IEEJ：March 2018○ｃIEEJ 2018
Special Bulletin
A Japanese Perspective on the International Energy Landscape (369)

March 29, 2018

Analysis on Asian Natural Gas/LNG Trading Hub Development
Ken Koyama, PhD
Chief Economist, Managing Director
The Institute of Energy Economics, JapanOn March 27, I participated in an international conference in Tokyo on natural gas/LNG
trading hub development in Asia. Numerous Japanese and foreign LNG policy and industry
stakeholders joined the conference for active discussions focusing on the matter.
Natural gas and LNG, which are the cleanest among fossil fuels and feature great supply
potential, are much expected to play a greater role in the global energy mix. A broad consensus isthat global natural gas and LNG demand has been steadily increasing and will continue expanding in
the future. However, the so-called “golden age for gas”, which had been much touted once, has yet
to come to the whole of the world excluding the United States where gas has rapidly expanded under
the shale revolution. This is because natural gas and LNG are exposed to severe competition fromsuch rivals as coal, renewable energy, nuclear, petroleum products and LPG. Natural gas and LNG
must further increase their competitiveness and overall attractiveness to enter the “golden age”.
Natural gas is literally gas energy. Therefore, its energy density is relatively low andtransportation from production sites to consumption sites is costly. In the case where natural gas isused as LNG, particularly, a supply chain must include liquefaction facilities and special tankers,
meaning huge initial investment. For this reason, long-term, stable and fixed contracts have beenviewed as a key condition for establishing LNG projects. Such contracts have contributed tosecuring stable supply and developing long-term, stable relations between producers and consumers.
At the same time, however, they have led to a rigid, inflexible market. In Asia, LNG prices havetraditionally been indexed to crude oil prices to secure LNG projects and their economic feasibility.
When crude oil prices remained around $100 per barrel from 2011 to the first half of 2014, however,Asian LNG prices indexed to crude oil prices were viewed as outstandingly higher than U.S. naturalgas prices that plunged on rapid supply expansion under the abovementioned shale revolution. Then,the “Asian premium” problem for LNG prices has remarkably emerged as a structural problem of theAsian LNG market.
Becoming a key problem against such background is how natural gas and LNG would
enhance their overall attractiveness and play their expected great role in Asia where the demand isexpected to expand as the center of the global natural gas and LNG market. This problem represents
how to enhance the competitiveness of natural gas and LNG. In this respect, natural gas and LNGmarket stakeholders are required to continue strong efforts to reduce costs through such measures as
the introduction of new technologies and business models. If gas and LNG are to enhance theiroverall attractiveness and be selected “as preferred option”, however, supply and market flexibility
as well as price competitiveness may have to be improved to make well-functioning market available.
In an effort to increase market flexibility, stakeholders are moving to eliminate or ease thedestination clause for LNG transactions and have made some relevant achievements.
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Meanwhile, efforts have just started in Asia to develop natural gas/LNG trading hubs
where highly flexible, liquid transactions are actively conducted to fully reflect market conditions inpricing and contribute to developing market functions. As the Asian premium problem for LNG
prices has attracted attention, with the LNG market coming into oversupply, Asian countries such as
Japan, China and Singapore have promoted initiatives to develop trading hubs for the future.
However, an analysis on backgrounds and conditions for the development of representative US andEuropean hubs indicates some key problems that Asia must overcome for developing regional hubs.
A key point is that natural gas instead of LNG is actively traded on Western hubs. A backgroundfactor behind active, liquid transactions on these natural gas trading hubs is natural gas market
liberalization or deregulation through which numerous, various players have participated in markets.
Domestic or nearby gas production sites serve as key supply sources for hubs. Also important for
hubs are advanced pipeline networks and other infrastructure to physically enable such transactions.
Given these matters, Asia has various challenges to be resolved before hubs are fully
developed. Japan has promoted electricity and gas system reform, becoming a top runner inliberalization or deregulation in Asia. As indicated by Western cases, however, a long period of timeis required for highly liquid transactions to be realized even after full-fledged liberalization.
Singapore, which has freer markets than other Asian countries, has promoted specific efforts todevelop an LNG trading hub. However, Singapore itself represents a small market and is physicallydistant from Japan, China and South Korea that form the largest Asian LNG market. China withgreat market potential is trying to develop hubs in such cities as Shanghai under government support.
China has some advantages including various supply sources like domestic production sites, pipeline
imports and LNG, and relevant infrastructure development. However, full market liberalization isstill left for the future, with problems existing with relations between the government and the market.
These Asian initiatives to develop hubs have thus left their respective problems to be resolved.
However, this means that a well-functioning hub could be developed at any of these candidate sites.
A fundamental problem regarding LNG trading hub development is how to enhance theliquidity of LNG transactions. The liquidity may be enhanced if progress is made to freer and more
flexible LNG trade due to the effect of removal of destination clauses and large scale introduction ofU.S. LNG with greater supply flexibility. At the international conference, however, an interesting
point was made as a reference regarding spot and forward transactions that rapidly developed in thefirst half of the 1980s for the benchmark Brent crude oil.
The activization of Brent transactions, as well as the development of relevant pricereporting services and a futures market, has allowed Brent to become a global benchmark. However,
the average number of spot Brent crude cargoes is limited to one or two per day, compared withthree to four cargoes for LNG imported into Japan. A key point for Brent transactions is that a cargo
is resold frequently in a “daisy chain” manner, leading to numerous transactions and pricing signals.
In fact, however, there have been unique conditions for Brent transactions, including a great numberof market players, their active transactions for tax-saving purposes and a great number of middlemen
engaging in speculative trading in anticipation of price volatility. Any simple comparison or analogy
between Brent and LNG cannot be warranted. Given necessary conditions for active transactions on
Western natural gas hubs and time-consuming hub development, however, it is important to further
increase the liquidity of LNG transactions to develop LNG hubs in view of the current oversupply.
To this end, various ideas and innovations are required. Initiatives responding to market players’ realneeds should be promoted.
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