The Pakistan Tehreek-i-Insaf (PTI) government just completed three years in office. And for the third winter in a row, the government is left scrambling at the very last minute to arrange supplies of liquefied natural gas (LNG) for the winter months, when demand spikes and domestic production is unable to keep pace.
This year, LNG prices have shot up at a dizzying pace and are hitting record highs. Some countries secured themselves by placing orders for their winter demand much earlier, but those that missed the boat, or find themselves dealing with more local demand than they had forecasted, are facing almost unprecedented costs and volatility. The price spiral is expected to continue throughout the winter, since Pakistan’s reliance on LNG is growing at a rapid clip as domestic gas fields dwindle.
For a number of months now, the government of Pakistan has been struggling to deal with this price spiral. On a number of occasions, they have invited international bids for LNG supply, then cancelled the tender after seeing the prices and then reissued the tender to invite fresh bids. Sometimes this has worked, but other times it has not. As the winter months approach and demand within the country rises, the problem is set to aggravate.
Expensive LNG means rising price of electricity, as well as a rising subsidy bill, because the government is committed to providing LNG at subsidised rates to export-oriented businesses. The price spiral could also put pressure on the reserves, public debt as well as inflation.
So how did we get here?***
Pakistan buys LNG from two separate markets: long-term contracts and short-term spot markets. The cargoes coming under three long-term operational agreements have a fixed price, pegged to Brent crude. But spot markets are a different game, where bids are invited and the lowest among them is awarded the contract.
Spot markets see more price volatility and are typically used to meet demand fluctuations whereas contract cargoes — bought under the long-term agreements — are used to meet what is called “baseline demand”, or requirements that are steady throughout the year.
Just this week, Bloomberg reports that two spot cargoes were invited for delivery in September and Pakistan State Oil (PSO), the entity that invited the bids, received two bids, one pegged at 24.5 percent of Brent crude and the other at 34.6 percent. By comparison, the cargoes under long-term contracts cost between 11 and 13 percent. “This is one of the priciest cargoes that Pakistan has ever procured,” Bloomberg says citing traders.
But this same story has been repeating itself for almost three years now, with Pakistan repeatedly being forced to settle for very expensive bids, drawing fire from the opposition parties and pushing the government on the defensive. The question to be asked is, why is this happening again and again?
THE BLAME GAME
In 2019, the first winter when this happened, PTI blamed the previous government for the resultant mess. They claimed that they were left saddled with expensive LNG contracts. Then in 2020, they blamed the “lack of LNG storage” as the reason for their inability to secure sufficient supplies in time. And this year, the Petroleum Division of the Ministry of Energy tweeted, “no one, without a crystal ball, can perfectly time or beat an international commodity market.”
Global markets are seeing a spike in prices these days as large parts of northeast Asia see colder temperatures and the continuing unwinding of Covid lockdowns ramps up demand elsewhere. But many countries are dealing with this volatility by arranging cargoes earlier than normal. Pakistan’s position is different because, for almost three years now, the government has been placing its orders far too late, thereby earning for itself a front row seat to the full impact of the price volatilities that LNG spot markets typically see every winter.
And as of this writing, the government also seems to be desperately trying to invite bids a second time for an October delivery, because the tender the prices they received for four cargoes in that month attracted bids ranging between 19 dollars and 22.6 dollars — prices that are far above the cut-off point of 15 dollars, at which LNG cost for power generation comes at par with furnace oil.
Every one-dollar difference in the price can drive up the price of an individual cargo by 3.2 million dollars, so each dollar difference adds up considerably, given the growing number of spot cargoes the country is forced to rely on with continuous demand growth. Currently, the government has until September 8 to inform the bidders from the first round whether or not their bids will be accepted.
A ROUTINE AFFAIR
This last minute scrambling amid a tightening global LNG market has now, unfortunately, become a routine affair.
Last year in November, the government advertised for six cargoes to be delivered through December. With just about 30 days between the date when the tender closed and the date of delivery — which is a very tight delivery schedule for winter supplies because the global market is known to be flooded with buyers during these months — they received offers ranging from 15.8 dollars to 17 dollars, just at or slightly above the cut-off point at which LNG ceases to be economically viable compared to its competitor fuel. That bid was followed by stinging commentary in the media about how LNG imports are being mismanaged, mostly by very late tendering, which causes the price to rise sharply.
