Enerdata Analysis Brief

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Procuring competitively priced gas and establishing a regional price indicator has become a critical
concern for the governments in the Asia-Pacific. After bringing its new LNG terminal on stream in
May 2013, Singapore has announced its ambitious aim of becoming a natural gas trading hub in the
Asia-Pacific. In September 2013, Japan and India considered the option of joint tenders to procure
LNG at a competitive price and to bring down their soaring import bills. Suffering from huge costs
due to expensive LNG imports, Japanese government announced in April 2014 to move away from
zero nuclear policy in the new Basic Energy Plan. The decade long history of the gas deal signed in
May 2014 between CNPC and Gazprom shows the importance of natural gas price in the gas contract
negotiations. LNG importing countries like Japan, China and India have expressed their concern about
high LNG import prices and argued about developing an Asian price index for natural gas. Many
buyers in the Asia-Pacific economies have expressed interest in moving towards a regional gas
market indexed price (or gas-on-gas competition) from an oil-indexed system for pricing the
imported gas. This article explores the concept of trading hub in the Asia-Pacific region and explains
how the LNG industry developments can affect the development of a trading hub with reliable price
indicator.
Many believe that moving to gas market indexed pricing will make gas cheaper and the wish of
switching to a gas market indexed pricing from oil-indexed pricing has become a pressing issue for
government and industry players. However, there are many questions to be answered to support the
general belief that gas market indexed pricing will make gas cheaper in Asia. Few key questions to
answer are: Is there any real incentive to switch to a gas market indexed pricing in Asia-Pacific? Given
the higher volatility of historical gas hub prices as compared to oil prices, will gas market indexed
price be reliable and stable for producers and consumers alike? Do the current inter-regional
differences in gas prices provide a sufficient rationale to switch to a regional gas market indexed
pricing system for Asia-Pacific economies? All these questions are crucial to determine the success of
a regional price indicator in the Asia-Pacific.
Oil-indexed LNG pricing in Asia-Pacific dates back to 1970s when Japan was the main importer of
LNG. At that time, majority of end-users like electricity generators had a choice between burning gas
and oil and this gave birth to the system of oil-indexation. However, the rationale behind oil-indexed
gas price seems to have weakened with time. Figure 1 shows the consumption of natural gas and oil
for electricity generation in Japan from 1970 to 2013. The natural gas input to power plants in 1970
was a tiny share of just 1.3 Mtoe as compared to 45.7 Mtoe of oil on an energy equivalent basis.
Gradually, the natural gas consumption in the Japanese power plants surpassed the oil consumption
in 1996 and in 2013, the consumption of natural gas was around 78 Mtoe and oil was just 26 Mtoe.
The gradual increase in natural gas input and corresponding fall in the oil consumption shows that
the rationale behind oil-indexed gas price should be reconsidered. However, it is important to
consider many more factors to get a full picture of the debate on the pricing of natural gas.


Natural Gas Trading Hub in Asia-Pacific
Analyst Brief May 2014


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Figure 1: Consumption of Natural Gas and Oil for electricity generation in Japan from 1970 to 2013

Source: Enerdata, Global Energy & CO2 Data

The argument for an alternative pricing regime is compounded by the prevailing lower price level of
Henry Hub in the USA and the high prices of oil-indexed contracted gas. A gas market indexed pricing
system leads to a price that is formed by the gas supply and demand fundamentals. It may or may
not lower the price level. In short, gas market indexed pricing will affect the formation of prices and
not just the level of gas price. The prices will reflect the market value of the gas. It can be either
lower than oil-indexed prices or higher than the oil-indexed prices. Figure 2 shows the price of
natural gas at Henry Hub and average Japan LNG price. In 2013, the price differential between Japan
LNG price and Henry Hub was around $12/MMbtu. After 2006, the differential between Japan LNG
price and Henry Hub started to rise due to increase in gas supply in the US and growing demand in
the Asia-Pacific. This was compounded by the 2011 Fukushima nuclear disaster which led to a sudden
surge in Japanese LNG imports. It is interesting to note that between 2002 and 2005, Japan LNG price
was lower than Henry Hub gas price. This illustrates the previously discussed idea that a hub does not
necessarily lead to lower average prices.

