The search for spot

Strong demand for US liquefied natural gas is accelerating the development of an active global spot market and pricing benchmarks, as Catherine Lacoursière discovers

The US liquefied natural gas (LNG) market makes up only 2% of global liquefied natural gas (LNG) trade. Yet growing demand for US LNG imports is already affecting LNG physical and financial trading patterns worldwide, particularly in the spot market.

US LNG import capacity almost doubled in 2002, despite significant physical constraints. And Massachussetts firm Cambridge Energy Research Associates (Cera) expects the domestic US market to average growth of 1.1 to 1.2 billion cubic feet (bcf) a day in 2003, with the potential to absorb 10% of global LNG supply by 2010. Yet all three LNG-receiving terminals in the US, with a total capacity of around 50 bcf, have long-term contracts which means they may find it difficult to achieve required volumes through spot trading.

Nevertheless, many analysts are predicting a boom by 2007, when new terminalsand regasification facilities come on line and LNG starts to flow under the long-termcontracts that secure them. Spot market activity makes up almost half of US LNGtrade but just a few percent of the global LNG trade, which tends toward long-termcontracts.

But the long-term oil majors that dominate the LNG market are increasingly lookingfor short-term plays to optimise their LNG supply chain around the globe. TheUS market is providing that opportunity.

“We will have 100% of capacity on long-term commitment,” says Marc Evans,vice-president of trading and strategy at BG Group, the biggest LNG importerinto the US. He was referring to the expansion of BG’s largest facilityat Lake Charles facility in Louisiana. “But from time to time, spot capacitywill be available, and we will be opportunistic as to its use,” Evans adds.

But the main benefit both for BG and the global LNG trade of increased integrationwith US markets is likely to be improved correlation with the world’s mostliquid natural gas price indexes and futures markets. It is hoped that the world’smost liquid natural gas trading hub, the Henry Hub in Louisiana, will do forLNG what Brent crude has done for the oil business.

Global pricing proxy
Increasingly, Henry Hub is being written into long-term LNG contracts as the pricing index for LNG liquification and regasification facilities being developed worldwide to meet growing US demand for LNG. Market observers expect Henry Hub and the New York Mercantile Exchange’s (Nymex) natural gas futures contracts to become pricing proxies for many international deals.

Trinidad, for example – responsible for 90% of US LNG imports in the first quarter of 2003 – has insisted on Henry Hub-based prices in talks with Jamaica over processing its stranded gas. In the transatlantic market, players are already looking at spreads between Henry Hub and Zeebrugge, the major trading point for European pipeline gas.

While it is ultimately location that will determine price, Henry Hub will be a logical pricing point for some LNG projects proposed and under way in Louisiana and Texas. Marathon Oil says it is in talks with BG Group to use pricing linked to Henry Hub for LNG. BG Group will buy on a free-on-board basis from Marathon’s Equatorial New Guinea project.

Another active LNG pricing benchmark is likely to emerge on the US west coast. Many LNG projects are being considered for the west coast, many of which plan to trade with the Asia-Pacific region. Here a SoCal benchmark, based on the natural gas pricing index on the southern California border, is expected to develop, but oil indexing is also likely to play a role.

Meanwhile, the Asian region has turned to the more liquid fuel oil or crude oil indexes as proxies for LNG, in the absence of a liquid natural gas market. Greg Hopper, vice-president of Houston-based Lukens Energy Group, says: “There is the expectation that the Henry Hub price will become an index that will be used if not in parity then in tandem with the Japanese Crude Cocktail Index [JCC].” The JCC is a basket of crude used as a pricing benchmark for LNG in Asia.

And, while the Atlantic Basin is a natural LNG supply source for the US due to its proximity, the development of new west coast LNG terminals means trading with the Asia-Pacific region will also make economic sense.

Bob Ineson, director of North American gas at Cera, says Asia-Pacific LNG is competitive in the “mid-3s” for western-Pacific projects, referring to the price in dollars per million British thermal units (mmBtu). “Because the fields behind them are so prolific and the gas price comparatively low, it offsets the extra transportation costs,” he adds.

Some LNG majors are planning to leverage their Pacific LNG businesses with new receiving terminals in California. Five companies were vying to build LNG terminals and regasification facilities in Baja, California. ConocoPhillips has left the race, but BG Gas, Marathon, ChevronTexaco and Royal Dutch Shell Group remain. In addition, Mitsubishi plans to ship natural gas from its 20% investment in Russia’s Sakhalin gas fields to a regasification facility it is building in Long Beach, California.

