Asiangashub Final Web

PARTNER COUNTRY SERIES
Developing
a Natural Gas
Trading Hub
in Asia
Obstacles and
Opportunities
PARTNER COUNTRY SERIES
Developing
a Natural Gas
Trading Hub
in Asia
Obstacles and
Opportunities
Warner ten Kate

Lszlo Varr, Anne-Sophie Corbeau
INTERNATIONAL ENERGY AGENCY
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OECD/IEA2013 DevelopingaNaturalGasTradingHubinAsia
ObstaclesandOpportunities
Tableofcontents
Acknowledgements...................................................................................................................5
Executivesummary...................................................................................................................6
Introduction..............................................................................................................................8 Page|3
1.NaturalgaspricinginAsiaPacific........................................................................................10
Pricingnaturalgas...................................................................................................................10
PricingnaturalgasinAsiaPacific............................................................................................13
TherationaleforgastogaspricinginAsiaPacific..................................................................17
2.TheAsianPacificnaturalgasmarket...................................................................................20
AsiaPacificsupplydemandbalance.......................................................................................20
NaturalgasdemandbysectorinAsiaPacific..................................................................21
NaturalgastradeinAsiaPacific......................................................................................22
LNGtradeinAsiaPacific..................................................................................................23
NaturalgaspipelinesinAsiaPacific................................................................................25
LNGsupplychainflexibilityinAsiaPacific.......................................................................27
NaturalgaspricedevelopmentinAsiaPacific........................................................................29
Towardsaregionalinterconnectedmarket?..........................................................................31
3.Creatingaliquidnaturalgastradinghub.............................................................................32
Requirementsforafunctioningnaturalgasmarket...............................................................32
Institutionalrequirementstocreateawholesalenaturalgasmarket............................33
Structuralrequirementstocreateawholesalenaturalgasmarket................................35
Creatinganaturalgasprice:fromhubtomarket...................................................................35
Tradingplatforms:physicalversusvirtualhubs..............................................................36
Mergingphysicalandvirtualnaturalgastrade...............................................................37
Contractualconsequences?....................................................................................................42
Factorsinfluencingpricing...............................................................................................42
Hubsasasourceofflexibilityinnaturalgasmarkets.............................................................44
Priceinteractionwithothergasmarkets................................................................................45
ImplicationsforAsiaPacific.............................................................................................47
Marketmaturity:whenisaliquidgasmarkettrulyliquid?....................................................48
Settingthepaceofchange:theroleofaregulator.........................................................49
Atransparentandcompetitivepricefornaturalgas..............................................................50
4.PerspectivesonAsiangashubdevelopment........................................................................51
Perspectives:consumersinAsiaPacific..................................................................................51
Japan................................................................................................................................52
TheRepublicofKorea......................................................................................................55
China................................................................................................................................57
Singapore.........................................................................................................................60
CreatingcompetitioninAsiaPacificnaturalgasmarkets.......................................................63
ObstaclesinupstreamLNGsupplyflexibility?........................................................................64
LNGcontractstructure....................................................................................................66
Perspectivesforchangeincontracts...............................................................................71
DevelopingaNaturalGasTradingHubinAsia OECD/IEA2013
LNGasalinkbetweenmarkets?......................................................................................74
Ashocktothesystem?....................................................................................................74
Conclusion:chickenoregg?.....................................................................................................75
Acronyms,abbreviationsandunitsofmeasure.......................................................................78
Page|4 References..............................................................................................................................80
Listoffigures
Figure1 PriceformationofnaturalgasconsumptionintheworldandAsiaPacific200510.....11
Figure2 Pricingmechanismsinglobalnaturalgastrade,200510...........................................12
Figure3 MarketbasedpricingingastradeinNorthAmerica,EuropeandAsiaPacific...........13
Figure4 AsiaPacificpricingmechanismsfornaturalgastrade(pipelineandLNG).................13
Figure5 AverageJapaneseLNGimportpricesandpricerange................................................15
Figure6 ShareofoilandgasinelectricitygeneratedinJapan,19902011..............................17
Figure7 Japaneselongtermandspotvolumesimport,201012.............................................18
Figure8 NaturalgasdemandinAsiaPacific,19902017..........................................................20
Figure9 AsiaPacificnaturalgasconsumptionproductionforecast,19902017......................21
Figure10SectoraldemandfornaturalgasinAsiaPacific,200017............................................22
Figure11PipelineandLNGtradeinAsiaPacific,200017..........................................................23
Figure12ForecastedgrowthinLNGtradeinJapan,China,IndiaandASEANnations,201117...24
Figure13LNGimportintoJapan,Korea,China,ChineseTaipeiandIndia,200712...................24
Figure14AtlanticLNGdeliveredintoJapan,KoreaandChineseTaipeiatimportprice,200712...25
Figure15Regasificationoperational,underconstructionandplannedinAsiaPacific,200017.....27
Figure16RegionalgaspricesandJapanCrudeCocktail,200712...............................................30
Figure17Increasingcompetitioninanaturalgasmarket...........................................................33
Figure18Creatingacompetitivewholesalenaturalgasmarket.................................................33
Figure19Bilateral,OTCandcentraltradingandtransparencyonspotandfuturesmarkets....37
Figure20AschematicOTCtransaction........................................................................................38
Figure21Aschematicfinancialtransactiononanaturalgasexchange......................................38
Figure22Shipperandfinancialpartyactivityonthespotandfuturesmarket..........................39
Figure23Productstradedonthecurve...................................................................................41
Figure24Marketdevelopment,contractdurationandmarketmaturity...................................44
Figure25SaleofflexibilityservicesthroughvirtualhubsinEurope...........................................45
Figure26 PricedevelopmentintheAtlanticBasin,200312.......................................................47
Figure27LongandshorttermcontractedLNGintheworldandAsiaPacific,200711...........64
Figure28ShorttermcontractedLNGintheworldandAsiaPacific,200711............................65
Figure29LongtermcontractedLNGdeliveredFOBorDESin2011...........................................69
Figure30ConstructioncostsforvariousLNGprojects................................................................73
Listoftables
Table1LNGspotcargoesdeliveredinJapan,KoreaandChineseTaipei,2007Q12012...........14
Table2LNGimportintoJapan:atJCCparity,historicalaverageandaveragespreadofdeliveries..16
Table3Intraandinterregionalpipeline(s)inAsiaPacific..........................................................26
Table4Competitivemarketrequirementsinselectedcountries................................................63
Listofboxes
Box1Otherpartiesinvolvedinnaturalgashubdevelopment...................................................40
Box2TheJapan/KoreaMarker....................................................................................................67

Acknowledgements
Warner ten Kate (formerly of the IEA) is the lead author of this report, produced under the
supervisionofLszloVarrandwithcontributionsbyAnneSophieCorbeau.
The author is grateful to the Head of the Gas, Coal and Power Markets Division (GCP), Lszlo Page|5
Varr,forhisinvaluableadvice,unrelentingsupportandextensivediscussiononthetopic.The
authoristhankfultoAnneSophieCorbeauforherinspirationalgasteamleadership.Thisreport
benefittedfromthesupportoftheauthorsGCPcolleagues,IchiroFukudaandHideomiIto,who,
as LNG experts, provided clarity and direction. Special thanks go to Alexander Antonyuk for
rigorouslyattackingthereportsassumptions,makingthemeitherstrongerorirrelevant.
Significant contributions, comments and feedback were received from within the International
Energy Agency (IEA), and from a panel of external industry reviewers. In that regard, special
thanksgotoThijsvanHittersum,KarelvanderLingen,ColinLyle,JulieJiang,JonathanSintonand
DougWoodfortheircarefulreviewandchallengingcommentsthathaveconsiderablyimproved
thequalityofthispaper.
ThankyoutoJanetPapeandPeterChambersfortheireditorialwork.
CherylHaines,BertrandSadin,AstridDumond,MurielCustodioandAngelaGosmannattheIEA
Communication and Information Office (CIO) provided essential support in terms of editing,
productionandpublication.
Executivesummary
Natural gas has the potential to improve energy security and economic and environmental
performanceintheAsianPacificeconomies.Howeverexpandingitsrolewilldependonregional
marketconditionsthatallowgastocompeteautonomouslyinenergymarketswhicharethemselves
Page|6 connected to global energy markets. The future role of gas in Asia will depend on whether
naturalgaspricingistiedmorecloselywithsupplyanddemandfundamentalsintheregion.
The Asian natural gas market is the fastestgrowing gas market worldwide, and is expected to
becomethesecondlargestby2015,with790billioncubicmetres(bcm)ofnaturalgasdemand.
ThemarketfornaturalgasinAsiaisdominatedbylongtermcontractsinwhichthepriceofgasis
linked, or indexed, to that of oil. Developing countries might require longterm contracts to
ensure security of supply for their fastgrowing economies, and producers will look to secure
returnontheirconsiderableinfrastructureinvestments.
Inrecentyears,thishashelpedkeepAsiangaspricesmuchhigherthanthoseinotherpartsof
the world, leading to competitiveness concerns and serious questions about whether such a
systemcanlast.Inordertoexpanditsmarketshare,naturalgashastobecompetitivewithinthe
energymixoftheregionorcountrywhereitisdelivered.InAsia,however,currentconstraints
includetheregionslackofbothatradinghubtofacilitatetheexchangeofnaturalgas,andthe
developmentofatransparentpricesignaltosteerinvestmentsinnaturalgasinfrastructures.
Theconfidenceinthelegitimacyandtransparencyofnaturalgaspricinggeneratedonanatural
gas hub is crucial for investment decisions in such a capitalintensive industry. This confidence
canbederivedtoalargeextentfromtheinstitutionalandstructuralrequirementsputintoplace,
but ultimately it lies in the longterm resolve of government to allow markets to determine
naturalgaspriceswithminimalinterferencefromshorttermpoliticalconsiderations.
To successfully develop a reliable natural gas price in the AsianPacific region would require a
competitivenational/regionalmarket,whichwouldthenneedtomeetasetofinstitutionaland
structural requirements to create the market confidence to attract new participants (namely
financials) and to encourage market players to use a trading hub for the balancing of their
portfolios.
Ahandsoffgovernmentapproachisnecessary.Thiswouldinvolveseparatingtransport from
commercialactivities,pricederegulationatthewholesalelevel,sufficientnetworkcapacityand
nondiscriminatoryaccess,andacompetitivenumberofmarketparticipantswiththeinvolvement
offinancialinstitutions.
Prospects for a competitive wholesale natural gas market in Asia are limited. Even in the most
mature AsiaPacific markets, the basic requirements for a wholesale market are missing, as
governmentscontinuetoemphasisesecurityobjectivesovereconomicones.OftheAsiaPacific
economies reviewed in this paper, Singapore seems the candidate best suited to develop a
competitivenaturalgasmarketandtradinghubinthemediumterm.
AuniquecharacteristicofthenaturalgastradeinAsiaPacificisthelimitedamountofnaturalgas
thatistradedviapipelines,andtheregionsgrowingdependenceonthegloballiquefiednatural
gas(LNG)supplychain.ThatglobalLNGmarkethasbecomedecidedlymoreshorttermoriented
and flexible over the past decade a result of the expansion of global LNG production, the
emergenceofglobalportfolioplayersandenhancedcompetitionintheAtlanticBasin.
AndyettheseAtlanticBasindevelopmentshavehadalimitedimpactonsupplyflexibilityinthe
AsiaPacificregion.AcompetitivenaturalgasmarketinAsiawouldneedan evenmoreflexible
LNG supply than is currently in place. This will require a continued expansion of shipping

availability and thirdparty access (TPA) to regasification terminals in the AsiaPacific region.
Furthermore,itwouldinvolverelaxingdestinationclausesinLNGsupplycontractsthatallowfor
marketsegmentationandstiffentheoverallsupplychain.Anysuchmodificationofthecontract
structuremustproperlyincorporateaspectsthatpreserveinvestmentsecurity.
In the AsiaPacific region, competitive natural gas markets and a reliable gas price will not
develop overnight, and will not necessarily lead to lower prices. However, such a development Page|7
willallowmarketplayersinAsiaPacificeconomiestoincreaseportfolioflexibilityasnaturalgas
marketsinthisregioncontinuetomature.
Governmentsintheregionwillneedtosignaltheirwillingnesstofacilitate competitionfurther
downstream.Singaporeaneffortstodevelopacompetitivenaturalgasmarketandcomplementary
trading hub might be considered small relative to the size of the entire AsiaPacific natural gas
market. However, the example of an alternative market model which is able to adapt global
supplychangestotheregionalmarketwouldbeapowerfulone.
Introduction
Globalnaturalgasdemandisexpectedtocontinuetogrowrapidly,outperformingallotherfossil
fuels. Global demand is fuelled by the economic growth of emerging economies (aided by air
quality concerns), notably China, and to a lesser extent India. In the short to medium term,
Page|8 regionalgasdemandisalsoboostedbytheaftermathoftheFukushimaDaiichinuclearaccident,
as gas is one of the key available energy sources to replace nuclear power generation in the
Japaneseelectricitymix.
In recent years, significant revisions in global natural gas resource estimates have alleviated
concerns about the longterm availability of natural gas in both developed and developing
economies. As a result of the exponential growth of United States shale gas production, new
globalLNGliquefactioncapacityandtheimpactoflowerdemandduetotheeconomiccrisis,a
gapemergedin2009betweenspotprices(thepricesatwhichthegascanbeboughtorsoldata
specifiedtimeandplace)intheUnitedStatesandUnitedKingdomontheoneside,andoillinked
gaspricesprevailinginAsiaPacific1andEurope,ontheother.
Asof2012,naturalgaspricesin the UnitedStatesremainedatlowlevelsofaroundUSD3 per
millionBritishthermalunits(MBtu);Europeanspotprices,albeitthreetofourtimeshigherthan
those in the United States, are still at a discount to European longterm contract prices, while
prices in Japan peaked at a level considerably higher than those in Europe. This is raising the
question,bothinEuropeandAsia,oftheappropriatewaytopricenaturalgas.
TheEuropeanUnionhassoughttoanswerthisquestionthroughthedevelopmentofalternative
pricingmechanismsviagastogaspricingongastradinghubs.Europehasaliquidtradinghubin
the United Kingdom, the National Balancing Point (NBP), and more recently developed some
trading hubs in continental Europe, notably the Title Transfer Facility (TTF) in the Netherlands
andNetConnectGermany(NCG)inGermany.However,nosuchdevelopmentshavetakenplace
intheAsiaPacificeconomiessofar.
A key change for many individual natural gas markets in AsiaPacific is the growing reliance on
imports, in particular, LNG imports. Aside from Japan, the Republic of Korea and Chinese Tapei,
importingLNGisarelativelynewphenomenonforAsiancountries:Indiastartedin2005,Chinain
2006, Thailand in 2011, and Indonesia and Malaysia in 2012. Additionally, a few other Asian
countriesareexpectedtobecomeLNGimportersthisdecade.
TogrowandconsolidatetheroleofnaturalgasintheAsiaPacificregion,naturalgaswillhaveto
be competitive on price, notably against coal. Simultaneously, countries should continue to
attract new sources of supply, which are likely to be more expensive. AsiaPacific natural gas
exportershavehistoricallyreliedonlongterm,oilindexedcontractstoselltheirproduction.This
makesnaturalgaspricesintheAsiaPacificregionlargelydependentonoilmarketfactors.
Expanding the role of natural gas, and thereby improving the energy security, economic and
environmentalperformanceoftheseeconomiesinthelongrun,willdependonmarketconditions.
Thesemustallowgastocompeteautonomouslyinlocalenergymarketsconnectedtotheglobal
marketthroughapricingsysteminAsiathatiscompatiblewithregionalgassupplyanddemand.
This paper will focus on the obstacles and opportunities for the AsiaPacific economies to
establish natural gas trading hubs that allow for natural gas prices to reflect local demand and
supply.Inthefirstchapter,pricingmechanismsfornaturalgasareexplainedandcurrentregional