Then they did it again.
When another tender was closed in December 2020 for six more cargoes to be delivered in the month of January 2021, there was again barely a one-month gap between the closing date and the date when the first delivery was supposed to arrive. The results were even more disastrous.
They only received bids for three of the delivery windows (out of six advertised) and the prices were between 15.3 dollars and 17.3 dollars, making it the most expensive LNG Pakistan would have bought until that point. Both these records have since been blown multiple times — most recently this week, when the bid price works out to 17.85 dollars per unit. The results came to be known in LNG circles as ‘the December debacle’.
It’s important to reiterate that this kind of bidding behaviour is not normal in spot markets. “Usually buyers go to spot markets for the next 2-3 months for delivery,” says Abhishek Rohatgi, LNG analyst for BloombergNEF. “But companies do buy some part of their winter and summer volumes earlier also.”
“We have also seen some buyers coming to pick up what are called ‘strip cargoe’, where a buyer picks up one cargo a month for the next 10 months as an example,” he adds. Earlier this year, some buyers from China and India, for example, placed their winter orders far in advance.
That is how Pakistan also did it in the early days of its LNG tendering as well, until things changed in 2018.
The only time when rapid tendering took place in LNG spot markets was when the Covid-19 lockdowns began, as LNG prices collapsed to record lows. But, as we shall see later, Pakistan remarkably decided to opt out of that buying spree, for reasons that are difficult to understand.
A DISASTER FORETOLD
The results of this delayed tendering and the resultant elevated prices started rolling in by early December 2020, when reports of gas load-shedding began running in the media. But it wasn’t till the months of January and February, when the National Electronic Power Regulatory Authority (Nepra) released the data for fuel utilisation in the power sector, that the real cost of the December and January fiascos came before us.
In one month, from November to December 2020, the cost of the LNG used in power generation went up by one rupee per kilowatt hour (kWh). If you consider the fact that they intended to generate almost 2.2 billion kWh using re-gasified liquefied natural gas (RLNG) in December, you will get some perspective of what a one-rupee hike in the fuel price actually means.
The government managed the month of December by curtailing the total amount of power they intended to generate by about 11 percent, cutting RLNG-based power generation by almost half, and hiking the amount of power generated from coal by about 46 percent. Despite these steps, the fuel price for December rose by 1.5 rupees per unit for all consumer categories except lifeline consumers. That charge showed up in people’s February bills in 2021, applied retroactively.
The main gas utility that serves the provinces of Sindh and Balochistan — the Sui Southern Gas Company (SSGC) — also sent a letter at the end of December to all industrial associations, warning of an impending gas closure for all captive power units of non-export industries. The company said it is “facing acute shortage of gas supplies from different fields and around 150mmcfd gas is being short supplied during this winter as compared to last year.”
The last time such a move had happened was in December 2018, but in that year the utility had blamed the shortage on a “technical fault being experienced in some gas fields.” The gas shortages that hit the country in the winter of 2020 were protracted, however, and lasted well into February, by which time the Prime Minister’s Special Assistant was advising a moratorium on gas supply to captive power plants for industry as a means to deal with the shortages.
The month of January 2021 brought no respite; an additional 0.9 rupees (per unit) was added on the fuel cost for power generation, on top of what was already applied in the month of December. This despite the fact that power generation was again curbed by 400 gigawatt hour (GWh) and LNG generation was slashed from the planned 27 percent of the total mix to 11 percent instead, with coal picking up the slack once again.
Serious gas shortages that hit the country in December 2020 mounted to near crisis levels in January 2021, as industry faced the prospect of shutdowns and had to raise the matter with President Arif Alvi, who was on a visit to the city of Karachi early that month.
“The KCCI chief informed the president that the ongoing gas crisis in Karachi has become a very serious issue that needs to be probed because, at a time when the exports were picking up, some elements somewhere in the system abruptly intervened and created gas shortage which has resulted in closure of many factories,” said a press release issued then by the Karachi Chamber of Commerce and Industry.
Winter gas shortages had become a seasonal matter in Pakistan about a decade ago, when depleting supplies of domestic gas created an ever-widening gulf between supply and demand whenever temperatures dropped. Supply cut-offs to industry in the winter months were a standard feature in those years. But the start of LNG supplies since 2015 had begun to mitigate that. A combination of factors is now turning the clock back to the days when winter temperatures brought severe gas supply disruptions.
