Developing
liquidity in the
LNG market
Asia’s challenges and outlook

January 2017

kpmg.com/energy

Contents
Introduction
CHAPTER 1

CHAPTER 2

Three reasons to develop an LNG trading market

6

Securing hedging tools against price risk

7

Addressing long positions

9

Securing flexibility and agility in management

10

Nascent LNG trading hubs in Asia

12Singapore� s moves towards an LNG trading hub

CHAPTER 3

2

12
14

Possibility of LNG trading hubs developing outside Singapore
Possibility of coexistence of multiple trading hubs

16

Current position of the LNG market as derived fromcomparisons with other commodity markets

17

Conditions in other commodity markets

18

Formation process of the iron ore market

18

Current position of the LNG market

20

Growth of spot trading

21

Development of spot price indices

21

Emergence of ﬁnancial trading

21

Collapse of the traditional pricing system

22

Development of liquidity in futures markets

22© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

CHAPTER 4

The challenges in developing a liquid LNG market

23

Concentration of players

23

LNG’ s suitability for trading

Price transparency

Conclusion

26
27

29

© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

2

Developing liquidity in the LNG market - Asia’s challenges and outlook

Introduction• The LNG market remains an illiquid market, where trading based on long-term contracts with inflexible
contractual terms is the mainstream. Market participants are hoping for a transformation of the LNG
trading market into a liquid and open market.
• The purpose of this report is to bring to light the realities of a predawn market. We will first review
the reasons for the need to develop an LNG trading market (Chapter 1), investigate the situation at
the forefront of the market through interviews in Singapore and Japan (Chapter 2) and highlight theposition of the LNG market by comparing it to other commodity markets (Chapter 3) before reviewing
the challenges and outlook for this market (Chapter 4) and offering market participants a perspective forthe future as our conclusion ("Conclusion").

The environment surrounding LNG trading has been undergoingsignificant changes in the last few years, including the fall inspot LNG prices stemming from the fall in crude oil prices since2014 and the emergence of new LNG importers and suppliers.
Nevertheless, the LNG market remains illiquid, with trading
based on long-term contracts with inflexible contractual terms
still the dominant market practice.
Notably, the Japanese power and gas markets are experiencing
heightened uncertainty over the country’s LNG demand dueto the progress of regulatory reform known as the “Powerand Gas Systems Reform.” In response to this situation,
Japanese LNG buyers including power and gas utilities are
beginning to actively optimize their LNG portfolios with respect

to fuel procurement and selling (management)1 by reviewing
contractual terms, procuring LNG more flexibly, agilely reselling
their LNG holdings in response to market conditions. Thus,
establishing an LNG trading market is expected to be aprerequisite for improving flexibility in LNG procurement andsales.
The LNG market has developed mainly in Northeast Asia
— i.e. Japan, Korea and Taiwan — a region without connections
to global pipeline networks. Partly due to the influence ofthe market conditions prevailing in the early days of LNG
procurement — which started after the oil shocks in the 1970s— which gave sellers the upper hand, trading based on longterm contracts with inflexible and exclusive contractual terms

Chart 1-1. LNG importers around the world

Source: KPMG based on Wood Mackenzie research1

ALM at financial institutions is meant to maximize the profit through the optimization of “funding and investment.” Accordingly, referring to it simply as “selling” brings
about risks of viewing “optimized operation” in its narrow sense since investment management of the procured fuel as an asset will be more and more important.
We expect, however, that the use of these terms will be determined in due course depending on how the development of liquidity in the LNG market and thediversification of the products traded, including financial instruments, evolve and the extent to which market players use the market in response.
© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

Developing liquidity in the LNG market - Asia’s challenges and outlook

gradually becoming the norm in LNG trading.
As a result, a liquid market did not develop for a long time.
In recent years, however, the increase in the number of
new LNG buyers in Europe, South Asia, the Middle Eastand elsewhere is causing trends not previously seen in the
traditional LNG market. A market participant in Singapore
noted, “The widespread use of floating LNG storage andregasification units (FSRU) can be cited as one reason for
the increase in new LNG importers. Using FSRU has madeit possible to introduce flexible LNG import facilities withrelatively small investments.”
These new LNG importers are giving diversity to the LNG
market by procuring mainly from the spot market relying on
long-term contracts2 and procuring at price terms that are
different from the conventional ones.
Spot LNG prices have been on a downtrend since 2014.
The main factor behind this is the fall in LNG prices caused byweak crude oil prices — which were already weak due to theglobal recession but plunged when it became clear that OPEC

would not resolve to cut production to maintain prices at its
meeting in November 2014, as well as eased geopolitical risks.
As for factors specific in the LNG market, a market participant
in Singapore pointed out, “One factor was that an oversupply
created by the LNG supplies from new producers like Papua
New Guinea, coupled with lower LNG demand due to a warm
winter in Northeast Asia, depressed spot prices.” Considering,
among other factors, that exports will begin from the LNG
projects currently under construction in North America andAustralia, the supply of LNG is expected to continue growing(Table 1-1), and the trend of low LNG prices is expected tocontinue for a while.
At the same time, low LNG prices are expected to affect theplans of future LNG projects. There is an increasing number ofcases in which the final investment decision3 is deferred4 since
low LNG prices have made it difficult to cover the capital costof LNG projects and financial institutions have become reluctant
to finance them. The decrease in the number of LNG projects
results in less LNG production in the medium to long term andcould ultimately turn into a factor that drives up the price of LNG.

Table 1-1. LNG projects under construction
Country

Project

Volume(bcm/y)

Shipment begins inAustralia

Gorgon(T2)

7.1

2016

Indonesia

Sengkang LNG

2.7

2016

Malaysia

MLNG T 9

4.9

2016

Malaysia

PFLNG SATU

1.6

2016

Australia

Wheatstone LNG

12.1

2017

Australia

Gorgon (T3)

7.1

2017

United States

Cove Point LNG

7.1

2017

United States

Sabine Pass (T3-T4)

12.2

2017

Cameroon

Cameroon FLNG

1.6

2017

RussiaYamal LNG (T1-T3)

22.4

2017

Australia

Prelude FLNG

4.9

2018

Australia

Ichthys LNG (T1-T2)

12.1

2018

United States

Freeport LNG (T1-T3)

18.0

2018

United States

Corpus Christi LNG (T1-T2)

12.2

2018

United States

Sabine Pass (T5)

6.1

2018

United States

Cameron LNG (T1-T3)

18.3

2018

Total

150.5
Source: IEA

2

Market participants in Singapore note, “The increased demand will be covered with spot contracts.”

3

FID (Final Investment Decision)

4“Shock of low oil prices (1): FID postponements on new projects revealed” Rim Energy Newshttps://www.rim-intelligence.co.jp/news/select/category/feature/article/580055
A Singaporean information vendor also notes, “Due to low LNG prices, there are few FIDs made and banks are also hesitant to lend.”© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

3

4

Developing liquidity in the LNG market - Asia’s challenges and outlook

Japan has long been buying LNG from Malaysia, Australia,
Qatar, etc. based mainly on long-term contracts linked to crude
oil price (Table 1-2). However, when nuclear power plants weresuspended across the country in response to the accident at the
Fukushima No.1 Nuclear Power Plant following the Great East
Japan Earthquake in March 2011, the country substituted nuclear
power generation with thermal power generation and othermeans (Table 1-3). This had a considerable impact on Japan’s
LNG procurement strategy.
The subsequent turn of events made it unlikely that nuclear
power generation would restart soon and, in response to thissituation, power and gas utilities have been actively increasing
spot LNG trading, concluding new long-term contracts, andinvesting in LNG projects in the US, Australia and elsewhere to
significantly increase their LNG procurement as part of an effort
to ensure stable procurement of primary energies.
On the other hand, the demand for electricity is not expected
to return to pre-earthquake levels after the drop in the wake ofthe earthquake, partly due to the rapid spread of the awarenessfor power and energy conservation after the disaster. Japan’s
demand for LNG is expected to decrease in the long term
due to its shrinking population, among other factors5, which is
causing concerns about potential future redundancies in LNG
procurement.
The Japanese government’s projection for the power mix
until 2030 (Table 1-4) assumes a large increase of renewableenergy and restarting of the nuclear power plants. While thereduction in future LNG demand might be smaller than currently
anticipated if those assumptions do not materialize, the basic
policy of reducing the proportion of thermal power generation
will be unchanged. Hence, a higher demand for LNG for thermal
power generation in the future cannot be expected.
Japan’s imports of LNG are expected to increase further from2018, when imports from North America begin (Table 1-5).
Coupled with the expected decrease in future demand, there isa growing sense of oversupply of LNG in the country. Moreover,due to the full liberalization of retail markets that took place inthe power sector in 2016 and is to take place in the gas sector
in 2017, power and gas utilities will have to bear the market pricerisks that they had traditionally been able to pass through to theconsumers under the full-cost principle and other arrangements.
Mitigating risks and securing flexibility in the procurement of
LNG has become an urgent issue to enable Japanese powerand gas utilities to maintain their market competitiveness underthese circumstances.

Table1-2. Origin of Japan’ s LNG imports(2014)
Import volume(000 tons)

Share

Australia

18,336

20.6%

Malaysia

15,31817.2%

Indonesia

5,184

5.8%

Brunei

4,431

5.0%

Country

Papua New Guinea

3,403

3.8%

Qatar

16,50018.5%

United Arab Emirates

5,695

6.4%

Oman

3,002

3.4%

Yemen

957

1.1%

Russia

8,514

9.6%

Nigeria

5,108

5.7%

Other

2,627

2.9%

Total

89,075100.0%

Source: Agency of Natural Resources and Energy

Table 1-3. Japan’ s power generation by energy
source before and after the earthquake
100 mill.
kWh10,00010,064

1.1%

8.5%

9,101
3.2%
9.0%

7.5%
8,000

10.6%
29.3%
6,000
46.2%
25.0%

4,000

2,000

0

28.6%

31.0%

2010

2014

Nuclear power

Coal

Hydro

Geothermal and new energies

LNG

Oil, etc.

