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The glut still weighs

Higher oil prices will lift some LNG contracts, but do little to support the spot market

Long-term contract prices for liquefied natural gas in Asia-Pacific, which are indexed to crude futures, should move higher with any increase in oil prices this year, but spot LNG prices are unlikely to be much affected thanks to persistent oversupply.

A large portion of LNG contracts globally are linked to oil prices - typically the Japan Customs Cleared (JCC) price in Asia - with a lag of three months. The gradual recovery in oil prices last year- given momentum by the recent Opec deal - is now feeding into LNG prices.

"Global oil-price movements in 2017 will flow through into oil-indexed contracts in the same manner," Tomás O'Loughlin, senior credit officer for infrastructure finance, at ratings agency Moody's says.

The JCC link and the fact that most LNG into Asia is still sold under long-term contracts means S&P, another ratings agency, also expects some inflation in contracted LNG prices - though the extent depends on the specifics of the formula agreed between LNG producers and off-takers.

"If you have a steeper slope you get more benefit from an increase in oil … but if your slope in the formula is flatter then maybe we're talking about getting only a percentage of the increase in oil prices," says S&P's primary credit analyst, May Zhong. "I expect 2017 to be slightly better [for producers] than 2016 and 2015."

Across Asia-Pacific, about 80% of LNG supply is sold on contracts that price the fuel as a function of oil, but indexation varies widely. In a recent research note, Wood Mackenzie calculated that every $1-a-barrel increase in Brent equated to an increase of $0.07-0.15 per million British thermal units in LNG contract prices.

So the gains aren't exactly huge, yet. S&P's Zhong thinks oil prices would need to rise above $65/b to lift contracted LNG prices to $10/m Btu. "We assume that 2016 would be the worst year and then increase incrementally - but still it won't be above $10/m Btu in 2019. That's driven by our oil price assumption as well," Zhong adds.

Neither S&P nor Moody's expects much of a lift in oil prices this year and only a gradual increase to 2020, despite Opec's efforts. That should be reassuring to LNG importers in Asia-Pacific. Off-takers in the region remain fairly comfortable with their oil-indexed deals, says Daniel Glazner, a natural gas and LNG consultant.

"What we might see is a reduction in the slope of the oil indexation," Glazner says. "This will likely be facilitated by the abundance of short-term LNG available and used as a tool to support the buyers' negotiation." He pointed to India's successful efforts to barter down the formula for some Qatari LNG it imports, as well as its recent supply discussions with Russia as evidence that this is underway. "I suspect this will continue once the US and Australia are at full production."

Longstanding relationships between LNG producers and buyers - particularly those with stakes in Australian liquefaction facilities - remain a significant deal-making factor in Asia-Pacific, Glazner believes. "Buyers in Japan prefer a good deal for everyone. Recently there has been mention of Japan looking at previous contracts, but it appears to me this is in respect to destination clauses, not price," he adds.

Spot prices lower

As for Asian spot LNG, the lack of established, fully liquid trading exchanges means the relationship with oil prices is less obvious. Spot prices can depend on weather, as well as near-term supply and demand - both hard to predict. Spot prices ended 2016 at $9.50/m Btu, but Bank of America Merrill Lynch believes they could fall to $4.50/m Btu this year as new supply comes online.

S&P believes Asia-Pacific prices will remain under $10/m Btu this year, in part thanks to lower-than-expected demand in key markets such as Japan, Taiwan and South Korea. Some of them may sell unneeded cargoes elsewhere, worsening an already glutted market.

Wood Mackenzie expects spot LNG prices to remain similar to 2016 levels, albeit with a widening disconnect between legacy contracts and emerging spot markets as new capacity comes on line. "With LNG supply in ramp-up mode lower prices are necessary to incentivise consumption," Shanks says, adding that non-indexed US LNG will look especially attractive if oil prices rise.

Moody's sees the global LNG supply surplus growing over the next few years as new Australian and US projects come on line. It expects these projects to add more than 100m tonnes a year to global supply by 2020, pressuring prices for the rest of the decade.

Glazner says the market will figure it all out, as excess supply encourages more spot trading, sheltering buyers from the effect of an oil-price rise. But indexation won't end. "I think they will continue to retain a majority of their exposure to oil, just at a lower slope," he says.

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