Worldwide: Setting an Asian LNG Market Price – the Search for a Local Solution

This short note is to introduce two detailed papers that discuss the justification for the development of an Asian LNG reference price that is not benchmarked against the current 'Japanese Crude Cocktail' and suggests an approach to how that might be achieved. A short summary of the two papers is provided below.

As the market stands today, U.S. LNG prices tend to be set by reference to the price of natural gas at the Henry Hub, European LNG prices are usually set by reference to the price of natural gas at either the National Balancing Point in the UK or the Title Transfer Facility in the Netherlands and Asian LNG prices are typically set by reference to the price of the Japan Customs-cleared Crude (known as the 'Japanese Crude Cocktail' or JCC). There are historic reasons for Asian LNG to be benchmarked against Japanese oil prices but these reasons no longer apply today. The question is, what alternative is there to enable the long-term purchase of LNG to be done on the basis of an effective and liquid index other than the JCC?

There are currently a number of measures of the Asian LNG spot price which could form the foundation for a forward reference price. The most well-known are the following indices published by various price reporting agencies (PRAs): (i) the Japan Korea Marker (JKM); (ii) the Argus Northeast Asia index; (iii) the Singapore SLInG (SLInG); and (iv) the RIM DES Japan LNG Assessment. It is estimated that currently 40 per cent of spot and short-term LNG contracts are priced off the JKM, as published daily by S&P Global Platts. However, these indices lack liquidity and/or are considered not very transparent.

Many academic studies have considered the question of how an alternative to the JCC can be established for Asian markets, with most supporting the idea of the development of a liquid natural gas hub in locations such as Japan, South Korea, China or Singapore and the creation of an index based on that demand. There is consensus that there is a long way to go in each of the key LNG importing countries before a natural gas trading hub that has all of the necessary institutional and structural requirements in place for a hub, could operate. As such, an index based on a natural gas trading hub is five years away at the very least and may even be ten years away. Even if a natural gas trading hub can be developed in Japan, China, South Korea or Singapore, should the local price automatically equate to a price for the rest of Asia? Given the different economic, environmental and political differences that drive each country's priority for its LNG demand, it could be argued that simply following the U.S. or European approach of a physical or virtual natural gas hub is not the right solution for Asia. Instead, perhaps, what is needed is a 'made in Asia' solution for LNG pricing.

Such a solution may be in the form of an LNG (and not a natural gas) trading market and a reference price based on a virtual LNG hub. The features of such a reference price source are that it should be capable of providing an indicative price signal for the demand for LNG in the Asian market, have sufficient liquidity to provide confidence in its accuracy, be achieved with a transparency that enables users to understand what the price actually reflects, and be not so geographically 'national' so as to be unacceptable for other Asian users. Furthermore, the reference price should be available in time for the next significant swathe of long-term LNG supply contracts to be renewed or replaced (it is understood that many such contracts will need to be renewed or replaced in the next two to three years).

For a detailed discussion of the above, please follow this link to Part 1 of the two papers.

Depending on whether the choice of contract was for DES or FOB deliveries, at a virtual LNG hub LNG would be delivered either to or from a location within the vicinity of a specific country or, for example, a group of nearby ports in different countries rather than a specific geographical gas entry or exit point in one country.

Where the appropriate benchmarks for spot LNG charter costs for the most relevant LNG voyage routes are available, the significance of whether the underlying LNG index is a FOB or DES index becomes less relevant as determination of the appropriate net forward or net back can be carried out with accuracy. So, based on the features highlighted for a virtual LNG hub reference price above, how do the current, main spot LNG reference prices fare?

With respect to the JKM, which is the most liquid of the current spot measures, the average number of daily cargoes probably does not exceed two. Therefore, they all lack liquidity. A lack of a standardised spot or short-term LNG master sale and purchase agreement is also preventing liquidity in the physical market.

An analysis of the differences between the baseline assumptions applied in the methodologies used by the respective PRAs provides some explanation as to why different prices are reported by each of the agencies for, essentially, the same product on the same day. The reasons for these differences are not otherwise readily transparent.

The SLInG appears to be an attempt to create a reference price on the virtual gas trading hub model, but it lacks liquidity and does not provide the necessary net-forward or net-back tools required to ensure its success.

One challenge a virtual LNG hub would face is assessing the accuracy of the price signal it offers against physical LNG demand. Using Singapore as a case study and testing it against the required features for a virtual LNG hub, it could be argued that a virtual Singapore LNG index could be established. Although, currently, sufficient physical demand does not exist in Singapore, for a variety of reasons (including the Singapore government's focus on promoting itself as an LNG hub and the impact of environmental regulations, which encourage use of LNG as a bunker fuel for commercial shipping), there is potential for that to change in the immediate near term.

In terms of the geographic acceptance of a virtual Singapore LNG price, Singapore represents a neutral position as neither a major consumer nor producer of LNG. Its central location at the intersection of LNG trade routes within the Asia-Pacific region offers a practical locational point for the development of benchmark reference prices for spot and forward LNG charter costs to the key geographical locations of demand, whether that is Japan, China, South Korea, India or elsewhere. This will allow the necessary net-back and net-forward pricing to be accurate and transparent. By enabling the spot charter costs to be separated from the pricing reference methodology for a virtual LNG price (on the basis that Singapore was not the final destination of the cargo), the price discovery through the reference price would be more transparent.

This proposal is not mainstream in that it argues for a virtual LNG hub and not a natural gas trading hub. However, it is borne of the need to collapse the time differential between the establishment of a natural gas trading hub in Asia and the need to establish a credible replacement for the JCC in time for the forthcoming renewals of the long-term LNG supply contracts of various buyers due over the next two to three years.

Please follow this link to Part 2 of the two papers for a more detailed discussion on the above.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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