The disruptions appeared in the winter of 2018, but were not as severe in that year and were largely buried under the ongoing uncertainty brought on by the recent change of government. They grew in 2019 and are now harkening back to the old days of about a decade ago.
Last year, after the disastrous LNG tender of December 10, 2020 which saw bids for only half the deliveries sought, a debate broke out among gas sector professionals about what might lie behind the repeated failures on the part of the government to secure sufficient LNG cargoes during the winter months.
A RACE AGAINST TIME?
One view attributes the reasons to simple incompetence and points out that the government is tendering far too late. According to this view, the number of days between closing of a tender and the first delivery window should not be less than 60 days, or 45 days at an absolute minimum, and ideally 90 days or above. There are various reasons for this.
The closer you are to your own delivery date, the greater the volatility to which you will be exposed, according to this view. This doesn’t mean that all tenders with short intervals between tender closing and first delivery will necessarily fetch a higher price. It just means that the likelihood rises, especially in the winter months, when demand in the Asian markets rises sharply due to the onset of cold weather in northeast Asia, which is a high consuming region.
The other reason is transit times for the vessel. One of the largest suppliers of LNG in the world, and certainly the largest in our neighbourhood, is Australia, and the transit time for an LNG vessel from the various loading points there to Port Qasim can be anywhere from 15-22 days, approximately.
Any tendering window close to this makes it difficult for suppliers from Australia to participate in Pakistan’s tender, even if the participation is via a trader. That narrows the radius for participating suppliers, leaving just a few countries such as Qatar, Malaysia or Mozambique.
Figure 1 shows the number of days between the closing of the tender and first delivery of every spot market tender Pakistan LNG — the state-owned company created to place tenders in the spot market for Pakistan — has placed since May of 2017, when spot purchases began. Some of these tenders were discarded, some were modified, but many were finalised on the terms offered by the bidders. The idea for now is to look only at the quality of the spot market tendering process in Pakistan.
As the data makes clear, until February 2018, tenders were closed 60 to 90 days before the delivery window, as is the norm in LNG spot markets in normal circumstances. But from June 2018 onwards, only three tenders gave a 60-day window to the first delivery. All the rest fell short, and in 12 cases (out of 32) the time interval was 30 days or less. “Less than 30 days between bid closing and delivery means the cargo is needed immediately,” says Rohatgi. “Buyers usually don’t prefer this, as this could mean they have to pay more since the need is immediate.”
Giving suppliers sufficient lead time from the date of closing the tender to delivery is an important element in LNG pricing for spot market purchases, though it may not be the determining factor. Following the shock last December, the petroleum ministry released a statement arguing that “the wide range of prices offered for the same delivery date clearly showed that the time between the bid opening and the delivery date is not the price determinant.” The main driver, it said, is global demand and supply.
This is true, of course. The year 2020 demonstrated this in stark terms when the Covid-19 lockdowns began in February and rolled across the world in the months through July. LNG demand plummeted, as did its price, and many countries scrambled to lock in the lower prices and fired up their LNG power plants to take advantage of the collapsing prices. This was one time when spot markets saw a large number of fast tenders amid oversupply. But strangely, Pakistan declined to participate in this bonanza.
GLOBAL DEMAND AND SUPPLY
“In an abundantly supplied spot LNG market, due to a milder than usual winter and increased production from Australia, Russia and the US, the Covid-19 pandemic further exacerbated the supply glut due to the limited buying appetite of major importers in Asia,” says the World LNG Report 2021, released by the International Gas Union in June, summarising market conditions during 2020, the year of the pandemic.
As early as February 2020, BloombergNEF, Bloomberg’s primary research service, said India had imported “a record amount of LNG”, a track record that continued through the months ahead. Ramped up LNG purchases from the spot markets during these months worldwide meant “LNG traded on spot and short-term basis reach[ed] new highs,” according to the Gas Market Report of Quarter 1, 2021, released by the International Energy Agency (IEA).
Some Indian buyers, for example, either activated whatever flexibility their long-term contracts allowed to cancel those shipments and shift to spot markets instead, or immediately called the force majeure clauses in their agreements. According to the IEA’s report, the country rapidly increased its LNG-based power generation by 9 percent “thanks to cheap LNG spot prices, while coal declined 5pc.” The report points out further that Japan and Korea too switched much of their coal-based generation to LNG to reap the benefits of record low spot market prices, as did many other countries.
