Liquefied Natural Gas (LNG) has become a cornerstone of the global energy market, offering a flexible and efficient means to transport natural gas across vast distances. As the world transitions towards cleaner energy sources, LNG‘s role in the energy mix has become increasingly significant. However, the pricing of LNG remains a complex and dynamic subject, influenced by a myriad of factors including regional market dynamics, indexation methods, and recent geopolitical and economic challenges.
As opposed to crude oil, LNG does not feature a harmonized global price. In contracts, the price of LNG is segmented into regional markets, the main ones being:
- The Asian market (Japan, Korea, and China) with the Japan Customs-cleared Crude price index;
- The European market with the National Balancing Point price index;
- The North American market with the Henry Hub price index.
LNG pricing has historically been tied to crude oil, as the replacement fuel to natural gas. Pricing into Japan and much of Asia was based on a percentage of the price of Japan Customs-cleared Crude (JCC), which is the average price of custom-cleared crude oil imports into Japan as reported in customs statistics – nicknamed the Japanese Crude Cocktail.
As an example, a pricing formula may be LNG price = JCC · 0,135 where JCC is further defined as the previous three monthly averages of JCC priced in yen and converted into US dollars. In Europe, Brent has been favored in oil-linked LNG pricing formulas.
LNG pricing in parts of Europe and in North America have relatively recently been tied to readily available natural gas indices. In Europe, a main index is NBP or National Balancing Point, a virtual trading location for the sale and purchase and exchange of UK natural gas. In North America, a main index is Henry Hub, a distribution hub in South Louisiana that lends its name to the pricing point for traded natural gas futures contracts.
LNG Reference Market Price
As noted in the previous section, LNG pricing is following the global trend that has been underway for many decades, whereby instead of being priced relative to oil, it is starting to be priced based on a variety of established and emerging global reference prices. This is generally referred to as “gas-on-gas” pricing as it is a measure of the relative supply and demand in natural gas markets, independent of whether the oil market is in balance or not. From an economist’s point of view, this would be the established way to set the appropriate market clearing price for a globally traded commodity.
The US Market
The historical rationale for gas reference pricing emerged from the development of a liquids wholesale market in the US, with exchange-traded futures contracts to support a pricing mechanism that was not vulnerable to undue influence from a single buyer or seller, and was derived from a transparent, market-based mechanism. Historically, natural gas prices were fixed by the government, but in 1992, the Federal Energy Regulatory Commission (FERC) issued its Order 636. Prices were decontrolled and interstate natural gas pipeline companies were required to split-off any non-regulated merchant (sales) functions from their regulated transportation functions. This unbundling of gas contract pricing and transportation contract pricing meant that exchange-traded gas contracts, based on Henry Hub and other secondary hubs, were established, and the industry moved to market-based indices for pricing purposes.
The European Market
In Europe, this same trend was first established in the UK, following gas market deregulation in the mid-1990s, and the emergence of National Balancing Point (NBP) pricing, which, though similar to Henry Hub, is not a physical place. In Continental Europe, the so-called Title Transfer Facility (TTF) has now become an equally dependable mechanism for long-term pricing, though Southern Europe is still transitioning to a mechanism of gas-on-gas pricing, as new hubs start to emerge.
The Asia-Pacific Market
The first signs that a new pricing basis was emerging for the Asia-Pacific region occurred in the early 2010s with the signing of Henry Hub-based LNG tolling contracts. At the time, buying gas in the US and paying a tolling fee to put it through one of the emerging LNG liquefaction facilities, represented a lower landed price in Japan and other SE Asian countries, compared to traditionally oil-priced gas.
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A number of attempts are being made to establish a pricing index for the Asia-Pacific market, including the so-called JKM index (Japan-Korea-Marker) and also the Singapore Gas Exchange (SGX) spot price index known as SLiNG, which is intended to represent an exchange-traded futures market for LNG based on gas being traded at or around the Singapore LNG facilities. At the time of writing, no index exists that is considered sufficiently dependable for use on long-term contract pricing in Asia.
Current Developments
The LNG sector has been relatively slow to move away from oil-based pricing. There are many reasons for this, but the main brake on pricing change for LNG has been the lack of availability of a reliable, transparent pricing reference for gas, similar to Henry Hub or NBP, in the Asia-Pacific region, which accounts for about two-thirds of LNG consumption.
The other feature of LNG, compared to pipeline gas, is that it is bought and sold in single ship-borne cargoes, instead of being commingled within a pipeline system, and this too has tended to slow down the development of gas on gas mechanisms.
