LNG projects require substantial capital investments in liquefaction trains and other supply infrastructure, which developers must have assurance that they can recover. Therefore most LNG is traded under long term contracts, typically of 10-20 years duration.
Spot trading in LNG remains relatively modest, so some basis other than spot LNG prices must be found for setting LNG prices under these contracts. Although LNG (and natural gas generally) competes with both oil and coal in the electricity generation and direct-use markets, LNG is usually viewed as a premium fuel, like oil, due to its relative cleanliness, ease of use and ability to be transported by sea over long distances.
LNG spot prices have fluctuated from highs around $24 mmbtu during the summer of 2008 to lows of around $4 mmbtu during the first quarter of 2009. For these reasons, Asian LNG prices are indexed to crude oil. Long term LNG contracts in Asia have historically been linked to prevailing crude oil prices, and there are typically 3 pieces to the contract calculation: the oil price, the slope and the constant.
The calculation starts with an oil price reference benchmark, the one most commonly used is the JCC (Japanese Crude Cocktail), which represents the average monthly of a basket of carious crude oils imported into Japan. The JCC typically moves in line with other global crude benchmarks.
The second contractual price in the LNG price derivation is the negotiated factor, known as the “price slope”. Slope essentially defines the relationship between the oil and gas prices, and is then multiplied by the JCC. On average, 1 mmbtu of gas has about 16.67% of the energy content of a barrel of oil (i.e. the 6-to-1 heat equivalent parity). Contract slope is typically expressed in percentage terms, thus if the heat equivalent parity were used, the slope would be 16.67%. Contract slopes are typically slightly less than 16.67%, usually around 14%-15%, but they could be higher if the buyer were willing to pay a premium over the heat equivalent oil price.
To further add complexity some contracts will have varying slope percentages used at different oil price levels. There can be 4 basic forms: the simplest is the straight-line constant slope that exposes both the buyer and seller to adverse price movements. A second type is the s-curve, which will have a flatter slope at low oil prices to protect the seller and a flatter slope at high oil prices to protect the buyer. The other two types are variations on the s-curve, where either only the seller has some protection (a floor) or only the buyer has protection (a ceiling).
The final piece is the constant term, which generally represents a fixed price element that is independent of oil price movements. Most LNG contracts will include a modest constant, typically less than $1 mmbtu, which generally bears some implicit relationship to shipping costs.
LNG pricing in Asian markets, has historically taken the form of an “S-curve” (see also s-curve). There are often floors and caps on the LNG price. These floors and caps also vary with the price of oil, but with a lower slope thus resulting in an “S” curve. A floor price may effectively protect the producer’s investment whereas a price cap provides a quid pro quo for the LNG buyer.
Indeed, oil prices have historically been used as the basis for setting the price of LNG in the Asia-Pacific region under long term contracts. In China there are little local resources of natural gas so LNG does not have to compete with either indigenous sources or even pipeline imports from other countries and so can fetch higher prices than in the US. Therefore, any loose cargoes of LNG are attracted to the Asian market.
Henry Hub prices have lagged behind world prices since 2008, also because of greater production potential from local shale gas activity. In the USA, most of the LNG imported is either spot or short-term contracts and thus priced accordingly to the time of buy, rather than long term contracts. With the new shale revolution in the US, gas imports will fall to a minimum until the US becomes a net LNG exporter around 2015.
In Europe, LNG is usually linked to the price of Brent oil and here LNG prices are more diverse because they have to compete with both pipeline gas from a number of countries and local indigenous reserves.
LNG is still very much contract based market (and thus price details and terms are not readily available), especially in the US and Europe (mainly due to very large investments needed in infrastructure) rather than spot market, although there are spot deals, such as for diversion of cargoes from one market to another to be grabbed at higher market prices.
When comparing LNG prices it is important to ensure that these are compared on the same basis, namely “regasification” or “in-tank”. The only sensible manner to quote an LNG price in order to compare it to pipeline gas is after regasification.
The share of trade taken by the spot market has continued to increase albeit partly driven by short-term events. For a number of years, there has been the contention that the three regional markets, Asia-Pacific, Europe and North America, which have somewhat different pricing methods, will converge. There is now some evidence of this happening, for example, the “S-curve” being superseded by a near oil price parity (straight line) basis.
A number of suppliers, notably Qatar, which is now the world’s largest LNG supplier, have sought pricing parity with oil. Oil parity implies an “a” coefficient of around 0.1710. In reality, this may be hard to justify, particularly when inter-fuel competition with fuel oils and coal are considered. The “going rate” now appears to be around 0.145 (around 85% parity with oil) or even slightly above.