Note: Aggregate of ten power utilities including power purchasedfrom other companies. “Oil, etc.” includes LPG and other gases.
Source: KPMG based on "Power generation mix by energy source, May 20, 2016"
by Federation of Electric Power Companies (http://www.fepc.or.jp/about_
us/pr/pdf/kaiken_s3_20160520_1.pdf)
5

Multiple market participants in Singapore noted, “While LNG demand in Japan is expected to decrease, demand in Korea, China, and Taiwan is expected to increase
and be the main drivers of demand growth,” and “LNG demand in China and in other Asian countries is expected to grow.”© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

Developing liquidity in the LNG market - Asia’s challenges and outlook

Regarding Japan’s LNG market strategy, if Japan tries to be an
LNG hub under Japan’s initiative, it will tend to result in focusing
entirely on a closed strategy. For this reason, it is necessary tobuild Japan’s competitive advantages within an open strategy
that takes all of Asia into consideration. Since demand alone
does not constitute a market, Japanese players need to findways to secure profits in two-way trading straddling diverse
countries and areas. Moreover, when reselling LNG in thesecondary market, they will need to anticipate the possibility of
their primary market suppliers becoming competitors.
In addition, they will also need to improve their trading risk
management to address the transformation of the LNG market
into a financial market, as has happened in other commodity
markets.

Table1-4. Japan’ s power mix in 2030

Total power produced 1,065.0 bill. kWh
Renewableenergy22-24%

Biomas
3.7-4.6%
Wind 1.7%

Oil 3.0%

Solar

Coal
26.0%

The purpose of this report is to bring to light these realities of apredawn market. We will first review the reasons for the needto develop an LNG trading market (Chapter 1), investigate thesituation at the forefront of the market through interviews in
Singapore and Japan (Chapter 2) and highlight the position of
the LNG market by comparing it to other commodity markets(Chapter 3) before reviewing the challenges and outlook for thismarket (Chapter 4) and offering market participants a perspective
for the future as our conclusion ("Conclusion").

Geothermal
1.0-1.1%(photo-voltaic)

7.0%

LNG
27.0%

Hydro
8.8-9.2%

Nuclearpower
22-20%
Source: KPMG based on "Long-term energy demand and supply outlook, July,2015" by Ministry of Economy and Trade (http://www.meti.go.jp/
press/2015/07/20150716004/20150716004_2.pdf)

Table 1-5. Participation of Japanese LNG players inNorth American LNG projects
Liquefaction contract
holder

LNG off-taker

Osaka Gas
(2.2 mill. tons p.a.)
Chubu Electric(2.2 mill. tons p.a.)
Toshiba(2.2 mill. tons p.a.)

Osaka Gas
(2.2 mill. tons p.a.)
Chubu Electric(2.2 mill. tons p.a.)
Toshiba(2.2 mill. tons p.a.)

Mitsubishi Corp.
(4 mill. tons p.a.)
Mitsui & Co.
(4 mill. tons p.a.)
ENGIE(4 mill. tons p.a.)Tokyo Electric(0.8 mill. tons p.a.)
Tohoku Electric(0.57 mill. tons p.a.)
Toho Gas(0.3 mill. tons p.a.)
Kansai Electric(0.4 mill. tons p.a.)Tokyo Gas
(0.52 mill. tons p.a.)

Sumitomo Corp.,
Cove Point
Tokyo Gas
LNG
(2.3 mill. tons p.a.)Tokyo Gas
(1.4 mill. tons p.a.)
Kansai Electric(0.8 mill. tons p.a.)

Freeport
LNG

Cameron
LNG

Source: KPMG based on various materials© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

5

6

Developing liquidity in the LNG market - Asia’s challenges and outlook

CHAPTER 1

Three reasons to develop an LNG trading market• Triggered by the regulatory reform known as the Power and Gas Market Systems Reform in Japan, thelargest LNG consumer, there is heightened momentum to optimize procurement portfolios through more
flexible LNG procurement and reselling.
• The addition of new LNG-importing countries and other factors are expected to create a growing need for
trading to conduct flexible buying and selling of LNG.
• This chapter discusses the need to develop a global trading market for LNG, similar to those for crude oiland coal; focusing on three reasons.

The domestic energy markets of the Asian countries that
consume large amounts of LNG have been relatively slow
in implementation of regulatory reform when compared toWestern markets. Among them, however, Japan, the largest
consumer of LNG, is currently in the midst of a regulatory
reform of its power and gas markets (“Power and Gas Systems
Reform”), which will fully liberalize the retail gas market from
April 2017, following the full liberalization of the retail electricity
market in April 2016. The legal unbundling of transmission/
distribution in the power sector and the gas pipeline networks
in the gas sector are to be implemented in 2020 and 2022,
respectively6.

In fact, due to such concerns, there is a growing momentum
among Japanese LNG buyers to optimize their procurement
portfolios by switching to more flexible contractual terms
regarding off-take volumes, contract period, and the destination
clause.

Various factors, including the increased supply capacity of otherpower sources (e.g. increased renewable energy and restartingof the nuclear power plants) and lower energy demand due toshrinking population and other factors, coupled with intensified
market competition as a result of the regulatory reform, arecausing concerns over Japan’s domestic demand for LNG.

A flexible and global trading market for LNG — similar to thosefor crude oil and coal — needs to be developed to solve issues
such as securing flexibility in LNG trading and utilization of amarketplace to trade LNG.

These circumstances, combined with other factors such as
the increasing number of new LNG importers and other trends
encouraging the development of liquidity in the market are
requiring LNG players to respond to the transforming LNG
market. Due to these reasons, we expect a growing need for
trading that enables flexible buying and selling of LNG.

Chart 2-1. Determination of the "full-cost"

Business
returnDeductions

Operatingexpenses etc.
- Fuel/raw materials

Full cost- Depreciation- Repairs- Labor, etc.

Source: KPMG based on "Regarding gas tariff system, July 12, 2013" (http://www.meti.go.jp/committee/sougouenergy/denryoku_gas/gas_ryokin/pdf/001_05_00.pdf) by
Ministry of Economy and Trade.

6

To be implemented concurrently with the “removal of retail rates regulations” after an assessment of the competitive environment over 2018-20.
© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

Developing liquidity in the LNG market - Asia’s challenges and outlook

Securing hedging tools against price risk
• Japanese power and gas utilities have traditionally been able to pass through the fuel price risk toconsumers thanks to the full-cost principle. However, with the full liberalization of retail power andgas markets, they are now facing fuel price risk.
• Given the absence of direct hedging tools at present, unlike for crude oil and coal, an LNG trading
market needs to be developed to hedge the risk.

Thanks to the full-cost principle (Chart 2-1) and the fuel costadjustment system7 Japanese power and gas utilities havetraditionally been able to pass through the fuel price risk totheir consumers. In the case of the power market, however,an assessment of the competitive environment after the full
liberalization of the retail market is to be conducted around2018-20. If this results in a green light for the removal of therate regulation based on the full-cost principle, which currently
coexists with deregulated rates as a transitional measure,Japanese power utilities will be unable to continue with the
management premised on the traditional pricing system tocontrol the fuel price risk8. In other words, if the rate regulations
are abolished in the power sector when transmission/
distribution are unbundled in 2020, and in the gas sector when
the pipeline networks are unbundled in 2022, Japanese powerand gas utilities will need to face fuel price risk (Chart 2-2).
Hedging such price risk requires offsetting the risk from thepositions of physical trading by trading futures and swaps9,
etc. In the case of crude oil and coal, these hedging tools are
relatively easy to access in the market. In the case of LNG,
however, they are almost nonexistent and those few existing
tools do not have sufficient market liquidity. Hence, it is not

currently possible to perform flexible hedging operations in LNG,
as in the cases of crude oil and coal.
Given that long-term contracts for LNG imported to Japan havepricing formulae linked to crude oil price, cross-commodity
hedging10 using crude oil trading is a conceivable substitute.
In reality, however, this does not allow a perfect hedge thateliminates the basis risk11 between the price of LNG and theprice of crude oil, which are not strictly the same. For thisreason, developing a liquid LNG trading market is an urgent
necessity from the viewpoint of securing a hedging tool directly
using LNG12.
Meanwhile, price indexation in LNG procurement is becoming
more diverse, as exemplified by the new LNG projects in theUS, which will be linked to Henry Hub prices. The increased
diversity in price benchmarks should produce some risk
diversification effect, but this alone will not serve as risk
hedging. If the LNG market becomes more liquid and reliable
LNG price indices become widely used, it will be possible tolock in profit margins by hedging procurement contracts linked
to LNG price indices with LNG futures and swaps13.

7

The system which adjusts electricity rates based on fuel price fluctuations to reflect changes in the prices of LNG, crude oil, coal, etc. The adjustment is mademonthly. A similar system of adjusting for fuel cost is also used in setting gas rates. (Source: “360 Key Terms in the Power System Reform Explained,” the Japan
Electric Association, 2015. Compiled under the general supervision of the Society of Public Utility Economies and the International Environment and Economy Institute).

8

The electricity rates liberalized to date are already unable to pass through the price risk. However, since those power rates are often reviewed in similar ways to the
traditional pricing system, the problem may not present itself immediately.

9

A swap trade is a trade in which floating prices and fixed prices are exchanged.

10 If a commodity to be hedged is not listed, hedging can be achieved by using another commodity that has a strong positive price correlation.
11

Basis risk is the risk of incurring a gain or loss as a result of divergences between the prices of two highly correlated instruments.