1
AsiaPacific in this Information Paper is defined as NonOECD Asia, China including the Hong Kong area, and OECD Asia
Oceania minus Israel. Alphabetically, these are as follows: Australia, Bangladesh, Brunei Darussalam, Chinese Taipei, India,
Indonesia,Japan,Korea,Malaysia,Myanmar,NewZealand,Pakistan,China,thePhilippines,Thailand,Vietnam,andother.

trendsaresetinaglobalperspective.TheoutlookforthenaturalgasmarketintheAsiaPacific
region is discussed in Chapter2. In Chapter3, the process of developing a trading hub and a
transparentnaturalgaspriceissetout.Thischapterexplainsbasicrequirementsneededtocreate
acompetitivewholesalenaturalgasmarket,thesubsequentroleofahubinsuchacompetitive
market, and the respective roles for government and market parties in such a transformative
process.Finally,Chapter4analysestheperspectivesforselectednaturalgasmarketsinAsiaand Page|9
theglobalLNGsupplychaintocreateandsupportacompetitivenaturalgasmarket.

1.NaturalgaspricinginAsiaPacific
Pricingnaturalgas
Page|10 Broadlyspeaking,therearetwowaystoestablishawholesalepricelevelfornaturalgas:either
viamarketbasedpricingorthroughpriceregulation.
The marketbased way implies that the price of natural gas is determined by supplydemand
forcesinamarketthatis notnecessarilythenaturalgasmarket.Infact,indexationtoanother
commodity(oil,coal,oilproductsorelectricity)willallowsupply/demandfactorsinothermarkets
to set the wholesale price of natural gas. The exact wholesale price of natural gas varies by
contract,sincecontractconditionscansetafloor,cap,timelagornone/alloftheaboveforthe
priceofnaturalgasforaperiodofdelivery.Mostimportant,however,inpricingtheeconomic
way is that the price development of natural gas over time is being determined by market
participantsratherthangovernmentregulation.2
TheInternationalGasUnion(IGU)hasidentifiedthreemajormarketbasedpricingmechanisms,
coveringOECDandnonOECDmarkets(IGU,2012).Thesemechanismsare:
oil(product)indexation,wherebygaspricesarelinkedtootherfuelprices(mostlyoilorrefined
products,sometimescoal);
gastogascompetition,indicatinganindexationtospotpricesthatreflectsupplyanddemand
fornaturalgasinamarket;and
netbackfromfinalproduct,whichrefersmostlytocontractswherethegaspriceislinkedto
thepriceofammonia.3
Governmentregulationisabletosetnaturalgasprices(priceregulationispossibleateverylevel
ofthenaturalgasvaluechain:wellhead,wholesale,citygateordifferentiatingbetweenvarious
segmentsofconsumers)atalevelrequiredtosuitthegovernmentsdomesticpolicyobjectives.
Inherently,priceregulationofnaturalgastomeetdesiredpolitical,social,economicorenvironmental
outcomeswillleadtolesstransparentpricesignalsandanunstableinvestmentclimateforthe
future,asgovernmentpolicyobjectivescan(easily)change.
Frequently, but not necessarily, gas price regulation will lead to belowcost prices for certain
segments of consumers. This is most likely to occur in natural gas producing countries. In such
cases,itisverydifficult(ifnotundesirableforaregulator)toregulatepricelevelstoaccurately
reflectgassvalueinanationaleconomy.Thismismatchfrequentlyresultsin(unintended)distortions
intheusageofnaturalgas,whichlimitefficienteconomicdevelopment.Aclearconsequenceof
belowmarketpricingofnaturalgasistheinefficientuseoftheresource.Thispotentiallylimits
exportrevenues(throughincreaseddomesticdemand)foraproducercountry;or,itcouldincrease
importexpendituresforaconsumercountrythroughhigherdomesticdemand.
TheIGUhasidentifiedfivemajorgovernmentregulatedpricingmechanisms,coveringOECDand
nonOECDmarkets(IGU,2006).Thesemechanismsare:

2
Governmentscaninfluencepricelevelsbyregulatingthenaturalgasmarketsasawhole,butthepricelevelthatwillderive
fromtheseregulationsisnotaseasilydeterminedasthroughdirectpriceregulation.
3
Netbackpricingofnaturalgasofafinalproduct(suchasammonia)isperhapsthemoststraightforwardwaytocoupleprice
developmentsofnaturalgastopricedevelopmentsinanothermarket,butcompletelydisregardsdevelopmentsinthenatural
gasmarketitself.Thisisfrequentlythecasewhencostsofnaturalgas(feedstock)representaconsiderableshareofthecost
oftheendproduct,therebyguaranteeingaprofitmarginonthesaleoftheendproduct.Alternatively,thenetbackapproach
canbeusedtodeterminethepricelevelbeforeindexingittootherproducts.

Regulation cost of service (RCS) covers the price of service, including investment and a fair
return.Suchpriceswouldbepublishedbytheregulatororministryandaimatrecoveringthe
wellheadprice.
Socialandpoliticalregulation(SPR),wherebythepriceissetbyministriesonanadhocbasis
dependingonperceivedsocialneeds,supply/demandbalanceorgovernmentrevenueneeds.
This means natural gas prices can increase (or decrease) very sharply, independently of any Page|11
specificdevelopmentinthegasmarket.
Regulation below cost (RBC), where the price does not cover the basic production and
transmissionprice,reflectingsubsidies.Thisgenerallyhappensonlywhenthegascompanyis
stateowned,andismorelikelywhennaturalgasisassociatedwithoilproductionthatprovides
thebulkofthegovernmentsrevenues(ineffectoilprovidesasubsidyongasconsumption).
Bilateralmonopoly(BM),referringmostlytobilateralagreementswithinformerSovietUnion
countries,wherepricesareagreedonayearly/multiyearbasisbetweenthegovernmentsof
twocountries.
Noprice(NP),occasionallyusedbyproducersforinternalconsumption.
This paper will focus on the perspectives for marketbased price formation in the AsiaPacific
region;itisthereforerelevanttocomparetheshareofmarketbasedpriceformationwiththatof
other regions. Research by the IGU has shown that through the period 200510, global natural
gaspricingwasslightlydominatedbymarketbasedgasprices.In2010,thepricelevelof63%of
allwholesalenaturalgassoldgloballywasdeterminedbymarketforces.Thisdominantsharefor
marketbasedpriceformationisprimarilytheresultofthedominanceofgastogaspricinginthe
NorthAmericannaturalgasmarket,whichcomprised25%ofglobalgasdemandin2010.
Figure1PriceformationofnaturalgasconsumptionintheworldandAsiaPacific,200510
3500
3000
2500
2000
bcm
1500
1000 63%
55% 60%
55%
500
51% 53% 50% 52%

0
2005 2007 2009 2010 2005 2007 2009 2010
World AsiaPacific
Market Regulated
Sources:IGU,2006;IGU,2008;IGU,2010;IGU2012.
In other markets, most notably the Middle East, Africa and the Former Soviet Union
(FSU), price formation was dominated by regulatory preferences throughout 200510.
In the AsianPacific region government regulations to a large extent continue to determine

naturalgasprices.4
Globally,marketbasedpricingmechanismsarebasedonoilindexationorgastogascompetition.
Thenetbackfromfinalproductpricemechanismisusedforlessthan1%ofglobalgasconsumption,
andisnotusedininterregionalnaturalgastrade.Participationbymarketpartiesininternational
Page|12 gas trade (either by pipeline or LNG) exposes market areas to different price concepts and
signals. This gives both consumers and producers an incentive to adapt price mechanisms in
responsetopressuretoaligndomesticpriceswithimportprices(IGU,2012).
Overtheperiod200510,theglobaltradeofnaturalgas,bothtransportedbypipeandLNG,was
predominantly priced on the basis of oil indexation. Although oil indexation has continued to
declineasapricingmechanisminnaturalgastrade,thepriceof65%ofglobalgastradein2010
wasstillindexedtooil.
Figure2Pricingmechanismsinglobalnaturalgastrade,200510

1200
1000
800
65%
bcm
600
69%
68%
400 75%
200
84% 88% 88%
95%
0
2005 2007 2009 2010 2005 2007 2009 2010
World AsiaPacific
Gastogascompetition Oilindexation
Sources:IGU,2006;IGU,2008;IGU,2010;IGU,2012.

InEuropeandAsiaPacific(andindeed,globally),oilindexationisthedominantpricemechanism
fortradedgas,althoughEuropecontinuestoshifttowardsmoregastogasbasedprices.Yetall
NorthAmericangasispricedonagastogasbasis,andin2010NorthAmericacomprised14%of
global natural gas trade. European markets are also moving in this direction, owing to a
continuedincreaseintradethroughcontinentalEuropeangashubs,asmarketconfidenceinthe
pricesetting ability of these hubs has increased. Moreover, the European longterm supply
contracts (from Russia, Norway and the Netherlands) are being adjusted to index part of the
volumeongastogascompetitionratherthanoil(CERA,2009b).
Traditionally,naturalgastradeinAsiahasbeendominatedbyoilindexedpricing,withashareof
88% of natural gas traded in the region in 2010. No significant changes in this trend can be
observedthroughout200510.

4
In the IGUs Wholesale Gas Price Formation, the AsiaPacific region consists of the combined IGU Asia and AsiaPacific
regionsencompassing:Afghanistan,Australia,Bangladesh,Brunei,ChinaHongKongregion,ChineseTaipei,India,Indonesia,
Japan,Myanmar,Malaysia,NewZealand,Pakistan,China,thePhilippines,Singapore,Korea,Thailand,andVietnam.

Figure3MarketbasedpricingingastradeinNorthAmerica,EuropeandAsiaPacific
600
500
400 Page|13
67%
bcm
300 77%
84%
94%
200
100 88%
84% 88%
95%
0
2005 2007 2009 2010 2005 2007 2009 2010 2005 2007 2009 2010
NorthAmerica Europe AsiaPacific
PricingnaturalgasinAsiaPacific
In2010,justoverhalf(52%)ofthenaturalgasconsumedintheAsiaPacificregionwaspricedon
marketbased price formation mechanisms. The majority (67%) of this marketbased gas was
imported(pipelinesorLNG),while33%wasdomesticallyproduced.
NaturalgastradeinAsiaPacificispricedthrougheitheroilindexationorgastogascompetition.
Allpipelinetradedvolumesofgasarepricedwithalinktotheoilmarket,whilesomegastogas
competitionhasstartedtoemergeinLNGtradinginAsia(Figure4).
Figure4AsiaPacificpricingmechanismsfornaturalgastrade(pipelineandLNG)
200
180
160
140
120
bcm
100 86%
81% 87%
80
60 95%
40
20
0
2005 2007 2009 2010 2005 2007 2009 2010
Pipeline LNG
Most gastogas competition pricing in AsiaPacific is LNG spot trade. However, one can argue
thatthepriceforspotcargoesintheglobalLNG marketisnotnecessarilysetthroughgenuine
gastogascompetition,as70%ofglobalLNGimportsin2010wereoilindexed.Inaddition,onlya
limitedamount(18%)ofLNGisdeliveredinmarketswithagenuinecompetitivewholesalegas
market(e.g.intheUnitedKingdomandtheUnitedStates)andpricedataleveldeterminedby
supply/demandfactors.
ThismeansthatthepriceforspottradedLNGinAsiaisnotbasedonsupply/demandintheAsia
Page|14 Pacificregion.Instead,theoilindexedgaspricesetsareferencepricelevelwhichmarketconditions
thenmodify.Thosemarketconditionsaredeterminedbytherelationshipbetweenabuyeranda
seller,theavailabilityofsurplusgasintheLNGsupplychain,andthe buyersneedforthegas.
ThesemarketconditionsshifttheLNGspotpriceaboveorbelowtheoilindexedlevel.
Inthisregard,theLNGspotpriceinAsiaisnotonethatisrealisedthroughmarketcompetitionin
the AngloAmerican sense. As Asia has no trading hub to facilitate gastogas competition, the
termspotpurchasesignifiesthepurchaseofasinglecargothatcanvaryinsize,andthatwillbe
liftedinarelativelyshorttimeframe,usuallylessthanoneyearinthefuture.5WhileinNorth
Americatherearenooilindexedvolumesthatinfluencethespotmarket.
The sale of an LNG spot cargo is frequently negotiated without reference to other sources of
natural gas, because the main Asian LNGimporting economies have no connection to pipeline
naturalgas.Spotcargoesaregenerallypricedaboveorbelowalongterm,oilindexedLNGprice
intheimportingmarket,thepricelevelofwhichdependsonglobalmarketdemandforoilrather
thanregionalsupply/demandfornaturalgas.
Asaresult,spotLNGhasfrequentlybeenmoreexpensivethantheoilindexedcargoesbought
under longterm contracts in the Asian region. Over the period 2007 to Q1 2012, Japan, Korea
and Chinese Taipei have frequently paid a spot premium compared to their longterm supply
contracts;onaverage,77%oftheimportedspotcargoeswerepricedabovelongtermcontracts
(Table1).
ThecurrentoilindexationintheAsiaPacificgastradeistheresultofhistoricaldevelopmentsand
contract negotiations between suppliers and, originally, Japanese customers. In 1969 the first
LNGsupplycontractwas signedthat madevolumesavailablefromAlaskainthe UnitedStates.
The first 15 to 20year LNG supply contracts (Brunei and Abu Dhabi started to deliver LNG to
Japan as well) adopted a fixedprice setting that valued LNG at around USD0.5/MBtu. Initially,
the LNG price was set at a premium versus crude oil; and was then progressively raised as oil
pricesroseduringthe1970s.
Table1LNGspotcargoesdeliveredinJapan,KoreaandChineseTaipei,2007Q12012
Spot cargoes Spot price
bcm % LNG import > long-term < long-term
Japan 29.6 6% 74% 26%
Korea 32.7 20% 83% 17%
Chinese Taipei 12.3 17% 71% 29%
Total 74.5 11% 77% 23%
Note:spotcargoesforJapanoriginatefromAlgeria,Egypt,EquatorialGuinea,Nigeria,Norway,Peru,Trinidad,Yemenandreexported
cargoesfromnonproducingnations.SpotcargoesforKoreaoriginatefromtheUnitedArabEmirates,Algeria,Brunei,Egypt,Nigeria,
Norway, Peru, Qatar, Trinidad, the United States and reexported cargoes from nonproducing nations. Spot cargoes for Chinese
Taipei originate from the United Arab Emirates, Algeria, Brunei, Egypt, Equatorial Guinea, Norway, Oman, Peru, Russia, Trinidad,
UnitedStates,Yemen,andreexportedcargoesfromnonproducingnations.
Sources:customsdataJapan,KoreaandChineseTaipei.

