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The International Energy Agency pushes for Asian LNG trading hub development

26 Feb 2013 18:33:09 | glm

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The emergence of a traded global spot LNG market in recent years - with Asia as its centre - has created the need to develop a regional Asian trading hub, International Energy Agency executive director Maria van der Hoeven said in Tokyo on Tuesday.

There is now a need to "create more flexible markets" to reduce the "dramatic price differentials among the three regions - of Europe, the US and Asia - in which Asia loses out," van der Hoeven told a conference organised jointly by the IEA and the Institute of Energy Economics, Japan (IEEJ).

The regional differences in global gas pricing has meant that Asia pays almost six times more for LNG than the US, according to van der Hoeven.

Asia currently represents the largest source of incremental demand for natural gas, and is expected to become the second largest consumer overall by 2015, when demand is projected to reach 790 billion cubic meters, according to the IEA. But the future role of natural gas in Asia "will depend on whether natural gas pricing is tied more closely with supply and demand fundamentals in the region", the IEA said in a policy paper that was released as part of the Tokyo event.

Singapore has initial advantage

A number of Asian countries have announced plans to develop LNG trading hubs, but the IEA said there are three main candidates, each with its own benefits and disadvantages: Japan, China and Singapore. Among these, "Singapore seems the candidate best suited to develop a competitive natural gas market and trading hub in the medium term," according to the IEA report.

Although Singapore faces the dual challenge of having a small domestic market and administrative controls on LNG imports and re-exports, it boasts an ideal location as a hub of international physical trade, and offers third-party access (TPA) and bilateral storage to support spot trade.

The Singapore LNG terminal is expected to start commercial operations in Q2 2013 with an initial capacity of 3.5mtpa, which will increase to 6mtpa by the end of the year, laying the foundations for a rise in regional LNG trading activity from the terminal.

In the case of Japan, the country offers the benefits of mature and reliable legal and financial systems, as well as Asia's most well-developed LNG import infrastructure to date. However, the market in Japan is constrained by a lack TPA to LNG, monopolised downstream electricity markets and segmented onshore infrastructure, according to the IEA.

Looking at China, van der Hoeven pointed out that, on the plus side, the country is rapidly building up its gas and LNG import infrastructure and benefits from diversified gas supplies, in addition to imported LNG. These include piped gas from central Asia and Myanmar as well as domestic conventional and non-conventional sources of natural gas. However, the lack of clear TPA regulation and the presence of strong capital controls, as well as infrastructure bottlenecks, would present challenges.

Physical first, derivatives second

As the volume of LNG spot and short-term trade in Asia has risen significantly over the past three years, these three countries have sensed the need to develop their own financial derivatives to hedge against the risk of unpredictable price volatility.

Over-the-counter swaps have been developed out of Singapore, and the Shanghai Futures Exchange and the Tokyo Commodity Exchange are looking into LNG futures contracts. However, van der Hoeven noted that a viable and active physical spot market needs to be developed before derivatives can be used. "A liquid physical [spot] market is key," van der Hoeven said.

There are a number of ways to foster the development of this market, chief among them being open access and changes in long-term contract structures.

While a number of long-term LNG contracts into Europe have been negotiated to remove destination clauses between seller and buyer, many have not and cannot be diverted to higher priced markets such as Japan. The IEA called for such clauses need to be made more flexible to allow supply/demand fundamentals to direct the most efficient flow of trade.

Only with the ramp up of US LNG exports from 2017 onwards will the physical spot LNG market in Asia grow, van der Hoeven said.

Another key to allowing the physical market to flourish is deregulation, which would allow prices to respond more naturally to competitive pressures in the market.

"A 'hands-off' government approach is necessary," the IEA said. "This would involve separating transport from commercial activities; price deregulation at the wholesale level; sufficient network capacity and non-discriminatory access; and a competitive number of market participants with the involvement of financial institutions."

Van der Hoeven also encouraged governments to free up their downstream electric power markets in tandem with the gas markets, as the two markets are closely integrated. "Asia needs to deregulate electricity too," she said. In all of this, governments will need to follow a "step-by-step" process; deregulation cannot happen overnight.

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