12 A market participant in Singapore notes, “Players want to move away from oil indexation but have failed to do so.”
13 Securing these hedging tools will be critical when the need to address customer needs such as fixed power and gas rates, futures-linked rates arises.
© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

7

Developing liquidity in the LNG market - Asia’s challenges and outlook

Chart 2-2. Historical development of unit - Cost, Insurance and Freight (CIF) - prices of LNG and
crude oil in Japan
Unit prices of LNG and crude oil in Japan25

LNG CIF unit price
Crude oil CIF unit price

USD ／ MMBtu

20
15
10
5
0

2006

2006

2006

2007

2007

2008

2008

2008

2009

2009

2010

2010

2011

2011

2011

2012

2012

2013

2013

2013

2014

2014

2015

2015

2016

1 / 1 6 / 1 11 / 1 4 / 1 9 / 1 2 / 1 7 / 1 12 / 1 5 / 1 10 / 1 3 / 1 8 / 1 1 / 1 6 / 1 11 / 1 4 / 1 9 / 1 2 / 1 7 / 1 12 / 1 5 / 1 10 / 1 3 / 1 8 / 1 1 / 1

LNG CIF import price and contractual-basis spot price in Japan25

LNG CIF unit priceContractual-basis LNG spot price18
16
USD ／ MMBtu

8

14
12
10
8
6
4
2
0

2014

3/1

2014

5/1

2014

7/1

2014

9/1

2014

11 / 1

2015

1/1

2015

3/1

2015

5/1

2015

7/1

2015

9/1

2015

11 / 1

2016

1/1

2016

3/1

2016

5/1

Source: KPMG based on "Spot LNG price survey, Statistical tables of monthly authentic reports from March 2014 through May 2016" (http://www.meti.go.jp/statistics/sho/slng/result-2.html" by Ministry of Economy and Trade and "Statistics 07. Crude oil and oil products import prices as of July, 2016" (http://www.paj.gr.jp/statis/statis/
index.html" by Petroleum Association of Japan.

© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

Developing liquidity in the LNG market - Asia’s challenges and outlook

Addressing long positions• With Japan� s demand for fossil fuels as a whole on a downtrend, power and gas utilities run the risk ofthe supply of LNG procured under long-term contracts exceeding demand.
• With the development of a liquid LNG trading market, players holding over-procured LNG will be able
to optimize their risks by reselling them or obtaining price hedging in the trading market.

Amidst a growing sense of oversupply in the global LNG market
due to the increase of shale gas production, completion of LNG
projects, etc., Japan is experiencing a downtrend in its demandfor LNG as well as other fossil fuels as a whole. Deployment of
renewable energy in Japan is expected to increase to 2.2 to 3.2
times current levels by 2030 (Table 2-1). In addition, resumed
nuclear power generation is expected to account for 20-22%of the fuel mix in 2030 (Table 1-4). As such, the proportion ofthermal power generation is expected to be reduced graduallyin the future. In such a market environment, Japanese powerand gas utilities are facing the risk of the supply of LNG
procured under long-term contracts and other arrangements
exceeding the demand for LNG which is used in gas-fired power
generation, gas retailing, etc. In other words, they are facing a
volume risk due to excessive procurement.

Using an LNG trading market may be an effective way of
mitigating this volume risk. The development of a liquid
LNG trading market will enable players with excessive LNG
procurement to optimize their risks by reselling the excess or
obtaining price hedging in the trading market. Notably, China,
India, and Southeast Asian countries are expected to see
continued growth in energy demand and are also becoming
more aware of greenhouse gas emissions, which makes itlikely that they will have a growing demand for natural gas withsmaller CO2 emission compared to oil and coal.
Thus, developing an Asian LNG trading market is also critical to
make it possible to trade smoothly between these countries.

Table 2-1. Deployment of renewable energy in Japan by 2030
2030
Renewable energy
source(100 mill. kWh)

Most recent
year*

Level of renewable energy deployment
Low

Medium

High

150

777

1,173

1,280

Other

1,011

1,637

1,949

2,286

Total renewable energy

1,161

2,414

3,122

3,566

Solar (photo-voltaic)* As of end-March 2014 for solar, wind, small andmedium hydro, and geothermal as published by
METI; 2009 figure for large hydro (METI); biomass
includes an estimate (2.28 mill. kW-equivalent) for
black liquor and scrap wood-fired power generationin 2005, in addition to METI-published figures for
waste and biomass power generation.

Source: KPMG based on "Forecasted installation of renewable energy"(https://www.env.go.jp/earth/report/h27-01/H26_RE_4.pdf) by Ministry of the Environment.

© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

910

Developing liquidity in the LNG market - Asia’s challenges and outlook

Securing flexibility and agility in management• While LNG procurement under long-term contracts is beneficial in terms of securing volume andstability of supply, they deprive management of the options and latitude to respond flexibly toenvironmental changes that may occur during the long life of the contract.
• An LNG trading market can be used as a mean of securing flexibility and agility in management.

Procuring LNG under long-term contracts is believed to be better
than procuring through spot trading to secure the intended
volume and ensuring stability of supply.
For this reason, Japanese power and gas utilities have beenprocuring LNG mainly under long-term contracts, using spot
trading when necessary. When the buyers’ bargaining power
is relatively weak, however, they may not be able to securesufficient flexibility in a long-term purchase contracts thatlast from over ten to twenty years, depriving of the options
and flexibility in management to respond to changes in theenvironment during the life of the contracts, thus potentiallycompromising management agility. This is one of the causes ofthe volume risk that Japanese power and gas utilities may facein the future.

Table 2-2. Volume of LNG imported through spot trading and short-term contracts
Tons
80,000,000

70,000,000
60,000,000
50,000,000
40,000,000

30,000,000
20,000,000
10,000,000

0

2006

2007

2008
Europe

2009

Japan

China

Korea

Asia (excl. Japan, China, Korea)

2010

2011

2012

2013

2014

2015

North and South America (excl. USA)USA

Middle East

Note:
― Short-term contracts are contracts of four years or less.
― Off-take volume shows net import volume after accounting for re-exports.
― 2006 figure includes spot trading only.
― Calculated assuming 1m3 of LNG＝0.45 tons of LNG (2.21m3 of LNG = 1 ton of LNG).
Source: KPMG analysis based on "The LNG Industry Reports from 2005-15" (http://www.giignl.org/publications) by International Group of Liquefied Natural
Gas Importers (GIIGNL).

© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

Developing liquidity in the LNG market - Asia’s challenges and outlook

Chart 2-3. Need for LNG trading

Globalenergy markets

Wholesalepower market

Domestic
retail market

Price fluctuation

Improved liquidity

Full liberalizationof retail markets

Responding to futures trading

Need for price risk managementin global markets

Price drivers emerging also on the demand side
Price risk pass through no longer possible

Power and gas utilities
LNG/coal imports

Fuelprocurement

Wholesalepower trading

Retail gas/
power sales

Consumers

Price risk pass throughno longer possible

LNG storage
terminals/
coal depot
Thermal power plants

Thermal power plant operation became
difficult due to impact of increased
renewable power sources.

Restart ofnuclear power

Unbundling oftransmission/distribution

Renewable
power generation

Large impact on market pricelevels depending on
supply volume resumed.

Need to secure management options/flexibility against
increased uncertainties
This requires hedging tools against price riskThis enables Japanese players to address long-term LNG positions

Strategically reviewing the procurement ratios of long-term
contracts and spot trading, taking into consideration theiradvantages and disadvantages, will be critical to secure
flexibility in management options and management agility in aderegulated era. Using an LNG trading market is one possible
option to accomplish this.
Having to rely on thermal power generation as an alternative
power source due to the suspension of nuclear power plants
after the Great East Japan Earthquake, Japanese power utilities
used the LNG spot market as an emergency measure to procure
natural gas for power generation (Table 2-2).

Triggered by this event, Japanese power and gas utilities
increased their spot LNG trading and began reviewing their
LNG procurement strategies. Improved liquidity in the LNG
spot market will give Japanese power and gas utilities greater
flexibility in LNG procurement by making it possible to optimize
their procurement portfolios by, for example, making changes inthe spot procurement ratio with an eye on the market trend.
It will also be possible to optimize procurements portfolios
under long-term contracts by price hedging with LNG futuresand swaps, forward resale agreements using forward contracts,
etc.

© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

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Developing liquidity in the LNG market - Asia’s challenges and outlook

CHAPTER 2

Nascent LNG trading hubs in Asia
As an LNG trading market develops in Asia, Singapore and Japanare considered to lead other Asian economies in developinga trading hub, the former owing to its advanced market
infrastructure, and the latter to its large LNG trading volume
stemming from its enormous domestic demand.

In this chapter, we will explore the future development of the
LNG trading market from a variety of angles through interviews
with market participants about the potential of these countries
to be LNG trading hubs, as well as their challenges andprospects, in addition to examining their initiatives to increase
LNG trading.

Singapore� s moves towards an LNG trading hub• Singapore began commercial operations of its LNG terminal in 2013. Singapore has also announcedplans for a second LNG terminal.
• Given its size, LNG demand within the country may be relatively small. Although liquidity for physical
LNG trading is to be further developed, this is set to improve as Southeast Asia� s LNG demand grows.
Today, more than 50% of global LNG passes through the Straits of Malacca and Singapore.
• Singapore has also awarded two LNG bunkering licenses in January 2016 for companies to supply
LNG bunker to vessels in the Port of Singapore by 2017. Physical LNG trading is expected to become
increasingly active.
• Singapore is also actively promoting the creation of a secondary gas trading market.
• The Singapore Exchange created a price index, the SGX LNG Index Group (SLInG), and had launched
SLInG LNG derivatives contracts in January 2016.
• As the global oil hub and financial center of Asia, Singapore ― has an established trading ecosystemthat provides an advantage for it to become the LNG trading hub in Asia.
• International and national oil companies, financial institutions with commodity trading businesses,
trading companies, etc. have set up offices in Singapore, creating a cluster of players.
• Singapore� s legal system is based on English common law. Singapore is also a leading arbitration
centre in Asia.

