Tuesday, January 20, 2015

The crude price plunge and LNG, a tenuous link

Over the last several months there has been much discussion about the impact of falling crude oil prices on the liquefied natural gas market. The conventional argument goes something like this: lower crude prices are making oil-linked LNG contracts cheaper and are putting pressure on the spot market as these contracts increasingly undercut spot prices.
At first glance, this argument appears quite compelling. On January 14, 2015, the price of Platts-assessed Dated Brent was $45.73/b. For buyers using 14.5% slope to crude, not uncommon in the Asia-Pacific market, that would equate to an LNG price of just $6.63/MMBtu. By comparison, the Platts JKM price (a spot index for the Asian LNG market) was assessed significantly higher at $9.38/MMBtu on the same day.
Taking a deeper look at the market, a more complex picture emerges in which crude prices have had, at best, a minor and mostly psychological impact on the spot market for LNG. In fact, during four of the last five months, the average price of the JKM has undercut the price of oil-linked contracts. The key to this mystery is, of course, in the details of contract-pricing.
For most buyers in Japan and South Korea, the world’s largest LNG consumers, the price of an imported cargo is calculated at a 14.5-15% slope to crude on a lagged “3-0-1” pricing formula. That sounds complicated. However, each of the digits in this formula is simple, signifying, respectively, the number of months used for averaging, the number of months to count back to the end of the lag period, and the number of months being priced.

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