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Figure 2: Gas and crude oil prices

Source: Enerdata, Global Energy & CO2 Data

A trading hub will lead to gas-on-gas competition based price that will be based on supply and
demand and does not necessarily mean lower prices. An increase in gas supply in the USA and
availability of infrastructure for gas transmission led to low Henry Hub prices which currently are
formed on the basis of internal North American gas-on-gas competition. On the other hand, current oil
prices are at a much higher level as compared to 2002-2005. The Japanese LNG contract prices are
mainly oil-indexed and hence, the spread between Henry Hub and Japan LNG have been growing after
2006. The recent increase in price differential is also due to speculative spot trades that reflect the
temporary surge in Japanese demand after 2011 nuclear disaster and the difficulty of getting marginal
supplies to it. Oil-indexed prices are driven by the oil markets and not by the supply demand
fundamentals of Asia-Pacific gas industry. A presence of a competitive trading hub in Asia-Pacific will
lead to prices that will reflect more the regional gas market dynamics rather than the global oil market
dynamics.

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What is trading hub?
Trading hub is a location (physical or virtual) where multiple parties interact and change the
ownership of a commodity. A competitive gas market is indispensable to establish a liquid trading
hub. A competitive gas market should have: a single price zone, accessibility to incumbents and new
entrants on equal terms, sufficiently liquid trading and reliable price signals in the spot and forward
markets. Trading hub
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can be classified into two types physical hub and virtual hub.
Physical hub refers to a geographical point in a gas transmission network for which the price is set by
the market dynamics. It is usually a point where multiple pipelines connect and there is an ample gas
storage capacity. Henry Hub (HH) is an actual physical interconnection point in the natural gas
transmission pipeline in Louisiana, USA. The Henry Hub price was selected by the New York Mercantile
Exchange (NYMEX) as a benchmark price for trading natural gas in the USA. All gas in the USA is priced
against Henry Hub using price differentials that accounts for the transportation costs from the Henry
Hub and regional supply and demand dynamics when the pipeline capacity from Henry Hub to the
region is constrained.
Virtual hub refers to virtual point in the network for which the price is set. National Balancing Point
(NBP) is a virtual point in the United Kingdom gas transmission system and is used as a daily balancing
tool by the British regulator. It was initially set up as a balancing point for the transmission grid and
gradually it evolved as a trading point. Natural gas trading on the Intercontinental Exchange (ICE) uses
NBP as the benchmark price. Prices for Henry Hub and NBP are available from early and mid-90s which
show that both of them are well established hubs.
Natural gas trade in Asia-Pacific is dominated by LNG. Figure 3 shows the LNG imports for China, India,
Japan and South Korea from 1980 to 2013. Japan is the largest market for LNG although China and
India are catching up fast. Total gas consumption in Asia-Pacific has outpaced total gas production and
this gap is forecasted to increase due to dwindling natural gas resources (in particular in Indonesia and
Malaysia) and growing demand.


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Glachant, Jean-Michel and Ascari, Sergio. A Target Model for the European natural gas
market, European energy regulators 2
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workshop on Target Model for the European gas
market, Bonn, 22 February 2011

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Figure 3: LNG imports for China, India, Japan and South Korea from 1980 to 2013