5
ThisqualificationofspotpurchaseandshorttermLNGtradeisderivedfromInternationalGroupofLiquefiedNaturalGas
Importers(GIIGNL).

Subsequently,thefirstLNGsupplycontractsignedbetweenIndonesiaandJapanintroducedoil
indexation. Initially, this would establish a link with the average oil price or the government
selling price (GSP) of Indonesias crude oil sales. However, near the end of the 1980s, Saudi
Arabiaintroducednetbackpricingforitsoilexports;thisreducedIndonesiasGSPandconsequently,
thepriceofLNGexportedtoJapan.Therefore,itwasintheLNGproducersinterestthattheoil
indexed price would be determined in the market where the LNG would be delivered; the Page|15
JapaneseCustomCleared(JCC)priceprovidedthatrequirement.6
WhenKorea(1985)andChineseTaipei(1990)startedtoimportLNG,theirsupplycontractswere
alsolinkedtotheJCC,makingthisthedominantoilmarkerintheregion.Thedeclineinoilprices
duringthe1980sledtotheintroductionofScurvepricingformulas.Scurveformulasareusually
establishingalinearrelationshipbetweenthepriceofgasandoilaslongasoilpricesstaywithin
apredeterminedrange.Whentheoilpricemovesoutofthisrange,therelationshipbetweenthe
priceofoilandtheresultinggaspriceweakens,thereforereducingtheriskoflowoilpricesfor
producers, but also introducing protection against high oil prices for consumers.7 As the first
Scurve contracts were developed to protect producers (and their upfront investments in LNG
infrastructure),atanaverageoilpricebelowUSD20/bblduringtheperiod198599,thisresulted
inmoreexpensiveLNGthantheenergyequivalentinoil.
Figure5AverageJapaneseLNGimportpricesandpricerange
25
20
15
USD/MBtu
10
PricerangeLNGpurchase LNGatJCCparity JapanLNGaverage

Source:Japanesecustoms.
During the 2000s, oil prices increased significantly, but Scurves protected LNG buyers against
this increase, reducing the price of LNG imports on a calorific basis in relation to that of oil.
Despitetherenegotiationoflongtermcontractsduringthefirstpartofthedecade,arapidrise
inoilpricesresultedinlongtermLNGpriceslowerthantheiroilequivalent.However,theadditional
import of spotmarketed cargoes would frequently be above prices equal to the calorific oil
equivalent(Figure5).
6
TheJCCisalsofrequentlyreferredtoastheJapanCrudeCocktail.
7
ForanintroductiontoLNGpricingandtheScurvesee:Flower(2008).
After2004,LNGproducerstriedthroughnegotiationstoraiseorabolishtheScurve(Miyamoto,
IshiguroandYamada,2009).CurrentlythediscussioninlongtermLNGsupplycontractsfocuses
ontheslopeinanLNGpriceformula,basicallydeterminingLNGpricesatacertainpercentage
oftheJCCprice(plusorminusaconstant).Asaconsequenceofincreasingoilprices,increased
availability of spotmarketed LNG on global markets, the rigidity of longterm LNG supply
Page|16 contracts and additional gas demand shocks (primarily, the Fukushima accident in 2011), LNG
spotpriceshavebecomemorevolatilesince2004.
AlthoughoilandLNGpricesdivergedconsiderably,theoverallmovementoftheLNGpriceisstill
comparablewithoilprices.TheincreasedimportofspotpurchasedLNG,however,hasincreased
thepricespread,makingLNGanincreasinglyvolatilecommodity.
Table2LNGimportintoJapan:atJCCparity,historicalaverageandaveragespreadofdeliveries
USD/MBtu LNG at JCC parity Japanese LNG import price Average spread Spread
2000 4.89 4.70 1.02 22%
2001 4.27 4.61 0.56 12%
2002 4.36 4.28 0.71 16%
2003 5.05 4.79 0.63 13%
2004 6.37 5.19 1.24 24%
2005 9.02 6.02 2.51 42%
2006 11.08 7.12 6.14 86%
2007 12.30 7.74 5.02 65%
2008 16.92 12.66 11.16 88%
2009 10.92 9.04 7.23 80%
2010 13.83 10.90 6.15 56%
2011 19.07 14.78 7.36 50%

On average, the price spread between monthly LNG imports during a year has increased since
2004.Asaconsequence ofthefinancialcrisis,spreadsbetweenvariousLNGsuppliesforJapan
peakedatUSD11.16/MBtuin2008.Thisequatedtoaround85%oftheaverageimportpricefor
Japanese LNG that year. Although the differential in price between various LNG imports has
decreased somewhat in the following years, it remained over 50% of the average LNG import
pricethrough200911.
Thisdoesnotnecessaryimplythatspotpurchasedcargoesarealwaysmoreexpensivethanoil
indexed LNG imports (as seen in Table 1).8 The price formulas in longterm supply contracts
generally set the average price of LNG at a level below the level of the oil equivalent, but are
responsive to the relative changes in the oil price through time. Asian longterm contracts for
naturalgastradedviapipelineshaveasimilaroilindexedpricemechanism,althoughtheoverall
pricelevelisgenerallylowerthanLNG.
Currently,then,thelackofacompetitivenaturalgasmarketintheAsiaPacificregionhindersthe
development of a price reflecting appropriate supply and demand criteria.9 Consequently, the
price of natural gas in the AsiaPacific region is set by LNG buyers and based on a different
market (oil). Oilindexed LNG contracts set a price benchmark, while spot LNG is imported at
increasinglydivergingpricesrelativetotheoilindexedbenchmark.Underthesecircumstancesit

8
In2011,thevolumeimportedasspotcargoesinJapanwasgenerallypricedbelowoilindexedlongtermcontracts(IEA,2012a).
9
AnalternativeJapan/KoreaMarkerdoesexistandisdiscussedinBox2inChapter4.

isdifficultifnotimpossibleforbothlongtermLNGandspotLNGpricestoreflecttheaccurate
marketvalueofnaturalgasinthevariousdevelopinganddevelopedeconomiesinAsia.
TherationaleforgastogaspricinginAsiaPacific
As LNG did not have a market in Asia, the original rationale for oil indexation in Asian LNG Page|17
contracts,muchlikeintheEuropeangasmarket,wastolookforitsreplacementvalue.InJapan,
LNG wasseenasanalternativeforoilthatwasstillprominentlyusedin powergeneration.On
thesupplyside,theOrganisationofPetroleumExportingCountries(OPEC)agreedin1980onan
LNGexportpolicythatexplicitlyaimedatcalorificparitywithoilprices.Morerecently,in2011,
the Gas Exporters Country Forum (GECF) also endorsed oil indexation as the preferred pricing
schemetotradenaturalgas(GECF,2012).
AlinktoagloballytradedcommoditysuchasoilgivesinvestorsinLNGliquefactionplantsand
transportinfrastructuretheabilitytohedgerevenuesoverlongerperiodsoftimeandtherefore
provides a secure flow of revenues. The global oil market is generally perceived with a high
degree of confidence with regard to its lower probability for price manipulation and lower
volatilitycomparedtonaturalgas(G20,2011).Onthedownstreamside,mostoftheinitialLNG
buyerswereregulatedutilities,whichenabledthemtoshiftmarketrisktotheirendconsumers
(Jensen, 2004). Oil indexation was therefore initially readily accepted by both producers and
consumersasoneofthekeyprinciplesunderpinninglongtermLNGsupplycontracts.
Timeshavechanged,however.AlthoughfurtherinvestmentinLNGproductioncapacityneedsto
beproperlyfacilitated,naturalgasalsoneedstobecompetitivewithintheendusermarket.Oil
islessandlesstheprimarycompetitortonaturalgasintheAsiaPacificregion.
Figure6ShareofoilandgasinelectricitygeneratedinJapan,19902011
40%
35%
30%
25%
20%
15%
10%
5%
0%
Gasfiredpowergeneration Oilfiredpowergeneration

Note:unlessotherwisestated,allmaterialinfiguresandtablesderivesfromIEAdataandanalysis.
Source:IEA,2012c.
Takethefollowingasanexample:intheJapaneseenergymix,oilhaslostitsdominantsharein
power generation to natural gas, coal and (until the Fukushima accident) nuclear power. This
development has significantly redressed LNGs competitive environment in power generation

fromoildominatedtodirectlycompetingwithoil,coalandnuclearpower.Oilhasmaintainedits
dominantshareinJapanstotalprimaryenergysupplythroughitsroleintransport(currentlyalso
strengthened by the use of oil to replace nuclear power generation, but this is likely to be
temporary),adevelopmentnotspecificallyJapanese,butglobal.
Page|18 Linkingthepriceofnaturalgastooilonaccountofendusercompetitionmakeslittlesensewhen
oil does not directly compete with natural gas (Jensen, 2011). Yet, in developing natural gas
markets, oilindexed contracts have been the backbone for market development (as described
above).ThesecontractsarelikelytocontinuetodominateinthedevelopingeconomiesinAsia,
asconsiderationsotherthanprice(environmentalfactorsandsecurityofsupply)arefrequently
morerelevantforcompaniesandpolicymakers,andanalternativenaturalgaspriceisgenerally
notavailableintheseeconomies.
However,formaturenaturalgasmarkets,thelimitsofoilindexationasapricesettingmechanism
forLNGbecameclearin2011,whenJapanneededanincreasingamountofLNGtosatisfypower
demandaftertheFukushimaaccident.Japanesespotcargopurchasesincreasedtorecordlevels,
andalthoughaverageLNGimportpricesdidthesame,thiswasnotanimmediateconsequence
ofsupplyanddemandontheglobalLNGmarket.
MostoftheadditionalvolumeofspotLNGpurchasedbetweenJanuary2011andApril2012was
pricedbelowlongterm,oilindexedvolumes(andlongtermLNGexportersthatbenchmarkspot
cargoes to oil) (IEA, 2012a). As a consequence, these lower priced spot supplies (from, among
others,NigeriaandEquatorialGuinea),reducedtheaveragepriceofacubicmetreofLNG,despite
recorddemand.Consequently,theriseinLNGpriceswasmainlycausedbythesimultaneousrun
upinoilpricesduring2011(asaconsequenceoftheArabSpringinNorthAfricaandissueswith
Iran)ratherthantheincreaseinJapanesedemand.
Figure7Japaneselongtermandspotvolumesimport,201012

12 18%
16%
10
14%
8 12%
10%
bcm
6
8%
4 6%
4%
2
2%
0 0%
Spot% JapanimportLNGlongterm JapanimportLNGspot


While consuming nations might see a need for longterm contracts to ensure supply security
(although this ultimately depends on the physical availability of gas), producers generally use
these contracts to secure financing and a return on investment. For developing natural gas
markets,oillinkageisfrequentlyreadilyacceptedbybothproducersandconsumersasapricing

mechanism, for lack of a reliable alternative. A developing gas market is initially unable to
generate a reliable natural gas price, as the infrastructure investments required to develop a
marketwillsettheseatanuncompetitivelevel.
However,inmaturenaturalgasmarkets,oilpricelinkageisaweakinstrumentforgeneratinga
competitiveprice.Sincetheinitialinfrastructureinvestmentsinmanymaturegasmarketshave
depreciated,governmentsmightwishtointroducemorecompetitionthroughtheseparationof Page|19
networksandsupplyactivitiesinthenaturalgassector.Thisprocessseparatesprocurementcosts
fromdistributioncostsinthewholesalenaturalgasprice,allowinginfrastructureinvestmentsto
befinancedonthebasisofaservicefeefordeliveryofthecommoditytocustomers.
Simultaneously,thenaturalgaspriceresultingfromcompetitionwillincreasetransparencyinthe
gasmarketbecausecommodityandtransportcapacityarepricedseparately,atlevelsreflecting
theirrespectivesupply/demandbalance.Whenanaturalgasmarketisproperlysetup,theresulting
price will reveal inefficiencies or bottlenecks in the supply chain (which beforehand were only
known to vertically integrated monopolies), allowing for efficient accommodation of these
bottlenecks through financial incentives. The introduction of competition thus allows for more
efficientprocurementanddistributionofnaturalgasbycompaniesthroughoutthevaluechain.
Oil indexation simply cannot deliver the increased transparency and information required in a
mature natural gas market. As price incentives to generate investments (or change consumer/
producer behaviour) are generated in a market that has very limited interaction with the gas
market,itwillbeincreasinglydifficultfornaturalgascompaniestoefficientlysupplycustomers
asamarketmatures.
Introduction of competition in natural gas markets will generate price signals different from
thosegeneratedbytheoilmarket.Acompetitivenaturalgaspricewillnotmeanthatnaturalgas
isautomaticallypricedlowerthanequivalentoilindexedvolumes.Whenproperlysetup,itwill
meanthatanaturalgasmarketwillpricenaturalgasatitsrelativevalueinaspecificenergymix,
providingcustomerswithareliable,flexibleandlowcarbonsourceofenergy.However,before
turning to the ways in which a competitive natural gas trading hub can be created, the next
chapterwillfocusontheoutlookfortheAsiaPacificnaturalgasmarket.

