LNG's Crude-Oil Link in Asia Weakens Amid a Supply Glut: Energy Markets

The link between liquefied natural gas prices in Asia, the world’s largest consumer of the cleaner- burning fuel, and oil prices is breaking down as a glut in capacity boosts supplies.

Crude oil futures in New York have more than doubled to $75 a barrel since the December 2008 trough of $33.87 while LNG prices stagnated at $7 per million British thermal units, according to buyers and official data. LNG prices and oil moved in lockstep in 2008, when LNG exceeded $20 per million Btu and crude hit an all-time high of $147.27 a barrel.

The pricing correlation in place since the 1970s, when Japan started buying LNG, is slipping as producers add capacity from new projects in Australia and Qatar. LNG output may exceed 300 million tons a year by 2020 from about 180 million tons in 2009, according to data from Sanford C. Bernstein & Co. While demand is forecast to rise to meet supply by 2020, the end of the price mechanism may delay projects by Total SA, Chevron Corp., Royal Dutch Shell Plc, Santos Ltd. and ConocoPhillips.

“The level of indexation in long-term contracts has declined since 2008, at least in deals with suppliers other than Qatar,” Frank Harris, global head of LNG at Wood Mackenzie Consultants Ltd., said in an e-mail May 11.

Developers haven’t concluded financing for any LNG projects this year though about seven companies had announced plans to approve projects, Regan said. BG Group Plc, ConocoPhillips, Santos, Chevron and Woodside Petroleum Ltd. are yet to give the final go-ahead for new ventures.

Project Delays

Inpex Corp. will delay final approval of its proposed $20 billion LNG project in Australia, Director Masahiro Murayama told reporters in Tokyo on May 12. The company won’t make a decision this year, and won’t start commercial operations in 2015, he said, without providing a reason.

Some of these projects may be delaying decisions after failing to sign up customers at higher crude price linkages, said Tony Regan, a consultant at Singapore-based Trizen International Ltd. Increased supplies with new units in Qatar, Yemen and Peru to be commissioned earlier than scheduled and slower demand growth is helping buyers step up demands.

New developments mean that they require a relatively high level of oil-indexation in order to be profitable because of reserves that are harder to extract, Harris said.

Crude oil futures in New York have fallen 4.7 percent this year, while natural gas contracts have tumbled 23 percent.

Japan’s Imports

LNG prices in Asia are typically calculated by multiplying a mechanism known as the slope, which reflects the degree of correlation to crude, to the oil price. If the slope is 17 and the oil price is $80 then the price of LNG is about $13.6 per million Btu, excluding other charges. Sellers tend to want a slope of 17.3 to optimize oil indexation while buyers try to bargain it down, Regan said.

Recent contracts may have been set in the range of 14.5 percent to 15 percent, Wood Mackenzie’s Harris said.

Asian utilities opt for relatively expensive term volumes because their gas-fired power plants must supply uninterrupted power to run Japan’s auto factories and South Korean semiconductor units.

“Buyers in Asia are fairly wedded to the idea of long- and medium-term contracts for security of supply and predictability,” Regan said. “There are significant fluctuations in spot prices and volumes.”

Spot Market

Spot prices leaped from $6 to as high as $9 last autumn when Japan and South Korea came in at the same time for supplies, Regan said. Prices have since fallen to $5. Suppliers sell less than 10 percent of their output in the spot market as banks insist on long-term contracts to fund LNG projects, reducing volumes available for spot trade.

Demand for LNG has increased this year as governments around the world committed to spend more than $2 trillion after the financial crisis froze lending, Regan and Harris said.

“There is potential demand upside, particularly in China, which could absorb more of the potential supply,” said Harris, who is conducting a study on China’s gas market.

Japan’s LNG imports rose 16 percent in March to 6.71 million tons as utilities increased power generation by 7.5 percent in February and the global economic recovery led to exports surging 44 percent.

Rising natural gas output in the U.S. has reduced demand for LNG, leading to an excess of supplies in Asia.

An “acute gas glut” is looming in the next five years because of rising shale gas production in the U.S. and Canada, and new production capacity in the Middle East, led by Qatar, according to the Paris-based International Energy Agency and official data.

LNG is natural gas that’s been chilled to liquid form, reducing it to one-six-hundredth of its original volume at minus 161 degrees Celsius (minus 259 Fahrenheit), for transportation by ship to destinations not connected by pipeline.

To contact the reporter on this story: Dinakar Sethuraman in Singapore at dinakar@bloomberg.net.

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