LNG Oil Index Not Easily Broken, Faculty Member Malcolm Johnson Says

Faculty member Malcolm Johnson contributes to the Intelligence Press to discuss the LNG Oil Index.

Over the next four to five years, about 70-80 million tonnes of liquefied natural gas (LNG) liquefaction capacity will be coming online, thanks mainly to Australia, expanding the global market for LNG by about one-third, Malcolm Johnson, a director at eMJay LNG Ltd. and industry consultant told /NGI/. Where all the LNG goes and at what price remains to be seen, he said.

"The question for me is whether the markets, particularly China and India, will absorb that sort of volume of LNG without major price implications," said Johnson, who is a member of The Oxford Princeton Programme.

The No. 1 priority for Asian LNG buyers has historically been supply security, and that is expected to remain the case going forward. Talk of linking LNG prices to natural gas rather than oil has been taking place for years with no effect. However, the relatively recent phenomena of abundant -- and inexpensive -- North American gas supplies and the potential for the United States and Canada to liquefy and export some of that gas have gotten the attention of buyers in Japan and elsewhere who would like to pay less for supply (see /Daily GPI/, Oct. 11, 2012 ).

Japanese buyers have begun contracting for North American gas at Henry Hub-indexed prices (see /Daily GPI/, April 3 ),
but that does not necessarily herald the beginning of the end for oil-indexed LNG, Johnson and said.

The large volume of LNG that flows to Asian markets under long-term contracts and the absence of alternative pipeline supplies to back-stop LNG are strong impediments to breaking the oil index, Johnson said.

There is no Asian LNG index, but Japanese interests are working to establish LNG futures trading on the Tokyo Commodity Exchange in less than two years (see /Daily GPI/, April 2 ).

"...I can see the logic, certainly, with the arbitrage value that's in there that basically the whole thing could really start to change, but you've got to have some alternative index and really there's not an Asian index as such," Johnson said. Further, Asian supplies contracted at Henry Hub-indexed prices will be too small in volume to move the needle and will make their presence felt mainly in spot cargoes, Johnson said.

"Most of these Australian [liquefaction] projects have been sold at oil-index prices at the moment, so it's really the spot cargoes, and the question is: how long do those actually continue to develop and when will they dominate the market?" he said.

Europe has also seen growing pressure to reflect natural gas prices in "the long-term formulae for new supplies," Johnson said. The region is closer to having an LNG index than Asia, but in Europe, Gazprom is working to develop new supply capacity and will likely be the dominant player. "Now given that the Russians are in a strong position overall -- assuming that they develop new supplies to Europe -- then obviously that's where the question hinges, whether they're prepared to accept very much of the gas price indexes in supplies say on [the National Balancing Point] or one of the other hubs..."

As for supply, the LNG market is tight now and will remain so for a while longer, Johnson said. The last global LNG supply surge was around 2009-2010, and it was largely absorbed by increased demand from Japan following the meltdown of the Fukushima Daiichi nuclear power plant.
From 2014 to 2016, the market will see the same sort of supply surge as the last time around. No one wants another Fukushima, but what will absorb the next LNG supply surge? "...[I]t's very difficult to predict the future like that because you get these sort of wild cards [like Fukushima]," Johnson said.

In the years ahead, top LNG suppliers will be Australia, "because the gas is there," the United States, "because the gas is there," and East Africa, "because the gas is there," Johnson said, adding that supplies from East Africa are quite a ways out. Johnson said potential exports of LNG from Alaska should not be overlooked either, as the state continues to pursue commercialization of its North Slope gas reserves.
Additionally, there is the Yamal Peninsula and the Russian far east, he said, adding that technological obstacles and other challenges will dictate large projects in these harsh environments with large slugs of output if/when they come online.

On the cargo receiving end, hub and spoke terminal development will become more popular, Johnson said, where a larger import terminal receives cargoes and re-exports LNG to smaller terminals. This is happening now in Japan. "I think that will probably increase in a number of other areas like the Caribbean and various places where instead of having to have a big terminal you'll have smaller terminals feeding off a bigger terminal," Johnson said.

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