As many of these hard assets – from ship building to liquification and regasification plants – move out of the planning stage, the market will increasingly become a skills-based business. Both sellers and buyers will seek to capture the arbitrage value between the price of gas in North America and the cost of acquiring stranded gas around the world.

Edging forward
Yet spot deals in LNG have different characteristics from those in, say, natural gas. Boston-based Matt Snyder, global consultant, natural gas/LNG at Wood MacKenzie, says: “Spot deals are not done overnight in LNG – it can take months to put them together and get the entire chain into alignment.”

So although ships have been rerouted mid-voyage in response to pricing signals, that is – and is likely to remain – more the exception than the norm. More likely is that large LNG majors with a presence in multiple markets will reschedule LNG shipments to capture the widest spread. As one analyst says, shipments scheduled for Spain out of Trinidad are increasingly ending up in the US market, where LNG demand and prices have been high.

So while global LNG trade will continue to be based on long-term contracts and relationships, the spot trade is slowly breaking new ground, with more facilities designating part of their offtake as uncommitted in order to exploit such price differentials. This year, the Malaysia LNG Tiga liquification project and Russia’s Sakhalin project secured financing with a percentage of offtake not committed to long-term contracts.

But the global spot market is also hampered by the limited supply of tankers that can move spot cargo. The majority of LNG tankers are committed to, and were commissioned under, long-term contracts. A large number of ships are expected to become available over the next two to four years to the spot market, providing more flexibility to move cargoes.

Physical delivery is not always an issue, however. The significant amount of US LNG market activity that takes place on a spot basis, 40%, has created a much greater opportunity for global players to monetise stranded assets.

Ira Joseph, director of global LNG at New York-based consultants Pira Energy Group, says: “The US market is appealing, because you do not necessarily have to have a customer at this end. You can just bring the LNG in and sell it into the spot market. It is different from the traditional way the LNG market does business, where every piece of the puzzle had to be solved.”

But Joseph says spot trading adds price uncertainty and requires a view of long-term prices.

In the long term, the US is in fact likely to put less of its LNG supply at risk. Wood MacKenzie’s Snyder says: “A lot is already spot or short-term, largely due to the fact that the US takes everybody’s unwanted cargoes in the warmer and more mild seasons.” But Snyder warns that the US will have to secure more supply through long-term contracts to reach the very high level of import volumes it needs to meet LNG demand in the critical winter months.

Meanwhile, the short-term market is providing flexibility and an interim strategy as much-needed LNG terminals are built in the US.

Pricing pressure
At the same time, supply competition is putting downward pressure on prices and narrowing pricing disparities in more mature markets. This is clear from the Asian markets, where market power is shifting to the buyer as competition intensifies. A group of Japanese industrials recently demanded lower prices for Indonesian LNG before they would agree to extend their long-term contracts.

The move is in response to lower-priced deals recently negotiated between Indonesia and China. The Japanese cartel is paying just above $3 for LNG and wants prices in line with China’s, at around $2.90. In 2002, Japan imported 75 billion cubic metres (bcm) of LNG. By comparison, Europe imported 41 bcm and the US 6 bcm, according to Pira. Japan consumes 65% of the world’s LNG.

On top of price pressures, the increasing linkage between LNG markets around the world also made itself felt this winter – particularly in respect of Japan’s considerable market power and influence on US LNG. A cold spell in Korea and the shutdown of nuclear plants in Japan resulted in cargoes from the Atlantic Basin going to Korea. Hence, the US received less spot gas. Cera’s Ineson says: “We are starting to see prices in Asia, Europe and the US being influenced by where cargoes go.”

In October 2002, the Japan-triggered US LNG shortage necessitated the diversion of more expensive cargo to the US to compensate. By 2007, a similar supply disruption is likely to have greater consequences for the US market, given the six new and expanded LNG facilities planned for the US west coast for trade with the Asia-Pacific region.

But by then, market players may leverage liquid markets based on JCC and SoCal to secure cross-commodity hedges and protect against a Japanese nuclear shutdown or the next cold Korean winter. says Lukens’s Hopper says: “One of the advantages of getting into the US is price transparency to manage risk on an international basis rather than just managing on fundamentals.”