2.TheAsianPacificnaturalgasmarket
TheAsianPacificnaturalgasmarketiscomplexandfragmented.Itiscertainlynotageographically
definedmarket:itisnothighlyinterconnectedbyhighpressurepipelines,liketheEuropeanand
North American natural gas markets. The main natural gasconsuming countries in AsiaPacific
Page|20 are:China,Japan,India,Korea,Thailand,Indonesia,Malaysia,Pakistan,BangladeshAustraliaand
ChineseTaipei.Thesecountrieseachconsumedover10bcmofnaturalgasin2011.
The region has three separate markets with have their distinct dynamics. First there are the
mature,wellestablishedmarketsofJapan,KoreaandChineseTaipei,whichareisolated,mainly
supplied by LNG and have limited scope for further growth.10 Second, the emerging giants,
China and India, which will develop considerable natural gas demand supplied through both
pipeline and LNG.11 Third, the area of SouthEast Asia, which consists of several large LNG
producers(Malaysia,IndonesiaandBrunei)andrapidlygrowingeconomiesinterconnectedtoa
limitedextentbypipelines.
AsiaPacificsupplydemandbalance
Since1990,thenaturalgasmarketintheAsiaPacificregionhasundergoneremarkablegrowth,
toabout560bcmin2010.Naturalgasconsumptionhasgrownbymorethan250%since1990,
representinganaverageyearonyearincreaseof6%forovertwodecades.Japaneseconsumption
representedthemainstayofAsiannaturalgasdemand,especiallyinLNG,until2010,whenChina
surpassedJapanasthelargestnaturalgasmarketinAsia.
Figure8NaturalgasdemandinAsiaPacific,19902017

900 OtherAsiaPacific
800 Bangladesh
700 Thailand
600 Pakistan
Australia
500
bcm
Malaysia
400
Indonesia
300
ChineseTaipei
200
Korea
100 India
0 China(incl.HongKong)
Japan
Note: Other AsiaPacific in this graph consists of: Brunei Darussalam, Mongolia, Myanmar, Nepal, New Zealand, Korea, the
Philippines,Singapore,SriLanka,Vietnam,andother.
Sources:IEA,2011b;IEA,2012a.

10
The full impact of the Fukushima accident on future power sector demand in the mature gas market of Japan (but also
Korea and Chinese Taipei) is still unclear. Natural gas is generally well placed to speedily replace generation capacity if
needed,asithasconsiderablylowercapitalexpendituresthancoalfiredgenerationandoffshorewindgeneration.
11
Indian pipeline connections with either Iran or Turkmenistan have been discussed in the past, but prospects for these
pipelineconnectionsremainveryunclearbecauseofgeopoliticaltensionsanduncertaintiesovereconomicviability.

Since1998,totalnaturalgasproductioninAsiaPacifichaslaggedbehindregionalconsumption.
Afewcountries,suchasIndonesiaandMalaysia,werenetexportersprovidingLNGforimport
dependentcountriessuchasKoreaandJapan.In2010,naturalgasproductionintheregionfell
around93bcmshortofconsumption,ashortfallthatisexpectedtoincreasetoabout200bcmin
2017,despiteaconsiderableincreaseinregionalproduction.
Page|21
Figure9AsiaPacificnaturalgasconsumptionproductionforecast,19902017
900
800
700
600
500
bcm
400
300
200
100
GasconsumptionAsiaPacific IEA2012forecast
GasproductionAsiaPacific IEA2012forecast
Sources:IEA,2011b;IEA2012a.
DependenceonnaturalgasimportsfromoutsidetheAsiaPacificregionincreasedby12%annually
throughout 200010. It is expected that this import dependency will grow by 5% annually over
theperiod201117.Therelativelymoderateincreasereflectsincreasinggasproductionprojected
for China and Australia. Overall demand in the AsiaPacific region is expected to follow global
demandtrends,growingataround3%perannumtoreach875bcmin2017.
NaturalgasdemandbysectorinAsiaPacific
Fastgrowingdemandfornaturalgaswillleadtogrowthineverynaturalgasconsumingsectorin
mostoftheAsianPacificeconomies.Thepowerandindustrialsectorspredominate,with71%of
the regions natural gas consumed in these sectors in 2010. Natural gas consumption in the
powersectorissettobedominantthroughouttheperiod201117,with44%consumedin2017,
downslightlyfrom47%in2010.
The residential/commercial sector in AsiaPacific consumed around 110bcm in 2011, which
madeitsoverallsharearound17%oftotalnaturalgasconsumption.Althoughthisrepresentsa
considerableamountofnaturalgas,itisamuchlowersharethantheUnitedStates(34%in2009)
andEurope(37%in2009).TheAsiaPacificresidentialsectorisforecasttocreateabout18%of
regionalnaturalgasdemand(160bcm)in2017(Figure10).
The main exemptions to this rule are Korea and the developing economy of China, where the
residentialsectorsmakeupaconsiderableshareofdemand,asnaturalgasisusedforheatingin
the northern parts of the countries. Although demand growth in Koreas residential sector is
expected to be fairly limited (up 2bcm in 2017), residential demand will continue to comprise
around40%oftotalgasdemand(FACTS,2012).DemandintheChineseresidentialsectorissetto
increaseconsiderably,by52bcm(11%annuallyuntil2017),increasing2017residentialdemand
toaround33%oftotal.Suchgrowthindemand,responsivetoseasonaltemperatures,wouldhave
tobeaccommodatedthroughincreasesinseasonalflexibilityinnaturalgassupply(bothLNGand
pipeline),muchlikethatobservedinothermaturemarketswithsignificantresidentialdemand.
Figure10SectoraldemandfornaturalgasinAsiaPacific,200017
Page|22
900
800
700
600
500
bcm
400
300
200
100
Observed IEA2012forecast
Residential/commercial Industry Power Other
Note:othercomprisesusebytheenergyandtransportindustries,andlosses.
Sources:IEA,2011;IEA,2012.

Althoughdemandfornaturalgasintheresidentialsectorissettoincreaseatafasterpace(6%
per year) than demand in the industrial and power sector (5% and 4% per year, respectively)
naturalgasconsumptionwillcontinuetobedominatedbyindustryandpowerconsumers,both
ofwhichusuallyrequirelittleseasonalflexibility.12Demandfromthepowersectorrequiresmore
shorttermflexibility,sincegasfiredpowergenerationisfrequentlyusedtobalancetheelectricity
networkthroughouttheday.Industrialgasdemandisprimarilyresponsivetooveralleconomic
growthandsectoralbusinesscycles.
NaturalgastradeinAsiaPacific
Natural gas trade in this region is growing by 6% per year, which makes it the main driver in
globalgrowthprojectionsof5%annuallyovertheperiod201117.Whilenaturalgastradeinthe
regioniscurrentlydominatedbyLNG,pipelinenaturalgasissettogrowby15%peryearthrough
theperiod201117.
Theshareofpipelinetradedgasistoincreasetoabout18%oftotaltradein2017,upfrom11%
in2011.PipelinetradeismainlydrivenbyincreasedimportsfromCentralAsiaandMyanmarinto

12
Seasonalflexibilityisconsideredlongtermandisusuallyprovidedthroughstorageindepletednaturalfieldswithconsiderable
workingvolumethatcanaccommodateseasonaltemperaturerelatedswingsinnaturalgasdemandintheresidentialsector.
Thiscontrastswithshorttermflexibility(i.e.withinday,withinweek)whichusuallyinvolvesstorageinsaltcavernsoraquifers
withlimitedworkingvolume,buthighsendoutcapacitythatcanaccommodateshorttermswingsindemand/supply.

China,asnoothernewpipelineinterconnectionsorexpansionsintheregionareunderserious
considerationintheregionatthemoment.
Figure11PipelineandLNGtradeinAsiaPacific,200017
400
Page|23
350
300
250
bcm
200
150
100
50
Observed IEA2012Forecast
PipelinetradeAsiaPacific LNGtradeAsiaPacific

Sources:IEA,2011a;IEA,2012b.
LNGtradeinAsiaPacific
ThetwomostmaturenaturalgasmarketsintheAsiaPacificregionareJapanandChineseTaipei;
coincidentally, both markets are nearly exclusively supplied by LNG, as local production is
practicallynonexistent.In2011,thesetwomaturemarketsconsumed87%ofallLNGdelivered
intoAsia.AmarkedshiftindemandforLNGisexpected,asmaturemarketssuchasJapanhave
limitedpotentialforanincreaseinLNGdemand,whiledemandgrowthinChinaandIndiaislikely
tobeconsiderable.
TheASEANnationsthatcurrentlyfunctionasalargesourceofregionalLNGproduction,supplying
about 66bcm of LNG to satisfy broader AsiaPacific demand, will see a marked change in their
netexportposition.13Inthemediumterm,thenetexportpositionwilldeclineasLNGproduction
decreases and regional consumption increases. Thailand started to import LNG in 2012, while
Singapore,Vietnam,andthePhilippinesareexpectedtostartimportingLNGwithinthisdecade.
Overall,LNGexportcapacityoftheASEANregiontosupplytheAsiaPacificmarketisprojectedto
decreaseby18%by2017.
Traditionally, the AsiaPacific demand for LNG was satisfied by regionally produced LNG, from
Australia as well as ASEAN countries. In the first quarter of 2012, 47% of AsianPacific LNG
imports originated from the AsiaPacific region, a level not seen since the 1970s. Despite the
forecastincreaseinAsianPacificgasdemand,aconsiderableincreaseinAustralianLNGproduction
13
MemberstatesoftheAssociationofSouthEastAsianNations(ASEAN)comprise:BruneiDarussalam,Cambodia,Indonesia,
Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam. Within the ASEAN, Malaysia, Indonesia and
BruneiDarussalamarenetLNGexporters.
willmaintainAsiaPacificLNGproductionaround52%oftotalregionalLNGdemand.TotalAsian
PacificLNGimportfromotherregionsisestimatedtobe147bcmby2017,anincreaseofabout
62%from2011levels.
Figure12ForecastedgrowthinLNGtradeinJapan,China,IndiaandASEANnations,201117

Page|24 150
+7%
100
+257%
50
+72%
Bcm
0
Japan China India ASEAN
50
2011 2017
-18%
100

Source:IEA,2012b.
Figure13LNGimportintoJapan,Korea,China,ChineseTaipeiandIndia,200712

200
180
160
140
120
bcm
100
80
60
60% 51%
40 69% 67%
65%
20
47%
0
2007 2008 2009 2010 2011 Q12012
ImportAsiaPacific ImportFSU ImportMiddleEast
ImportAtlantic ImportAmericas

Sources:customsagenciesofJapan,KoreaandChineseTaipei(plusChinaandIndiawhenavailable).

Inabsoluteterms,theAsiaPacificregionwillincreasinglydependonglobalLNGsuppliers,atrend
thathasintensifiedovertheperiod200711,whenaneardoublingofQatarisuppliesstrengthened
AsiaPacificdependencyonotherproducingregions(primarily,theMiddleEast).Producerslocated
in the Middle East (Qatar) are geographically well positioned to be the swing suppliers to both
the Asian and Atlantic basins (Jensen 2011). Volumes from the United States (Alaska) and the
FormerSovietUnion(i.e.FSU,ShakalinII,Russia)areeffectivelydestinedfortheAsianmarket.
The prevailing differential between the oilindexed LNG price in the AsiaPacific region and
EuropeanpriceshasattimesattractedconsiderablevolumesfromtheAtlanticBasin,namelyin

2008(duetohighoilprices)and2011(duetohighoilprices,theFukushimaaccidentandalack
ofdemandforLNGintheAtlanticBasin).Morethan75%ofvolumedeliveredfromtheAtlantic
into the AsiaPacific region in 200712 was priced at over USD10/MBtu (Figure 14). In 2011,
cargodiversionsandanincreasingnumberofreexportsboostedsuppliesfromtheAtlanticBasin
toAsiatoaround17bcm(equivalenttoroughly200largecargoes).14
Page|25
Figure14AtlanticLNGdeliveredintoJapan,KoreaandChineseTaipeiatimportprice,200712
100%
90%
80%
70%
cumulativesupply
60%
50%
40%
30%
20%
10%
0%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
PriceLNG(USD/MBtu)
Sources:customsagenciesofJapan,KoreaandChineseTaipei.
NaturalgaspipelinesinAsiaPacific
PipelinetradewithintheAsianPacificregionisminimalcomparedtoLNGtrade,becauseofthe
limited pipeline infrastructure connecting SouthEast Asias net exporters with net importers.
Similarly,thelargestconsumingnaturalgasmarketsofAsiaPacificareinternallyfragmentedasa
result of a still developing gas infrastructure (China) and a dependence on LNG supply with
limiteddomesticinterconnection(Japan).
IntheASEANregionthereisalongstandinggoaltoexpandtheregionalpipelinesystemintoa
transASEAN gas pipeline system (TAGP) connecting eight ASEAN nations by 2020.15 Despite
progressonsomeinterconnections,severalkeyinfrastructureprojectshavesofarnotmaterialised.
ASEAN has set completion of the TransASEAN Energy Network as a strategic goal, and the
developmentoftheoffshoreEastNatunanaturalgasfieldisconsideredthemaincriticalfactorin
achievingit.Sofar,thehighcarbondioxide(CO2)contentofEastNatunagas(nearly70%ofthe
depositisCO2)hasdrivenupthecosttodeveloptheresourceandconsequentlypushedbackthe
startup date (now believed to lie beyond 2022). The development of any TransASEAN gas
infrastructure is likely to be postponed beyond a similar date, even if commercial viability is
proven(apointalsorecognisedbyASEAN)(ASEAN,2009).
TheareaofSouthEastAsiaconsistsofseverallargenaturalgasproducers(Malaysia,Indonesia
andBrunei)ofwhichMalaysiahasthemostdevelopedinternaltransmissionsystemconnecting
producers with consumers and other producers. The Peninsular Gas Utilisation (PGU) project,
completedin1999,spansmorethan1400kilometresandconnectsMalaysiawithThailandand
Singapore.ThailandsuppliesMalaysiawithnaturalgasfromtheJointDevelopmentArea(JDA)in
which both countries have a share (through their national gas companies), while Malaysia
suppliesnaturalgastothecitystateofSingapore.
14
BasedoncustomsdataandassuminganaverageLNGcarrierof140000m3LNG.
15
Indonesia,Malaysia,Singapore,Vietnam,Myanmar,thePhilippines,BruneiDarussalamandThailand.
Singapore is supplied through four pipelines developed over the period 19912007, connecting
SingaporewithMalaysia(twopipelines)andIndonesia(twopipelines),withatotalannualsupply
capacityofaround9.6bcm.AlthoughSingaporehasnotransitfacilities,itcanbeconsideredas
aninterconnectionbetweenIndonesiaandMalaysia(andThailand).Thailandisalsoconnectedto
Myanmar and takes natural gas from the Yadana and Yetagun deposits through two pipelines
Page|26 with total capacity of 7.4bcm. In addition, Thailand is (technically) connected with Vietnam
throughapipelinethatconnectsasharedoffshoregasfield(PM3deposit)withtheVietnamese
mainlandatCaMau.Inthenearfuture,MyanmarwillbeconnectedwithChina,astheMyanmar
Chinapipeline,withanannualcapacityof12bcm,isscheduledtobecompletedin2013.
Table3Intraandinterregionalpipeline(s)inAsiaPacific
Intraregional Pipeline Operational (year) Capacity (bcm/yr)
Myanmar-China Myanmar-China Pipeline 2013 12.0
Myanmar-Thailand Yadana-Export Pipeline 1998 5.4
Yetagun-Export Pipeline 2000 2.0
Thailand-Vietnam PM3-Ca Mau Pipeline 2007 2.0
Thailand-Malaysia Trans-Thailand-Malaysia Gas Pipeline (TTM) 2005 7.7
Malaysia-Singapore Peninsular Gas Utilisation Pipeline System (PGU) 1991 1.5
Peninsular Gas Utilisation Pipeline System (PGU) 2007 1.1
Indonesia-Singapore West-Natuna Transportation System 2001 3.4
Grissik-Singapore Pipeline 2003 3.6
Interregional
Turkmenistan-China Central Asia Gas Pipeline (CAG) 2011 30.0
Sources:IEA,2012a;APERC,2000;APERC,2012;variouscompanywebsites.

