Episode Transcript
[00:00:00] Speaker A: And if you're doing a cargo a month, that's not a lot of learning you get to do before you've exposed the company to a very large number of transaction value.
Welcome to the Next Imperative, a podcast hosted by A and M energy leaders tackling key issues and trends in the industry.
[00:00:21] Speaker B: Hello, my name is Jeff Angulo and I'd like to welcome you back to the Next imperative. We recent growth in LNG export capacity in the US is creating an opportunity for North American natural gas producers to increase their revenues through marketing and trading of LNG on the international stage. In the second episode of our global gas marketing and trading series, we're going to talk about the operational risks associated with this global LNG trade. Joining me for this conversation are LNG thought leaders and Alvarezo Marcel's managing directors, John Corrigan and Alberto Corvo. Gentlemen, welcome back to the Next imperative.
[00:00:52] Speaker A: Thank, thank you.
[00:00:53] Speaker C: Thank you very much.
[00:00:54] Speaker B: Don, you want to get us started?
[00:00:55] Speaker A: Sure.
So, you know, as we think of the value chain of natural gas and we sort of break from the pipeline gas and go through the LNG process and on down to the trading and sales of the LNG and the international markets, I think we, you know, for operational purposes it's best to kind of step through that. And you know, the first step is the liquefaction. And you know, as, as people make commitments to shipping, to customers, to things like that, that's one of the, the points where you can have an operational upset, right?
Plants are very reliable, but even reliable plants go down and, or there's, you know, a ship that can't leave the berth and things like that. So there are some operational interruption related risks that you have just getting your LNG onto the boat and then when you, you know, sort of moving away from shore, if you will. As you think about the differences between selling spot gas in the US and spelling selling spot LNG in the international markets is you've got a lot of things that you didn't have to deal with before. You've got a boat that's going to be subject to weather.
You've got to make some decisions around where it's going to go. And you know, whether it's going to go west and through the Panama Canal into the Asian market or go east to the European market, you've got to make some of those calls. And those calls are going to be dependent on a lot of different factors that you have to take into account in terms of fees for changing the route, fees for going through the Panama Canal. Delays, making sure that you have, that you're scheduled into a birth. All those things are new to people who've been selling on the pipeline grid. And if, you know, hopefully they've been, they've got a robust liquids business where they have to, they've been dealing with those kinds of issues around scheduling and everything. So. But not everybody has. And even then it's a little different when you move into the international sphere. So from an operational risk, I think you've got to assume and understand what the likelihood and probability of these changes and these costs.
You know, I've seen a lot of deals, you know, they looked good until the demurrage bill came. And you've got this huge bill that just absorbed all your profit and you kind of scratch your head going, well, it wasn't our fault. And I think that goes towards risk in general is, it's the stuff that's not your fault that you've got to think about from a risk perspective.
[00:03:50] Speaker B: It's not your fault. You've got no control of it. And how do you.
[00:03:52] Speaker A: Exactly. It's those things that are out of, out of your control that are the most difficult to manage. And I think when US Producers start looking internationally, they're going to have to learn to do this and learn how to price that into the deals. Right. So you're always going to have some of these risks. Sometimes of the year it's going to be higher. So, you know, hurricane season, you know, they may have to shut down the LNG plant and you've got two or three boats stacked up waiting to load and they're down for a week and now your schedule's totally gone.
[00:04:29] Speaker B: You start over.
[00:04:30] Speaker A: Yeah. And that, that becomes a. Okay, so how do I manage that? Do I trade and try and redirect it and get a different, get a different transaction to fill the void or do I sit and wait? Those are the kinds of things that as the producers start building this capability, you're going to want to find people that are used to these kinds of issues, these maritime issues, if you will, that will sort of, A, they're used to them, B, they're aware of them, and C, they will be able to inform the risk quantification as well as different mitigation strategies.
[00:05:12] Speaker B: So kind of a playbook.
[00:05:14] Speaker A: A playbook, exactly. Having that. Right. Playbook with people that understand it is going to be critical and they're going to have to search around for those because those people are in very high demand right now.
[00:05:25] Speaker B: Few and far between.
[00:05:26] Speaker A: Exactly. We just added A whole group of new players in the international arena.
So getting those top tier marine logistics people is going to be a bit of a competition. And so again, some risks you can't, you can't anticipate. Some risks you can, but can affect. And a lot of risk, though, you can control somewhat. And it's a matter of sort of grasping those and understanding them. And a lot of these operational risks, you know, Alberto, we talked a little bit about in the last episode, a lot about financial risks, market risks, but these operational risks are the difficult ones to mitigate. There aren't, you know, there aren't a lot of financial instruments that will help you mitigate things like disruptions, storms, demurrage when the port is backed up and it, you know, because of somebody else, not you.