In Europe, over the last decade, the majority of traded gas has now migrated from oil-based to gas on gas based pricing, and some commentators believe that gas-on-gas based pricing will gradually replace oil-based index pricing, particularly as new LNG projects bring additional LNG into the global markets.
An increasing number of countries are considering moving to LNG imports, or establishing relatively smaller scale projects. Because these are under development and/or negotiations, no pricing has been established as yet.
Price Indexation
Natural gas may be sold indexed to the price of certain alternative fuels such as crude oil, coal and fuel oil. The natural gas feedstock prices into the LNG plants are sometimes indexed on the full revenue stream of the LNG plant including LPG and propane plus (other gas liquids), as in the case of the 2009 amendment of the NLNG contract in Nigeria. Such a pricing mechanism is markedly different from the one found in traded gas markets, where price is determined solely by gas demand and supply at market areas or “hubs”.
In the United Kingdom, around 60 % of the gas is sold at the National Balancing Point (NBP) price and the rest at an oil index price based on old long-term contracts. The oil-indexed and hub-priced contracts co-exist.
On the European continent, the case is different. Oil-indexed contracts dominate, with hardly any hub-priced long-term contracts. The continental markets are mainly supplied on a long-term take-or-pay basis. However, a number of short-to-medium contracts do exist which are either fully or partially hub-priced.
Crude Oil Prices
Different crude oil prices are used for the oil index in LNG long-term contracts such as:
Japanese Custom Cleared crude (JCC)
JCC is the average price of crude oil imported into Japan and published by the Japanese Ministry of Finance each month. The JCC has been adopted as the oil price index in LNG long-term contracts with Japan, Korea and Taiwan. LNG pricing for China and India is also linked to crude oil prices but at a discount to Korea and Japan. The discount reflects the fact that China and India, although short of natural gas supplies have other sources of natural gas that LNG complements. As a result, China and India have some additional market leverage in negotiating contracting terms.
Average Price of Indonesian Crude Oil (ICP)
PERTAMINA uses the average price of Indonesian crude oil (ICP) for the supply of LNG from the Bontang and Arun plants.
Dated Brent Crude
Dated Brent is a benchmark assessment of the price of physical, light North Sea crude oil. The term “Dated Brent” refers to physical cargoes of crude oil in the North Sea that have been assigned specific delivery dates, according to Platts. Kuwait, Pakistan, and many European LNG prices are indexed on Brent.
Coal Indexation
In markets where gas is used to fuel power generation, some LNG buyers have pushed for LNG indexing against substitute fuels such as coal. Coal indexation has been used for many years in a Norwegian gas sales contract to the Netherlands and is also an indexation parameter in the Nigeria NLNG contract to Italy. This parameter may become more common if clean coal technologies are used to satisfy incremental baseload electricity demand, or if electricity generators come under increased pressure to reduce carbon emissions.
Oil Indexed Price Formula
Approximately 70 % of world LNG trade is priced using a competing fuels index, generally based on crude oil or fuel oil, and referred to as “oil price indexation” or “oil-linked pricing“.
In the Asia-Pacific region, LNG contracts are typically based on the historical linkage to JCC. This is due to the fact that at the time that LNG trade began, Japanese power generation was heavily dependent on oil so early LNG contracts were linked to JCC in order to negate the risk of price competition with oil. The formula used in most of the Asia LNG contracts that were developed in the late 1970s and early 1980s can be expressed by:
where:
- PLNG = price of LNG in US$/mmBtu (US$/GJ · 1,055);
- α = crude linkage slope;
- Pcrude = price of crude oil in US$/barrel;
- β = constant in US $mmBtu (US$GJ · 1,055).
Historically, there was little negotiation between parties over the slope of the LNG contracts, with most disagreements centered on the value of the constant β. Following the oil price declines of the 1980s, most new LNG contracts incorporated a floor and ceiling price that determined the range over which the contract formula could be applied.
Since suppliers had to make substantial investments in LNG liquefaction trains, a pricing model developed that provided a floor price. For suppliers, this floor limits the fall in the LNG price to a certain level, even if the oil price were to continue falling. Conversely, buyers are protected by a price cap, which restricts LNG price rises when oil prices rise above a certain point.
More recently, the historic price linkages to oil have been called into question as more LNG supply comes on the market from new LNG exporters, such as the United States, which developed a pricing mechanism linked to US Henry Hub. At the same time, the traditional LNG buyers, such as Japan, have balked at new contracts linked to oil, claiming they no longer make sense. As the LNG market continues to evolve, there are likely to be more and more creative solutions to pricing LNG.
