Natural Gas Price in Asia: What to Expect and What It Means
Medlock, Kenneth B. III
A decade ago, the natural gas industry was preparing for a structurally transformative shift in the global market. Substantial capital investments were being made to facilitate the import of liquefied natural gas (LNG) to the United States from the Middle East, Africa, Russia, and other distant locations. The consensus market view at the time was that US domestic supply was in terminal decline. However, innovations involving hydraulic fracturing and horizontal drilling have led to dramatic domestic production growth from shale, which now has the US considered a possible exporter of LNG, which was virtually unthinkable just a decade ago. Development of LNG export capability from the US is only one margin of response that is being fueled by the recent price differentials between the US and Asia that are in excess of $14/mcf. Other margins of response include: (i) the potential development of shale gas resources in China; (ii) investment in pipeline infrastructure to move supplies from Russia, Central Asia, and South Asia to Northeast Asia; and (iii) expansion of LNG supplies sourced from locations such as East Africa, the Middle East, and Australia. Asian and European consumers generally view adding US exports to their supply portfolios as desirable, particularly because they are tied to a liquid gas market and there is low risk of disruption. Meanwhile, incumbent producers in these regions view the prospect of US exports as a competitive threat that could transform the Pacific Basin market. Constraints on the ability to meet the unexpected demand shock in the wake of the disaster at Fukushima resulted in the spot price of Asian LNG rising to unprecedented levels. We see similar circumstances arising in the continental North American market, when extreme cold grips certain regions and drives up local demand in excess of what existing pipeline capacity can deliver. Indeed, prices in these places can rise higher in the wake of these weather-driven demand shocks than what has been seen in Japan. But, fortunately for consumers in the US, these regional price shocks are very short-lived because the weather-related demand shocks are also short-lived, and the depth of the US market provides substantial liquidity through which price differences are quickly arbitraged. In the Asian market, the post-Fukushima price increase has not abated quickly. This follows from the fact that Japanese nuclear capacity is not being reactivated quickly, and construction of new delivery capability to supply the country's heightened natural gas demand is plagued with long lead times. Certainly, bringing new sources of natural gas online and/or reactivation of the nuclear capacity in Japan will relax the binding deliverability constraint to the Asian market, and, all else equal, will result in a decline in the spot price of LNG in Asia back to a level that is consistent with a globally arbitraged price. Absent greater liquidity in the Pacific Basin, sellers may be able to keep price elevated due to a lack of competition. This is where it becomes important to consider what increased trade in the global LNG market will do to the nature of pricing abroad. As the US begins to export LNG, the global market will deepen and become physically linked to the North American market, the most liquid natural gas market on the world. This should, in turn, facilitate more trade and alter the liquidity paradigm that has characterized the global LNG market heretofore. Indeed, as this happens, the nature of natural gas pricing in Asia will begin to change as well, and it could happen very quickly; after all, the rise to current price levels in Asia relative to prices elsewhere happened in only six months, a fact often forgotten in the discussion about future pricing in Asia.