And just, you know, a lot of people, I'll give you an example. A lot of people when the. Ellen, a couple of years ago when the Panama Canal reopened, it just happened to coincide with a big drought and all of a sudden people were waiting weeks and weeks to get through. And those were the kind of things you didn't price into your deal necessarily.
[00:06:52] Speaker B: Right.
[00:06:53] Speaker A: And so I would imagine there are a lot of people now that, that know that difficulty very well and are cognizant of it and schedule their deliveries through there or just quit playing in the Pacific. Right. I mean, there are different ways you can mitigate it. And sometimes it's, I'm going to change which markets.
[00:07:12] Speaker B: Yeah, I'm not going to that market anymore.
[00:07:14] Speaker A: Yeah, it's too difficult.
So I think those are the kinds of operational risks that you really have to look at and understand.
It's again, something you can't necessarily hedge away, but you can price it in if you know how to quantify it, or you can contract around those risks. Right. So you can use the contract structure to share the risk, to push the risk to the other party and things like that, which are more contractual as opposed to financial markets or something like that, to deal with the other risk is.
Well, you other sort of difference is, and it kind of plays into this notion of schedule and logistics is you've got to make a decision around what assets you're going to own, what you're going to lease and what you're going to contract.
So let's take a, a ship, an LNG ship or ships, plural. And you've got to decide do I want to, to buy one, do I want a long term lease or contract, or do I just want to play the spot market and charter on either Individual routes or short term charters such that I have the flexibility. And if the market goes south, you know, I may be stuck with my LNG capacity charges, but I'm not stuck with the shipping charge as well. So when you think of that value chain, again going back to the value chain is I've got a fixed cost risk with the liquefaction, I've got a fixed cost on a lease or ownership of a boat and then I've got usual market risks when I get there. But those two big asset risks are the first ones that you want to tackle and, and analyze and figure out what you want to do about it. Because those, when the market changes or when something happens, those are really expensive problems to have and it may, you know, unwind a lot of things that you, you risked or that you hedged on the other side of that transaction.
So again, there's a lot of thought and analysis and understanding of those risks that needs to go in as you set up this capability going forward. Alberto, on your, on your clients, what have you seen in terms of people trying to mitigate some of the currency and commodity risks around timing of delivery?
[00:10:05] Speaker C: Well, this is a bit what we were saying earlier on in the other podcast about understanding your risk and mitigating those risks. So when we were talking about the effects exposure, for instance, we were talking about one, the fact of the currency fluctuation, but also is the delivery of the cash situation. Imagine that you were expecting to get X amount of euros paid in this particular date because you were going to deliver the gas and all of a sudden you didn't make the delivery for whatever reason and you're delayed a week and you had an option that you had to deliver euros in exchange for dollars. All of a sudden you don't have the euros to deliver those dollars. So that's a, there was a time exposure. And again, all of these things are understood and they can be managed. But again, you need to have a way to manage them and say, okay, how many days of risk am I willing to take?
How variable is this? It could be a few days and then, you know, then I can get some flexibility on the option or use a different instrument or you know, I know that I'm gonna be protected for X days, but then if I go beyond that, I'm no longer protected and I'm gonna take some risk. Again, the step is always the same. Know what you're getting into, know how much are you willing to take on yourself versus Hedge three hedge and know how much it costs for you to hedge because none of these things are free and hedgers pay speculators. So there's going to be somebody on the other end of the trade who provides the liquidity and provides the hedging, but he or she wants to be paid on the other side. So there's, it's always at the end of the day understanding things and all of this that you say is just adding a whole new flow and a whole new layer of risk. But at the end the basis have been very well understood and it's tailor making what is already understood to your business and to the cause of the business. And that's why you and I have been successful when we go see clients, because we bring two sides that both impact them and we both can provide the two different perspectives to clients and how to think about mitigating and solving for those risks.
[00:12:41] Speaker B: John, one of the risks you mentioned was weather, right? Your destination six weeks later. The weather could be very different. And I believe there's a lot of weather data out there. Alberto, have you seen or heard of anyone talking about using AI to, to better predict the weather in a situation like this?
[00:12:58] Speaker C: Well, I mean predicting the weather, it's, it's difficult more than a few days out. Right. But what is possible is to understand historical data. A hurricane in Florida in September is much more probable than tomorrow.
However, there's ways to hedge against weather.
There is a cost and you need to understand it. I think it's to the point that John was making.
