It's easy to forget, but until the crises of the 1970s the oil market as we know it barely existed. The ``Seven Sisters'' -- grandmothers of today's Exxon Mobil, Chevron, BP and Shell -- controlled some 88 percent of the world's crude production. The price of oil was set according to long-term agreements between drillers and refiners, and few quoted it on the evening news or checked it in the day's financial pages.
The global market in liquefied natural gas looks a lot like that today. While gas pipelines have allowed the development of the Henry Hub and National Balancing Point benchmarks in the U.S. and Europe, Asia -- home to about three-quarters of LNG demand globally -- still prices its shipped gas in relation to oil on multi-year or even multi-decade agreements. Most LNG is sold directly to power stations, and comes encumbered with contract terms banning its re-sale.
That creates big differences between the way the two commodities trade. Refiners around the world pay broadly similar prices for a barrel of oil:
The market is so efficient that the U.S. House of Representatives voted last month to end a 40-year-old ban on crude exports, in part because of the spread that's opened up between West Texas Intermediate and Europe's Brent benchmark. While that discount has averaged about 12 percent so far this year, U.S. gas futures have traded at an average 70 percent below LNG Japan's index of import prices over the same period without a peep of concern:
Still, the gap is narrowing. U.S. LNG will be free of re-sale clauses and be priced off the Henry Hub benchmark when it starts sailing to Asia next year, according to Bloomberg's Sharon Cho and Sharmilpal Kaur. The Panama Canal is testing gates on expanded locks that will soon allow most LNG tankers to cross from the U.S. Gulf Coast to the Pacific, removing one of the main bottlenecks preventing global trade. The price premium charged for LNG in Asia is already narrowing thanks to oversupply in the market, BG Group CEO Helge Lund told an investor call last week. The Tokyo Commodity Exchange traded its first LNG forward contract in July.
Why does all of this matter? Well, as the LNG industry has developed, it's leaned heavily on certainty around pricing to justify the colossal cost of turning millions of tons of highly flammable gas into a chilled liquid, shipping it in insulated tankers, and converting it back into gas at its destination. At $54 billion, Chevron's Gorgon LNG Project off the northwest coast of Australia has a good claim to being the most expensive structure ever built. Shift the global reference price to the spot market, and that certainty evaporates. Will petroleum companies still develop new gas fields under such conditions?
There's reason for optimism. Pricing crude oil off the spot market since the 1970s hasn't stopped petroleum companies developing mega projects. The North Sea's offshore oil platforms were built at costs unheard of at the time. While still expensive, they're now dwarfed by mega projects such as Kazakhstan's Kashagan, which has consumed $48 billion and barely produced a barrel. Petrobras will spend $130 billion through 2019 on its projects, mainly in giant fields beneath a layer of salt off the coast of Brazil.
Upstream producers will also benefit from better price signals as the global energy mix grows more complex. By 2040, new natural gas plants won't be much more competitive than new onshore wind farms, and those that capture their carbon emissions will be less attractive in investment terms than solar photovoltaic arrays, according to the U.S.'s Energy Information Administration.
Unlike the ructions of the 1970s, which were sparked by Arab oil producers turning off the spigots in protest at the 1973 October War, any changes that come to LNG now will be driven by oversupply, not undersupply. But the result may be similar: a market where risk is spread not just between producers and consumers, but more widely as independent traders and processors look for a piece of the action. That can only be a good thing.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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