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Why LNG doesn’t trade like oil Transportation another difference between oil and gas and long-term contracts make natural gas pricing opaque, unlike crude oil Jeannette Lee Researcher/Writer, Office of the Federal Coordinator
Constraints on LNG transport
LNG shipments are also relatively inflexible. They need special, and very expensive, terminals for supercooling the gas to minus 260 degrees and then regasifying on delivery, and the gas usually is contractually bound to specific destinations under the long-term deal signed by seller and buyer. Oil, on the other hand, is more easily put on tankers and unloaded wherever it is needed.
Transportation constraints have historically limited LNG to production, trade and delivery in either of two basins - Pacific and Atlantic. Until Japan’s demand jumped and prices soared after the Fukushima nuclear disaster in 2011, there was minimal cross-basin traffic. At which point increased demand and higher prices drew more Atlantic Basin LNG to Japan.
Transportation by sea could one day connect the major gas regions into a worldwide market, but many more tankers would need to be built.
There are about 4,000 oil tankers in the world, 500 feet long and larger, according to Poten & Partners, a global broker and commercial adviser for the energy and ocean transportation industries. During 2013, about 360 LNG tankers were in service. An additional 108 LNG carriers were on order, according to an end-of-year report by the International Gas Union. There, too, oil has it beat - 600 oil tankers were on order, said an August 2014 report by Poten & Partners.
The expansion of the Panama Canal will help smooth the way for the budding LNG export trade along the U.S. Gulf Coast and cross-basin traffic. Most LNG carriers are too big to pass through the canal, but the expansion will enable 90 percent of LNG tankers to transit the isthmus.
The Panama Canal Authority said in 2013 that voyages to East Asia from Cheniere Energy’s Sabine Pass LNG export plant under construction in Louisiana will be slashed by 20 days, round-trip. (Even so, the round-trip voyage could still take more than six weeks.)
Liquefaction is expensive The price tags of contemporary LNG projects, both proposed and under construction, commonly reach the billions if not tens of billions of dollars. Estimates for the Alaska LNG project to export North Slope gas to Asia range from $45 billion to $65 billion for a gas treatment plant to remove carbon dioxide and other impurities, 800 miles of 42-inch-diameter high-strength steel pipe, a huge liquefaction plant, LNG storage tanks and a marine terminal.
The cost to process and ship oil to a refinery is small by comparison.
As an example, it costs less than $10 to pipe a barrel of Alaska North Slope crude almost 800 miles to the terminal at Valdez and send it by tanker to U.S. West Coast refineries - leaving 90 percent of the value of $100-a-barrel oil for production costs, taxes, capital investment and profit.
But for LNG, the pipeline, liquefaction and tanker costs of North Slope gas delivered to Japan could consume two-thirds of the fuel’s value at summer 2014 Asian spot-market prices. Simply put, the profit margin for investors is much slimmer.
The liquefaction process is a big reason for the significant added expense to LNG. Liquefying Alaska North Slope gas will cost more than moving it 800 miles by pipe to the tidewater plant.
Smaller market, fewer players The ubiquitous need for oil means many parties are either in the business of selling or buying it.
The huge number of crude oil buyers and sellers worldwide has enabled the creation of a transparent and liquid market.
Not so for LNG, which inhabits a much smaller realm. Oil pretty much has the transportation-fuel sector all to itself, while natural gas has to compete in the heating and electricity sectors with an array of energy sources including coal, nuclear, solar, wind, hydroelectricity, geothermal and even oil.
“Not every country in the world uses gas, and if they do, the quantities will be highly variable, because power generation fuel mixes vary so dramatically,” Nelly Mikhaiel, a New York City-based senior consultant at FACTS Global Energy, wrote in a July 2014 email interview.
And for consumers who do use natural gas, only a minority will be part of the LNG trade because pipeline gas deliveries cost less. In 2013, about 69 percent of gas traded between countries flowed via pipeline. The United States, the world’s largest gas producer and consumer, burns only a trickle of LNG.
For some customer nations, LNG is used to guarantee supply diversity and supplement existing pipeline imports, but in other cases, like Japan, it is a much more crucial part of the energy supply.
Japan buys LNG because no natural gas pipelines have been built to the island nation. In a move that shook the world LNG market, Japan’s purchases jumped 20 percent following the 2011 meltdown at Fukushima, a catastrophe that prompted the Japanese government to take all its nuclear plants offline.
The dearth of LNG-producing and consuming countries - or lack of market depth - is one impediment to LNG becoming a globally traded commodity, like oil.
“The huge number of global oil producers, consumers, traders and shippers were a factor in the creation of a truly global crude oil market,” Mikhaiel said.
She noted global LNG trade has grown in recent years, with new buyers and sellers joining the roster and more on their way over the next couple of decades. New or expanded LNG export plants in a dozen countries started production in the mid-2000s. Even the United States is poised to join the rush by 2016 when the first Lower 48 export project is scheduled to start shipping cargoes from Sabine Pass, La.
