Only a change in the price formation mechanism will reflect the current supply-demand situation for LNG in Asia, not just a bid to reduce the price level, Jonathan Stern, professor at the Oxford Institute for Energy Studies, said at a seminar in Tokyo earlier this week.
"What is really the problem with LNG prices? Is it price level or price formation?" he said at the seminar hosted by the Institute of Energy, Economics, Japan, on Wednesday.
"If the prices are too high then it is price level, and this could be solved by short-term solutions," Stern, chairman of the Natural Gas Research Program at the OIES, said. "You could reduce the base price, reduce the slope or adjust the S-curve [formula in oil-indexed LNG contracts]." The S-curve is designed to protect LNG suppliers and buyers from extreme price volatility.
Describing current LNG price as not reflecting market conditions, Stern said a change in price formation mechanisms were needed to ensure this.
Stern's comments come as Japan's average LNG import prices as well as Asian spot LNG prices have seen a steady rise year on year since the devastating March 2011 earthquake and subsequent nuclear outages.
Platts April spot LNG Japan Korea Marker was $17.20/MMBtu Thursday, a premium of $13.704/MMBtu to US Henry Hub futures and $6.873/MMBtu above UK's National Balancing Point. Japan's average LNG import price in 2012 was $864.07/mt or $16.62/MMBtu, up 13.4% year on year.
Stern suggested that different alternatives be explored if the current price formation mechanism was an issue by looking at alternative fuels market for gas to decide which would best reflect the conditions at present.
Spot LNG price indexation could be an option as it reflects current Asian demand and supply balance, he said, but added that the cargoes were too few to be used for long-term contracts.
HENRY HUB PRICING ONLY A SHORT-TERM OPTION
Henry Hub gas prices could also be an option as it is an established mechanism, but it is not based on Asian or Japanese market fundamentals, Stern said. Though current Henry Hub prices are lower than Japan Custom Cleared crude oil prices -- a dominant benchmark for long-term LNG imports in Asia -- this would not always be the case, he warned.
"If you see a possibility that Henry Hub prices could rise significantly above $6/MMBtu, and also if you believe it is possible for oil price to fall below $100/b, then suddenly you might get a reversal of those dynamics," he said, adding that Henry Hub pricing is "a short-term device to reduce price level, rather than a long-term solution to establish a different mechanism."
Japanese power and gas utilities are seeking ways to use gas benchmarks to cut their rising LNG import costs as the country buys LNG at oil-indexed prices, which contributed to a record trade deficit in 2012, after the first trade deficit in 31 years seen in 2011.
"But I think Henry Hub pricing entails significant risk, and a concept which should be critically examined as to whether it can be a long-term solution for importing LNG into Asia," Stern added.
ASIAN HUB AS PRICE REFERENCE POINT
He suggested the establishment of an Asian hub as an option for price reference, while weighing the different choices available.
"Everybody has to agree on where a hub should be," Stern said. "If you have too many hubs, you cannot get enough liquidity. Without liquidity, you cannot get an acceptable price reference."
Singapore "is a good start but probably not a long-term, large-scale solution" because the market is small and storage limited, he said.
While he saw Shanghai having a higher claim because "China is already Asia's biggest gas market and could become its biggest LNG importer sometime in the 2020s," he expressed certain reservations.
China has a good mix of domestic conventional gas, pipeline gas, imported LNG as well as the possibility of unconventional gas in the future. But market dynamics, dominated by three state-owned companies, are too different from Japan, South Korea and Taiwan. "For me it is not going to be a hub in the sense that we have described the Henry Hub or the European hubs. It is more a reference price for the Chinese gas market," he added. Japan was "a logical place for a Pacific LNG hub" but he wondered "whether Japanese stakeholders really want to create a hub" in the country.
All utility stakeholders and the government entities must get together to make it happen, he said, adding that a hub needs a degree of liberalization. "You probably need to have third-party access to regasification terminals and you probably need to have some degree of unbundling," he said, referring to a separation of operation and ownership of infrastructure from LNG supplies.
"Even without liberalization, I do not think it is impossible that a hub could be created," he said, adding that liberalization, however, would bring in more participants.
The future of trading in Asia could be via a number of different hubs, or the gradual emergence of a single Asian hub, Stern said. "But, I cannot over stress this: it depends on what market players want. This has to come from Asian LNG and gas market stakeholders."