Spot and Short-Term Markets
In recent years, LNG markets have seen the emergence of a growing spot and short-term LNG market, which generally includes spot contracts (for immediate delivery) and contracts of less than four years. Short-term and spot trade allows divertible or uncommitted LNG to go to the highest value market in response to changing market conditions. The short-term and spot market began to emerge in the late 1990s-early 2000s. The LNG spot and short-term market grew from virtually zero before 1990, to 1 % in 1992, to 8 % in 2002. In 2006, nine countries were active spot LNG exporters and 13 countries were spot LNG importers.
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Due to divergent prices between the markets in recent years, the short-term LNG market has grown rapidly. By 2010, the short-term and spot trade had jumped to account for 18,9 % of the world LNG trade. In 2011, the spot and short-term again recorded strong growth, reaching 61,2 MTPA (994 cargoes) and more than 25 % of the total LNG trade. Asia attracted almost 70 % of the global spot and short-term volumes primarily due to Japan’s increased LNG need following the March 2011 Fukushima disaster, which took Japan’s nuclear reactors offline. A large portion of the lost power generation capacity was replaced with generators fueled by gas imported as LNG. Spot and short-term LNG imports into Korea almost doubled (10,7 MTPA) and almost tripled for China and India with both countries importing a combined 6,5 MTPA of LNG.
By the end of 2011, twenty-one countries were active spot LNG exporters and 25 countries were spot LNG importers. The growing number of countries looking to participate in the spot market is indicative of the increased desire for flexibility to cope with market changes, unforeseen events such as Fukushima, as well as the increased number of countries now participating in the LNG markets.
The following chart shows the growing importance of spot and short-term sales in global LNG trade:
Source: GIIGNL
In 2016, global LNG trade accounted for 258 MTPA, a 5 % increase vs. 2015. There are now 34 countries importing LNG and 19 countries that export LNG. Approximately 28 % of global LNG volumes (72,3 MTPA) were traded on a spot or short-term basis.
Netback Pricing
The concept of “netback” pricing is particularly important for producing countries because netbacks allow the countries to understand the varying value of LNG in different destination markets. Netbacks are calculated taking the net revenues from downstream sales of LNG/natural gas in the destination market, less all costs associated with bringing the commodity to market, including pipeline transportation at the destination, regasification, marine transport and, possibly liquefaction, and production, depending on the starting point of the netback.
There is no single formula for determining the netback price as it depends on specifics of the deal and is determined on a case-by-case basis, depending on the start and delivery point of the LNG sales contract and the particular destination market involved. The starting point for calculating a netback price can be at the well, at the inlet to a liquefaction plant, or at the exit of the liquefaction plant. The delivery point of the LNG sales contract can be at the liquefaction facility (a free on board (FOB) sale, or a costs, insurance and freight (CIF sale)), or at the destination market (a delivered at terminal (DAT) sale, or a delivered at place (DAP) sale). The terms DAT and DAP have replaced the term delivered-ex-ship (DES), although some parties continue to use the DES reference term.
To determine costs in netback pricing, the following terms are relevant:
Free On Board (FOB) Pricing: contemplates that the buyer takes title and risk of the LNG at the liquefaction facility and the buyer pays for LNG transportation from the liquefaction facility to the destination market.
Delivered at Terminal (DAT), Delivered at Place (DAP) and Delivered Ex Ship (DES) Pricing: contemplate that the seller retains title and risk of the LNG until the receiving terminal in the destination market and the seller pays for LNG transportation from the liquefaction facility to the destination market.
Source: en.wikipedia.org
Costs, Insurance and Freight (CIF) Pricing: is a hybrid, which contemplates that the buyer takes title and risk of the LNG at the liquefaction facility but the seller pays for transportation from the liquefaction facility to the destination market. The significance of the delivery point is that costs are shifted between the seller and buyer.
The calculation of marine transportation and regasification costs are specific to the ship and receiving terminal to be used.
The destination market pricing is specific to the destination market. For example, US netbacks come from an average of the closing price taken from the New York Mercantile Exchange (NYMEX) on the 3 trading days before and including the date reported for delivery at Henry Hub. A local adjustment may be required for pipeline transportation costs depending on the location of the LNG receiving terminal. The calculation of United Kingdom netbacks comes from an average of the closing price on the Intercontinental Exchange (ICE) futures contract for delivery at National Balancing Point (NBP). Japanese netbacks are derived from the official average ex‐ship prices for the most recent month. A World Gas Intelligence European Border Price table is used to estimate the most recent ex‐ship prices for Spanish market netbacks.
Price Review or Price Re-openers
As previously discussed, unlike crude oil, LNG is not yet priced on an international market basis and most LNG is priced on a long-term basis of 20 years or more. The contractual and confidential nature of LNG pricing, coupled with a lack of transparency of individual cargo prices, means that a wide range of prices might exist even within the same country or region. For example, an LNG contract entered into many years ago may still be in effect under far different pricing structures than those that existed at the time it was first agreed.
