Asia's LNG conundrum

Jeremy Wilcox

Because of the lack of natural gas pipeline import infrastructure across much of Asia the region has increasingly turned to LNG imports, and in response to this growing demand a number of countries have entered the LNG export market in the past decade. But the sharp fall in crude oil prices in the past six months has the potential to change the dynamics of LNG pricing, and not necessarily to the exclusive benefit of Asia's importers.
Even allowing for a relatively mild winter, LNG imports into Japan increased by 1.2% last year according to preliminary statistics from the country's Ministry of Finance. Significantly, while the average annual value of these imports increased by 11% in 2014, reflecting the fact that LNG import prices are typically based on the average of the preceding six to nine months oil price, the LNG price for Japan and South Korea in December had fallen to around $10/mmbtu, and to $9.80/mmbtu in China, compared with prices around $16/mmbtu in January 2014.
The challenge faced by importers is - how do they react to the depressed oil price? For the past two years, faced with increasing LNG import demands as a consequence of post-Fukushima nuclear outages, Japan's importers have been calling for a change to LNG pricing with the US Henry Hub natural gas-linked pricing more competitive than oilindexed pricing. Other initiatives have seen a progressive shift from long-term to shortterm and spot purchases, while Japan's government launched a spot LNG market last year and plans to launch a futures market this year.
As a rough rule of thumb, when the crude price is $90/bbl and the US Henry Hub price $5/mmbtu then the market is considered agnostic, ie, there is no appreciable price advantage from either price indexation. The obvious assumption, with the Brent price currently below $60/mbbl, is that there would be no financial benefit through indexing LNG to Henry Hub prices. But this assumption is imperfect. Natural gas prices are also influenced by the oil price, even if they are not directly oil-indexed, with Henry Hub trading in early February around $3/mmbtu, down from over $5/mmbtu twelve months earlier.
At current prices, with an oil price just under $60/bbl and a Henry Hub price just below $3/ mmbtu, there is little difference between the indexers; against oil, LNG indexes to around $8.40/mmbtu, and against Henry Hub it indexes to around $8.90/mmbtu (CIF).
For importers, the issue is whether these indexation dynamics will diverge. It would appear that most importers that had been pressing for Henry Hub indexed pricing are now less vocal. While the current low oil price and abundant supply tends to support such a view the forward curves for Henry Hub and Brent suggest otherwise. While both curves exhibit a similar contango, with prices increasing 26% between March and June 2017 for both futures contracts, a June 2017 Brent price of $71/bbl would index LNG around $9.80/mmbtu compared to an indexed price around $9.50/mmbtu for a Henry Hub price of $3.50/mmbtu.
But there is no certainty in forward curves; a quick reversal of OPEC policy or a reemergence of Middle East geopolitical risks could spike prices, while an OECD economic contraction could maintain depressed prices. It is this uncertainty that argues against importers locking in to long-term indexed supply deals, whether the index is against natural gas or oil. And the growth in LNG exporters, with Russia, Yemen, Peru, Angola and Papua New Guinea becoming exporters in the last five years, provides the supply diversity that supports shorter-term and spot purchase contracts.
And even though the oil price has more than halved since last summer, LNG project construction that had commenced before the oil crash is still proceeding, with companies treating this investment as sunken costs. But there is less certainty toward proposed LNG projects that have not received Final Investment Decisions. As a result a number of proposed projects in Australia have been shelved, while proposed projects in Russia, Canada and East Africa are uncertain.
Low oil prices could also potentially impact LNG flow and supply security. An increasingly aggressive price stance by Asian importers, buoyed by depressed oil prices, could lead to more LNG cargoes being diverted from Asia to Europe with the knockon potential of a squeeze on Russian natural gas pipeline imports into Europe. Low oil prices will also impact US LNG producers, which seek a minimum export price around $11/mmbtu in order to be profitable.
With the peak Northern Hemisphere winter coming to and end, and, in the absence of any unforeseen market developments, oil prices likely to remain subdued throughout the forthcoming summer, there is likely to be continued pressure on LNG prices in the near term. This will be to the benefit of LNG importers, but longer-term the benefits are less certain. LNG import prices can only fall so far due to the costs of gasification and transportation, and oil prices are more likely to increase than fall further.
BP's announcement in February that it would cut capital expenditure by 13% in 2015 pushed up the price of Brent 6% with other producers also likely to review investment during a low oil price scenario. Similarly, Saudi Arabia may be able to sustain a nearterm low oil price but other OPEC members are less cushioned against low prices, which may test the cartel's collective will not to manipulate output in order to shore up prices.
LNG will continue to be a demand-led market. Since 2003 the number of exporting countries has increased from 12 to 17, while the number of importing countries has more than doubled from 13 to 29. But much of this increased demand has come from countries that also import pipeline natural gas, which provides more gas import price flexibility. Japan and South Korea, Asia's largest LNG importers, lack this flexibility.
Buoyed by the low oil price, and the forecast growth in LNG supply capacity, Asia's large LNG importers are banking on lower LNG prices to reduce their energy costs. But increased demand from new LNG import countries that also have natural gas pipeline import capacity could potentially undermine this lower price vision, even if oil prices remain depressed and future LNG projects are not cancelled.
This being so, the medium-term conundrum potentially faced by Asia LNG importers is whether they prioritise supply security, or affordability.

Jeremy Wilcox is managing director of the Energy Partnership*, an independent Thailand based energy and environment consulting firm. *353 Supalai Premier, 9 Ratchadapisek Road, Chongnonsi, Yannawa, Bangkok 10120, Thailand. T:+66 2 163 4073 Mobile: +66 8 6099 3375