Since 2000, diverging regional gas demand and production trends have induced a wider and more flexible network of trade-flows in an increasingly interconnected gas world, accelerated by unforeseen shocks in both supply and demand. North America and the UK entered the 2000s with liberalised markets and after many years of pro-competition EU regulatory initiatives, the dominance of oil-indexation in continental Europe began to wane in the aftermath of the 2008 financial crisis. In 2013 a combination of base price reductions and rebates brought Russian long term contract prices in competitive markets close to hub levels.
The major lesson from North American and European gas markets is that financial distress of major utilities is transformative. This certainly pertains to the situation of Japan’s power generation companies who, excluding TEPCO, are currently losing in excess of $10 billion per year because of the need to import higher quantities of LNG (due to the shutdown of nuclear plant) at prices linked to crude at prices in excess of $100/bbl.
Given the scale of the Asian importers existing oil-indexed LNG contracted portfolios (and hence the limited scope for adjusting price dynamics much before 2020) and the oil-indexed pricing expectations of non-US prospective suppliers, there is a developing mismatch in pricing aspirations not just for future, but also possibly for existing, contracts. The prospect of new supplies of US LNG post 2015 offers an alternative to the status quo in terms of pricing models.
This paper argues however that rather than basing new contracts on a US price benchmark, Asian buyers should develop a price formation mechanism more attuned to national or regional fundamentals. The paper concludes that we may move from todays ‘contractual impasse’ scenario to either a ‘smooth contractual transition’ or, less desirable for all parties, a scenario described as the ‘contractual train wreck’. While the growth of an liquid LNG trading hub is seen as a key enabler to move to a more rational pricing reference point for Asian LNG contracts, the paper recognises the not insubstantial challenges in achieving this, calling for institutional and policy change on the part of buyers as well as sellers in this crucial, historically high growth, market segment.
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