InterregionalpipelinetradeissofarlimitedtotheTurkmenistanChinapipeline,whichconnects
TurkmengasproductionwiththecentresofnaturalgasdemandineasternChina.Thepipelineis
currentlybeingupgradedtofacilitatethetransportofaround40bcmofnaturalgasannually.In
addition,spursofthepipelineinKazakhstanareunderconsiderationtobeabletofarmmorenatural
gasfromtheregion,withapossible65bcmoftotalcapacityforthepipelinebeingdiscussed.
It is unlikely that any of the gas from Central Asia (including possibly Russia in the future) will
reachothermarketsintheAsiaPacificregion(HongKongbeingconsideredasanintegralpartof
the Chinese supply system). As Malaysia has one of the most extensive natural gas pipeline
networksinSouthEastAsia,itconnectsThailandandSingaporethroughitsPGUsystem.However,
that is all the intraregional transit capacity that exists. Other connections in the ASEAN region
arededicatedupstreampipelinesconnectedtocentresofdemand,withoutthetransitcapabilities
observedinmorewelldevelopednaturalgasnetworks.
ExpansionofthenumberofinterregionalpipelinesconnectingtheAsianPacificwithotherproducing
areas,suchastheMiddleEastandCentralAsia,seemshighlyunlikely.Despitedecadesofspeculation,
thegeopoliticalobstaclestonaturalgaspipelinesthroughAfghanistanandPakistanseemasintractable
asever.Besidegeopoliticalobstacles,interregionalpipelinetransportisfrequentlyuncompetitive
withLNGtransport,asthisisusuallymorecosteffectiveoverlongerdistances(Jensen,2011).
ThemostlikelydevelopmentmightbeanaturalgaspipelinebetweenChinaandRussia.Despite
manyhighlevelpoliticalagreementsoverthepastdecade,afinalinvestmentdecisionbetween
commercial parties is still considered to be years away. The issue of the natural gas price has
proventobeaninsurmountableobstacle.Inaddition,Chinahasdevelopeditsownenergybridge
with Central Asia, supplying China with adequate volumes of attractively priced natural gas for
thetimebeing(Henderson,2011).

As natural gas consumption in the AsiaPacific region continues to grow and interregional and
intraregional transit capacity remains limited, nations look increasingly at seaborne LNG to
supplytheireconomieswithnaturalgas.AgrowingnumberofcountriesintheAsiaPacificregion
areconsideringbuildingregasificationterminals.
LNGsupplychainflexibilityinAsiaPacific Page|27
LNGsuppliesneedtobedeliveredinawaythatassuresflexibleandreliablesupplyforcustomers.
TheymustbelocatedinareasservicedbyLNGregasificationterminalsandbepartofacomplete
LNGsupplychain.16Thismustaccommodateshorttermdemandfluctuationsfrom(large)individual
consumers,seasonaldemandchanges,anddemandthatfollowseconomiccycleswhilemaintaining
economicefficiency.
Regasificationterminals
Regasification terminals are a crucial part of the LNG infrastructure, not only for the access to
globalLNGsuppliestheyprovide,butalsoassuppliersofdownstreamflexibility.
Figure15Regasificationoperational,underconstructionandplannedinAsiaPacific,200017
700
600
500
400
bcm
300
200
100
Operational Underconstruction Planned LNGimportAsiaPacific

Sources for data on Bangladesh, China, Chinese Taipei, India, Indonesia, Japan, Korea, Malaysia, New Zealand, Pakistan, the
Philippines,ThailandandVietnam:IEAdatabases;variouscompanywebsites.
Traditionally, there has been ample capacity in the AsiaPacific region to receive and despatch
theannualLNGtotal(Figure15).However,thisshouldnotbeseenasovercapacity.Regasification
terminalsarebuilttoaccommodatepoliticalandeconomicaswellastechnicalrequirementsof
themarket.Theserequirementsinclude:theforecastedpeakdemandoftheareathatissupplied
bytheterminal,thenumberofalternativesourcesofsupply(i.e.theinterconnectedness)ofthe
suppliedmarketwhichisfrequentlydeterminedbygeographicconstraints.Inadditiongovernment
regulations(suchastherequiredreservemargintoensuresecurityofsupplyorTPArequirements)
andsupplycontractcharacteristicsalsoinfluenceterminalcapacitychoicesoftheuser(s)ofthe
terminal.17TheyearlycapacityutilisationinAsiaPacificisestimatedtohavebeen34%in2000,
slowly rising to around 50% in 2011 and projected to stabilise around this level as new and
16
LNGliquefaction,LNGcarriers,regasificationterminalsanddownstreamdistributioninfrastructure.
17
Suchascargosize,seasonalityrequirements,swaparrangements,LNGqualityspecifications,etc.
plannedcapacitycomesonstream.InadditiontoChina,India,Japan,KoreaandChineseTaipei,
which already had regasification terminals, Thailand came on stream in 2011and several other
countriesarebuildingorconsideringbuildingterminals.
Newcomers such as Singapore, Thailand, Pakistan, Bangladesh, Vietnam, New Zealand and the
Philippines have announced plans to construct regasification terminals or are in the process of
Page|28 doingso.Inaddition,thetraditionalbigLNGexporters,MalaysiaandIndonesia,haveconstructed
LNGregasificationterminalsthatallowthemtoimportLNGtosupplytheirdomesticmarket,as
domesticpipelinedistributionhassofarnotmaterialised.
SeasonalflexibilitythroughLNGsupply
AsianPacific economies generally have limited needs for seasonal flexibility in gas, because of
the preeminence of natural gas usage for power and industry sectors. The two exceptions, as
discussedabove,areChinaandKorea.
Atfirstglance,Chinahasaconsiderablenumberofoptionstosupplyseasonalflexibilitycompared
to other AsianPacific markets. These options consist of domestic production, underground gas
storage (UGS) and access to pipeline supplies from other suppliers (allowing LNG to supply
seasonal flexibility, as it is generally not the baseload supply option). However, as the Chinese
naturalgasmarketisrapidlydeveloping,theseoptionsneedtobefullyexploredandutilisedto
keepupwithdemand.
Duetoisolationfrompipelinessuppliesandlimitedgeologicaloptionsforundergroundstorage
(either seasonal or shortterm), Korea increased the flexibility of its LNG supply chain to meet
domesticdemand.Thishasinvolvedtheexpansionofhighcoststorageonshoreinregasification
terminals,additionalspotpurchasesontheglobalLNGmarket(nationalgascompanyKOGASis
thelargestspotcargopurchaserintheworldtoensurewintersupplies)andequityparticipation
inLNGupstreamprojects.
LNGupstreaminfrastructureflexibility
Despite considerable regasification capacity that can service the flexibility requirements of the
individualeconomies,overallflexibilityintheLNGsupplychainislimitedbyinfrastructuralrigidities
in the upstream sector. LNG liquefaction plants are frequently producing baseload, as they are
verycapitalintensiveventuresthatneedtorecouptheseinvestments.Thislimitstheiravailability
toprovideflexibilityforgasmarketsthatrelyonLNGfortheirsupply(i.e.rampingupanddown
whenrequired).
Therefore, in order to limit the extensive usage of highcost LNG storage, flexibility in the LNG
supplychainwillfrequentlycomethroughportfoliomanagement.Companieswillcombinevarious
upstream sources into the required downstream supply profile for the overall economy (while
regasification terminals ultimately provide shortterm supply flexibility to the customers in the
areasuppliedbytheterminal).
LNGcarriercapacity
AconsiderablebarriertoengaginginshorttermportfoliomanagementistherestrictionofLNG
carriercapacitydedicatedtoupstreamprojectsonalongtermbasisanddestinationclausesthat
preventresellingcargoestothirdparties.Asaresultoftheglobaleconomiccrisisandshalegas
development in the United States (which freed up tanker capacity originally destined for the
UnitedStatesmarket),freetankeravailabilityincreaseduntilthefirstquarterof2011.Subsequently,
the Fukushima accident reduced the midterm availability of LNG carriers, as Japanese parties
contracted available tankers to transport spot purchases (Poten, 2012). This has resulted in

significantly increased shortterm tanker rates throughout 2011 and the first quarter of 2012
(IEA,2012a).
Asofmid2012,thenumberofLNGcarriersunderconstructionthatarenotdedicatedtolong
term projects comprises 37 out of 81 carriers globally until 2016. Although independent ship
owners might opt to lease out their carriers under longterm contracts (which might limit any
increaseinshorttermavailabilityofLNGtransportcapacity),thisshowsthatmoreshipowners Page|29
see an attractive business in operating LNG carriers. With more parties willing to provide LNG
transportservices,LNGsupplyislikelytobecomemoreflexibleinthemediumterm.
Theimpactofgovernmentpoliciesonmarketstructure
TherigidityoftheLNGsupplychainhastraditionallyprovidedconsiderableimpetustogovernments
to secure longterm security of supply through state owned natural gas companies. These
organisations can match supply and demand for LNG through the vertical integration of their
activities along the value chain, especially through longterm supply contracts and acquiring
equityinupstreamdevelopment.Regasificationterminalsaregenerallydevelopedtoaccommodate
longterm supply contracts concluded by stateowned enterprises and, without unbiased third
partyaccess,furtherlimitLNGsupplyflexibilitytoconsumers.
In addition, the natural gas market structure in most Asian economies limits competition as a
resultofstrongnationalorganisations,whicharegenerallyregulatedmonopolies.Theseaimto
maximiserevenuesontheirlongterm,oilindexedLNGcontractsintheirrespectivehomemarkets
(Rogers, 2012). The continued state involvement of various AsianPacific economies in the
natural gas sector is also visible in the regasification terminals ownership of stateowned
enterprises.Nearly79%oftheterminalsinoperation,underconstructionorplanneduntil2017
areownedandoperatedbyverticallyintegrated,governmentownedentities.
Despitetheincreaseinregasificationcapacity,thecurrentinfrastructureoftheLNGsupplychain
limitstheabilitytorespondtochangesindemandorsupply.Evenwithanincreaseinthenumber
ofLNGcarriersavailableshortterm,thecurrentLNGcontractingstructureisdominatedbylong
term contracts that limit the availability of spot LNG on world markets (see Chapter 4). This
meansLNGsupplycannotrespondcosteffectivelytochangingdemandpatternsindownstream
AsiaPacificmarkets.
NaturalgaspricedevelopmentinAsiaPacific
ThefactthatAsianLNGimportingeconomiesaremainlysuppliedthroughlongterm,oilindexed
contracts has driven natural gas prices in the AsiaPacific region to record highs. Historically
(before2004),LNGpricesbetweenthethreemajorcentresofconsumptionwerelinkedthrough
the oil price movement. However, shale gas development in the United States and increased
liberalisationofnaturalgasmarketsinEuropehavesettheglobalwholesalegaspricesatthree
distinctlevelsbetween2009and2012.
Since2011,AsiaPacificLNGpricesarebackatprecrisislevelsforthematureAsiangasmarkets
Japan,KoreaandChineseTaipei.IndianandChineseLNGimportpricelevelshavebeenmarkedly
lowerthanthoseofotherAsianeconomiesduetodifferentcontractualarrangements.Chinain
particular negotiated favourable longterm price formulas at the start of this century for its
Australiansupplycontracts.ThismadeChineseLNGimportpricescompetitivewithcoalimport
untilJanuary2011.ButasimportsfromotherLNGsuppliershaveincreased,ChineseLNGimports
havebecomelesscompetitivewithcoal(IEA,2012a).
Figure16RegionalgaspricesandJapanCrudeCocktail,200712

25
20
Page|30
15
USD/MBtu
10
USLNG UKLNG AsiaLNG JCC Asiancoalmarker

Note: the interruptions in the UK LNG curve signify that no LNG cargoes landed in the UK during those periods, resulting in no
priceinformation.
Sources: IEA databases; US Energy Information Administration; UK customs; Japanese customs; Korean customs; and Chinese
Taipeicustoms.

DespitethedominanceofoilindexationinimportcontractsforbothLNGandpipelinesupplies,
other indexation models are sometimes considered, e.g. coal indexation in the negotiations
betweentheRussianandChineseadministrationsforlongtermnaturalgasimports.Onthebasis
of market value (natural gas is priced at the level of the fuel it replaces in the energy mix), it
couldbearguedthatnaturalgasisprimarilyincompetitionwithcoal,asthisisthepredominant
fuelinChina.
Theinclusionofalinktothecoalpriceinlongtermgascontractshasproventobeunacceptable
fortheRussiangascompanyGazprom(IEA,2011a).Forthisexporterthelinktocoalpricesisa
significantrisktoinvestmentrecovery,ascoalpricesaregenerallylowerthanoilindexednatural
gasprices.Inaddition,thelinkagetothecoalmarketisarisktothepricesettingmechanismas
Chinese(frequentlystateowned)coalproducershaveconsiderableswayoverinternationalcoal
prices,thuspresentingathreattomarketbasedpricing.However,despitetheseinitialdevelopments
new benchmarks for indexation are likely to be used in the future in commercial negotiations
betweensupplierandconsumer.
TheAsianPacificmarketbroadlycomprisesthreeareasofmarketmaturity(seeIntroductionto
thisChapter):
thewellestablishedmarketsofJapan,KoreaandChineseTaipeihaveendusernaturalgasprices
thatreflectthedominanceofoilindexedsuppliesatacostplusbasis:oilindexedcommodity
plusservicesforconsumers;
theemerginggiants,notablyChina,havesubstantialdomesticproductionandregulatedend
userpricesacrossvariouseconomicsectors;thesearesetataleveltoprovideenergyforthe
growingeconomy(IEA,2012b);and
the area of SouthEast Asia where enduser prices are regulated at a level frequently below
costofservice,namelyineconomieswithconsiderabledomesticproduction,leadingtoasubsidy
forconsumers(IEA,2011c).