There's people who do this for a living and understand all these levers to be played, but they're few and far between. And then you got to support them and understand what you're doing. But yes, there's data and the data gets better and better and there's more and more, you know, the satellite data that tells you what's going on. And there's a, there's a lot of data out there. But again, data is not cheap and using of the data is not cheap. And then fantastic. Now you know, or at least you have a better idea and it's not completely uncertain because obviously uncertainty you can address. So now you're entering more the realm of risk because you have all this data and now, okay, how do you manage that?
[00:14:07] Speaker A: And on the data issue, I think that's really a big point. I think our listeners might need to think about is the, the, the data you need is you need all the data that you're currently getting for the US market, then you need data for the continental Europe market. The Asia market, Australia, Australia, all these, all these markets now are interconnected and play a role in what's going to happen with supply and demand, with price, pricing and things of that nature. And you know, some of that data is, is like Alberto said, getting shipping rates on, you know, that are up to date and accurate is, you know, there's only a few, a handful of companies that do that well. So you're going to have to go to those companies and get that data. You're going to have to get good weather data. You're going to have to. There are services that, I mean there's free access to data that shows where ships are, but there are other services that go a step beyond and look at inventories and can tell you, you know, how much is riding on a given ship and things of that nature that will inform the trading. The good news is unlike domestic gas trading where you're doing a large number of smaller transactions on a day to day basis, the number of transactions is much smaller and the time you have to analyze that transaction is greater. Right? You don't have to, I mean at some point you have to, you know, make a decision in a short period of time. But once you engage in that, you've got days to do some analysis before you make that commitment. So you do have time to assimilate the data, to analyze the data, to create scenarios, to price in the risk, to look at different hedging options. All that makes it a lot nicer that you get that time to do it.
But then I'm going to bring in the other complication and that is you're doing much bigger trades, right? You're doing, stakes are higher, you're doing 1, 2, 3, 4 BCF in a given trade. So the stakes are very much higher. And you've got to understand that these, they're not binary risks but they're much bigger impact. I can take a lot of little risks and the law of numbers helps me out on my risk. I do one of these deals and you know, if it goes south that's, it's, it's a big impact, right?
And that's part of some of the challenge I think operationally for these people is just like anything else. To get good at something you have to do it many times over. And if you're doing a cargo a month, that's not a lot of learning you get to do before you've exposed the company to a very large number of transaction or transaction value. Right? The notional value is very big. After five cargoes but you've only done it five times.
So the overall, there's this notion of portfolio risk of a few very large transactions that changes the risk dynamic from a hundred smaller transactions. And that's going to have to play into how you quantify and look at that risk. It's going to play into a lot of the compliance decisions. Right, so who's got trade authority to approve a tanker trade? Right, right.
You don't need, you know, somebody on the floor can have trade authority to do a bunch of small deals, but when you do one of these big deals, who's signing off? And you know, what are the protocols around that? How do you document that sign off? What are the expected analyses presented as part of the deal approval?
Alberto, have you seen any parallels from other industries where you've got just a few very big deals, so you have to kind of change your approach to the risk and approvals?
[00:18:32] Speaker C: Well, I mean, look, again, it's an understood problem.
Who decides what, right. And at what level and the based on what. So how are we evaluating the risk of something? Is it the var, is it the delta? Is it the gamma? Is it? What is it?
And so there's a whole literature and all the practitioners that have this. Now, when you start making bigger deals, small, I would say if you're thinking about smaller trades that happen more frequently, you're more thinking like a hedge fund. When you think of less trades that have a bigger bearing, you're more thinking like a private equity fund. Right. If I had to make an equivalent in finance. And so how you decide to do the two things and how you monitor the two things, it's different. But then again is how do you break down the risk and how much are you taking, how much are you floating, how long are you taking that risk? Because you could even say, okay, we're going to do the trade and I'm going to be on the hook for 100% of the risk and then I'm going to syndicate a part of it this way and another part of it another way, and depends what's available, what are the costs and on and on. But again, these are things that are understood, that have been done in the past. And it's just learning, taking the learnings from a different area and moving it to your area with appropriate adjustments and, and, and then continue focusing on what you do best while making sure you're not being surprised by things that you weren't thinking about.
[00:20:24] Speaker A: Right, That's a good point. I guess if I were to translate to the natural gas environment. It's more like doing a structured term transaction where you've got multiple types of risks based on the contract structure. Some of it's going to be price risk, some of it's volume risk. And there's just a different process for pricing, there's a different process for approval, there's a certain number of predefined elements that go into the analysis. So, so again, it's probably not as foreign as it probably feels the first few times, but the process probably looks a lot like that where you just get some normal sign offs along the way so that it doesn't take, it's not that difficult to understand what the process should be. It's just a matter of making sure you know that that list of analyses that are going to support the deal have been done and that people have looked at and quantified the risks and discussed the risks in order to approve the deal. Which means both doing the deal, but the pricing and the quantification of the risk that we're going to carry and how that risk will behave as that transaction plays out.
