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Gas breaks the oil price link

The proportion of LNG priced on an oil-indexed basis fell to its lowest ever level in 2019

The LNG industry broke records last year in terms of global trade volumes, sanctioned new capacity and the share of spot shipments. An annual survey of wholesale gas prices and price formation mechanisms conducted by lobby group the International Gas Union (IGU) throws up another—the global share of oil and oil products price-linked LNG dipped below 60pc for the first time.

The IGU began regularly surveying world wholesale gas pricing in 2005, initially every couple of years and annually from 2012. For much of that period, the story was one of a shift from oil-price escalation (OPE) to gas-on-gas (GOG) competition—mainly because of changes in long-term pipeline gas contracts in Europe as oil-indexed contracts came to an end or were renegotiated and traded markets flourished. North America was already dominated by GOG pricing, while Asia was mostly OPE.

The share of GOG European pipeline imports in 2019 was 76.5pc, while OPE accounted for 23.5pc. This was a stark contrast with 2005, when OPE had a share of 91pc and GOG just 7pc.

“The big story this year is LNG imports,” says Mike Fulwood, the report’s project manager and senior research fellow at thinktank the Oxford Institute for Energy Studies (OIES). OPE and GOG volume shares have tended to fluctuate over time, he says, largely in response to changes in spot LNG imports. But, over the past three years the trend away from OPE and towards GOG has been marked (see Figure 1).

Continuous rise

“In 2016, the share of gas-on-gas in LNG imports declined slightly on the previous year, to 25pc,” says Fulwood. “But since then it has risen continuously—to 30pc in 2017, 34.5pc in 2018 and 41pc in 2019.” In 2019, pure spot LNG breached 30pc for the first time.

“Part of the rise in the gas-on-gas share in 2019 was the surge in LNG supply going to European traded markets [which will include contractual gas delivered against a gas index], but also a rise in spot LNG cargoes, which have been growing rapidly since 2016,” says Fulwood. “In part this has been in line with the growth in US exports, but also a general rise in spot LNG cargoes worldwide.”

“Average world wholesale gas prices in 2020 are likely to be at their lowest ever levels—with the supply glut being exacerbated by the impact of Covid-19” Fulwood, IGU

In 2019, China was the largest spot LNG market, followed by Japan, India, Spain and South Korea, according to the IGU. Other significant importers of spot cargoes were Italy, France and Turkey. Together, these eight countries made up 83pc of all spot cargoes. The UK, Belgium and the Netherlands were defined as accounting for 60pc of GOG traded volumes, which perhaps illustrates the methodological challenges faced by all compilers of LNG trade data.

Internationally traded gas continues to be a minority in the global industry—cross-border pipeline and LNG trade combined accounted for just 27pc of 2019’s total world gas consumption, of which 16pc was pipeline (645bn m³) and 11pc LNG (446bn m³).

But the size of the US domestic market, which prices on a GOG basis, means that this price formation method dominates globally, accounting for 48.4pc of all gas. Non-liberalised purely domestic gas ­markets account for the vast majority of the IGU’s regulated categories (see ­Figure 2).

The shift to more GOG pricing in LNG from OPE or bilateral monopoly (BIM) has been marked, but due to its relatively low market share, its global impact is muted. OPE’s share of the global gas pricing pie dipped by just 1pc year-on-year in 2019, to 18.5pc.

In pricing, 2019 saw wholesale levels plummet, largely because rising global supply led to sharp falls in spot prices around the world as a long-predicted ‘wave’ finally made itself felt. The average wholesale price fell to under $3.90/mn Btu, with only 2016 recording a ­lower mean.

European and Asian prices saw dramatic divergence. “Since 2015, prices in Asia-Pacific and Europe have broadly tracked each other,” says Fulwood. “This link was decisively broken in 2019 as spot prices collapsed. The European market was impacted much more than Asia Pacific, where, because of the predominance of OPE, prices barely changed.”

48.4pc – Global gas priced on GOG basis

This year, international gas prices “continued to reach new record low levels” as demand tumbled—due to lockdowns imposed to combat Covid-19—while supply remained strong, says Carlos Torres Diaz, head of gas and power research at consultancy Rystad Energy, speaking at the launch of the IGU report.

At one point, the European benchmark TTF price dropped below the US Henry Hub equivalent for the first time—an unsustainable situation, Torres Diaz says, given this meant US exporters could not even cover the cost of their feedgas. “We have seen that, during June, prices started to recover and maybe this is a signal that spot prices have already reached the floor,” he continues.

For their part, Asian oil-indexed prices, which have remained close to $10/mn Btu, are starting to fall as cheaper crude filters into price formulas, which generally have a lag of three-to-nine months.

But the supply availability pushing prices lower has also led to a sharp downturn in contracting for new LNG volumes this year. As a result, Diaz expects to see little new LNG production capacity sanctioned in 2020—perhaps only 2mn t/yr. This in turn could lead to a tightening of the LNG market from around 2023/24.

US pain

“Average world wholesale gas prices in 2020 are likely to be at their lowest ever levels—with the supply glut being exacerbated by the impact of Covid-19,” predicts Fulwood. “Total LNG imports may be at or slightly above 2019, but the share of gas-on-gas may fall back a little, depending on which LNG cargoes are shut in.”

“US LNG pricing is currently unappealing—because of trade economics and the convergence of price spread between JKM and Henry Hub and between Henry Hub and TTF,” agrees Leslie Palti-Guzman, president of New-York based advisory firm Gas Vista. “But that is temporary. We are likely to see periods of time when US LNG is in the money and periods where it is out of the money.”

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