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The Future of Long-term LNG Contracts

Long-term contracts have long dominated the international market for LNG. Since 2000, however, the proportion of LNG-traded spot or under short-term contracts has grown substantially, while long-term contracts have become more flexible. While long-term contracts increase the debt capacity of large, long-lived, capital investments by reducing cash flow variability, they also may limit the ability of the contracting parties to take advantage of profitable ephemeral trading opportunities. After developing a model that illustrates these trade-offs, we argue that increased LNG market liquidity resulting from a number of exogenous changes is likely to encourage much greater volume and destination flexibility in contracts and increased reliance on short-term and spot market trades. These changes would, in turn, reinforce the initial increase in market liquidity.

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JEL Codes: F18: Trade and Environment, Q41: Energy: Demand and Supply; Prices, Q42: Alternative Energy Sources, Q35: Hydrocarbon Resources, G13: Contingent Pricing; Futures Pricing; option pricing

Keywords: Long-term contracts, LNG, Investment project leverage, Opportunistic trades

DOI: 10.5547/01956574.36.3.phar

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Published in Volume 36, Number 3 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.


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