[00:21:41] Speaker C: And to your point that you made earlier on, John, is how do you not get surprised the second time? Right. How do you, how do you remember the learnings, understand the learnings, understand what those learnings are, why they came and all of that. And of course don't bet the wrench.
But, but at the same time, if something happened, which you know, then how do you learn from that and how you make sure it doesn't happen. And at the same time is how do you not put too much of a straitjacket then? Because the best way is to not trade, then you're not taking any risk. You're also not making any money.
The famous adaging technology, we say a secure machine is a machine that is switched off. Yes. It's not doing much. Right.
So there's always a trade off and it starts with the understanding.
[00:22:39] Speaker A: Right. And I guess that's a good thing for our audience to think about is the engagement of senior management, the risk committee of the board, getting them up to speed and a full understanding of the journey that they're going to go on as they move into the international markets is very important. Right. You don't want people to overreact to a bad experience and shut down a program just because one deal went bad and you've, you've already spent the tuition. Right, Right.
Let's, let's make sure that we've got a commitment to keep moving forward and you know, learn from our mistakes and just be better as we go forward. Because you're going to spend a lot of money standing up this capability. You're going to spend a lot of money investing in liquefaction contracts, in ships, in traders and people and technology platforms and data services. So you're making a big investment to get into this market. It's, it's probably well worth everybody taking a pause and all getting aligned on. Okay, what are the risks of this program? What has happened to other people who have done this? And you know, what are we going to do when we have a bad outcome? Because not every trade is great.
[00:24:03] Speaker B: Yeah. And have a plan and.
[00:24:05] Speaker A: Yeah.
[00:24:06] Speaker B: And I guess after the fact have a plan to study it and understand what went wrong and change your procedures as you need to.
[00:24:14] Speaker A: Exactly. And yeah, sometimes. And it may be that after studying it you say well this is a risk that we can never manage or, and it's just not worth us doing it. And we'll take a different strategy to entering into the international markets. And that goes to probably another element we haven't talked about and that is, you know, what's your approach to going into the international markets? Is it going to be just doing a one off deal or you know, finding a trader to and do a joint venture or some kind of revenue sharing agreement? Or are you committed to become an international trader to understand the market and to know where the value is so that you can be better at capturing that value than to seed the value and try to claw back through a trans, through a contract.
[00:25:08] Speaker B: Right.
[00:25:08] Speaker A: Some of that value because that trader who's very experienced is not going to let you claw back 100% of that value Right there. There's, there's a premium that they're going to take for your sort of playing from the outside and not having enough market knowledge to know enough about the pricing of different deals and things of that nature. Which may be fine because your risk profile could be such that yeah, we're never going to do that. Or your working capital commitments are elsewhere and not in the trading realm. So there's a lot of decisions to be made there. But if you do pursue the path of getting into the international markets, you've got to make that commitment to weather a few of the, the clunky deals that just don't turn out like you planned and hopefully they're not too bad.
[00:26:03] Speaker B: Yeah, it's all part of the learning curve.
[00:26:05] Speaker A: Exactly.
[00:26:06] Speaker C: And also, I mean the conversely don't think you're invincible if everything goes to plan. The first 20 times or 10 times or five times. Right. And don't let your guard down. It's all about managing the risk. And, you know, the fact that things have gone well, it means that you did well in managing the risk, but you need to keep your guard up. Which is. Which is sometimes, you know, that's why they talk about beginners, like, because beginners tend to be very careful and then. And then they. They stop being careful and then surprises happen. So. But. But again, to me, the. The message of all of this maybe is it's well understood. It's been done before. You're not pioneering anything. You just gotta learn from. People have been there before. And you can minimize your learnings out of your own pocket by being thoughtful as to how you get in and how you do it and what you do and how you manage. I think that's. That's the message. It's doable. Just learn from other people who have done it before and you'll be fine.
[00:27:12] Speaker A: Yep, exactly.
[00:27:13] Speaker B: Great message and a great ending. Really?
[00:27:14] Speaker A: Yeah, that's. I couldn't think of a better way to end the podcast. Alberto, that was awesome.
[00:27:19] Speaker B: That was perfect. That was perfect. So, John, Alberto, thank you very much for sharing your insights and your knowledge. We really appreciate it. To the audience, thank you for joining us. We hope you found this conversation stimulating. We look forward to seeing you on a future episode.
[00:27:34] Speaker A: Thank you for listening. Make sure to subscribe to the next imperative so you never miss a new episode. Also, visit our website atalvarez and marsal.com to learn more and to connect with us.
