Asia pushes for free-market liquefied natural gas
Liquefied Natural Gas (LNG) prices have long been linked to the price of oil鈥攚ith gas priced at roughly 13% or 1/8th the price of Brent, with the details determined in confidential contract negotiations.
Asian consumers are tired of this linkage, especially since it has meant prices that are four times higher in Asia than in North America.
In fact Japan spent US$75.4 billion on LNG last year, paying an average price of US$16.60 per million BTU鈥攚hile gas prices in the United States averaged just US$2.75.
No Japanese politician, economist, or grocer thinks that makes sense. So Asia is trying to lower prices for Liquefied Natural Gas (LNG) as fast as they can.听
It鈥檚 a fact that de-linking LNG prices from oil to Henry Hub makes a BIG difference for Asian buyers. For example Cheniere agreed to sell 1.6 to 1.8 mtpa to Korean Gas for US$3 per MMBTU plus a 15% premium to Henry Hub prices.
Here's some context to that: On听April 30, 13% of Brent would equal $13.47/mcf. On the same day the Cheniere deal would have Korean Gas paying ~$7.51/mcf. That鈥檚 a big difference! Cheniere has signed similar Henry Hub-indexed deals with three other buyers.
But Asia doesn鈥檛 just want lower prices in individual deals. No, Asian buyers want the market to determine how much LNG is worth 鈥搕hey are convinced the market will push LNG prices down fast with waves of new supply on the horizon.
They may or may not be right on this one.
Futures contracts are the way markets determine how much a commodity is worth. For LNG such a system would also improve the credibility of pricing information and act as a valuable hedging tool.
Japan is pushing for a futures market for LNG鈥攁nd the potential Canadian supply could be the first to get priced this way.
It鈥檚 not just talk. In March Japan鈥檚 Ministry of Economy, Trade, and Industry (METI) announced plans to launch the first LNG futures contract at the Tokyo Commodity Exchange in two stages starting in 2014.听(Related article:听)
The first step would be a cash-settled contract, with settlements based on the spot price on the last session of the month. These cash-settled futures could be sold up to one year forward and would be based in US dollars and metric tonnes.
When I heard this, I called听听in New York, former floor trader and author of Oil鈥檚 Endless Bid鈥攖he best book I ever read about the financialization of commodity prices and what it means for retail consumers (it means higher prices and more money out of our pockets).
My overall question was鈥攚ould a futures market lower prices? Or would the financialization of LNG do what it did for oil: create endless bids and higher prices? The short answer on both was no.
鈥淐reating a futures market won鈥檛 help create a cheaper pricing mechanism,鈥� he told me. 鈥淵es, it鈥檚 going to be less related to Brent and more to nat gas鈥攂ut more to local/Asian nat gas, where prices are high鈥攏ot North American natural gas. If I was trading physical, that鈥檚 how I would expect the new market to react.鈥�
Dicker is the kind of trader who would play in a LNG futures market 鈥� and he thinks Asian prices would stay high.
The problem is that a commodity market needs a full complement of players. Producers, wanting high prices, are already long in an emerging futures market. To counter, LNG buyers are naturally on the short side. Then traders enter the scene, playing the difference and speculating on the actual supply-demand situation.
Dicker says it took years for this financialization of natural gas to take hold in the US and it was the investment banks who added enough outside players to make that happen.
To find out what Dan Dicker is investing in now 鈥� start a 30 day free trial to Oil & Energy Insider 鈥撎�
Japan may want free market LNG, but to financialize LNG it will need a bigger playing field.
Japan's utilities are huge buyers of LNG.听 But what Japan doesn鈥檛 have is a natural market of sellers 鈥� they don鈥檛 have a large homogeneous group of providers, like the United States has with its oil producers.
So the question is: Could financialization of LNG give rise to an endless bid cycle?听(Related article:听)
Might Japan be putting the cart before the horse?
Not only are the players lacking, but Japan鈥檚 proposal has some gaping holes. For one, the futures LNG market it imagines would be for true physical delivery鈥� buyers would actually want to take possession of LNG.
In the US, the futures almost never become physical 鈥� which is the case with most futures markets. So they 鈥� Henry Hub and Japan鈥檚 LNG proposal 鈥� are very different markets. And there鈥檚 little in the way of a blueprint for Japan鈥檚 version.
That doesn鈥檛 mean we don鈥檛 need a better pricing mechanism for LNG. The growing spot market desperately wants one.
The spot LNG market is growing, and fast. Spot trades grew from 10% of global LNG trade in 2003 to 25% in 2011, and volumes continue to climb.
There鈥檚 a good reason the spot market is hopping 鈥� buyers and sellers want more options. A natural disaster here, a hurricane there 鈥� LNG needs can change quickly and so supply flexibility is an increasingly important concept in the LNG world.
For a spot market to hop, however, requires a recognized and reputable spot price鈥uch as a futures market.
It鈥檚 a chicken-or-egg scenario, for sure.
While Japan鈥檚 futures market could start next year, it will still take years for global LNG prices to break free from oil indexes and secretive long-term contracts. The next wave of LNG supply to come online will be in Australia, in 2015鈥攁nd they have sold their gas in long-term contracts at oil-indexed prices.
But the system will change, eventually, because LNG is outgrowing its pricing and trade systems. Such is the cost of success.
It will be very interesting to see how it all pans out 鈥� and how LNG proposals in Canada react.
Original Source:听
