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Oil-linked LNG not reasonable, says Japan Gas Association

Japanese buyer wants imports linked to gas hub prices, rejects argument for oil-indexation

Japanese gas importers want to buy liquefied natural gas (LNG) linked to US or European gas hub prices and move away from traditional oil-linked contracts, the Japan Gas Association told reporters at the WGC2012.

The world’s largest LNG importer buys most of its gas on oil-linked contracts, but soaring demand after the Fukushima Daiichi disaster last year and high crude prices means Japanese customers are paying up to seven times more compared to US gas prices.

“For the natural gas price to be linked to the oil price right now has lost any economic rationale,” Japan Gas Association chairman Mitsunori Torihara said.

“Looking at the main uses of natural gas right now, it’s for power generation and such use of natural gas is becoming more prevalent, which means it’s not really in competition with oil but rather in competition with nuclear and coal. So… to still link with the crude oil price will no longer be that reasonable,” he added.

Japanese long term contracts are based on a percentage, usually around 12-13%, of Japan’s oil import price, commonly known as the Japanese Crude Cocktail (JCC), plus a number, usually $1-2. So if JCC is $100/barrel, then the LNG prices will be $13-15/million per British thermal units (Btu).

Meanwhile, spot LNG prices have climbed even higher as Japan imports LNG to offset lost nuclear power generation. Before the earthquake and tsunami struck last March, Asian spot LNG was trading around $10-11/m Btu, but is now around $18/m Btu.
Year-on-year LNG imports jumped by 8.5m tonnes in 2010 to 78.5m tonnes in 2011, and could climb to between 85-90m tonnes in fiscal year ending-March 2013 if all the nuclear reactors remain offline, Torihara said.

But LNG producers have said that Japanese buyers would not be comfortable with contracts based on US Henry Hub or UK NBP gas hub prices, an argument Torihara rejected.

“Truly, it used to be that Japanese buyers were not that willing, or did not see that much of a need, to purchase LNG linked to Henry Hub or European hub prices, but that was a long time ago. Right now, they are more willing and placing importance and emphasis on hub-linked prices,” he said.

Japan’s desire to buy LNG linked with hub pricing can be seen in recent deals signed with US LNG export projects. For the Cameron and Cove Point LNG export projects, Japanese companies have signed tolling agreements with terminal owners and operators, meaning the Asian firms would buy their own gas from the US gas market – at Henry Hub prices – and pay a liquefaction fee.

Only the US Sabine Pass LNG project has approval to export LNG to any country while other projects can only ship to Free Trade Agreement (FTA) countries, which does not include Japan. But the Japanese government has been lobbying its US counterparts to allow LNG to be a special case, while the Cameron and Cove Point projects have also applied to export to non-FTA countries.

“Undoubtedly, the biggest challenge for us is how we will be able to contain the purchasing cost of LNG,” Torihara said.

“And because most of the long term contracts are based upon a formula linked with crude oil, and because we see the price of crude oil staying at a very high range, the cost of LNG will also be high. So the most important challenge for us is how we will be able to change the formula of the gas prices which is now linked to crude oil.”

And the Japan Gas Association sees the US as a potential source of LNG, perhaps linked with hub prices. “I myself would hope the US will start LNG exports as early as possible,” Torihara said.

And to secure supply, he also believes Japanese firms investing in overseas gas and LNG projects will continue.

“As I watch how the individual companies invest, I believe the position is they will actively invest in the upstream projects. And I’m sure east Africa and Russia are naturally included in the possible coverage and scope of their investments going forward,” he said.

Tanzania and Mozambique have recently discovered huge offshore gas field which could feed several LNG liquefaction trains. Russia has a number of LNG projects – such as Yamal and the Sakhalin II expansion – which could be viable.

Japanese companies have already taken sizable stakes in Australian LNG projects with the country predicted to be the world’s largest exporter within a decade.

In the short to medium term, Japanese LNG imports are expected to increase further due to uncertainty over nuclear reactor restarts. Utilities shut reactors for periodic maintenance but have been unable to restart any due to additional government safety checks after Fukushima and local opposition.

But worried about blackouts and rising energy bills, utilities and manufacturers want to restart the reactors, putting them in direct opposition to public opinion.

“Looking at the short term or medium term, I don’t think we will be able to see any alternative sources, so it means in order to have a stable power supply we need, perhaps, to restart as many nuclear power plants as possible. Realistically, we would have to think about that,” Torihara said.

Japan has 54 reactors and the last one shut down in May this year. Before the earthquake, the Japan government wanted to raise nuclear power in Japan’s energy mix from 30% to 50% over the next few decades. But this is unlikely to happen, which would mean Japan ups fossil fuel imports and renewables.

“It goes without saying we’d have to reduce the dependency of nuclear power going forward. But whether we are able to reduce the dependency on nuclear depends on if the alternatives will be able to replace it. Looking at the short term or medium term, I can’t think we will be able to see any alternative sources,” Torihara said.

“We can see confidence has broken down, so unless we are able to regain the trust and confidence of the local community to support nuclear power plants – and we’ll try our best to make that happen – at this moment in time, we are uncertain if the nuclear power plants will be able to be restarted.”

Although regional government has no legal right to stop restarts, the national government and utilities would be very unlikely to switch on reactors without local support. Japan has burnt more coal and gas to offset lost nuclear as well as reduced electricity consumption through efficiency drives.

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