Pipeline-system based producers are coming under greater pressure as the problems associated with the predominance of the established oil-indexed pricing system have become increasingly apparent. LNG challenges this increasingly out-dated pricing system and promises to break traditional monopolies in the sector, offering flexibility in the choice of suppliers, and therefore ensuring increased security of supply.
Gas market pricing in different parts of the world remains fragmented, mostly driven by regional as well as local level dynamics rather than global factors. For instance, in Asian and emerging market economies, gas prices are determined mostly by indexing them to oil prices, whereas in the North American gas market, prices are set by liquid trading hubs, the most important of which is the Henry Hub. In the European market, however, natural gas is sold almost exclusively via gas hub pricing or long-term contracts, which is based on oil product-linked pricing.[1]
Due to the shale gas revolution in North America, in the last 5 years, natural gas prices have decreased considerably, hitting the lowest rate in 2010 of 1.9 USD million metric British thermal unit (mmBtu). Nevertheless, the rate rebounded in 2014, reaching 5.9 USD/mmBtu at Henry Hub prices. In Europe and Asia, in contrast, gas market prices remained significantly higher than the prices in the North American market, which stood at 8-10 USD/mmBtu and 14 USD/mmBtu, respectively.[2]
Although spot prices in Asian and European markets were much higher than the prices in North America, two major effects that took place in 2014 have put downward pressure on short-term gas prices. First of all, prices have gone down due to weak gas demand in Asia and Europe thanks to the mild weather conditions, and secondly, the crude oil price has plunged since 2014 from an average price of 100 USD/bbl to below 50 USD/bbl. Consequently, gas prices in the EU market have plummeted rapidly, falling from 10.8 USD/mmBtu to 6.4 USD/mmBtu in 2014.[3]ÌýÌý
Previously, LNG was traded almost exclusively under inflexible, long-term fixed destination contracts. Since 2000, however, the number of contracts signed as spot and short-term, covering less than a two year time period, have risen significantly.[4] Especially after the global economic crisis of 2008, the European demand for gas diminished substantially. With the help of new LNG supplier countries, which have come on stream the amount of short-term gas supply has increased. This surplus gas has pressured the EU gas market to change its price setting mechanism. As Jonathan Stern underlines, “during the late 2000’s, the rationale for retaining oil-linked gas pricing changed from an argument that this was the most appropriate mechanism, to an argument that no other mechanism was availableâ€�.[5]Subsequently, this had brought a change from oil-indexed pricing to a spot gas pricing. As the LNG market has become more liquid, the number of sellers and buyers in the market has increased at an exponential rate and short-term, spot market trading in the LNG market share has also experienced dramatic overall increase. This increased liquidity has improved the overall resilience of short-term LNG trading.Ìý Although this change has not totally shifted the oil-product-indexation system, spot market pricing has ıncreasıngly been accepted.
As a result of this shift in the pricing system towards more market-friendly spot pricing in the LNG market, long-term LNG contracts have become more flexible, permitting quantity adjustment with better destination flexibility and greater price options. Therefore, flexible long-term LNG contracts have brought greater benefits, as Peter Hartley suggests, “such contract provisions allow parties not only to cope with temporary operational disruptions but also to exploit profitable short-term trading opportunities�.[6] Additionally, according to the International Gas Union, “the growth of flexible destination supplies, the proliferation of portfolio players and a range of other factors� were reasons for the emergence of new contract agreements.[7]While the percentage of non-long-term LNG trade was only 10% in 1997, in 2014, 27% of all LNG trade deals were agreed under spot and short-term pricing, indicating that LNG trade has undergone significant change.
A number of other important factors have contributed to the incremental increase in the number of non-long-term contracts. First, the capacity of global regasification has increased. Second, without a pipeline system or any domestic production, the large increase in demand in South Korea, Taiwan and Japan has forced these countries to rely on non- long-term LNG contracts in order to deal with sudden demand changes in the domestic market, as was the case for Japan with the Fukushima crisis. The third reason is the great discrepancy in price between Pacific and Atlantic basins, which has increased the appetite among traders for arbitrage. Buyers would clearly prefer these contracts signed as spot and short term to maximize the opportunity to profit from profit from fluctuations in the value of currency. A further reason for non-long-term trade is related to the contracts signed with destination flexibility, particularly from Qatar and the Atlantic basin. This has simplified diversification to better-priced markets. Lastly, the percentage of non-long-term traders has increased substantially in recent years. In 2000 there were only eight spot importers and six spot exporter countries, whereas in 2014 twenty-eight countries imported LNG as end-users from twenty-six countries including re-exporters of spot trade.[8]
Given the advantages of recently developed spot and short-term pricing, LNG has become more affordable, and it therefore constitutes a viable challenge to the increasingly out-dated oil-pegged gas pricing system. This development has also shown that LNG meets the requirements for diversification strategy of major natural gas consumer countries. The new dynamics created by LNG put further pressure on major suppliers and, in potential times of crises, it creates an option to obtain gas from a variety of sources based on hub pricing.
Ìý
[1] Timera Energy., “A Framework for Understanding European Gas Hub Pricing�, (2013) http://www.timera-energy.com/a-framework-for-understanding-european-gas-hub-pricing/
[2] International Gas Union, World Gas Conference Edition, World LNG Report, 2015, P.16
[3] Ibid, P.17
[4] Hartley, P., “The Geopolitics of Natural Gas, The Future of Long-Term LNG Contracts�, Harvard University’s Belfer Center and Rice University’s Baker Institute Center for Energy Studies, (October, 2013)
[5] Stern, J., “Continental European Long-Term Gas Contracts: Is a Transition Away From Oil- Product-Linked Pricing Inevitable and Imminent?� Oxford Institute for Energy Studies, (2009), P.3.
[6] Ibid, P.7
[7] International Gas Union, World Gas Conference Edition, World LNG Report, 2015,
[8]Ibid, P.15