WholesalepricesintheAsianPacificregionaresetatacostplusbasisfromoilindexednatural
gas prices or at a regulated level, depending on the economy and sector where natural gas is
consumed.ApartfromtheisolatedmarketofAustralia18andtheJapan/KoreaMarker(JKM)from
Platts(discussedinChapter4)thereisnoAsiaPacificwholesalepricefornaturalgasthatreflects
thefundamentalsofdemandandsupply.
Page|31
Towardsaregionalinterconnectedmarket?
Although the overall dependence of AsiaPacific on natural gas imports from other producing
regionswillstabiliseatroughly50%overthenextdecade,theoverallvolumeofimportednatural
gasintheregionwillcontinuetoincrease,toaround200bcmin2017.However,asthelargest
individual natural gas markets (Japan and China) suffer from a lack of interconnectedness, a
physicallyinterconnectedregionalnaturalgasmarketisunlikelywithinthistimeframe.
Currently, the pipelines connecting different centres of demand in the region are generally
dedicatedtoupstreamdevelopments.AconsiderableexpansionoftheintraregionalPNG(pipeline
supplied natural gas) trade (with Russia) of natural gas remains unlikely for the time being.
Limitedprogressonpipelineinfrastructure(evenwithindomesticmarkets)hasledtoasurgein
regasificationterminalstoconnectthenationalgasmarketstotheglobalLNGsupplysystem.
In principle, there are no technical barriers that would hinder the emergence of a regionally
interconnected AsianPacific market with LNG trade as its backbone. However, the current
structuresoftheLNGsupplychain(liquefactionandtransport)offerlimitedflexibility.Inaddition,
theimportinggasmarketsarefrequentlydominatedbyafewverticallyintegratedorganisations
that with supply infrastructures that suit their specific longterm, oilindexed contracts, but do
notpromoteflexibilityorcompetition.
Finally, there is currently no effective regional cooperation between large natural gas markets
(bothdevelopingandmature)thatwouldsupportamoreinterconnectedgasmarketintheAsia
Pacificregion.AlthoughASEANhasproposedambitiousobjectivesforfurthercooperation,progress
islimited.Asaresultofdifferingnationalpolicies,mostnotrelatedtoenergy,cooperationthat
couldleadtoaregionalnaturalgasmarketsimilartothat(stilltobecompleted)fortheEuropean
Unionisunlikelyforthetimebeing.
Developmentofanaturalgaspricereflectingregionalsupply/demandinanLNGdominatedsupply
system does not necessarily require political and economic cooperation on a level such as the
EuropeanUnions.Transparentnationalgaspricesderivedfromlocalsupplyanddemandcanprovide
incentivestodirectLNGflowsacrosstheregion,facilitatefurtherinvestmentinfrastructureand
generatearepresentativeregionalpricelevel.Thiswouldbesimilartothepipelinebasednatural
gasmarketintheUnitedStates.
Thefirststepstocreateasupply/demandresponsivenaturalgaspricewouldinvolvegovernments
restructuringtheirnationalgasmarketssoastoallowanalternativepricesignaltodevelop.The
steps needed by governments to develop such a transparent pricing signal are outlined in the
followingchapter.

18
Technically,AustraliadoesimportnaturalgasfromtheshareddevelopmentwithTimorLeste,butitremainsageographically
isolatednetexporter.
3.Creatingaliquidnaturalgastradinghub
Asgovernmentstrytocreateacompetitive,sustainableandsecurenaturalgasmarket,increasing
competition in the gas market is seen as a way to deliver all three of these policy targets at a
minimumcosttosociety.Ingeneral,thisprocesswillinvolvethreeinterlinkedtrends.
Page|32
amovefrompublicownershipintheenergysectortoamoreprivateone;
amovetolessverticallyintegratedenergycompanies;and
lessgovernmentinterferenceinthenaturalgasmarket(MingZhiGao,2010).
A monopolistic market structure is fairly common in the takeoff phase of natural gas market
development,duetotheneedforacapitalintensiveinfrastructureandthesubsequentlowreturns
oninvestmentinthedevelopmentstage(IEA,1998).Ingeneral,pressureforamorecompetitive
naturalgasmarketstartstobuildwhenagasmarkethasdevelopedintoamaturemarket.19In
thisstage,infrastructureinvestmentshavedepreciatedandreturnsstarttoincreaseinrelation
tofurtherinvestmentrequirementsasexistinginfrastructurecanbeutilisedatlowmarginalcost.
Although the starting point of various national natural gas markets may differ, governments
generallyneedtotakeanumberofstepstoallowmarketstoopenupandthentocontinueto
function.Agovernmentneedstoguaranteeasetofinstitutionalandstructuralrequirementsto
(further)openamarket:accesstoinfrastructure,introductionofconsumerchoice,reductionof
wholesale price regulation and application of competition policy. These steps should initially
createtheconfidenceforconsumersandproducerstostartusingthemarketplaceastheprimary
platformtofacilitatetheexchangeofownershipofnaturalgasinthemarket.
Requirementsforafunctioningnaturalgasmarket
Thischapterwilllookatwaystocreateafunctioningwholesalenaturalgasmarket,whichcanbe
definedas:asinglepricezoneaccessibletoincumbentsandnewentrantsonequaltermsand
wheretradingisliquid,sothatitcreatesareliablepricesignalintheforwardandspotmarkets
whicharenotdistorted(Dengel,2011).
The primary goal of a deregulation process is to increase competition among natural gas
suppliersandconsumersinamarket.Ingeneral,amoveawayfromamonopolisednaturalgas
market will lead from a noncompetitive market, via a developing market stage to a mature,
functioningmarketwithfullretailcompetition.IEAhasidentifiedtwomarketmodelsthatserve
asanalternativetothemonopolymarketstructure:thepipelinetopipelinecompetitionmodel
andthemandatorythirdpartyaccesstothenetworkmodel.
Anyfunctioningmarketwillhaveadegreeofcompetitionamongsuppliers,eitheratthebeginning
ofthevaluechainorthroughtheentirevaluechaindowntotheretaillevel.Inthepipelineto
pipeline model, competition is organised between suppliers who build the infrastructure to
deliver to customers. In mandatory access to network, a distinction can be made between a
marketwithwholesalecompetitionandamarketwithfullretailcompetition;inthelattercase,
competition is introduced into the final part of the value chain, while wholesale competition
stopsshortoftheretailsegment.
As governments start to deregulate their natural gas markets, they will embark on a complex
process to meet their respective social, economic and supply security objectives for this sector
andtheenergysupplyasawhole.However,newpartiesthatwillenterthenaturalgassectoras

19
Maturemarket:amarketthathasreachedastateofequilibriummarkedbytheabsenceofsignificantgrowth.

a result of deregulation will influence the ongoing process in a way that might require further
changesintherulessetbythegovernment.Itisthereforeacontinuousreciprocalprocessbetween
agovernmentandmarketparties,withoutcomesthatwillneverbeentirelyclearfromtheonset.
Figure17Increasingcompetitioninanaturalgasmarket
Noncompetitive Competitive Page|33

Deregulated/developingmarket
market market
Pipelineto Wholesale
Fullretail
Monopoly pipeline market
competition
competition competition
Monopolyrights Possibilityfor Thirdpartyaccess Thirdpartyaccess
ongas competitorsto Unbundlingof Fullunbundling
transmissionand build transportand Competitionin
distribution transmission marketing gassupplytoall
Supplyobligation pipelines functions endusers
Regulationofgas Directsalesto Competitionin Nopricecontrols
prices largeendusers gassupplyto ongassales
andlocal largeendusers
distributors Regulationof
andlocal accessincluding
Regulationof distributors useofsystem
(bundled)gas Nopricecontrols charge
sellingprices ongassales
Regulationof
accessincluding
useofsystem
charge
Increasingcompetition

Sources:IEA(1998);author.
Figure18Creatingacompetitivewholesalenaturalgasmarket
Futuresmarket
Spotmarket
SufficientNetwork
Linkwithfinancials
Capacity
Competitive CompetitiveNumber
suppliers Participants
Sufficientnetwork
LinkwithFinancials
capacity
Thirdpartyaccess ThirdPartyAccess ThirdPartyAccess
Wholesaleprice WholesalePrice WholesalePrice

deregulation Deregulation Deregulation
Handsoffattitude HandsOffAttitude HandsOffAttitude
Noncompetitive Functioning
Deregulated/developingmarket
market market
Afunctioningwholesalemarketultimatelydeliversareliablepricesignalthataccuratelyreflects
the supply/demand balance, now and in the future. Each country will have a different point of
departureandadifferentobjectivewhenimplementingpoliciestosupportacompetitivenatural
gasmarket.Governmentactionisnecessarytocreateatransparentandlevelplayingfieldthat
increasescompetitionbetweensuppliersandconsumers.
Increasing competition in the natural gas market is a process usually set in motion by the
government,butultimatelyneedingtobeselfsustainedbythemarketinwhichthegovernment
Page|34 hasasupervisoryrole(e.g.throughacompetitionauthority).Thiswillmeanthatthegovernments
roleitselfwillshiftduringthisprocessfrombeingthemarket(throughastatecompanyorother
entity)toaregulatorthateffectivelymonitorsandsetstherules,tofinallyarolesimilartothatof
acompetitionauthority.
Theestablishmentofagasexchangewithaspotandfuturesmarketthatprovidesareliableprice
signal is considered to be a key attribute of a competitive natural gas market. The institutional
andstructuralrequirementsforaderegulatedwholesalenaturalgasmarketthatisthefoundation
ofanaturalgasexchangearesetoutbelow.20
Institutionalrequirementstocreateawholesalenaturalgasmarket
Tosupportcompetitioninanaturalgasmarket,firstsomeinstitutionalrequirementsneedtobemet.
Governmentsmustactivelycreatethefoundationsofanaturalgasmarket,dismantlingoldinstitutions
whilebuildingnewones.Thewaytheserequirementsaremetcanvaryfromgovernmenttogovernment,
dependingontherespectivestateofthenaturalgassectorinacountry,amongotherfactors.
In general, a successful attempt at increasing competition will meet the following institutional
requirements(innospecificorder):
Ahandsoffgovernmentapproachtonaturalgasmarkets:thisimpliesagovernmentalmindset
that will be carried on through the respective natural gas market governing entities. It also
impliesashiftfromdirectpolicymakingandmarketinvolvementtomarketmonitoringthrough
anindependentantitrustagency.However,theparticularinstitutionalarrangementstowithdraw
directgovernmentinfluencefromthemarketmaydiffersignificantlyamongcountries.
Separation of transport and commercial activities: the natural gas industry is known for its
tendencytobehaveasanaturalmonopoly,sincethehighcostsofinfrastructureinvestments
prohibitthedevelopmentofparallelinfrastructurestosupplythesamecustomers(especially
atretaillevel).Itiswidelyrecognisedthattheseverticallyintegratedsupplysystemsneedtobe
brokenup.Whetherthisbreakupisestablishedthroughfullownershipunbundlingorthrough
financialseparation(fromthemothercompany)isimmaterial,aslongascommercialandtransport
activities are run as separate entities.21 Subsequently, the independent transport entity will
levyafairandindiscriminatetransmissionfeeonaproportionalbasisforallshippers.
Wholesale price deregulation: part of the governmental handsoff approach would involve
lettingthemarketsetthewholesalepricelevelfornaturalgas.Thiswouldimmediatelybreak
theformerbundled,regulated,naturalgaspriceintoatransmissionprice(throughunbundling)
andawholesalepricethatincludescommodity,servicesandaprofitmargin.Itwouldallowlarge
customerstoseekthesupplierthatcandelivertheproductthatsuitstheirneedattheleast
possiblecost.Eventually,thisfreedomofchoicecanalsobeofferedtoindividualhouseholds,
butitisnotstrictlynecessaryforafunctioningwholesalemarkettoemerge(althoughitwould
spreadthesocialeconomicbenefitsofgreatereconomicefficiencytothesecustomers).

20
Basedon:R.HaasandH.Auer(2006),pp.857864.Althoughelectricitymarketsaredecidedlynotthesameasnaturalgas
markets,bothareheavilydependentoninfrastructureaccessandthereforeallowforasimilarmarketdevelopment.
21
There is ongoing debate on what would be required to guarantee unbiased thirdparty access. In the light of market
confidence,itmightbeadvisabletoconsiderfullownershipunbundlingasameasuretoincreaseconfidencethatnetworkand
commercialactivitiesaretrulyrunseparately.

