Around three quarters of global trade in LNG is transacted within long-term contracts between buyers and sellers rather than on spot markets. Contracts do not specify exact delivery times and shipment-level data suggests they operate as call options. Buyers receive shipments at times of high demand due to weather shocks, which is also when local spot prices are relatively high. For contracts to be incentive compatible for sellers, contract shipments must generate surplus for buyers that is shared with sellers via contract prices. We model how relationship-specific investments create contract surplus and how the share of surplus going to the seller compensates for both their investment costs and their spot market opportunity costs. We estimate the model with data on all global LNG shipments between 2009 and 2019. Preliminary results suggest investments within contractual relationships mitigate spot market frictions arising from distance and LNG shipping technology. Given the relatively inelastic supply due to liquefaction constraints, contracts also limit the size and value of spot markets, contributing to dispersion in global gas prices and price volatility over time.
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