Era of flexibility
Buyers are taking control of an oversupplied market and they want shorter contracts and freedom to sell what they don't use
East Asia's liquefied natural gas market is undergoing an inexorable shift as buyers push for more equitable contract terms and an impending supply surplus boosts trading and liquidity. Japan, South Korea, China and Taiwan between them account for 60% of all global LNG imports, so the consequences will be felt across the world's projects and operators.
"The industry is moving in the direction of a more flexible and transparent market," says Hiroshi Hashimoto, senior analyst of the gas group at the Institute of Energy Economics, Japan.
In August, South Korea joined Japan in probing contractual constraints for reselling LNG cargoes under destination clauses in Free on Board (FOB) contracts. China has also spoken out against the clauses and the EU has banned them.
In June, Japan's Fair Trade Commission ruled such restrictions were anti-competitive, putting LNG exporters in Australia, the US and the Middle East on notice that flexibility is now expected from Asia's largest LNG buying nation.
Meanwhile, emerging buyers are pushing for shorter contracts. While the first wave of large-scale LNG projects were underpinned by 20-year sales-purchase agreements, a McKinsey survey of LNG buyers and experts now suggests more than half expect their next LNG term contract to last for just 5-9 years.
Such efforts are expected to free up volumes and increase liquidity in the Asian LNG market, facilitating market liberalisation and enhancing price transparency. Ultimately, Japanese and South Korean buyers are looking to introduce more flexible indexation mechanisms—and do away with the so-called Asian premium that kept prices in the region higher than elsewhere—so that LNG contracts are not just linked to the Japanese Crude Cocktail (JCC) but also to Henry Hub or a hybrid of both, say lawyers Baker McKenzie.
"In other words, they are sending a clear message to the majors that they now have choices," says Anne Hung, head of Baker McKenzie's energy practice in Tokyo. "We think Japanese buyers on the whole may be looking at achieving a ratio of JCC 70-80% and Henry Hub 20-30%, whereas Korean buyers may be looking a bit more aggressively at JCC 60-70% and Henry Hub 30-40%," Hung added.
In return for greater flexibility on destination, sellers are expected to push for greater profit sharing in diverted FOB and Delivered Ex Ship cargoes, in turn prompting scrutiny under competition law because of cartel implications.
The global LNG market is expected to shift into surplus in the coming 12 months and it is expected to remain oversupplied until 2022-24. But plans by Qatar to raise production from its North Dome field could see the surplus extend further out unless demand rebounds in East Asia and picks up sufficiently in new markets in Southeast Asia.
For now, the forecast surplus is providing enough incentive to boost trading preparations. Singapore, China and Japan are all looking to establish physical and financial derivative-trading hubs, alongside indices such as Platts' Japan Korea Market (JKM), the SGX LNG Index Group, Icis's East Asia Index, RIM/CME's DES Japan and the Intercontinental Exchange.
For physical trades, Singapore-based GLX is emerging as the first digital-trading platform, making it likely the Asian nation will become the prime location for a regional LNG hub. Over 80% of respondents surveyed by Deloitte believe this is most likely in the next 5-10 years. Meanwhile, Singapore LNG is expanding its storage send-out capacity to 11m tonnes a year by 2018 in expectation of rising demand from trading entities.
"Singapore is already a trading hub for oil so a lot of the traders and infrastructures are already based there. The problem is that the trading volume is not big enough to make the pricing method credible," says Hung.
But there is competition. Backed by the government, the Japan OTC Exchange has ambitions of its own, launching a physical LNG market platform in April 2017, with indexing to JKM. "There is a danger that the split at the moment will weaken both hubs because both need trading volume to boost momentum," Hung says.
Meanwhile, Japan's Jera, a group of Japanese firms that together make it the world's largest LNG buyer, is working with China's Cnooc and others to offload surplus supply and modify its buying habits. While not yet a fully-fledged monopsony, Jera is actively centralising and diversifying Japan's LNG-purchasing strategy, including buying from the US for the first time.
It all adds up to an evolving market. "Now the door is open and customer expectations are for more attractive, flexible contract structures, it's hard to see the industry go back to the long-term offtake model with limited buyer-resale options," says Bernadette Cullinane, a partner in Deloitte Consulting's energy division.