Structuralrequirementstocreateawholesalenaturalgasmarket
In addition to institutional requirements, it is generally accepted that market parties need a
minimumdegreeofcertaintythatamarketisactuallycompetitiveandisfunctioningassuch.This
requiresstructuralrequirementstobesecured(bythegovernmentortheindependententity).
The governmental role will then shift from active participant to regulator, setting rules and
Page|35
monitoringthesector.Thesestructuralrequirementsarethefollowing(innospecificorder):
Sufficientnetworkcapacityandnondiscriminatoryaccesstonetworks:essentialtoawell
functioning natural gas market is its accessibility via nondiscriminatory access to networks,
andtheavailabilityofcapacityonthesenetworks.Nondiscriminatoryaccesswillincreasethe
numberofmarketparticipants,whilesufficientnetworkcapacitywillensurethatnoseparate
islands that behave according to their own supply/demand dynamics will exist within the
natural gas networks. Essential elements to guarantee these structural requirements are an
independenttransmissionsystemoperator(TSO),eitherdivestedorfunctionallyseparated;and
aclearandunbiasedinvestmentregimebasedonawelldevelopednetworkcode(setofrules).
Competitive number of market participants: lowering the barrier to entry through a well
regulatednetworkcodeshouldincreasecompetitionfortheincumbentnaturalgascompany.
A genuinely competitive gas market requires a number of parties with competitive market
sharesalonganonregulatedvaluechain(upstreamanddownstream).Thequestionofhow
many market participants, and with what share of the market, constitutes true competition
depends on marketspecific circumstances and needs to be answered by the government/
regulator.Theregulatorthenneedstoenforcetheappropriatestructure,increasinglybehaving
asacompetitionauthority.
Involvement of financial institutions: enabling a market to efficiently service supply and
demandwillrequireinvestmentthroughoutthenaturalgasvaluechain(upstreamdevelopment,
transport, storage and distribution capacity). Apart from capital investments that will be
recouped byoperationalrevenues,acompetitivenaturalgasmarketwillalsoneedfinancial
partiesthatarewillingtocoverfinancial/operationalrisksforpartiesinvolvedinthenatural
gas trade, providing tools for customers to smooth out and optimise revenue streams from
theiractivitiesinthenaturalgasmarket.Ifanaturalgastradingplatformisestablished,alink
betweennaturalgasmarketsandfinancialinstitutionsisneededtoreducecounterpartyrisk
andtoprovideaclear,longtermpricesignal.Itiscrucialthatfinancialpartiestakelongterm
positionsinthegasmarketandgeneratealongtermpricesignal,asfinancialscurrentlydoin
theglobaloilmarket.
The structural requirements (available capacity with unbiased access, a competitive number of
market participants and a link with financials) are essential to kickstart a natural gas market.
Theyshould beguaranteedbyaregulator(ideallyindependentofcompanies andgovernment)
that monitors the market and can act independently, when needed (e.g. force an incumbent
companytofacilitatemorecompetition).Theexistenceofanindependentregulatorshouldalso
boost the confidence of parties in the market. However, a transparent natural gas price that
reflectsthecurrentandfuturestateofthemarketwillnotberealisedunlessaplatformforthe
ownershipexchangeofnaturalgasisdeveloped.
Creatinganaturalgasprice:fromhubtomarket
Duringacomplexprocesssuchasthederegulationofanaturalgassector,theultimatepolicyaim
wouldbethatthesectorwouldsustainitselfbyattractingoutsideinvestmentstomoreefficiently
serve its customers. However, to allow gas supply and demand to meet in a market place, a
platformforexchangeisneeded,morecommonlyreferredtoasahub.
A natural gas trading hub is where the title for natural gas is exchanged between a number of
buyersandsellers.Initiallyithasapurelyadministrativefunctiontofacilitatetrade,butonethat
is crucial to enable competitive markets to function, as trade without ownership exchange is
simplynotpossible.Onthehub,bothaspotmarket,wheregasistradedforlimitedtimeintothe
future,andafuturesmarket,wheredeliveryofthegascanextendseveralyearsintothefuture,
Page|36 cansubsequentlyberealised.Globally,twotypesofhubsfornaturalgastradinghaveemerged:a
physicalandavirtualhub.
Tradingplatforms:physicalversusvirtualhubs
Aphysicalhubisageographicalpointinthenetworkwhereapriceissetfornaturalgasdelivered
onthatspecificlocation.AprimeexampleofsuchaphysicalhubisthatoftheUnitedStates,the
bestfunctioningandmostliquidnaturalgasmarketintheworld,whichessentiallyconsistsofa
physicaltradingpoint(theHenryHubinLouisiana),whichsetsthebenchmarkpricefortheentire
NorthAmericantradingarea.However,theUnitedStatesalsohasmanyregionalphysicaltrading
hubs reflecting local and regional supply/demand balances. At these local hubs, natural gas is
frequentlytradedatadifferentialfromHenryHub,takinginto accountregionaldisparitiesand
productionandtransportcoststothatspecificregionalhub.
In essence, the whole North American natural gas system operates around a price set by
the natural gas exchange at Henry Hub, resulting in prices across the United States that differ,
albeit staying reasonably close together. Within the United States geographical area, arbitrage
opportunities between regional hub prices drive investments in transport capacity by private
pipeline companies. However, for this to work in other countries markets would probably
require a regulator that can regulate access to interconnecting pipelines throughout the gas
market,suchastheFederalEnergyRegulatoryCommission(FERC)intheUnitedStates.
HenryHub(HH)wasnotselectedbythenaturalgasmarketregulator,butbytheNewYorkMercantile
Exchange (NYMEX), which was looking for a centrally located and sufficiently interconnected
pointfortheexchangeofnaturalgasownership.Adifferentapproachwastakeninthe United
Kingdom.WhentheBritishnaturalgassectorwasderegulatedinthe1990s,theBritishregulator
establishedanetworkcodethatcreatedthevirtualNationalBalancingPoint(NBP).Thisvirtual
tradingpointwasestablishedasadailybalancingtoolfortheentireBritishgeographicarea.The
NBPpricereflectsthecommoditypriceintheentireareawithoutgeographicdifferentialsdueto
transportcosts.TransportcostsareleviedseparatelybytheTSOthatrunstheBritishgasnetwork
andareregulatedbytheBritishenergyregulator(Ofgem).
Currently the European Union prefers to continue to integrate its natural gas markets through
theestablishmentofvirtual(regional)tradinghubs.22Thisisapragmaticapproach,sinceitbuilds
ontheexistingarrangementsofnationalTSOsandregulators(ratherthancreatingoneoverarching
European regulator) and an infrastructure built to facilitate longterm import contracts with
nationalbalancingandlimitedinterconnections.ThedemiseinrelevanceofthephysicalZeebrugge
hub has shown that in the current developing European market environment, a virtual hub is
consideredlesscumbersomeduetosimplifiedentry/exitarrangements,attractingnewpartiesto
gasmarkets.23
Physical and virtual gas trading hubs have different setups to accommodate the different
structures of their industries (i.e. fully privatised transport activities in United States versus

22
TheEuropeanUnionacceptedaproposaltodevelopcompetitivenaturalgasmarketsinEuropebytheCouncilofEuropean
EnergyRegulators(CEER,2011).
23
Consequently,theBelgianregulatorCREGandTSOFluxyshavedecidedtodeveloptwovirtualhubsinBelgiumaheadofa
decisionbyEuropeanregulatorCEERtorecommendvirtualhubdevelopmentasthebasisoftheEuropeanGasTargetModel.

regulatedTSOintheEuropeanUnion)andpurposeofthehub(tofacilitatetradeintheUnited
States versus balancing in the European Union). But both platforms have proven to be able to
facilitatetrade,tosustainthetransitiontowardsaliquidfuturesmarket,andtogeneratereliable
pricingsignalsformarketparticipants.
Mergingphysicalandvirtualnaturalgastrade Page|37
Regardless of the hub is physical or virtual, when moving from physical balancing on the spot
markettoaliquidfuturesmarket,thephysicalgassupplyandthevirtualgassupplywillmeetat
this hub. The natural gas hub will then bring together market participants that use the same
naturalgasmarketfordifferentaims.Thishasconsequencesforthewaythatnaturalgasistraded,
forthetypeofmarketparticipantsactiveinthemarket,andfortheproductsthataretradedin
themarket.
Markettrading:bilateralversuscentralisedtrading
Inanoncompetitivemarket,theownershipexchangeofnaturalgaswouldbearrangedinabilateral
fashion between the endconsumer and the (regional) supplier. As wholesale markets increase
competitionbetweensuppliersandbetweenconsumers,otherarrangementsopenup.Inwholesale
markets,naturalgasistradedeitherbilaterallybetweenmarketpartiesandoverthecountertrades
(OTC,frequentlythroughbrokers)orcentrallyonanexchangeoperatedbyamarketingorganisation,
suchasNYMEX,APX/Endex(AngloDutchenergyexchange)orIntercontinentalExchange(ICE).
Bilateraltradeinvolvestradingnotonlyinstandardisedproducts,butalsocustomisedproducts
thatarewidelyusedbysupplierstoaccommodateaconsumersspecificrequirementsfortiming,
flexibility,volume,etc.Thesebilateraltradescanbeclosedbothinthefuturesmarketandspotmarket;
however,thesewillbedeliveredonthehub,asitisaplatformfacilitatingownershipexchange.
Figure19Bilateral,OTCandcentraltradingandtransparencyonspotandfuturesmarkets
Spot market Futures market
+ Central:exchangebasedtrading
Transparency
Forward curve
Bilateral:OTCtrading
Bilateraldealbetweenmarketparties

Time of delivery in future

Aperceivedbenefitofexchangebasedtradingisthattransactionstakeplaceonexchangesthat
facilitate transparent, centralised trade in standardised products, with the gas hub as delivery
point.Thiscentralisedtradethroughtheexchangewillincreasetransparencyinthenaturalgas
market through the price signals and indices that these transactions will provide. In general,
tradingthroughcentralisedexchangesisconsideredtobemoretransparentbyregulators,since
OTCtradingdoesnottakeplaceonscreen.
Although this transparency argument is viable, it does not necessarily mean that OTC trading
limitsthefunctioningofanaturalgasmarket,sinceallmarketpartiesinvolvedinOTCtradehave
equalaccesstothisinformation.24
Animportantfactorinchoosinghowtotradenaturalgasonahubisthewaycounterpartyriskis
managed.Toalargeextent,thisreflectsthemergerofthephysicalnaturalgasindustrywiththe
Page|38 financial industry, with increased financialisation of the natural gas trade as a wholesale gas
marketdevelops.
In bilateral (or OTC) transactions, counterparty risk will to a large extent rest with the parties
involved in the transaction. The primary advantages considered for these transactions are the
lowercosts(e.g.clearingfeesandotherservices)andthefactthatOTCtransactionsallowparties
to buy and sell customised products. Customised products can decrease the need to set up
portfolio management structures and trading desks. Generally, companies that engage in OTC
transactions reduce their counterparty risk by internal corporate regulations that assess credit
worthiness,whichsometimesresultsinbilateralclearingagreements.Ifamarketpartywishesto
insure itself against counterparty risk, this is still possible through clearing houses, but this
reducesthecostadvantageofanOTCtradingtransactionversusanexchangebasedtransaction,
wheretransactionsarealwaysclearedandsosafer.
Figure20AschematicOTCtransaction
Regulator:energy/competitionauthority
Physical/OTC transaction
Non clearing Clearing Exchange

member house market
Optional risk mitigation available through brokers

Partofthecostofusingaclearinghouse(CH)isincurredbytheCHcarryingtheriskofsettlement
failures.ACH(frequentlypartofthemarketingorganisationthatoperatestheexchangemarket)
facilitates risk mitigation between the clearing member (CM, frequently a financial institution)
and the market counterparty. Counterparty risk, both financial and legal, is then isolated from
thenonclearingmembers(NCM,amarketparticipant)tradingonthefutureandspotmarket.
Figure21Aschematicfinancialtransactiononanaturalgasexchange

Regulator:financialmarketauthority
Financial transaction
Non clearing Clearing Clearing Exchange

member member house market
Risk mitigation

24
Thisisadebatethatfrequentlyresurfacesaspoliticiansblameinvisiblespeculatorsforhighcommodityprices(frequently
crudeoil,butalsostaplefoodsandotherstrategiccommodities).TheyfrequentlyrefertotheOTCmarketasthemarket.In
fact,bothOTCandexchangebasedtransactionsincreasethefunctioningofanaturalgastradinghub,asbothprovidespecific
servicestomarketparticipantsandsoattractmarketparticipation.

Animportantdistinctionisthatthetransactiondescribedhereasafinancialtransactiononan
exchangedoesnotnecessarilyinvolvephysicalnaturalgasexchanginghands;naturalgashasbecome
anenergyderivative.Consequently,thegovernmentsregulatoryauthoritythatwillbemostlikely
involved is the financial market authority (FMA), since this type of transaction generally fits well
withinthecompetenceofsucharegulator.Usually,aphysicaltransactionthroughOTCtradeson
thespotmarketwillfallundercompetencyoftheenergymarketregulatororcompetitionauthority. Page|39
This shift in regulatory regime through the merger of the physical and financial trade on an
exchangehubexemplifiesthederegulationprocess.Asaconsequence,financialpartieswillcome
to recognise market mechanisms and regulatory frameworks, creating increased confidence in
the market which will encourage them to integrate natural gas trading into their mainstream
activities.Asaresult,financialmarketswillproviderealtimepricednaturalgasderivativestoall
market parties,therebyfurtherincreasingtransparencyandconfidencein themarket.Thiswill
ultimatelydrivetheprocessofcreatingacompetitivewholesalemarketforward.
Marketparticipants:physicalversusfinancialplayers
Asexplainedabove,involvementfromfinancialpartiesiscriticaltodevelopingfuturepricing,as
thesepartiesarewillingtotakeriskexposuretocreateamargin.Theentryoffinancialentitiesin
amarkettendstoincreasecompetition,andinvolvementinthefuturesmarket.Physicalparties
(shippers)thatdelivergastoconsumersusethespotmarketasabalancingtoolfortheirportfolio
andwillbeconsiderablylessactiveonthefuturesmarket.
Ingeneral,financialpartieswouldliketogetoutofthemarketbeforephysicaldeliverytakes
place.Therefore,whilefinancialpartiesaremorepresentinthefuturesmarket,theysometimes
depend on the spot market to unwind their positions. The relationship between shippers and
financials is symbiotic. While increased trading by shippers on the spot market is essential for
financials to get out of their positions, shippers at the same time depend on the financial
derivativesthatfinancialpartiesprovidethroughthefuturesmarkettoreducetherisksassociated
withshipperactivities.
Figure22Shipperandfinancialpartyactivityonthespotandfuturesmarket
Trader/financial party activity

Market party activity
Forward curve
Shipper/trader activity (physical)

On a wellfunctioning trading hub, the price difference between the futures market and the
spot market at the point in the future where these markets meet is zero. This creates an
uninterrupted price signal for natural gas delivered now and at any point in the future (the
forwardcurve)(Figure22).25
Box1Otherpartiesinvolvedinnaturalgashubdevelopment
Page|40 Inthepreviouschapter,tradersandtheiractivitiesaredistinguishedonthebasisoftheirphysicalor
financialtransactions.Besidesthepartiesthatuseahubforownershipexchange,thereareanumber
of other parties involved in the establishment of a hub and natural gas market. Their subsequent
emergenceonahubandtheirindividualrolesandactivitiesmirrortheprocesssetoutinChapter3
fortheestablishmentofafunctioningwholesalemarket.
Infrastructure operator: ensures that a system remains physically balanced, manages the
capacitytoandfromahub,andadministersthetransferofownershiprights.
Broker: mediates between market parties and thus simplifies the search for counterparties to
sell/buygasandhelpscreateawarenessofOTCdeals.
Huboperator:provideshubserviceagreements(forwheeling,parking,etc.),ensurescontractual
firmnessthroughbackup/downservices,facilitatestransferofgasandstimulatesstandardproduct
development.
Exchange:standsbetweentradesandallowsanonymity,reducesorremovescounterpartyrisk,
ensuresthatpricesarereported,andenablesstandardproductstobecleared.
Thesepartiesallprovideservicesforatradinghubthatenableahubtofunctionandefficientlyseta
pricethatreflectstheoverallsupply/demandbalanceofthenaturalgasmarket.
Marketproducts:physicalversuspaperproducts
Toestablishawholesaletradingmarket,bothshippersandtradersneedstandardisedcontracts
thatenablethemtotradequantitiesofgaslabelledasaproductbytheirtimeofdeliveryinthe
future.Thisisasimplenecessitytomakegasatradablecommodity.Inturn,financialpartiescanmore
easilyvaluethesecommoditiesandstartbuyingandsellingtheseproductsonthefuturesmarket.
Asexplainedabove,productstradedonthefuturesmarketdependonanunderlyingliquidspot
market to create trade in products in the future. The more liquid the trade in an underlying
productormarket,themoreeasilyaproductistradedinthefuture.Marketpartiesperceiveless
riskastheycanmoreeasilygetoutoftheir(financial)positions.Thenumberofproductsoffered
onspotandfuturesmarketsthereforedependsontwofactors:
Underlying product liquidity for short duration, close to expiry contracts (prompt of the
curve26)thatwillstimulateandpushouttradeinproductsfordeliveryinthemoredistant
future(inshort:themoreliquidtheprompt,themoreliquidthecurve).
The demand from market parties for certain products to be introduced to balance their
physical portfolio on the spot market or to hedge their financial portfolio in the futures
market.Thisneedforproductsissetbyvariousmarketcircumstances,suchasregulationsin
the physical gas market that drive the need for new balancing tools or financial regulations
thatrequirebetterhedgingfacilitiesonthefuturesmarket.

