Journal of Energy Markets

The liquefied natural gas spot market and valuation of the rerouting option

Hélyette Geman and Sofia Philippou

  • Natural Gas is increasingly replacing crude oil in industrial applications because of its fewer emissions and Liquid Natural Gas emerging as a commodity in its own right
  • LNG tankers are smaller and more efficient and allow for the introduction of optionalities in standard supply contracts
  • The rerouting option is described and priced under a mean-reverting model

The liquefied natural gas (LNG) market has experienced remarkable changes in the last few years, with long-term contracts being replaced by short-term ones and optionalities being granted by suppliers in the context of a large increase in natural gas production. Flexible LNG contracts give buyers the option to redirect their cargo if they identify a higher spot price at a point different from the original destination. The goal of this paper is twofold: (1) to describe the new outlook of LNG markets, which has become more and more spot-centric, with Asian LNG futures bringing transparency to spot and forward prices; and (2) to address the valuation of the rerouting option, a number that must be accounted for by the buyer when assessing the profitability of a given cargo. As an example, we apply the rerouting option valuation methodology to a scenario in which the supplier is the United States, the original destination is Germany and the alternative destination is Japan. We assume the rerouting of the vessel takes place when the cargo reaches the waters of Germany. This approach can be used for any group of three countries by adjusting the transportation costs. Our paper also depicts the value of the option as a function of the volatility of the natural gas spot prices in the alternative destination.

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