Within the movement to develop an LNG trading market in Asia,
Singapore is the most advanced along the path to becoming an
LNG trading hub.
Singapore began importing natural gas from Malaysia throughpipelines in 1992; pipeline imports from Indonesia began in
2001. In the first half of the 2000s, however, gas supply fromIndonesia experienced disruptions, causing power failures overwide areas of the country. To address the growing demand
for natural gas and to secure a stable supply of energy bydiversifying its sources, the Singapore government decided in2006 to build an LNG terminal, which went into operation andbegan receiving LNG in 2013. The government continues todevelop LNG infrastructure with a plan to build the second LNG
terminal.
The Singaporean government is actively promoting not only
the development of LNG infrastructure but also the creation ofa Singapore-based LNG trading market. In October 2015, theEnergy Market Authority of Singapore announced its intention tocreate the Secondary Gas Trading Market (SGTM), a market for

short-term trading in physical LNG in Singapore.
This is expected to enable optimization of medium and longterm LNG procurement portfolios through price hedging
with improved liquidity for physical LNG trading and theestablishment of a price index reflecting Singapore’s domestic
LNG supply and demand.
In January 2016, SLInG LNG derivatives contracts were launchedby the Singapore Exchange (SGX). A market participant noted,“While it is unusual to create a market before there is liquidity
for the product, the creation of a marketplace was implemented
first, given the market’s strong demand for an LNG price index.”
The final settlement prices for LNG futures and swap contracts
are published by the SGX and use the monthly average of theSingapore LNG Index Group (SLInG), which represents Free on
Board (FOB) spot prices for LNG delivered in Singapore. With
this, Singapore aims to distance itself from the traditional oilindexed pricing system and to establish a liquid index for LNG.
SGX also introduced the North Asia SLInG in September 2016 toinclude LNG delivered to ports in Japan, Korea, Taiwan and China.

© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

Developing liquidity in the LNG market - Asia’s challenges and outlook

International Enterprise Singapore14 noted, “Singapore is a
thriving trading hub with a complete ecosystem for the energy,
agri-commodities and metals & minerals trading clusters.”
International and national oil companies, financial institutions
and trading companies undertaking commodity trading activities
have set up offices in Singapore, creating a cluster of trading
players.
At the same time, securing enough transactions is necessary
to establish a Singapore-based LNG price index, but

Singapore’s LNG demand is smaller compared to that of Japanor China. Thus, the lack of liquidity in physical trading could
become a challenge for Singapore in becoming a trading hub.
Nevertheless, LNG demand in Southeast Asia is expected tocontinue growing, and it is possible that LNG will be received
and distributed in Asia through Singapore, thanks to its
geographic location. Additionally, Singapore is also considering
creating an LNG bunkering station, which is expected to help
activate physical LNG trading in the future.

14 International Enterprise (IE) Singapore is a government agency that promotes international trade and partners Singapore companies in going global.

© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

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Developing liquidity in the LNG market - Asia’s challenges and outlook

Possibility of LNG trading hubs developing outside
Singapore• Apart from Singapore, potential candidates for Asia� s LNG trading hub are Japan and China.

• Japan, as the world� s largest LNG importer with numerous existing LNG terminals around the country,
has an advantage in becoming an LNG trading hub in terms of its tangible physical infrastructure.
• In terms of the financial aspects, however, Japan lacks a sufficient cluster of commodity traders.
Thus, it needs to encourage the formation of a cluster of market players, as well as to recruit anddevelop trading expertise.

• China� s natural gas demand is expected to grow rapidly. Its LNG imports are also expected to growand LNG infrastructure development is underway.
• China has pipeline networks connecting its domestic LNG production sites, as well as neighboring
countries, including Russia. An environment that enables arbitrage between pipeline gas and LNG is
China� s advantage in establishing a liquid gas market.

• On the other hand, China� s judicial system, corporate governance, and the government� s involvement
across the gas value chain cause apprehension to foreign players. China could do more to promote theindependence of its markets and promote liberalization of wholesale prices.

• In addition, both Japan and China need to open up their LNG terminals and other infrastructure to third parties.

Apart from Singapore, we can assume Japan and China as
potential candidates for an LNG trading hub in Asia.
Japan, the world’s largest LNG importer with numerous
existing LNG terminals around the country, has an advantage inestablishing an LNG trading hub in terms of the physical assets.
It also has an increasing need to mitigate risks by using a liquid
LNG trading market, rather than relying solely on long-term LNG
contracts; given the progress of the Power and Gas Systems
Reform and the growing uncertainty over its future LNG demand
due to a shrinking population, among other factors. Japanese
power and gas utilities have begun reviewing their LNG
procurement strategies after the Great East Japan Earthquake,and changes can be seen in their posture towards procurement
methods, away from long-term contracts to short-term and spot
contracts.
The Japanese government is also supporting the developmentof an LNG trading hub in Japan. In May 2016, the Ministry of
Economy and Trade announced the “Strategy for LNG Market
Development15” and presented Japan’s role in fostering the
growth of a liquid LNG market. In addition, the Japanese
government proposed a plan to create an international LNG
trading market in Japan by the first half of the 2020s at a
meeting of G7 energy ministers, and expressed its intention toprovide the necessary assistance to create a liquid LNG market.
Furthermore, the Amended Gas Business Act was passed inJune 2015, which is expected to promote third parties’ use of
the LNG gas terminals currently owned mainly by power and gas
utilities.

Chart 3-1. Sites of LNG import terminals in Japan
Primary LNG terminals in operation
Primary LNG terminal in planning/under construction
Note: as of August 2016

Source: KPMG based on "Present status of city gas business"(http://www.gas.or.jp/gasfacts_j/)by Japan Gas Association.

15 Strategy for LNG Market Development: Creating Flexible LNG Market and Developing an LNG Trading Hub in Japan”© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

Developing liquidity in the LNG market - Asia’s challenges and outlook

In September 2014, the Japan OTC Exchange (JOE), whose
shareholders include the Tokyo Commodities Market (TOCOM),
created an LNG futures market. JOE offers non-deliverable
forward OTC (bilateral) and futures contracts and the averageof the DES Japan Index published by Rim Intelligence is usedas the price index (Table 3-1). Like Singapore’s SGX, TOCOM
and JOE aim to break away from oil-price indexation and toestablish an LNG price index reflecting supply and demandof LNG. Therefore they are expected pursue the creation ofa marketplace for physical LNG. Like SLInG, however, DES
Japan will need to make sustained efforts before it can earn theconfidence of the market players and secure liquidity.
An informed sources noted, “If power futures become widelyused in Japan, it will also invigorate the LNG futures market bycreating the need to lock in profits using LNG futures.”
There are many cases of Japanese companies establishing
offices in Singapore, rather than Japan, to start their trading
operations, even among power and gas utilities. The challenges
for Japan to become Asia’s LNG trading hub will therefore
be to encourage the formation of a cluster of market players
engaged in trading and to recruit and develop human resources
experienced in trading.

construction of LNG terminals in its coastal areas.
An environment that enables arbitration between pipeline gas
and LNG is a significant advantage for China in establishing aliquid gas market.
In December 2010, Asia’s first LNG spot market was opened on
the Shanghai Petroleum Exchange, and a natural gas spot market
was also opened later. In addition, a liquid LNG derivatives
market is also developing. An informed sources noted, “Withoverseas LNG market players beginning to reference China’s
derivative prices, the country’s derivatives market is beginningto have an impact on the overall LNG market in Asia indirectly.”
Considering the state of development of its LNG infrastructure
and the feasibility of price arbitration with pipeline gas, Shanghai
has significant potential to become Asia’s LNG trading hub.
On the other hand, many people have concerns about China’s
judicial system and corporate governance. Given that the
Chinese government is believed to be heavily involved acrossthe country’s gas value chain, China will need to promote theindependence of its markets and promote the liberalizationof wholesale prices to earn the confidence of market players.
In addition, like Japan, it will also need to open up its LNG
terminals to third parties.

China, the other potential candidate for Asia’s LNG trading hub,is expected to continue seeing a rapid growth in natural gas
demand, and its LNG imports are expected to grow alongsidedomestic LNG production and pipeline imports from neighboring
countries. In addition to having pipeline networks connecting
its domestic LNG production centers, as well as neighboring
countries including Russia, China is also actively promoting the

As we have seen above, when we compare the requirements
to become an LNG trading hub in Singapore, Japan, and China,
Singapore seems to be ahead of the other candidates in many
respects, particularly in financial infrastructure, although it has
a disadvantage in terms of demand for LNG in physical trading(Table 3-2)16.

Table 3-1. Comparative table of LNG futures in
Singapore and Tokyo

Table 3-2. Requirements for a competitive market:
Singapore, Japan, and China

Singapore

Requirement

Japan

Singapore

Japan

China

Contract
name

SGX FOB Singapore
SLInG LNG Futures

DES Japan LNG futures

Demand for LNG as physical
trade

D

A

A

Trade type

Futures

Futures

Arbitrage between pipeline gas
and LNGU

D

A

Trading unit
(MMBtu)1,000

50,000Liberalization of wholesalemarketA

A

U

Clearing
price

Monthly average of
SLInG announced
weeklyAverage of DES Japan publishedby Rim Intelligence Co. from the16th of the month preceding themonth including the final trading
day to the final trading day.

Third party access to
infrastructure

A

D

D

Participation of ﬁnancial institutions, traders

A

U

D

Up to 12 months

Up to 12 months

Legal, institutional framework

A

U

D

Maturities
tradedSource: KPMG based on "LNG Contract Specifications"(http://www.sgx.com/wps/
portal/sgxweb/home/products/derivatives/commodities/gas/gas/contracts) by SGX,and "LNG(Non-deliverable Forward / Futures)Contract Specifications"(http://www.j-otc.com/guideline/20160322_LNG_Spec_Web.pdf) by JOE.

