Gas & LNG Pricing

=Gas Markets=

Natural gas prices are highly dependent on the market where the gas will be delivered as there is no internationally traded price like that of oil, mainly due to the relatively higher cost of gas transportation as compared to oil. If the market is liquid, pricing is open and transparent at the trading hub. This traded gas market will in turn be affected by the gas supply and demand. Several factors that can affect the supply side are the volume of gas being imported and exported, the volume of natural gas being produced domestically and the amount of gas in storage facilities. On the demand side, factors such as economic growth, severe weather conditions and prices of competing fuels such as oil can affect the natural gas price. As a country's economy expands, it will require more energy to sustain its development and needs therefore demand will increase. Weather conditions directly affect demand for instance during severe winter periods, heating requirements increase so energy consumption increases. On the other hand, if a liquid market does not exist, the value is determined at the burner tip where competing fuels such as fuel oil have a direct influence on the price. The gas will be priced on the most economical alternative fuel available.

There are three main regional gas markets in North America, Europe and Asia. The US and UK have developed gas markets with many buyers and sellers so prices are based on competition between different gas suppliers whereas Asian gas prices are linked to the price of crude oil. In Continental Europe there are prices are mainly linked to oil products. The map below illustrates traditional price linkages for gas and LNG in different regions of the globe.



North America
In the 1980s, the US was the first country to deregulate upstream and midstream pricing and liberalise access to pipelines. Prior to this, the Natural Gas Act of 1938 established the basis for regulating gas prices. Interstate regulations were regulated by the Federal Energy Regulatory Commission (FERC). However, this regulation resulted in low wellhead prices which discouraged exploration and imposed high costs on consumers. This prompted the Congress to authorize FERC to liberalise gas markets.

This allowed prices in the US to be determined by the supply and demand of the domestic gas market based on the price at a trading hub referred to as Henry Hub (a physical trading hub located in Louisiana, US). Gas at other geographic locations in the US pipeline network carry a price differential to Henry Hub.

Gas prices in the US averaged $2-3/MMBtu (million British Thermal Units) until the end of the 1990s when prices fluctuated drastically exceeding $12/MMBtu in early 2006 and 2008. Then, in 2012-2013, Henry Hub prices were much lower in the range $2-4/MMBtu due to the US Shale Gas Revolution.

Europe
Then in the 1990s, the UK market was liberalised and created a virtual trading hub known as the National Balancing Point (NBP). At this time, the dominant commercial structure in Continental Europe remained indexed to oil products such as gas oil and fuel oil. However in 2012, almost 75% of gas in North West Europe was hub-based pricing (gas prices linked to gas trading hubs and therefore gas-to-gas competition). This region accounts for approximately 50% of European gas demand, thus a large volume of European gas is no longer oil-linked. There are several trading hubs in Europe including ZEE (Zeebruge) in Belgium, TTF (Title Transfer Facility) in Netherlands, CEGH (Central European Gas Hub) in Austria. There also other 'transition' hubs that have just started liberalisation including Gaspool and NCG in Germany, PEG (Points d'Echange de Gaz) in France and PSV (Punto di Scambio Vituale) in Italy.

Asia
Oil price linkage was introduced into Japanese LNG import contracts in the 1970s when crude oil was the main competing fuel to gas in power generation. South Korea and Taiwan followed in 1986 and 1990 respectively. Asian gas prices were based on the average price of crude oils imported into Japan called the Japanese Crude Cocktail (JCC). However, when oil prices collapsed in 1986, LNG suppliers found it difficult to cover their costs so pricing formulae were renegotiated. The S-curve was introduced to protect suppliers from extremely low oil prices and buyers from extremely high oil prices.

The graph below gives a snapshot of gas prices in the US (Henry Hub), UK (NBP), Japan (JCC) and German CIF import from 2005-2013.

=LNG Pricing=

LNG prices are also based on the market where the transported gas is consumed. The market price is determined by the pricing formula in the contract which will either be hub-based or oil-linked. However, in most instances, government revenues are based on a "netback price" which estimates the gas price at the wellhead.

Netback Price = Market Price - Regasification Cost - Shipping Cost - Liquefaction Cost - Pipeline Cost

=LNG contracts=

Traditional Long-term contracts
Long-term contracts for LNG, called Sales and Purchase Agreements (SPAs) usually have a duration of 20-25 years. The main terms include start date, delivery point, duration, quantities, take-or-pay (TOP) provisions (this guarantees payment to seller for contractual quantities, if buyer cannot take agreed volumes, buyer must still pay for LNG which can be delivered at a later date),make-up or carry forward (this refers to gas that is previously paid for by buyer and is carried forward to the following contract year), pricing, price review clauses, force majeure and termination. It was necessary for sellers to negotiate long term sales contracts in order to attain financing for the high investments required to develop an LNG project.

There are three types of sale agreements depending on how risk is shared. The point of delivery can be FOB (Free on Board), DES (Delivered Ex-Ship) or CIF (Cost, Insurance, Freight). FOB means that the buyer has to bear all costs and risks once the goods are loaded onto the ship at the loading port. DES means that seller has to bear all costs and risks involved in bringing goods to the unloading port. CIF means that seller is obligated to transport goods to the unloading port and provides insurance against risk of loss or damage during the journey which is normally included in the price.

However, since 2000 there has been growth in short-term and spot contracts globally. In 2011 and 2012, spot cargoes represented 21% and 19.5% respectively of total LNG trade..

Short-term and Spot Market
Short and mid-term contracts are defined as those having a duration of six months to five years. Spot sales are defined as those where cargoes are delivered less than six months from the transaction date. In 2011, spot and short-term sales accounted for approximately 25% of total trade.

=References=