Asia – tight link between oil, gas prices
Part 2 of 4
Japan, South Korea and Taiwan have practically no gas production of their own. They are far from the nearest gas pipeline. So they import LNG by tanker.
Natural gas might be a hassle to obtain for these nations, but gas has an overpowering allure: It's an alternative to oil.
The case of Japan illustrates.
In 1973, Japan got 77 percent of its energy needs from imported oil and 1.5 percent from natural gas, including LNG from a then-4-year-old plant in Alaska's Cook Inlet.
That year, the Arab oil embargo began as the Organization of Petroleum Exporting Countries flexed its muscles on the world energy stage. Oil consumers such as Japan got double-whammied: oil prices soared and the reliability of their imported oil supplies became questionable.
Japan launched a conscious effort to diversify away from oil as an energy source.
By 1990, natural gas provided 10 percent of Japan's energy and nuclear 9 percent, according to the Petroleum Association of Japan, with oil's market share falling to 57 percent.
By last year, Japan got 40 percent of its energy from imported oil, 17 percent from LNG and 13 percent from nuclear – the nuclear share plunged this year after the Fukushima disaster in March. Interestingly, coal supplied 25 percent last year – yes, Japan is more reliant on coal than natural gas for its energy needs; so is South Korea.
Last year, Japan imported an average of 9 billion cubic feet of gas per day, and Korea imported 4.3 bcf/day.
Like Korea, Japan has a trickle of its own natural gas production – about 6 percent of the gas consumed in Japan. In 2009, the domestic production averaged about 500 million cubic feet a day, over double current production from Alaska's Cook Inlet basin.
To make their big move away from oil toward natural gas, Japanese utilities (and those in South Korea) made some decisions that continue to affect the price paid for gas there today.
One decision involved signing contracts for suppliers to provide natural gas for periods of 20 or 25 years. The early LNG suppliers – Indonesia, Malaysia and Brunei – were endowed with large gas fields, so they could guarantee long-term shipments.
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This long-term arrangement helped Japan fulfill a critical national goal: security of supply. LNG makers also got what they needed: long-term customers so they could finance the huge up-front cost of developing gas fields and building liquefaction plants. Most of Japan's LNG imports arrive under long-term contracts.
These long-term deals were satisfactory to all. Buyers assumed the risk that they would need all the volume they were purchasing. Sellers took the risk that prices would remain adequate over time.
LNG tanker companies got into this game, too, locking their ships into these long-term deals, keeping the vessels busy for decades.
Linking gas price to oil
Another decision linked the LNG price to the price of oil. At the time, gas was replacing oil as a fuel, so the linkage made sense. Japanese buyers typically use a formula that blends prices of various imported crude oils, a blend known in the industry as the "Japanese Crude Cocktail," or JCC.
Gas is often sold in units of a thousand cubic feet, while oil is sold in units of 42-gallon barrels. Because a thousand cubic feet of gas holds roughly one-sixth the energy of one barrel of oil, a rule of thumb is that a thousand cubic feet of gas might be priced at around one-sixth the JCC price of a barrel. Whether on purpose or by accident, that has been the case. For example, from 1996 through 2007, the average LNG price in Japan was almost exactly one-sixth the price of oil.
The downside of this linkage is evident today, however. Oil prices lurched upward in 2004 and 2005, and kept rising, hitting a peak in the pivotal year of 2008.
Japanese LNG prices soared along with oil, although not quite as fast. This year's high oil prices – topping $100 a barrel for most of the year – mean very high LNG prices in Japan. In fact, the Japanese right now are paying the highest gas prices in the world.
Japanese utilities aren't being passive price takers, however.
Some Japanese utilities and other industrial gas buyers have sought to renegotiate terms of the long-term contracts in recent years. Some are investing in LNG projects in Australia, Indonesia and Russia's Sakhalin Island north of Japan to secure future supplies, the U.S. Energy Information Administration said in a March 2011 report.
The price of emergency spot LNG cargos in Japan, as the nation replaces power generation lost after the Fukushima nuclear disaster, has been even higher than the contract LNG price. However, spot cargos remain a small fraction of the overall LNG shipments to Japan.
Redundancy of infrastructure
The "security of supply" principle shows up in another feature of the Japan LNG industry: The country has far more capacity to receive and regasify LNG than is typically found among the bigger LNG importers. This redundancy lets Japan import more gas during winter and gives the Japanese peace of mind that if an earthquake, tsunami or even routine maintenance take out LNG infrastructure, the nation's gas-dependent industries will hum along.
The linkage of LNG prices to the Japan Crude Cocktail explains generally how the pricing scheme works in Japan, but digressions from the formula occur based on a variety of factors, including volumes shipped, distance the LNG travels, and how desperately the buyer and seller need the deal.
For example, Argus Media, which tracks the LNG market, reported that the July weighted average price in Japan was $16.19 per million Btu. But Japan took LNG shipments from 13 nations that month, with the price varying from $9.04 for Trinidad and Tobago LNG to $17.47 for Malaysian LNG. Spot cargos are selling for top prices, although most shipments are sailing under long-term contracts.
The story of how LNG is priced in South Korea and Taiwan is similar to that of Japan. Argus reported that Korean buyers paid an average of $13.36 in July. The shipments came from eight nations. The low price was $6.26 from Yemen and the high was $17.24 from Oman.
Other Asian buyers pay less than those in Japan and Korea for imported LNG.
For example, last January, the average price was $11.44 per million Btu in Japan and $10.12 in Korea. But, according to Argus, the average price was $6.40 in India and $5.92 in China, two nations with significant domestic gas production, although not enough to fill all local demand.
LNG makers aren't selling gas to China under the same long-term pricing contracts as Japan. China cut some particularly tough deals for its first long-term LNG buys about a decade ago.
Spot cargos are different, and LNG makers have been asking top dollar. In Japan, the spot LNG price jumped to over $17 per million Btu in October, up from $10 in March before Fukushima. Prices have climbed so high that some refineries in India are switching to fuel oil rather than paying premiums for spot LNG shipments.
In some cases, the link between oil and gas prices in long-term contracts sets a ceiling on the maximum oil price used in the formula. Indonesia recently has been trying to renegotiate the $38 oil price cap in an LNG-supply contract it has with a China buyer, according to Platts. That cap was set in 2006 and was a negotiated increase from the original ceiling of $25 per barrel from 2002, Platts said.
China appears to be in a particularly strong position when it comes to gas-price negotiations. It doesn't buy very much yet, but virtually all of the world's gas exporters would like to be selling into the world's hottest economy. China buys both pipeline gas and LNG, but it also has its own domestic production and is investing to boost that production.
Many analysts believe Japan and Korea will continue to favor long-term LNG contracts, with prices linked to oil. But if oil prices remain high, and nuclear power production comes back in Japan, some softening of the gas price could occur.