The World Energy Council predicts that between 2020 and 2050 global natural gas exports by pipeline and as LNG will almost triple. The push for cleaner-burning fuels is driving much of that demand growth, along with expanding economies in China, India and elsewhere.
Nonetheless, the enormous increase forecast by the council will not raise the numbers of buyers and sellers to the levels of those trading oil.
“It cannot and will not approach the sheer number of players that comprise and literally shape the world’s crude oil market,” Mikhaiel said. “LNG will never have the penetration enjoyed by oil, and hence, will remain comparatively small.”
How much is it, really? With high-speed electronic deals around the world, traders know how much oil costs at a particular moment. Not so for LNG.
Over the past 30 years, three streams of crude have emerged as the primary price benchmarks for the oil trade: West Texas Intermediate, Brent Blend and Dubai. For any contracted amount of oil, one of these benchmark prices is plugged into a formula that also takes into account all sorts of variables that affect price, including quality, transportation and refining costs.
“The global prices of various grades of crude oil are exceedingly transparent, and can be learned by anyone with a telephone and/or an internet connection,” Mikhaiel said.
But because of the different market conditions that prevail in various regions of the world, there is no such thing as a global LNG price. Rather, natural gas and LNG prices can generally be categorized by region.
They tend to trade regionally in large part because of transportation costs and logistics.
Each natural gas market - Asia-Pacific, Europe and North America - has separate internal dynamics that dictate their pricing. Their gas markets have different histories, sources of supply and varying degrees of reliance on imports:
Pricing in North America’s gas market is pegged to gas-on-gas competition; with so many producers and so much gas in the United States and Canada, the competition is every other supplier with the same access to the same pipelines.
Asia’s gas prices rise and fall with oil prices, as oil-derived products are a key alternative source of energy.
Europe’s system tends to be a blend of the two.
Oil’s benchmarks are based on spot crude prices. But spot LNG markets aren’t deep enough to serve as benchmarks, so they must rely on the closest substitute fuel to serve as an approximate price marker. In Asia, it’s the crude oil price - calculated on an energy-equivalent to gas - because LNG and oil were used interchangeably there for electricity and heating in the 1970s.
Most of Asia does not have the option of pipeline gas imports, which is one reason its LNG contracts remain chiefly pegged to crude oil prices. Buyers and sellers generally negotiate a pricing mechanism in their contracts called an S-curve to protect both sides in times of high and low oil prices. The curve softens the effects of the oil-price linkage, helping buyers when oil prices are high and ensuring that sellers don’t give up too much when prices are low.
Change is possible In recent years, Asian buyers have led the call to delink the historical price connection to oil and instead would like to see upcoming North American LNG deliveries priced against the publicly traded U.S. gas market price. (If Lower 48 LNG export plants were operating in the summer of 2014, and their cargoes were pegged to U.S. prices, the LNG would be delivered to Asia at a significant discount to the traditional, long-term oil-linked prices.)
Some North American LNG project developers have balked at this, arguing that volatile U.S. gas prices would not provide the security they need to underwrite costly liquefaction plants. But other export project developers, particularly on the U.S. Gulf Coast, are open to the new pricing structure, as long as the customer takes the market price risk and they get paid a fixed rate for their liquefaction services regardless of gas market prices.
“One indexation is not necessarily better than the other. It simply depends on how much risk an individual buyer is willing to assume in order to have the price-risk diversity they want,” Mikhaiel said.
While price negotiations continue, several gas buyers already have signed contracts for LNG from Gulf Coast and East Coast plants pegged to the U.S. gas pricing point at Henry Hub, Louisiana, giving them the new supply and price diversity they want.
In addition to changing benchmarks, LNG pricing could become more transparent in the future. Because so many deals are made privately in long-term contracts, prices are often hard to pinpoint. The Japanese government in April 2014 took a small step to clarify pricing by releasing average prices for spot-market liquefied natural gas sales.
The move by Japan’s trade ministry, according to Reuters, was intended to “add transparency to an opaque market” amid concern about rising costs in the wake of the shutdown of nuclear plants after the Fukushima crisis.
But reshaping LNG pricing and markets to more closely resemble the oil trade will be a long, slow process.
In its 2013 report on establishing a gas trading hub in Asia, the International Energy Agency said the transition from a market dominated by long-term contracts and oil-index-based pricing to a competitive market with short-term contracts and market-based pricing “doesn’t happen overnight.”
Editor’s note: Part 1 of this story appeared in the Oct. 19 issue.
Editor’s note: This is a reprint from the Office of the Federal Coordinator, Alaska Natural Gas Transportation Projects, online at www.arcticgas.gov/why-lng-does-not-trade-like-oil.
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