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The Liberalization Opportunity in Global Gas Markets

While the global natural gas market is large and growing, only a small portion of international trade is transacted based on liberalized spot market prices. The pricing paradigm underpinning the world’s gas trade is heavily dominated by oil indexation, which adjusts prices for natural gas by referencing lagged oil product prices.  Oil indexation is the dominant method for long-term contracting across Europe and Asia, and has historically defined terms between suppliers and customers of LNG projects.  In 2008, only 16 Bcf/d of the international gas trade was transacted on the basis of spot gas pricing, and the bulk of this trade took place between Canada, the U.S. and Mexico.

Oil indexation pricing practices have come under unprecedented strain in recent years, as a rise in U.S. natural gas production has coincided with the start-up of large-scale LNG supply trains in the Middle East and Asia-Pacific to create a global gas supply bubble, at the same time that major gas-consuming countries have seen a retrenchment in demand owing to the global recession.  The result has been increased spot LNG sales, and surging liquidity at freely traded gas hubs, particularly in Northwest Europe. There wholesale buyers have opted for cheaper spot gas and turned down to minimum or, even below minimum, thresholds for buying oil-indexed gas. This development resulted in the partial or temporary “re-engineering” of many traditional long-term oil-indexed contracts to avert crisis, but has opened the door further toward the unified and liberalized gas market European policies aim for.

Attractive Oil Linked Markets

The growing gap between prices for oil and natural gas in freely traded markets is widely expected to persist and potentially widen. Whereas gas is increasingly available and can be transported to markets by both pipeline and LNG, oil prices are widely expected to be pressured upward by demand for transportation fuels in emerging economies, led by China and India. This dynamic has encouraged established LNG buyers to consider alternative pricing mechanisms for their gas supply, such as indexation to the US Henry Hub market hub, to meet their future demand needs.