Historically, some Asian buyers have been able to introduce price caps or “S-curves” into their pricing mechanisms, which protect them against very high oil prices and in return, protect sellers against very low oil prices.
An S-curve is so-called because the relationship between the oil price and the gas price is altered to give the seller relief in a low oil price market (a higher price than would apply from strictly applying the oil index – 14 % JCC as an example), and to give the buyer relief in a high oil price market (a lower price than the oil index would generate). Thus in a plot of gas price against oil price, the start and end of the line has a flatter slope than the middle and the resulting line has an S-shape which gives rise to the name. Sometimes, the S-curve approach can be used to derive a price floor at low oil prices, and a price ceiling at high oil prices. The graphic below illustrates a generalized S-curve.
In addition, a price review or price “re-opener” clause is found in many long-term contracts. An example of the language typically used is as follows:
“If . . . economic circumstances in the [buyer’s market] . . . have substantially changed as compared to that expected when entering into the contract for reasons beyond the parties’ control . . . and the contract price . . . does not reflect the value of natural gas in the [buyer’s market] . . . [then the parties may meet to discuss the pricing structure]” (Susan Sakmar “Energy for the 21st Century”).
Price review clauses have been a feature of continental European long-term pipeline gas sale contracts for a long time. Lawyers from other regions and legal traditions are often uncomfortable with such clauses because when they are invoked, the parties usually find that their interests are more divergent than expected.
Nonetheless, price review or reopener clauses still remain a key clause of most long-term LNG SPAs and many, if not all, LNG suppliers and buyers enter into negotiations without fully grasping how difficult it is to negotiate such clauses, especially if they are to be enforceable if invoked. As such, the following are key elements that must be addressed with negotiating a price reopener clause:
- The trigger event or conditions entitling a party to invoke the clause must be defined. Usually, this is a change of circumstances beyond the control of the parties.
- The elements of the price mechanism which are subject to review must be defined and usually include:
- The base price;
- Indexation;
- Floor price;
- Ceiling price;
- Inflection points of the S-curve formula.
If a requesting party has satisfied the trigger event or criterion, then there is the challenge of determining which benchmark should be applied to determine the revised price mechanism and often the buyer’s and seller’s view of the relevant market differ significantly. Moreover, since the LNG market is still mostly long-term negotiated contracts that are not public and transparent, the parties may not always be able to access the information and data needed in relation to the broader market for the price-reopener negotiations.
If the parties cannot agree on a revised price mechanism, then the parties should consider referral of the matter to a third-party or arbitration. However, many LNG contracts contain “meet and discuss” price review clauses that do not allow for such referral, leaving the parties without recourse unless some specific recourse is specified. For example, the parties could provide that if the parties are unable to agree on the revised price mechanism, then the seller has the right, upon written notice, to terminate the long-term LNG SPA.
Recent Pricing Issues
Given the volatility and significant variations in regional gas pricing over the last few years, both LNG sellers and LNG buyers are becoming increasingly focused on how to develop gas pricing mechanisms that give sellers a revenue that reflects the global value of their product, in a manner that will support project development. These pricing mechanisms also provide buyers with a market clearing price, which will enable them to supply gas to their customers at a competitive rate.
With the increasing power of buyers in the currently over-supplied market, new pricing mechanisms are emerging, which give the buyer a choice or mix of pricing indices. This new flexibility is sometimes coupled with short-term volume and destination flexibility, with the ability to turn back cargoes that are priced at what the buyer may consider an uncompetitive level.
These increasingly complex price-and-volume provisions are leading sellers to more complex hedging and risk management strategies. New pricing provisions are also supporting the LNG aggregator business model, where an intermediary, either an IOC or an LNG trading entity, takes on the role of accommodating both buyer and seller pricing concerns and manages a portfolio of gas sources and destinations in order to appropriately manage risk.
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LNG pricing formulas are evolving at the moment from pure oil-linked pricing to pure gas-linked pricing, although the full evolutionary process is still underway. As a result, there are various mixed pricing formulas in use at the moment, including pricing techniques that modulate fluctuations in oil pricing, such as an “S” curve which bends the percentage of a crude price at extreme highs and lows.
Another consideration in pricing is the emergence of ‘pricing review‘ clauses in LNG SPAs, where the LNG price can be examined and changed at periodic intervals if specified market conditions are triggered. While the intent of these clauses is to preserve a link between a long-term contract and the actual market pricing, such clauses can be very contentious and lead to disputes between sellers and buyers.
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