Innovation of the year: Lacima

Energy Risk Awards 2022: Lacima develops innovative LNG deal valuation and shipping optimisation tools

Chris Strickland, Lacima

In recent years, the liquefied natural gas (LNG) market has grown quickly and experienced rapid changes to the way it is traded. The growth of the spot market and the proliferation of LNG facilities have increased optionality around physical delivery while new flexibility clauses make valuing a deal with embedded optionality increasingly difficult.

These new market dynamics have been particularly important recently with the effects of the pandemic and the war in Ukraine, which have blown out volatility, reduced correlation between hubs and significantly changed shipping dynamics. Risks and opportunities are now huge for holders of LNG portfolios and holders of LNG flexibility. Individual flexibility terms are often worth hundreds of millions of dollars and occasionally over a billion dollars. Understanding and valuing flexibility can make, or break, LNG businesses.

Across an entire portfolio, the flexibility and embedded optionality is even more challenging. Flexibilities embedded in a contract are often interdependent, requiring a series of decisions. Additionally, decisions around the exercise of flexibility and associated nominations need to be tied to shipping programmes so that deliveries match demand in the most efficient way.

Lacima, winner of the 2022 Energy Risk Innovation of the year award, has developed tools that address these two significant analytical problems: firstly, how to value and understand the individual components of structured trades that have flexibility terms and embedded optionality; and secondly, how to optimise shipping schedules for a portfolio of LNG deals. This could involve, for example, optimising and nominating a firm’s annual delivery programme (ADP).

“How market participants construct LNG portfolios, and subsequently optimise the shipping of the gas can create millions of dollars of value,” says Chris Strickland, chief executive at Lacima. “To maximise this value, participants are increasingly building large portfolios of physical and financial contracts with overlapping optionality.”

For example, a buyer with a contract for 12 LNG cargoes a year and the option to cancel up to four a year, might decide to cancel them if it becomes cheaper to buy them in the spot market. However, if the contract also gives the buyer the flexibility to divert cargoes, it might decide to buy them and move them to Europe, especially with today’s high prices. This choice might change again according to how the LNG is priced in the contract – for example, whether it’s priced against Brent or using the Japan Korea marker.

“There’s lots of layers of embedded optionality that make the decision quite complicated,” Strickland says. “Historically, a lot of flexibility in contracts was given away, but now LNG firms are understanding that there’s huge value attached to this flexibility, and they want to price it. Similarly, buyers are trying to understand how much they should pay for that flexibility and what flexibility they should be asking for.”

There is a lot at stake. With gas prices recently trading around $40 per metric million British thermal unit in Europe, a single LNG cargo has a value of around $120 million, while an LNG train of 60 cargos a year has a book value of $7.2 billion per year. A company with 10 trains would then have a book value of $72 billion per year.

Rising prices have also increased the value of flexibility. “Flex terms alone can be worth more than the underlying intrinsic deal, creating huge potential profits and enormous risks,” says Strickland.

Up to now, efforts to value these flex terms and optimise shipping schedules have tended to over-simplify the issue using basic models that don’t take the optionalities into account, says Strickland.

Lacima’s deal valuation and shipping optimisation products, which have been developed over 18 months through working with a number of major LNG market players, have a robust modelling framework that can accurately handle the complex interrelationships between various gas, oil and freight variables, as well as optimisation engines to compute the complex exercise of the inter-linked flex components.

The ADP optimisation engine also enables users to perform deep portfolio analysis. The framework handles key elements such as indexation and destination flex, the vessel types, which ports they can go to, their speed, fuel type and burn, boil off, and constraints around canals such as speed, fees and size of ships allowed. It uses a proprietary iterative approach that, depending on the portfolio being addressed, can result in runtimes of eight hours being reduced to under five minutes.

“With shorter runtimes you can do a lot more ‘what if’ analysis, such as adding or subtracting trades and vessels from the portfolio, as well as stress test analysis and stochastic simulation for risk purposes,” says Strickland. “Relatively small improvements in the shipping schedule deliver millions of dollars of additional portfolio value.”