Note:
A＝Advantageous for creating competitive natural gas market;
U＝Unknown whether advantageous or disadvantageous for creatingcompetitive natural gas market;
D＝Disadvantageous for creating competitive natural gas market

16 TOCOM and SGX have signed a memorandum of understanding to cooperate in developing the LNG market in Asia as well as to share their experiences indeveloping electricity futures including a joint study of the benefits of product initiatives, such as the co-listing of LNG derivatives based on relevant indices.
http://www.tocom.or.jp/jp/news/2016/20161122.html© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

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Developing liquidity in the LNG market - Asia’s challenges and outlook

Possibility of coexistence of multiple trading hubs
• Multiple trading hubs could coexist in Asia, rather than just one.
• For example, the US has multiple physical hubs for natural gas and Europe also has multiple natural
gas hubs, such as the Natural Balancing Point (NBP) in the UK and the Title Transfer Facility (TTF) in the
Netherlands.
• Considering the size of its LNG market and its growth prospects, multiple LNG trading hubs could
emerge in Asia.
• A division of roles may be possible: Singapore becoming a paper trading hub and Japan and China.
becoming physical trading hubs.
• Whether a single price index will prevail in Asia as the standard index or multiple indices will coexist,
with an index in each region depends on how the market develops.

As we have seen above, Singapore, Japan, and China, among
others, have strong potential to become the LNG trading hub
in Asia. However, we can also contemplate the possibility of
having multiple trading hubs in Asia.

We think that whether the multiple indices will converge into
one or will continue to coexist, with an index in each region will
be determined as the market develops (Chart 3-2).

In the US, for example, there are multiple physical hubs fornatural gas, although in most cases Henry Hub’s price is thereference price for transactions. Europe also has multiple
natural gas hubs, such as the Natural Balancing Point (NBP) in
the UK and the Title Transfer Facility (TTF) in the Netherlands.
While these are hubs for natural gas, not LNG, many industry
players think it likely that multiple LNG trading hubs will emerge
in Asia considering the size of its LNG market and its growthprospects.

Chart 3-2. Cooperation among trading hubs in
Singapore, Japan, and Shanghai

An informed sources in Singapore noted, “We can contemplate
the possibility of a division of roles between Singapore andJapan and China together; the former, which has an establishedenvironment for trading and a cluster of a large number ofplayers trading LNG, becoming a paper trading hub and thelatter, which have large domestic demand for physical LNG,
becoming physical trading hubs,” as an example of having
multiple LNG trading hubs. Furthermore, “The growth ofmultiple LNG trading hubs could contribute to improving eachother’s liquidity and lead to the growth of Asia’s trading market
as a whole.”

Tokyo, Japan
Shanghai,
China

Singapore

When it comes to an LNG price index, however, it is unclear
whether a single price index will prevail in Asia as the standard
index. An informed sources noted, “If DES Japan, SLInG,
and JKMTM 17 coexist and come to move in tandem with eachother, they will become easy to use indices for the players.
Converging to a single index is not necessarily a good thing.”

17 JKM™: Japan Korea Marker© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

Developing liquidity in the LNG market - Asia’s challenges and outlook

CHAPTER 3

Current position of the LNG market as derived fromcomparisons with other commodity markets• In addition to the crude oil market and the natural gas markets of the US and Europe which have longsince evolved into traded markets, markets have also been developing for other commodities for which
the development of a trading market was previously considered difficult.
• Given the wide quality deviations, establishing a trading market was considered difficult in the case of
the coal market. However, with the development of a financial market, coal trading is becoming activein the marketplace.
• With a limited number of producers, evolving into a traded market was also considered difficult for theiron ore market. However, as the major producers shifted to market transactions as a result of market
deterioration due to the fall in iron ore prices, the establishment of a trading market advanced rapidly.
• Assuming that the LNG market will be influenced by similar events, if there is a breakthrough in thissituation, optimization of power and gas utilities� procurement portfolios prompted by the Power and Gas
Systems Reform in Japan, which accounts for half of global LNG demand, could be one of the catalysts.

In this chapter, we will examine the current position of the LNG
market based on comparisons with other commodity markets
that have already become liquid. Crude oil and natural gas in the
US and Europe have traditionally been advanced in terms of a
trading market. In recent years, liquid markets are developing
even for other commodities including coal, which had been
considered difficult to be traded in a marketplace.
In every commodity that is advanced in terms of a trading
market, a liquid market developed through a process in which
the wide adoption of financial trading was preceded by thewidespread use of physical trading.
What are traded in physical trading and in financial trading arereferred to as the “underlying asset” and “derivative product(derivatives)” respectively. Physical trading, also known as“spot trading,” is executed by exchanging the payment andphysical goods at the prevailing market price. Derivatives —which refer to futures, swaps, and options — are, literary,
derivatives of underlying assets developed to be used forhedging by holding positions that offset those of the physicalgoods. Physical trading and derivative trading are closely linked,

as exemplified by the existence of arbitrage between physicaland futures trading.
In a system where the price risk in the upstream could be
passed through to the downstream under the traditional fullcost principle, it was sufficient to conduct only physical trading
after securing the supply through long-term purchase contracts.
There was no need to hedge the future price risk that may
arise from the difference between the procurement price in themarket and the sales price to the customers through futures
trading or other means, or to make use of a range of possible
trading to improve one’s procurement cost and seek to optimize
the balance between risk and return. In the post full-cost era
that follows the Power and Gas Systems Reform, however, theliberalization of the downstream market will make the cost passthrough impossible, leaving power and gas utilities exposed
to price risk. These changes in the market environment willcompel market participants to use financial trading to hedge therisks that cannot be controlled through physical trading alone.

Table 4-1. Formation process of the iron ore market
Growth of spot trading

2003

2004

Developmentof spot price indices

Emergence ofﬁnancial trading

2006

2008

2005

2007

Collapse of
the traditional pricing
system
2009

2010

2011

Development ofliquidity infutures markets
2012

2013

Early 2000s

2000s

2008

2010

2013

Expansion of iron ore
demand in China

Development ofspot price indices

Demand fall
after Lehman shock

Shift of large producers
to spot prices

Listing ofiron ore futures© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

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Developing liquidity in the LNG market - Asia’s challenges and outlook

Conditions in othercommodity markets

Formation process of theiron ore market

The crude oil market is one of the oldest of the fuel markets
and has achieved a level of development on a par withfinancial instruments markets. As well, the natural gas
markets of the West, which are connected through pipelines,
saw the introduction of market mechanisms earlier thanthe power sector. In addition, even coal — whose large
deviations in quality seemingly made it difficult for a market
development — is forming a liquid marketplace as a financial
market developed in recent years.

Although having lagged in development of a liquid market, much
like LNG, iron ore can be cited as one of the commodities thathas seen rapid improvement in liquidity in recent years. In thissection, we will look at the formation process of the iron ore
market to date in order to establish a benchmark for examining
the current status of the LNG market.

In the world of crude oil trading, which boasts the largest
trading volume of all commodity markets, three price indices
are referred to as the “Big Three”: the Middle Eastern Crude
Oil price, calculated by averaging the Dubai crude and Oman
crude prices (which are both spot contracts) and the New York
Crude Futures price and the Brent Crude Futures price, which
are both futures contracts. Derivatives other than futures,
e.g. swaps and options, are also available, just as in a financial
instruments market.
In the US, the typical benchmark for physical trading inpipeline natural gas is the Henry Hub price. Europe has
multiple benchmarks for physical trading, including the NBP.
Derivative contracts — much like those for crude oil — arealso available. In the world of physical coal trading, globalCoal
has established itself as the Asia Pacific benchmark for thesettlement of spot trading, while regional API indices are usedin the respective regions around the world. Bilateral OTC
swap contracts and option contracts are available for some of
the APX indices (Table 4-1).
As we have seen above, fuel markets other than LNG havethe tools which are necessary to address risk managementin the post full-cost era, but the LNG market at present lacks
the convenience that is available in other markets. If there
is to be a breakthrough in this situation, the Power and Gas
Systems Reform in Japan, which accounts for half of global
LNG demand, could be one of the catalysts. Further efforts
to develop the market is expected to support a smooth
expansion in the utilization of the market — from physicaltrading only to also include financial trading — in responseto the needs of the market players facing the enormous
challenge of implanting a management system for the postfull-cost era.

