Trading and credit teams in LNG markets will be tested by this winter as never before, as they have to take account of new counterparties and more complex supply lines while the industry innovates to replace Russian pipeline supplies to Europe. LNG supply chains have always been complex and credit-hungry, with cargoes worth tens of millions of dollars at sea for days, and at risk of being delayed there or at other parts of the liquefaction, gasification or offtake process.
Now the stakes are much higher.
Cargoes worth tens of millions in 2021 are now worth hundreds of millions. The number of counterparties has doubled, with many new entrants coming from jurisdictions whose creditworthiness is not established. Within the supply chain there is renewed pressure on existing terminal infrastructure, but new terminals in long gestation are being opened up.
With a bigger pool of counterparties and a more complex supply chain comes more risk. You have to understand the risk in the trade as a whole, because it depends on the highest-risk member of the chain, who may be otherwise an un-regarded part of the chain. How many cargoes of all sorts were delayed when the Ever Given ran aground in the Suez Canal?
So you need to know and understand what is affecting the smallest counterparties along the route – without having to hold up action by the need to assess new and changing counterparties stringently and comprehensively.
Booming prices have knock-on effects.
In these strange days for LNG markets there is no playbook that can be followed for risk control. Booming prices have knock-on effects on the stability of long term contracts, because price hikes mean the value available if a cargo is redirected is more than the penalty for diverting it. You have to have a deep understanding of your risk profile and detect unexpected or unusual trades, or those that raise concerns of other types.
Meanwhile, overlaying those changes in market structure lies the threat of a cold winter and the pressure for governments to take action – in concert or individually – and to make decisions to protect their voters that directly affect market fundamentals. New terminals and gas saving programmes are on the cards, but so are interruptions in gas flow between countries, new price caps, changes in user behaviour or windfall taxes on producers and shippers. From relief for energy-intensive industries to helping consumers save gas, as LNG moves towards becoming a dominant source it becomes more vulnerable to third party actions. You have to be alerted to critical events and key decisions when they happen and you have to be able to quickly move from alert, to assessment, to P&L effect over the contract term.
With this level of market volatility and the likelihood of a political response the probability of counterparty defaults has grown. And when prices are multiplying, instead of adding, fast analysis of the change is vital to profitability.
New data points from different sources have taken on increased importance: how has the credit risk of your new counterparty been assessed; exactly where, on its route, is your cargo and has its arrival and regasification window shifted;? And given those uncertainties along the supply chain, if there is some flexibility in the contract, what is its value to you and to third parties, and how does that interact with the credit risk of the parties?
Relying on longstanding credit risk teams alone is a big risk
What is more, market participants are being tested at a time of high turnover in expert staff. Market participants cannot rely on having longstanding trading and credit risk teams whose history together means they understand both the market and each other. Fast ‘time to action’ now cannot rely on the shorthand that exists in a history of dealmaking among your trading and credit management teams. Instead it requires automated processes that will reduce the time and cost of onboarding and ongoing contract management. Pre-deal checking with fast potential future exposure analysis is vital so you can be confident that a trade will be approved by other departments before making the deal.
Don’t leave value behind
With no playbook, caution may be required. Profits have to be protected, so you have to have tight cash flow control and precise liquidity management. But protection cannot be the watchword: an overly cautious approach leaves value behind. For all this, top-notch software is no longer the ‘icing on the cake’. Now more than ever credit risk management has to be comprehensive, unambiguous, consistent across your teams, able to absorb a range of data types – and fast enough to mean you can be assured of profitability. Talk to us to learn how Brady’s CRisk solution for credit risk management and liquidity forecasting can help.
Written by
Ian Tobin
Business Lead – Risk Management
