By Ersin Merdan
Impending revolution in spot LNG pricing

- The Writer holds an MSc in Eurasian Political Economy & Energy from King’s College London and also an MA in European Studies from Sabanc─▒ University.

Until the late 2000s, most LNG deals were signed under long-term, inflexible and oil-indexed contracts. However, from 2000 onwards, the idea of oil-indexed pricing as the best mechanism to be implemented began to take root and changed the argument that no other alternatives to the existing long term contracts existed.

The LNG market has become more liquid with the constant increase in the number of LNG exporter and importer countries, the commercial developments in the spot market, and the flexibility of short-term LNG trade. These factors have increased the flexibility of LNG trade in the natural gas market.

A few important factors in the global LNG market have contributed to the formation of spot market prices. Firstly, the serious increase in the gasification capacity on a world-wide scale has altered the market. Secondly, the amount of LNG used in Japan and South Korea, countries which prefer not to use pipeline gas due to energy supply security concerns and diversification aims, have opted for LNG. Flow has reached 150 billion cubic meters (bcm) per year in both countries. Due to the unexpected increase in demand in this region, the need for a short-term spot market has increased and contributed to the price formation. In addition, the price gap between the Atlantic and Pacific regions continues to expand with countries in the Pacific region paying more than their counterparts in the Atlantic region. The increase in the number of LNG producers who want to benefit from this Pacific market have forced the market to acclimatize to the new conditions.

According to the International LNG Importers' Group data, a total of 68 million tons of spot market sales were realized by 2015, which accounted for 27 percent of global gas trade. The short-term spot market, which constituted only 1 percent of the world’s LNG trade in 1995, has achieved a notable rising trend over the years and future projections assume that this trend will continue. According to the figures provided by the International Group of Liquefied Natural Gas Importers (GIIGNL), the spot and short-term volumes of LNG is expected to exceed 150 bcm by 2018, and is projected to surpass 200 bcm by 2025. We can deduce that many countries will play an increasing role in the energy mix in the upcoming period, assuming that short-term spot pricing in this framework is more than just a temporary phenomenon, gaining momentum both for the LNG market and hub pricing.

The GIIGNL report on the portfolio of spot LNG highlights that the spot and short-term LNG trade amounted to 10 million tons per annum (mtpa) in 1999, and reached around 70 mtpa by 2014. The report predicted that global LNG trade in 2015 had risen by more than $120 billion on a contract basis and that this increase was due to spot market increases and the loss of oil’s dominant market position over the previous years.

LNG prices, which reached the lowest price level in the last seven years in April 2016, have created the expectation that the low price level will continue due to surplus of market supply, low oil prices and the slowdown in demand. LNG prices in Japan have gone down to the level of $4 per million British thermal unit (MMBtu). When this price level is compared with three years ago, it is predicted that there will be a three-tier loss and that this figure would decrease to $3.40/MMBtu next year. Spot-market LNG prices in the Asia-Pacific region have declined to $4.70/MMBtu, while in Europe this has dropped to $4.30/MMBtu in 2016.

When assessing global natural gas market prices, regional and local dynamics have proved to be more effective in determining prices than the global price mechanism. While Henry Hub determines the price of natural gas in North America, the Asian natural gas market benefits from oil-indexed contract prices. The Henry Hub in the U.S. and the NBP in the U.K. provided a significantly lower price tag for U.S. and U.K. consumers. Although Europe has maintained its oil-indexed pricing in the natural gas market, it is also been observed that the market has been increasingly influenced by spot pricing.

LNG prices have been relatively more costly compared to natural gas via pipeline, and this has prevented the increase in investments in many countries. The shale gas discovery in America, spot market pressures at Henry Hub and the increasingly strong short-term and spot market in the EU gas market have put a downward pressure on LNG prices. Moreover, oil prices at a level of $50 depressed upward price hikes, causing LNG prices to decline to a more reasonable level.

The short-term spot prices in the European and Asian liquid gas markets were higher than the hub prices in North America in the period up to 2014.However, as the temperatures were not as cold as they had anticipated in the past years; along with the weakening of demand and the ongoing global economic recession, the gap between short-term spot pricing and long-term oil-indexed pricing has begun to decline in the past few years.

Although hub pricing has been effective in the U.S. and the EU spot gas market, this structure has not yet been an effective pricing mechanism in the Asian market. Long-term oil-indexation is an effective pricing method in the Asia-Pacific LNG market, however short-term spot market contracts are not fully effective. The International Energy Agency stated that 50 percent of the total LNG contracts in the Asia-Pacific region will end in 2017, suggesting that there is an opportunity for U.S. and other LNG exporters to implement a pricing mechanism that will offer more flexible conditions. According to the IEA’s data, they predict that the Asian market will be the largest LNG market by 2035 and the quantity of LNG supplies will exceed that of North American and the European market. However, as there is no strong competitive market in the Asian natural gas market, there is much speculation as to how the market will evolve in the near future.

When looking at recent developments, LNG can be evaluated as playing an effective role by providing flexibility through various supply options and in energy supply security. With the impact of changes in market dynamics leading to a more efficient sport market, LNG’s potential will become clearer. A total of 10 percent of LNG consumption on a global scale is predicted to be used in the transport sector in the years to come. This amount is thought to be equivalent to Japan's annual LNG consumption, and consequently, conventional monopoly structures will be forced to change and adapt.

- Opinions expressed in this piece are the author’s own and do not necessarily reflect Anadolu Agency's editorial policy. 

09 Jan,2017
ANALYST