The market for seaborne iron ore is an oligopoly in which threelarge producers — Brazil’s Vale and Australian’s BHP-Billiton and
Rio Tinto — control the bulk of the market. Before the spot
market became widely used, coal trading was predominantly
based on the long-term purchase contracts of five years or moreby the established steel manufacturers. These were mostly
Japanese and Korean and transaction prices were set basedon the benchmark price agreed on in the annual negotiations
between the iron ore producers and the steel makers.
The traditional iron ore market had great similarities with today’s
LNG market in that East Asia is the center of demand and that it
was dominated by market practices based on a pricing systemthat was hardly transparent in the sense that prices were set
based on long-term contracts and through bilateral negotiations.
The spot market for iron ore started in the early 2000s, driven
in part by the late-coming but rapidly-growing Chinese steel
manufacturers who aggressively expanded iron ore purchaseson the spot market. On the supply side, in the meantime, Indian
producers began selling more of their products in the spot
market — amidst the predominance of the trading based on thelong-term contracts of mainly large iron ore producers — which
gradually led to the growth of the iron ore spot market.
As the iron ore spot market became more liquid, the reporting
frequency of the price indices also improved — from monthly
initially to daily in the late 2000s. The Steel Index (TSI) and theindex published by Platts, which could be cited as the typicalindices for spot iron ore prices, are all indices representing
62% Fe and 58% Fe (these are typical grades for iron ore in the
spot market) and CFR18 prices at import ports in China, a majordemand center, not FOB19 prices in the place of production.
As the reporting frequency of spot iron ore prices improved,
they also earned the confidence of the market as price indices.
Financial contracts that trade spot iron ore prices have also
emerged, including swaps listed on the SGX in 2009.
As seen above, the growth of a marketplace for iron ore was
gradual, but the collapse in spot iron ore prices caused by thefall in demand due to the recession following the Lehman shockin 2008 was a significant turning point for a further improvementof market liquidity. As spot iron ore prices plunged below the

18 CFR: Cost and Freight
19 FOB: Free On Board© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

Developing liquidity in the LNG market - Asia’s challenges and outlook

benchmark price, the established steel makers switched frombenchmark price-based trading to spot price-based trading.
At the same time, large iron ore producers including BHP andVale expressed their support for spot prices by 2010, solidifying
the trend of growing liquidity in the iron ore spot market.
As the iron ore spot market grew more liquid, so did the financial
market. Swaps on spot iron ore prices have increased rapidly
since the early 2010s and have grown into a liquid market.
The CME and the SGX listed futures based on spot iron ore
prices in 2013 and futures trading also continue to expand
steadily. Increased liquidity in the iron ore futures markets is
expected to enable both iron ore producers and steel makers tohedge market risks even more efficiently (Table 4-2).

Table 4-1. Typical spot and futures indices for energy commodities
Type

Crude oil

Spot

Index

Exchangeindex provider

Dubai / Oman

DME

Futures available for both the Dubai and Oman crude oil prices

WTI Crude Oil

NYMEX

Futures (New York Crude Oil Futures) on WTI, a generic name for crude oil
produced mainly in Texas and New Mexico.

Brent Crude

ICE

Futures on North Sea (Brent) crude oil traded on former London IPE

Henry Hub

NYMEX

Price index for physical gas at pipeline hub in Louisiana.

ICE

Used respectively as the region’ s virtual trading point in UK’ s NBP and
Netherland’ s TTF.

Henry Hub

NYMEXElectronic trading on CME Globex also available

NBP

OCM

TTF

ICE

globalCOAL
NEWC

globalCOAL

Benchmark for Asia Paciﬁc

API2, etc.

Argus
McCloskey

API is a set of indices ranging from API2 (CIF ARA) to API12 (CFR India).

globalCOAL
NEWC Futures

ICE

Established as Asia Paciﬁc index though volume still small compared toother markets.

API2, etc.

NYMEX
EEX

API2 and API4 (FOB Richards Bay) have higher liquidity.

JKM™

PlattsPrice index for spot trading of LNG in Japan and Korea

DES Japan

JOE

Listed on NYMEX, clearing service provided by CME.

SLlnG

SGX

Named after famous cocktail, Singapore sling.

FuturesNatural gas

Spot

NBP
TTF

FuturesComments

Trading system provided by ICE Endex

Coal

Spot

Futures

LNG

Spot

Futures
Source: KPMG based on various materials© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

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Developing liquidity in the LNG market - Asia’s challenges and outlook

Table 4-2. Representative spot and futures contracts for iron ore
Type

Index

Exchangeindex provider

Comments

TSI iron ore

TSI

Five grades including iron ore ﬁnes 62% Fe - CFR Tianjin Port
(China) /Iron ore ﬁnes 58% Fe (low alumina) - CFR Qingdao Port
(China) / Iron ore ﬁnes 62% Fe (low alumina) - CFR Qingdao Port
(China).

IODEX Iron Ore

PlattsIron ore ﬁnes 62% Fe - CFR Qingdao, North China

the SGX TSI Iron Ore CFR
China (62% Fe Fines) Index
Futures, etc.

the SGXThe SGX TSI Iron Ore CFR China (62% Fe Fines) Index Futures / theSGX Platts Iron Ore CFR China (Lump Premium) Index Futures, etc.

Iron Ore 62% Fe, CFR China(TSI) Futures, etc.

CME

Iron Ore 62% Fe, CFR China (TSI) Futures, Iron Ore 62% Fe / CFR
North China (Platts) Futures / Iron Ore 58% Fe, Low Alumina, CFR
China (TSI) Futures

Spot
Iron ore

20

Futures

Source: KPMG based on various materials

Current position of the LNG market
Looking at the process in which the iron ore market becameliquid, some characteristic developments, as listed below,
were observed. In this section, we will examine the current

position of the LNG market by comparing and examining its
current condition in respect of these developments:― Growth of spot trading― Collapse of the traditional pricing system― Development of spot price indices― Emergence of financial trading― Development of liquidity in futures markets© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

Developing liquidity in the LNG market - Asia’s challenges and outlook

Growth of spot trading
While the current LNG market is dominated by trading basedon long-term contracts of the established, mostly Japaneseand Korean players, a large number of new LNG importers haveentered the market in recent years, and these new importers
tend to prefer procuring through short-term contracts and spot
trading. While the spot trading of the new LNG importers only
account for a limited share of the total LNG market so far, thepicture of new importers expanding their spot trading resembles
China’s expansion of its spot trading in the iron ore market.

The trend of favoring spot trading can also be observed inestablished LNG-importing countries. In particular, spot trading
by Japanese players has increased as the power utilities
increased their spot market procurement, driven by the shortageof LNG supply as an alternative fuel due to the suspensionof nuclear power plants after the Fukushima accident. It is
expected that growing use of spot trading by establishedplayers, and the entry of new LNG importers, will continue todrive the growth of spot trading in the LNG market.

Development of spot price indices
JLC (Japan Liquefied Natural Gas Cocktail) is a price benchmarkthat has been widely used in the LNG market for a long time.
JLC represents the average CIF20 price of LNG imported toJapan, the world’s largest LNG consumer. Although JLC isa price benchmark in the place of consumption, it is basedon the LNG import prices compiled in the trade statistics
including those under long-term contracts, i.e. it is not an index
representing spot prices.
On the other hand, JKMTM, published by Platts, is a spot pricebenchmark that is currently becoming popular. JKM™ is abenchmark based on the spot import prices of LNG deliveredin East Asia, the dominant market for LNG. With daily pricereporting started in 2009, the benchmark has gradually been
earning the market’s confidence.
Given the emergence of new LNG price indices such as DES
Japan and SLInG, players need to watch the developments going
forward, including which price index will become dominant asa result of convergence. Although indices for spot LNG prices
are in the process of development, price indices in the place ofconsumption have long been in formation in the LNG market.

Emergence of financial trading
With JKMTM beginning to be widely used in the market as a
price benchmark and increasingly used in contracts for physical
LNG, bilateral JKMTM swaps have seen significant growth,particularly since 201421. At present, swaps on spot LNG prices

have yet to establish a liquid market, but swap trading throughexchanges such as JOE and the SGX is expected to grow.

20 CIF: Cost, Insurance and Freight
21 Platts research© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

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Developing liquidity in the LNG market - Asia’s challenges and outlook

Collapse of the traditional pricing system
Regarding pricing systems, we need to look at developments
on both the demand side and the supply side. To look at thedemand side first, there is a trend among the Japanese players,
who need to respond to the Power and Gas Systems Reform,
to increase the use of spot trading to improve flexibility in LNG
procurement. In particular, JERA, Japan’s largest LNG importer,
has announced a policy to significantly reduce the proportionof long-term contracts by 2030 and to cover the reduction withshort-term and spot contracts to improve procurement flexibility.
In addition, the fact that LNG export projects in North America
will start exports of natural gas to Japan based on Henry Hub
prices is another development that will encourage a shift awayfrom the traditional oil-indexed pricing system.

On the supply side, we see no apparent trend to seek spot
price-based trading at present. However, if the spot market
becomes more liquid in the future, it is possible that the supply
side will also see advantages in trading based on spot prices.
Especially, if a sense of surplus develops in the market whenlarge LNG projects are completed and begin supplying; thesupply side may find themselves in a circumstance that compel
them to shift to spot price-based trading. However given therelatively large number of LNG players on the supply side,compared with the oligopolistic iron ore market dominated bythree large players, there may be difficulty for certain players totake the initiative in the shift to a new pricing system.

Development of liquidity in futures markets
To date, two LNG futures markets have been created: one inJapan, the JOE’s futures market based on the DES Japan index,
and the other in Singapore, the SGX’s futures market based on
the SLInG index. However, neither market has secured enoughtrading volume so far to be able to offer a liquid market.
At present, LNG futures markets have not reached a criticalmass where liquidity begets more liquidity and further
developments of the markets needs to be seen.

marketplace is in the process of developing. At the same time,
the traditional pricing system is still present in today’s LNG
market and financial markets, including futures markets, are far
from being liquid (Table 4-3). Nevertheless, it is possible thata sudden change in the market, such as we saw in the iron ore
market, becomes a catalyst that causes the collapse of the
traditional pricing system. The moves of the Japanese players,
the world’s largest LNG consumer, could play a pivotal role inthe case.

As we have seen above, we are beginning to see somedevelopments in the current LNG market with respect to thegrowth of spot trading, the development of spot price indices,and the emergence of financial trading, which suggest that a

Table 4-3. Summary of the LNG market’ s current position
Characteristic developments

Progress

Growth of spot trading

Spot trading increasing gradually

Development of spot price indices

Spot price indices such as JKM™, DES Japan, and SLInG beginningto develop

Emergence of financial trading

Financial trading such as JKM™ swaps beginning to emerge

Collapse of the traditional pricing system

Traditional oil-indexed pricing system remains

Development of liquidity in futures markets

Futures markets created, but lacking liquidity© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

Developing liquidity in the LNG market - Asia’s challenges and outlook

CHAPTER 4

The challenges in developing a liquid LNG market• Although LNG futures markets were created in some countries over the past few years, there iscurrently no liquidity in LNG futures markets. The three challenges addressed in this chapter need to be
overcome for LNG market to establish itself.

