In liberalised markets, the economics of natural gas are not intrinsically linked to the price of oil products. Developments in hydraulic fracturing drove the cost of gas production down but did not have any considerable impact on the price of oil. This relatively ‘cheap’ gas flooded the markets and drove the price of gas down, without a similar impact on the price of oil, according to a paper published by the international legal firm, DWF Law.
At the same time, electricity generated from gas and other fossil fuels is challenged by rising volumes of wind and solar power supply, produced at near-zero operating cost. This greatly impacts the cost of energy, although to a different extent in any given market.
“All of these factors undermine the notion of a ‘positive’ correlation between the prices of oil and natural gas. Furthermore, these factors argue against the proposition that oil products and natural gas are close pricing substitutes,” the paper states.
Hub-indexation
Oil-indexation is increasingly viewed as outdated. Due to its high liquidity, price transparency and relevance, many argue that hub-indexation is more preferable for the purposes of long-term gas sales agreements (GSAs) than oil-indexation.
“The indexation of gas to oil products made the gas price formulae volatile. A large movement in the oil price of oil affected the price of alternative fuels and, consequently, the potential margins of the sellers and buyers of gas,” lawyers at DWF pointed out. “In the past decade, we have seen oil volatility materialise through the peaks and troughs of 2010, 2011, 2015, 2016, 2018 and now 2020.”
“Due to its high liquidity, price transparency and relevance, many argue that hub-indexation is more preferable for the purposes of a GSA than oil-indexation,” they underlined.
The U.S. Henry Hub, created in the early 1950s, is the world’s most liquid gas trading hub by a long run. European hubs like the UK’s National Balancing Point (NBP) and the Dutch Title Transfer Facility (TTF) are more recent and date back to 1996 and 2003, respectively.
Asian markets open up
Gas markets in Asia are not fully liberalised yet. Most gas is still sold under oil-indexed long-term gas sales agreements (GSAs), using different baskets/cocktails of oil products).
Some buyers have partially linked their GSA prices to European hubs, but this is not an ideal proxy. The Platts Japan Korea Marker (JKM) is growing in popularity and has led to some buyers seeking to re-negotiate their terms under oil-indexed GSAs previously linked to the JCC (Japanese Crude Cocktail).
“In order to make the shift from oil-indexed contracts to gas-indexed contracts, a benchmark price will have to be generated. This could only be done by the liberalisation of the markets,” the report points out. “In the meantime, it is likely that the frequency of gas price review arbitrations will steadily increase as the price of oil has taken a dramatic turn.”
Many large Asian gas buyers have started reviewing their GSAs and market observers see companies like Korea’s Kogas, the Chinese majors and Petronet LNG in India “facing new price review challenges in the current economic climate.”
The Japanese market has been fully liberalised since 2007. “However, this growth is stunted due to limitations of domestic pipeline connections, which pose barriers to new entrants into the market,” said the report.
South Korea is at an earlier stage of liberalisation, with state-run Korea gas Corp. importing around 90 percent of the country's gas demand. China's increased demand for gas has also resulted in accelerated development in the country's infrastructure in order to accommodate the additional supply.