But, curiously, Pakistan chose to sit these months of record low spot prices out altogether. From February to July 2020, when the price trough was in full effect, Pakistan refused to take advantage of the collapsing prices of LNG in spot markets, preferring to stick to its long-term contracts throughout these months.
LNG price is computed as an average drawn from three preceding months, so when oil prices plummeted in March, it wasn’t until June that the full impact of the collapse was computed into the price, given all three preceding months (March, April and May) recorded monthly average prices of 34 dollars, 26.7 dollars and 31 dollars in Brent crude oil.
Some of the benefit of this drop in oil prices was felt because the country’s long-term contracts are linked to it. But the real drops were happening in the spot markets, and even though through all these months there was regasification capacity available in the two terminals at Port Qasim, no spot orders were placed.
The first spot market tender that the government advertised in this period of historic low prices was on June 27, when prices had already bottomed out and were starting to recover. And, strangely, the one time when urgency and speed would have worked to the country’s advantage, that tender was left open for a month. The delivery was on August 27, exactly 31 days from tender closing.
Not only that, power generation from LNG actually dropped during these months when spot market prices hit their lowest level ever. At a time when countries from China, Japan, Korea, India and many others were ramping up power generation from LNG, Pakistan’s generation from this low-cost fuel in the months running from April to July actually dropped below its reference level, in one case (the month of March) sharply.
QUESTIONS ABOUT THE DECISION-MAKING
Why did Pakistan choose to not avail itself of the record low spot market prices in those months? Why was it actually dialling down its LNG based power generation from its own reference targets rather than ramping it up like other countries? Why was coal-based generation consistently higher than its reference in the overall mix while LNG was consistently lower through these critical months? These questions demand serious answers.
In fact, at the height of the whole spot market crash in the summer months of 2020, Pakistan received an offer from one of its regular suppliers of LNG – Trafigura – to lock in some of the prices on offer at that time for either 12 or 24 months.
In a letter dated April 29, 2020, when spot prices were at record lows, the supplier offered a contract to Pakistan to sell LNG at prices ranging from 3.71 dollars to 4.25 dollars on a 12-month contract, and 4.11 dollars to 4.72 dollars on a 24-month contract, in exchange for the same cargoes from Pakistan’s own long-term contracts.
Consider that, in the same month, Pakistan imported seven cargoes from its long-term contracts at 6 dollars and 6.8 dollars. But the Trafigura offer was not taken up. By May of 2021, when the 12-month contract offered by Trafigura would have expired, Pakistan was paying 7.7 dollars to 8.6 dollars for the same cargoes, double what was on offer a year earlier. Many people from the opposition parties are accusing the government of negligence in not taking on this offer at the time.
Pakistan was not alone in turning down these kinds of deals, Rohatgi says. “Most countries were not picking up these offers,” he tells Eos. “The main reason was the uncertainty at the time and most countries believed the winter demand would not be very high. This is one of the reasons why there was such a big price spiral last year too,” he continues, because winter turned out to be much colder than normal, while countries also opened up their economies.
Curating the LNG supply chain is a tricky business if it is to be in government hands. It involves finding the least cost path to shield the economy from the price volatilities that are a part of the LNG market, as well as supply disruptions. Natural gas fills half of Pakistan’s primary fuel needs, and imported LNG is almost half of the country’s total gas supplies now.
Less than a decade ago, LNG was non-existent, meaning its spectacular growth as critical fuel is only going to grow in the years ahead, as domestic gas supplies continue to dwindle. Managing LNG imports, smoothing price and supply volatilities will become an increasingly important part of the government’s portfolio of responsibilities, and a high quality tendering process will be at the heart of this effort.
It is very difficult to calculate the full cost that Pakistanis have paid, through their bills, for this mismanagement. Just this week, however, Nepra said during a public hearing that LNG shortages have cost power consumers Rs9.6 billion in extra costs. Generating a proper dollar figure would depend on the assumptions one makes about the lost opportunity cost — from failing to ramp up spot market purchases when their price had crashed from April to July 2020, and from the poor quality tendering process.
Perhaps there is a good explanation for all this. At the moment, none are forthcoming. Several messages were sent to the Minister Energy, Hammad Azhar, seeking comment and clarity on these questions. Despite the passage of more than 48 hours, however, no response was received.