As discussed in Chapter 3, LNG futures markets have beencreated in Japan, Singapore, etc. over the last few years, but
those markets are not sufficiently liquid at present. Boostingof underlying LNG spot trading is essential to improving
the liquidity of LNG futures markets. Nevertheless, eventhough spot trading volumes have been increasing graduallyin response to increased LNG demand after the Great East
Japan Earthquake and the fall in LNG prices stemming from thedecline in oil prices, we cannot say that the LNG spot market atpresent is sufficiently active. For Singapore, Japan, China, etc.
to grow as LNG trading hubs, trading in the underlying asset,
i.e. physical LNG, needs to become more active. To this end,
multiple challenges, including those discussed below, need tobe addressed.

Concentration of players• The evolution of the LNG market into a trading market is believed to be difficult due to the fact that themarket players are limited to those few who can afford large infrastructure investments for liquefaction,transportation, etc. However, the iron ore market, which has a high concentration of players, has
evolved into a trading market, as seen in the previous chapter.
• The newly installed liquefaction/gasification terminals around the world will help resolve theconcentration of players, and an increased diversity of buyers and sellers could produce a positive cyclethat stimulates further infrastructure investments.
• LNG� s large trading volume is another factor limiting the number of market players. However, as LNG
comes to be traded in smaller quantities thanks to technological innovations in transport infrastructure,
new players can be expected to enter the market; potentially bringing depth and diversity to the set ofmarket players.

Increasing physical LNG trading volumes is considered an
important factor that leads to improving liquidity for spot trading
and consequently to the development of a marketplace for
LNG. In the traditional LNG market, however, supply originatedfrom certain limited regions and from certain limited playerswith large financial resources, since large development costs
were required. In other words, there was a “concentration of
suppliers.” At the same time, there was also a “concentrationof buyers” since the buyers were also limited to East Asia, such
as Japan.
Since such concentrations generally make it difficult for amarketplace with trading in both directions to develop and areconsidered a factor that favors bilateral trading, rather thanmultilateral trading in an open market (Chart 5-1).
In fact, the traditional LNG market was a closed market wheremost of the trading was bilateral. However, the LNG industry
landscape has experienced significant changes in recent years,
including increased LNG production in Australia, an increase in
the number of North American LNG export projects, a larger
number of LNG-importing countries, and the decline in LNG

prices induced by the sharp fall in oil prices. It is becoming
increasingly likely that these changes will become the forcesthat will transform the LNG market itself. This situation
resembles that of the iron ore market, where there was aconcentration of players but the development of a marketplace
progressed during a period of depressed prices.
At the same time, the increased supply of LNG and theincreased diversity of LNG suppliers in recent years havecreated competition among the suppliers, which has been
acting as a driver encouraging the shift to more favorable (moreflexible) terms for the buyers in traditional long-term purchase
contracts. It has also prompted an increase in shorter-term
contracts and spot trading, which may increase at a faster pacein the future given their role in securing management flexibility
for the buyers.
Furthermore, there is currently increased spare capacity of LNG
supply at low prices, which is encouraging the emergence of
new LNG importers, particularly among emerging countries thattraditionally viewed LNG as a relatively expensive fuel.
If infrastructure development progresses in these new LNG-

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Developing liquidity in the LNG market - Asia’s challenges and outlook

importing countries, it will contribute greatly to stimulating
the growth of trade in physical LNG. Among the required
infrastructure investments includes additional LNG importterminals and storage facilities, expanded natural gas pipeline
networks, and LNG bunkering stations. If the development ofsuch infrastructure progresses, it will lead to further increases
in the trading volume of physical LNG, which will in turn
become the factor that enables the first important step in thedevelopment of a LNG marketplace.
Nevertheless, developing LNG infrastructure requires enormous
funding. To date this has been undertaken by a handful ofplayers with large financial resources, as noted above.
However, increasing the number of LNG importers and LNG
demand requires demand-enabling infrastructure. This will
require the support of the oil majors and so forth as suppliers, aswell as financial support from donors, such as the suppliers andthe governments of the large established LNG markets. There
are also growing expectations for the development of new
financial schemes to leverage the financial resources of players
such as large infrastructure funds.
Another requirement is the freedom of access to thisinfrastructure. Even if the development of infrastructure
progresses, that will not help to make the market active if
freedom of access is not secured. Regulatory reform that
promotes third parties’ access to infrastructure such as LNG

terminals and invigorates market competition is essential toenable new entrants to compete with the incumbent players in
the liberalized gas market.
If LNG terminals and other infrastructure in importing countries
become freely accessible, it would create a virtuous cycle inwhich competition is stimulated on the demand side and in turnprompts the use of infrastructure by diverse players. Providing
access to LNG terminals is also an important agenda in Japan’sPower and Gas Systems Reform. Advancing this kind of reform
requires governmental support, as well as the creation ofprograms such as incentives to encourage the owner companies
to make their infrastructure available.
Increasing the trading volume of physical LNG may require
reducing the minimal unit of LNG traded. Installing natural gas
pipelines is considered uneconomical, particularly in areas thatare made up of islands, like some areas of Southeast Asia.
If there is a need for LNG in such areas, however, initiatives tosupply LNG in smaller units that are still economical are needed.
Accelerating such initiatives will require development of
infrastructure which is suitable for handling supplies that are
finely-tuned to the needs of the receiving side (e.g. small LNG
terminals). Since trading in smaller units has an economic
disadvantage, technological innovations that enable efficienttransportation in small units will also be necessary.

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Developing liquidity in the LNG market - Asia’s challenges and outlook

Considering that traditional bilateral trading, such as long-term
contracts assuming large quantities, are currently the core of
the LNG market, an increase in the number of small trades will
not immediately lead to increasing the overall trade volume.
Instead, improving trade flexibility in general by increases inshort-term trading (particularly spot trading) through an increasein physical trading, an improvement in market liquidity as aresult, low cost transportation for small quantities, etc., willprompt the trade volume of physical LNG to grow.
Lastly, a cluster of commodity traders who handle resellingand derivatives in LNG is essential to improving liquidity in the
LNG market, in addition to increased activity in physical LNG
trading driven by real LNG demand. Having a large number ofcounterparties is essential for a well-functioning trading market.
Therefore it is necessary to create a market environment which

is attractive traders from abroad. There is an important rolethat the government can play in developing an environmentthat allows easy entry for overseas players by developing atransparent judicial system and transparent regulations.
At the same time, limiting the government’s involvement in
the market and letting private sector lead the market to securetransparency and credibility should contribute to the market’s
healthy development. In addition, building a cluster of traders
will require measures in terms of human resources.
One strategy for Asian power and gas utilities, who do not havemuch experience in trading may be alliances with experienced
Western firms. By acquiring trading know-how through these
alliances, they will be able to set up their organizations properly
and to internally accumulate the capabilities required to conduct
trading.

Chart 5-1. Bilateral and multilateral trading

Bilateral
SupplyPlayer A

DemandPlayer B

Non-disclosed bilateral trading
resulting in closed markets

MultilateralSupplyPlayer A

DemandPlayer H

SupplyPlayer B

DemandPlayer G

SupplyPlayer C

DemandPlayer F

SupplyPlayer D

DemandPlayer E

Accommodation
trading among
buyers expands
secondary market

Diversity of counterparties createsan open market, promoting sophisticationof trading and standardizationof settlement systems© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

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Developing liquidity in the LNG market - Asia’s challenges and outlook

LNG� s suitability for trading• Due to the quality deviations in terms of calorific value equivalents, the development of a trading
market is believed to be difficult for LNG. Nevertheless, coal, which has wide quality deviations, hasseen the development of diverse local markets, which are collectively developing overall liquidity.
• If standardization of physical LNG trading proceeds and overall liquidity improves through thecoexistence of multiple indices, leading to the convergence into a single LNG index as a result, there
will be more possibility that a reliable financial trading also emerge in the LNG market.

It is sometimes said that the differences in quality in terms ofcalorific value equivalents is preventing the improvement ofliquidity in the LNG market. Given the issue of quality variations,the fact that the LNG market structure is not so simple as toallow you to forecast prices by simply relying on some limited
price drivers derived from the crude oil price, in addition to thedifferent uses on the demand side, may be effecting LNG’s low
liquidity.

on the supply and demand profiles of the regional coal markets,and the need to adjust supply and demand across them led to
an increase in the number of market participants joining intermarket arbitration. Following these developments, standard
specifications were established and it became possible to makecalorific value equivalent price conversions using price indicesbased on those specifications, which in turn led to the setting oftransparent transaction prices.

We can gain insights into the problem of differences in productquality by comparing LNG with the market characteristics ofcoal, which is also used as a fuel for thermal power generation.
A range of price indices have developed in the coal market, i.e.
by destination (Europe, Asia, China — places which are also
major markets), by loading point on the supply side (South
Africa, Australia, etc.), and also by specification based on thequality of the coal. Coal has these diverse price indices due tothe wide differences in quality depending on the origin.
On the other hand, one year contracts are the norm, which isa major difference from the long-term contracts of ten to thirty
years in the case of LNG.

The development of a process in which rational prices forphysical trading are formed also made derivative trading suchas futures and swaps possible and added depth to financial
trading. After all, even in markets where the product range
grows increasingly diverse, transaction prices become reliable
on their own when liquidity improves as the trading volume ofthe physical product in the spot market increases. The growth in
the derivatives trading having such assets as the underlying was
not an exception even in the case of coal, which has diverse
markets.