Sources: Enerdata, Global Energy & CO2 Data and Enerdata LNG World database

In 2013, Asia-Pacific accounted for 75% of the global LNG demand while Europe and North America
accounted for only 24%. Middle East consumed the remaining 1%. In the global context, short term
and spot LNG trade volumes have also increased from around 5% in 2005 to approximately 27% of the
total LNG trade. This is mainly due to the growing number of buyers and sellers, demand growth from
the emerging markets, price differentials between Pacific basin and Atlantic basin and the reloading
activity from the South American countries. The 2011 Fukushima nuclear disaster in Japan is also a
crucial short run factor for higher volume of LNG imports in the Asia Pacific region.
Development in the regional LNG trade can play a major role in the evolution of a trading hub and a
reliable price index in Asia-Pacific. By analogy with the pipeline trading hubs, the ideal location would
be able to source LNG from many locations, supply it to many locations and have storage to smoothen
out the short term price fluctuations. Pipeline trade is not feasible in Asia-Pacific due to geographical
and regional economic reasons and hence global and regional LNG market developments will play a
key role in the natural gas trading in the Asia-Pacific region. Evolution of trading activities in the region
will be influenced by the flexibility of the LNG supply chain. The factors that affect LNG supply chain
are availability of different supply options, shipping availability, regasification infrastructure, storage
facilities and contractual limitations.
The surge in shale gas production in the USA that has contributed to an increase in the availability of
LNG supplies as the LNG that was originally destined for US market now needs to find new markets.
The prevailing price differential between the Atlantic and Pacific basin has given the opportunity to
Middle East producers to divert the cargos to Asia-Pacific. Enerdatas estimate for LNG trade from
Middle East to Asia are around 75 MT in 2013. Short-term LNG supply is also affected by shipping
capacity. New supply from Australia is poised to enter the market. BG groups Queensland Curtis LNG
is expected to come online in 2014. Chevrons Gorgon Project is expected in 2015 or 2016. However,
the expensive nature of Australian projects always puts a question mark on the economics of new
supply.
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The escalation of spot charter rates in 2011 and 2012 due to higher spot demand in Asia have
increased the interest of market players in LNG shipping business. The total shipping capacity
increased from 51 mcm in 2011 to 54 mcm in 2013. Availability of LNG cargoes that are not under long
term contracts will be a key factor in determining the success of LNG trading in Asia-Pacific region.
A number of countries in the Asia-Pacific region are investing heavily in regasification infrastructure.
China, Japan, South Korea, Chinese Taipei and India already have regasification terminals. Indonesia,
Malaysia, Singapore and Thailand have recently come on stream and Vietnam and Philippines will soon
join the list. As per our LNG database for Asia shown in figure 4, there are a total of 49 terminals in the
planning stage, 20 under construction, 8 more have been approved and 8 are in bid process.
Figure 4: Regasification terminals in Asia-Pacific

Source: Enerdata LNG World database

A potential major bottleneck in setting up a regional price indicator is the different structure of
internal markets for Asia-Pacific. For example, if we compare the domestic market structure of Japan
and China, we see a fundamental difference in the way natural gas is valued by the domestic market.
Japan has a cost plus basis to sell the imported LNG but China follows a regulated cost of supply
approach. China is implementing new reforms but only time will tell if they are going to be successful.
Additionally, different Asia-Pacific economies are sensitive to different parameters. For example,
energy security plays a huge role in the energy policies of Japan but price is the key factor for India.
Also, from a geopolitics perspective, a unified LNG market seems a bit optimistic proposition. When
China and Japan are arguing over territorial disputes, it brings uncertainties for the private players
operating in the regional LNG market. US hubs operate with buyers and sellers that are under one law.
Geopolitical diversity in Asia-Pacific needs to be considered while thinking of one reliable price
indicator for the whole region.
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Another point to be mentioned is that no one can predict the level of the spot prices. It is highly
unlikely that spot prices in future will remain at levels of US$18-19/MMbtu in the New Asian Demand
Scenario after Japanese nuclear restarts and China-Russia deal that has locked 38 bcm of Chinese
demand to Russian supply. How the Australian projects that have costs around 2 000-3 000 US$/ton of
LNG will see themselves in this New Asian Demand Scenario will be interesting to watch. The reduced
LNG demand from Japan and China will affect the LNG trading opportunities as well as price levels in
the Asia Pacific region and LNG trading companies that were relying on massive Asian demand need to
rethink their strategy.
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