ENI and Gunvor – two LNG trading suppliers have defaulted on the contractual obligation of supplying one cargo each in November. Their contracts bound them to supply at around 11-12 percent of Brent. This makes the price on current rates around $30 million per cargo. However, the spot prices are around $100 million. In case of failure, the traders need to pay 30 percent of cargo value – it comes around $10 million per cargo.
It makes commercial sense for traders to default and provide low damages to Pakistan and provide cargos in the open market at exorbitant rates. The headache for the government is to ensure the supply in coming winters, as traders can very well default for the rest of the winters too, looking at prices.
This default was very much on the cards. It is not a buyer’s market in today’s scenario and buyer cannot do much in such unprecedented LNG market but to ration demand. Europe is doing it. What options does Pakistan have?
According to the government, the situation is not as bad as it appears. The government claims to have secured nine cargos for November (7 at terminal-1 and 2 at terminal-2) – without the two defaulting ones. And 10 in December (7 in terminal-1 and 3 at terminal-2), if the two traders keep commitments for December. The base load is 8-9 cargos (800-900 mmcfd) and usually in winters 12 cargos are required. There is going to be a gas shortage in winters, and government should plan it by diverting gas to domestic, industry and fertilizers. While for power and transportation, it should let them rely on other fuel options where the price increase is not as crazy as in the case of LNG.
The government should start working on procuring Furnace oil (FO) for power generation in winters as it doesn’t not make any commercial sense to buy spot LNG cargos at such expensive rates.
The important question is, how to deal with these defaulters, and how to ensure these traders do not default again. The government needs to show iron-hand here and now let these traders take Pakistan for a ride. The question is whether the default is on a commercial basis as it appears from the numbers. If that is the case, shall the traders pay full damages on market value?
It appears that ENI is not providing cargo due to force majeure from its supplier. While Gunvor’s explanation is that they are not getting cargo from the market. These two are portfolio suppliers and they do commit based on their margins, and these margins are to cover their risk in volatile market and act as a hedge for the buyers. However, here all the risk is being transferred to the buyer by paying 10 percent of market price.
The usual contracts with stable source long-term supplier – like Qatar, is to pay 30 percent damages on contract value for not supplying promised molecules. However, for traders (like Trafigura and Vitol) the norm is to have 125 percent of market value damages, and at 100 percent for stable international supplier (like Shell). Last year, 125 percent of market value of damages were paid to Koreans and Chinese when traders defaulted on commitment. Pakistan is a big player in the LNG market, it should not let these traders slip away easily. Government must press these traders on willful defaults and dissuade them from repeating the same in the future.
This article first appeared in Business Recorder on 2 Nov 2021.