil business remains gigantic, with annual physical crude deliveries of at least $2.3 trillion. LNG is enjoying more rapid growth with about $150 billion in revenue last year, according to McKinsey Energy Insights. By next year, LNG volumes will be more than triple what they were at the start of the century, making it the quickest-growing segment of the fossil-fuel industry, according to Shell.

The biggest reason for the expansion: tighter curbs on pollution have pushed power generators toward cleaner fuels.

“We are spending a lot of resources on developing our gas and LNG business,’’ said Gunvor CEO Torbjorn Tornqvist. “In any realistic scenario for cleaner fuel oil, you can’t bypass gas to replace the more polluting sources.’’

Several other factors are making LNG’s expansion possible:

New supplies are coming on-stream from Russia’s Arctic region to the U.S. Gulf Coast, both of which exported their first cargoes within the past three years. China, seeking to clean up its smoggy skies, is expected to double its demand for the fuel in the next two decades. Highly-populated nations including India and Bangladesh are likely to add to demand, according to Shell. The cost of LNG has plunged, putting its price within reach of more potential customers. New technology, such as floating production plants and receiving terminals and more advanced ships, has also made the expansion of LNG trading easier.

Trading houses have embraced the opportunity. Trafigura has signed deals for storage in Singapore and Vitol is looking to develop an LNG terminal in Sardinia and infrastructure in South Korea. Both these companies and Gunvor have also committed to LNG by signing long-term supply contracts.

They’re harnessing a boom in demand in places that are far from pipelines, especially Southeast Asia, Africa and the Caribbean. Europe also is absorbing more LNG to diversify its imports away from Russia. The advantage is that buyers can start taking cargoes without building a major link costing billions of dollars that crosses national borders. While buyers still need an terminal to turn LNG back into gas, that comes at a fraction of the cost of a dedicated pipeline.

“It’s a general trend, not for Trafigura and Vitol, but for everyone -- gas is going to have an increased share in energy,” said Bart Riemens, head of gas trading at the Swiss utility Axpo Group. “LNG is the fastest growing commodity, secondary only to renewables.”

While the commodity traders have bought and sold LNG for years, their increasing stakes in the industry’s infrastructure gives them an edge in the market, according to Rob Butler, a senior associate at the law firm Baker Botts LLP, which has been involved in more than 150 large LNG deals.

“If you have infrastructure assets within your portfolio, then it gives you a stronger platform to trade off, an ability to create markets for your product and an increased opportunity to take advantage of any trading opportunities,” Butler said. “We come across the trading houses a lot more frequently on the projects and transactions that we work on.”

In addition to bringing financial clout, those companies also apply professional skills in trading that’s helping attract more customers. By buying from producers and selling to energy consumers, those institutions are bringing fresh liquidity to the market that makes it easier to arrange deals. They’re also introducing swap arrangements and contract structures that allow both sides to hedge risks -- something that’s common in the oil business.

“Trading houses are looking at ways to diversify away from mature and low-growth markets like crude oil,” said Rosario Sgarioto, head of LNG trading at Socar Trading SA, an arm of the Azerbaijani oil producer that last year opened an LNG desk and has a gas-to-power project in Malta. “This is no longer just a trading game.”

Another potential advantage LNG has: each deal is smaller and requires less capital to complete. One LNG cargo is worth about $30 million to $50 million, depending on the prevailing market price and size of the vessel. Oil cargoes by contrast range from $50 million to $100 million for the largest vessels, said Dumitru Dediu, a partner at McKinsey Energy Insights.

The traders are also helping LNG develop as a spot market, giving new buyers without long-term supply arrangements confidence they can get hold of cargoes when needed. There were more than 1,400 spot cargoes delivered in 2018, triple the amount eight years ago. That increased the share of spot trade to almost a third of total deliveries, according to Shell’s LNG Outlook report. Long-term contracts are also becoming more flexible, removing once rigid rules fixing a destination for cargoes.

“It’s quite a good development,” said Mark Gyetvay, deputy chairman of Novatek PJSC, the Russian company that made Russia a major LNG exporter since the start of its Yamal LNG plant in the Arctic region in December 2017. “LNG was always sold point to point. Now you have a middle man coming in that’s willing to accept risk and increase liquidity.”

For many, a move into LNG is a longer term bet that pollution rules will continue to tighten, favoring cleaner fuels.

“The energy transformation is for us, in the short term, a real driver of gas and LNG,’’ said Alex Beard, head of oil at Glencore, the world’s biggest publicly traded commodity trader. “The increase in tradeable volumes of LNG is substantial, and that’s an area we have to become heavily involved in.’’