While the formation of a large number of coal markets basedon these diverse price indices is attributable to a combinationof factors, the growth of the demand for coal in China and other
Asian countries, the deregulation of Western power markets,
etc., are considered important trigger events. The growthof Asia’s coal demand (particularly in China and India), which
influenced not only the increase in trade volume but also market
practices in the West, and the concurrent increase in spot
trading are believed to be responsible for the increased diversity
in the forms of trading. The resulting emergence of competition
among the regional markets and the activities to complement
each other’s supply and demand imbalances are believed tohave led to the development of a wide variety of transaction
price benchmarks.

Considering this, regarding the formation of multiple priceindices as an obstacle to the improvement market liquidity could
mislead our future prospects. Even in the LNG market, where
products of different origins and qualities are traded, the same
pattern of increased trading volume in regional markets leading
to the formation of reliable price indices in each market, which inturn create a positive spiral in which reliable price indices beget
more trade volume and ultimately improve the market liquidity.

The increase in spot trading is attributable to the advanced
deregulation of the power sector in the advanced countries,
which shifted the market practice from the traditional oneyear contracts to spot trading. The emergence of imbalancesamong the different coal markets was the result of a change inthe market environment in the form of a rapid decline in coaldemand due to environmental issues. This had a large impact© 2017 KPMG AZSA LLC, a limited liability audit corporation incorporated under the Japanese Certified Public Accountants Law and a member firmof the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

Developing liquidity in the LNG market - Asia’s challenges and outlook

Price transparency• While anti-competitive market practices such as destination clauses and oil-indexed price terms are
believed to be factors impeding improved market liquidity, revisions to contractual terms including theremoval of the destination clause and increased spot trading not dependent on oil-price indexation,
could improve price transparency.
• As more transaction prices transpire as a result of improved LNG price transparency, market players
will naturally begin to demand indices to be used as a reference price, which could in turn accelerate
the improvement in market liquidity.

Some long-term contracts between LNG suppliers and buyers
prohibit or restrict the resale of LNG under destination clauses.
Destination clauses that restrict reselling in secondary markets
are a great obstacle in improving LNG market liquidity.
It is believed that impediments to liquidity, such as thedestination clause, need to be eliminated to create anenvironment in which both LNG suppliers and LNG buyers
around the world transact in a competitive market.
Revisions to contractual terms including the removal ofthe destination clause are set to increase. LNG buyers are
becoming increasingly vocal in demanding revisions to theircontractual terms aided by the combination of an environment
favoring the buyers — the product of the increased diversityof LNG supply and demand and an increase in overall supply— and low oil prices. LNG buyers are expected to conduct
secondary trading more actively with the removal of destination

clauses, it will help to further increase spot trading in physical
LNG22. Given that the contracts for the LNG to be imported by
Japanese companies from North America are free of destination
restrictions from the beginning, some players are looking
to conclude short-term contracts with a view to conducting
secondary trading in the future.
While the increase in the number of LNG importers has
slowed down slightly at present due to low oil prices, there
are many cases in the traditional LNG-consuming countries inwhich the strategy of increasing spot trading is chosen overrenewing existing long-term contracts, which have resulted inincreased spot trade volume. In other words, spot prices thatare competitive to some extent are currently developing basedon comparisons between the oil-linked prices under long-term
contracts and the spot prices.

22 In reality, as is also common in other markets, both primary and secondary trades are treated without differentiation as short-term physical trades and help toimprove liquidity as a whole.

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Developing liquidity in the LNG market - Asia’s challenges and outlook

There is criticism that the oil-indexed price mechanism adopted
in long-term LNG purchase contracts does not properly reflect
the supply and demand of LNG. Moreover, since price formulas
vary by contract and are decided bilaterally, transaction prices
are unknown except to the parties of the contracts, and even
if the formulas were disclosed to third parties, it would be
difficult to evaluate contracts without understanding the factorsthat determine the price. A market that lacks reproducibilityof transaction prices makes price comparisons difficult, even
if there was a desire to consider reselling the contract itself
to another company or swapping it, for example. Until now,
this opaque price-setting method has been considered normal
market practice in the LNG market.
Meanwhile, as increased spot trading volume, market players
will need price indices trusted by all market participants in order
to execute spot trading. In other words, there will be a need fora transparent price-setting method in the spot market. For thetime being, indices such as JKMTM, DES Japan, and SLInG willneed to gain acceptance, but improving transparency in physicalspot trading will have to come first. Once the LNG priceindices become widely used, price transparency will improveon its own. Furthermore, increased use of LNG price indicesas the transaction price in spot trading or as the benchmark for
setting the price in long-term purchase contracts is expected
to enhance the reliability of the price formation process andprompt market participants to use them more frequently. Thisis because the improvement in the effectiveness of the indicesin individual trades will produce a synergistic effect and help tofurther improve transparency in the formation of LNG prices.
If the LNG market becomes more liquid in this manner and thereliability of price indices improves as a result, this will increase
the need for the players of physical trading to hedge price risk
through futures trading, and in turn make futures trading more
active.
Increased futures trading will prompt the participation offinancial players and result in invigorating futures trading, as wellas the price indices establishing themselves. If futures trading
becomes active, other derivative markets based on futures, e.g.
swaps and options, should also grow in turn. This phenomenon
is commonly observed in the pipeline-supplied gas marketsof the West. While there are significant differences between
pipeline gas and LNG, there are fewer reasons why the LNG
market should not become like the pipeline gas market.
When this stage is reached, there will be a strong likelihood ofa convergence to a single index that represents the region, likethe Henry Hub index in the US and the NBP index in Europe.
If there is high market liquidity between the representative priceindex and the individual physical markets in Asia and between
the representative index and local price indices, arbitration
between different prices will also become easier. LNG
market players will be watching closely in which region such a
representative price index will develop.

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Developing liquidity in the LNG market - Asia’s challenges and outlook

Conclusion• The emergence of a liquid Asian LNG trading market is much awaited to enable LNG buyers, sellers, andtraders to optimize their profits while managing the risks appropriately.
• Although LNG prices are low and the business environment is challenging at present, the emergenceof liquid and transparent physical and financial markets will bring tangible and intangible benefits tomarket players since the shift from long-term contracts to spot trading is likely to increase volatility inthe LNG market, as seen in other commodity markets.
• The ongoing Power and Gas Systems Reform in Japan, the largest LNG consumer, will reveal its final
form over 2020-22. The progress of the regulatory reform discussions needs to be observed closely since
the developments in the regulatory reform and the speed of the transformation will have a large impact
on the development of liquidity in the LNG market.

While LNG demand in Japan is expected to decrease in thelong term, global demand is projected to grow. Against thisbackdrop, traditional market practices, such as inflexible longterm contracts and oil-indexed pricing, have become significant
obstacles in optimizing the diverse contracts of the LNG market
players as a portfolio. Developing a liquid LNG trading market in
Asia is essential to enable LNG buyers to optimize their profits
while managing the risks appropriately.
Furthermore, establishing a liquid LNG trading market is
expected to bring significant benefits to the sellers as well,since it will make it easier to find LNG buyers at fair prices.
For new LNG projects, it takes some time to establish stable
operations. However, LNG sellers may need to compensate forthe loss of the buyers when the production was disrupted due
to operational troubles of the plants. In the period when theliquidity of the market is low, it may lead to a rise of spot prices,and may spoil the sellers’ profitability. In the future, initiatives
to develop a trading market for LNG are expected also from thesellers.
The development of an LNG trading market will also offer
significant business opportunities to traders who broker LNG
trades, but the role of the traders will also evolve as the LNG
market becomes more liquid. Since the business model ofthe traditional trading companies, i.e. earning a margin byintermediating LNG sellers and buyers, is expected to becomeless significant as LNG buyers increase their participation in the
trading market, they will need to establish business models that
can add more value to trading itself.

With LNG prices staying low and the business environment
becoming more challenging, developing a liquid andtransparent LNG trading market is expected to expand the
profit opportunities available in the LNG market and bring about
great benefits for all three parties: the LNG sellers, buyers, andtraders.
Lastly, the impact that the Power and Gas Systems Reform inJapan, the largest LNG consumer, will have on the liquidity of
the LNG market needs constant monitoring. Once the retail
power and gas markets are fully liberalized and the power/gas
grids are unbundled, the uncertainty due to price fluctuations
will heighten across the value chains of power and gas utilities.
Demand projections will no longer be based on projections of
the macroeconomic environment alone, as the effect of volume
fluctuations due to customer acquisitions and losses resulting
from retail competitions will become more important. Amidst
these market environment changes, optimizing and managing
the risks associated with the enormous LNG assets throughtrading will become one of the most critical management
challenges for power and gas utilities.
With the expected decline in domestic LNG demand due toa shrinking population in Japan, and the addition of a range
of factors that will accelerate the fall in LNG demand, e.g.
increased renewable energy and coal-fired power generation,and the restarting of the nuclear power plants, it is not difficult
to imagine that the Japanese players will be the most eager tosee improved convenience in the LNG market.

Authors
Tsuneo Miyamoto

Takuo Sugiyama

Partner, KPMG FAS Co.,Ltd.

Manager, KPMG Consulting Co., Ltd.

Naoki Tatsumi

Hazuki Morishita

Director, KPMG Consulting Co., Ltd.

Business Analyst, KPMG Consulting Co., Ltd.

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29

Contact us
Mina Sekiguchi
Managing Director, Head of Energy &Infrastructure, KPMG in Japan andHead of Energy & Natural Resources
KPMG in Asia Paciﬁc
T: +81-3-3548-5555
E: mina.sekiguchi@jp.kpmg.com

Tim Rockell
Director, KPMG Global
Energy Institute, Asia Pacific
KPMG in Singapore
E: trockell1@kpmg.com.sg

Tsuneo Miyamoto
Partner, KPMG FAS Co.,Ltd.

T: +81-90-4663-2395
E: tsuneo.miyamoto@jp.kpmg.com

kpmg.com/jp/socialmedia

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