25
For schematic purposes in this graph and the ones below, the spot market is defined by withinweek products, such as
WithinDay(WD),DayAhead(DA),WeekendAhead(WA)andBalanceofWeek(BOW),astheseproductsallowforbalancing
proposes in the short term. How many products and how far in the future these products are traded as part of the spot
market differs between markets. In this paper we consider a spot market to be the market that is used for shortterm,
physicalbalancingpurposesbyshippers.
26
Thecurveisasetofpricesforvariousproductsfordeliveryinthefuture,whichgivesacustomerapricefornaturalgas
deliveredatanygiventimeinthefuture(fromnowuntiltheendofthecurve)

New products are usually developed by the marketing organisation that operates the energy
exchangeincloseconsultationwithmarketpartiesusingtheexchange.Themarketpartiesassess
theneedfornewproductsonthespotandfuturesmarket,usuallytryingtodevelopproductson
thecurvewhentradabilityinunderlyingproductsisdeemedsufficient.Thisisadelicateprocess
involving designated market makers who will try to kickstart the trade in these new products,
expanding the product portfolio offered on a hub.27 A schematic set of products that mimic Page|41
variousmarketpartyneedsinthespotandfuturesmarketisshowninFigure23.
Figure23Productstradedonthecurve
Forward curve
YA YA+2 YA+3 YA+

Tradedproducts
QA Q+2 Q+3 Q+4
MA M+2 M+3
Within
week

Through establishing a wholesale market for natural gas with spot and futures deals, a natural
gasmarketwillincreasinglyresembleacommodityderivativemarket.Thiswillmeanincreasing
thenumbersofOTCandexchangebasedtransactions,financialandphysicalpartiesactiveonthe
trading hub, and products traded with delivery in the future. As a consequence, the resulting
pricesonthespotandfuturesmarketwillincreasinglyreflectdominantsupply/demandbalance
forageographicalareainthenearfuture.
Anexchangeoperatorsabilitytoattractmarketpartiesandtosupportcontinuedincreaseinthe
productsandservicesofferedontheexchangeisalsoinfluencedbyanumberofotherfactors,
including the strong support of the incumbent companies. The support of market makers
(frequentlyalsoincumbents)inintroducingproductsandserviceswillreducetimetomarketand
willhelpanexchangetomeetitsusersneeds.28Finally,thequalityandcostsofthedeveloped
market model and services will determine the success of an exchange operator in relation to
otheroperatorsonthesamehuborintheregion.
27
Amarketmakerisamarketparticipantthatagrees(withthemarketingorganisation)tomakebid/offerspreadsforcertain
products,withinagreedparameters,inordertoincreaseliquidityinthetradeoftheseproductsforallparticipants.
28
Timetomarketistheamountoftimeittakesfromaproductbeingconceiveduntilitisavailableforsale;areductionin
timetomarketenablessuppliers(bothphysicalandfinancial)topromptlymeetchangesinproductdemand.
Contractualconsequences?
The introduction of competition and trading hubs will have impact throughout the natural gas
value chain, on both commercial parties and governments. Trade in natural gas is likely to
increasemarkedlyinscaleandscope,asanaturalgashubsabilitytobalanceportfoliosopensup
Page|42 newpossibilitiesforsuppliersandconsumersoutsidetheirlongtermcontractualobligations.
When natural gas is introduced as an energy source into an economy, there is a considerable
needforupfrontcapitalinvestment,asinfrastructureneedstobebuilttosupplycustomers.The
substantialinvestmentrisksassociatedwithbuildingsuchaninfrastructurearemitigatedthrough
longtermcontractsdesignedtoguaranteeanacceptablereturnoninvestment.
The volume risk in these longterm contracts is shouldered by the buyer of natural gas, who
guaranteestobuyacertainamountofannualcontractquantity(ACQ)overthedurationofthe
contract.Volumeriskcanbelimitedbyflexibilityinalongtermcontractprovidingforacertain
share of the volume not to fall under takeorpay obligations, or certain volumes that can be
consumedinthefuture(i.e.makeupgas).
Inthecaseofphysicalsubstitutionwiththeproduct(oil)thatformsthebasisofindexationPrice
riskisshoulderedbytheseller,whoguaranteesthathisproductwouldbecompetitive.Thisrisk
sharingarrangementinitiallyrequiresaguaranteeddistributionmarketforthebuyer,whocould
otherwisenotmeetthevolumeriskobligations.Thedistributionmarketneedtobesubjecttoa
restrictiononsupplycompetitionforageographicareathroughtheobligation/commitmentnot
toresellnaturalgasinothergeographicmarketswherenaturalgasmighthaveahighervalue(i.e.
finaldestinationclause).
Longterm contracts usually provide for a mechanism to deal with major changes in market
conditions,suchasasuddenupswingindemandorregulatorychangesthatseverelyaffectthe
competitiveness of natural gas in the energy market. The main mechanism is the facility to
renegotiatecontract conditions,tobringthemintolinewithprevailingmarketconditions. Asa
result of these contract clauses, the natural gas industry in Europe has seen a considerable
numberofrenegotiationsinresponsetothecollapseofdemandin2009.
Factorsinfluencingpricing
Thepriceformulainlongtermsupplycontractsisintendedtoestablishalongtermpriceforgas
onthebasisofthevalueforgasperceivedinthe(near)futurebyboththesellerandthebuyer.
Asmarketscontinuetodevelop,thevalueofnaturalgasintheoveralleconomyandenergymix
willchange;consequently,thepriceofnaturalgasneedstobeadjustedtorealignbothpriceand
volume risk. Generally, pricing arrangements in longterm contracts are adapted to changing
marketcircumstancesinoneormoreofthreeways:
the price level can be adjusted to the perceived markets value of gas (where there is no
competitivemarket)ortothelevelofthemarketprice(inacompetitivemarket);
the commodity to which a natural gas price is indexed can be changed to a more relevant
commodityforthesectorsinwhichnaturalgasisconsumed;and
the pace of the price review can be increased (or reduced), realigning a price more or less
frequentlytonewmarketcircumstances.
Theseadjustmentswillhavetobeachievedthroughnegotiationsbetweenbuyerandseller.Ina
competitivenaturalgasmarket,theserenegotiationsareconsideredtobeacost,astheyrequire
extensive contract reviews. This frequently involves expensive litigation, with the sole aim to
bringthepriceofthedeliveredvolumeinlinewiththeperceivedmarketvalueofthegas,usually
foronlyoneparty.Primarymotivationsforbothpartiestorealignthecontractpricearethecosts

thateitherpartycanincurfromthepricedisparitiesbetweenthelongterm contractpriceand
themarketprice(Sutherland,1993).
Inacompetitivemarket,buyerswillaimtoreducetheirprocurementcostscomparedtothose
of their competitors. Longterm oilindexed contracts will increase opportunity costs through
renegotiationsandriskassociatedwithpricedisparitiesversusstandardisedproductsboughtat
the spot or futures market. The incentive to reduce these opportunity costs may provide a Page|43
powerfulmotivationforconsumerstoreducevolumesboughtunderlongtermcontractsandopt
forshortterm,standardisedalternativeswithlowerassociatedcosts.
The existence of the two pricing mechanisms (oilindexed and natural gas) in one natural gas
market has considerable consequences for the distribution of risks between supplier and
consumerintraditionallongtermcontracts.Thesuppliercannolongerautomaticallypassonthe
risk of oil price indexation to endusers. As a result, from a risk management perspective it is
forced to have its own import contracts repriced on a market basis as well. The only way to
redistributethepricerisktowardsthesupplierwouldinvolveindexingthelongtermvolumes
onthegasmarket,whichwouldrequirefurtherrenegotiationofcontracts.
Gasconsumerswhodirectlydependfortheiroverallcompetitivenessonthecostoftheirnatural
gassupply(suchaselectricityproducersinacompetitiveelectricitymarketandfertiliserproducers)
have a direct stake in reducing supply costs, as they cannot easily pass price risk onto their
customers. These consumers are therefore usually the first movers into shorterterm, market
basednaturalgascontracts,astheycannotaffordtopricethemselvesoutofthemarketinrelation
totheir(international)competitorsandneedtomitigatethesepricerisksthroughshort(er)term
contracts.Althoughpricevolatilityassociatedwithcompetitivenaturalgasmarketsisapointof
concerntoindustries(andanobstacletomovingtowardhubbasedpricing),awellfunctioning
futuresmarketwillreducetheseconcerns.
Regulatedutilitieswithregionalmonopolieswillbemorecomfortablewithanypricestructurein
longterm contracts, as they can pass price risks on to (frequently residential) end consumers.
However,aregulatormightimposenaturalgaspricesinlinewiththeir(theregulators)perceived
marketvalue(Sutherland,1993)oragovernmentmightenforceacertainpricelevel.Apolicyof
adoptingmarketbasedpricinginsupplycontractswillprovideregulatedutilitieswithinsurance
againstsuchregulatorybias.
Producersarelikelytobereluctanttochangetowardsshorttermcontracting,astheywillgenerally
claim to be in need of longterm demand security for natural gas to develop capitalintensive
resourcestosupplycustomers.Theyfrequentlyarguethatthedemandfortheirproductwillbe
determinedthroughinterfuelcompetitioninamarket.However,thisneednotexcludemarket
basedpricinginsupplycontracts,aspricesdeterminedonthebasisofsupplyanddemandshould
provideanincentiveforinterfuelcompetition.
Anotherexplanationforproducerresistancetospotindexedpricingisalackofconfidenceinthe
gas hubs ability to provide a reliable price (due to a limited number of suppliers/consumers,
etc.). Producers may alsobe reluctant to abandon wellestablished contract practices that may
haveprovenreliableformanyyears.Finally,thecurrentmarketenvironmentwithhighoilprices
versus lower gas prices (in Europe and the United States) does not provide an incentive for
producerstochangetoanalternativepricingsystem(IEA,2008a).
Whenthenaturalgasmarketbecomesmorecompetitive,consumersandproducerswillhavethe
opportunitytointroducedifferentproductswithamarketpricesuitedtotheirrespectiveneeds.
This will not necessarily entail abandoning longterm contracts, because these contracts have
considerablevalueandbothbuyerandsellerhaveaninterestinsecurelongtermsupplyanddemand.
Figure24Marketdevelopment,contractdurationandmarketmaturity

Futuretrading
Page|44
Spot/futuredeals
Shorttermcontracts
Longtermcontracts
Competitive
Nomarket Deregulated/developingmarket
market
Source:ECS,2007.

Despitetheimpactoftradinghubsonlongtermcontracts,itisawidespreadmisconceptionthat
longterm supply contracts are not possible in a competitive market. As buyers and sellers
determinethecontractduration,theiroverallobjectivewillbe toreduceassociatedcosts.This
can be done by creating a longterm contract that uses a marketbased price; however, this
wouldleavetheofftakeobligationwiththebuyer,aspricerisknolongerposesanissue(andis
thusnotareasonforrenegotiations).
Itispossible(andfrequentlypreferredinfastgrowingmarkets)forconsumerstocontractlong
term volumes; however, this will only be advantageous if the total product (e.g. taking into
accountothercontractconditions)suitstheneedsofbothsupplierandbuyer.Indeed,thereare
attractions to a hybrid system of natural gas pricing (as is currently the case in Europe) where
longterm,oilindexedcontractscontinuetobethebackboneofnaturalgassupply,whilespot
indexedsuppliesprovideabalancingrole(CIEP,2008).Inacompetitivenaturalgasmarket(long
termorshortterm),contractsandtheirpricingmechanismswillhavetosuittheproducersand
consumersneeds,sinceotheroptionsarealwaysonthetable.
Themainconsequenceofanincreaseincompetitiononnaturalgascontractsisthatthenumber
ofavailablecontractswillincreaseassuppliersandconsumerslookforthecounterpartythatcan
providetheirspecificcontractualneed.DevelopmentsintheUnitedStatesandEuropehaveshown
that this will involve a shift away from longterm supply contracts and an increase of market
basedpricingmechanismsinthesecontracts.Thetransitionfromagasmarketthatisdominated
by longterm contracts with indexed pricing mechanisms to a competitive market environment
withshorttermcontractingandmarketbasedpricingschemesdoesnothappenovernight.Both
intheUnitedStatesandtheUnitedKingdom,thiscontractualtransitiontonearly100%market
basedpricingschemestookaroundadecadeandsometimeslonger(SternandRogers,2011).
Hubsasasourceofflexibilityinnaturalgasmarkets
Despite the introduction of concepts such as virtual hubs, paper trades and forward curves,
natural gas trading is fundamentally a physical process that needs a capitalintensive, physical

infrastructure.Thenumberofphysicalconnectionsbetweenanationalareaservicedbyanatural
gas hub and other markets determines the supply and demand options on that hub. An
increasingnumberofinterconnectionswithotherareas(bothLNGandPNG)allowsforincreased
competitioninamarketandsubsequentlysupportsthefunctioningofthenaturalgasmarket.
Inanomarketgassupplyenvironment,flexibilityinstrumentsareessentiallyusedby the TSO/
nationalgascompanytoadjusttochangesinthedemandandsupplylevelinthenetwork.The Page|45
TSO has various tools at its disposal, such as swing in supply (domestic production, pipeline
importsandLNG),undergroundstorage(bothshortandlongterm),interruptiblecontractsand
linepack.29TheseareallusedbytheTSO/nationalgascompanytokeepthenetworkinphysical
balance,frequentlywithinsafetymarginssetbythegovernment(IEA,2002).
Figure25SaleofflexibilityservicesthroughvirtualhubsinEurope
NBP flexibility reach
TTF flexibility reach
NCG flexibility reach

Source:GasTerraB.V.,2010.
TPA is essential for the development of competition and introduces a separate valuation for
transportcapacityandcommodityintheareaservicedbythetradinghub.ThroughTPA,trading
hubswillprovideadditionalinstrumentsfornetworkbalancing,withthefollowingconsequences:
As shippers can buy or sell their supply imbalances to other market participants, this will
reducetheamountofflexibilityinstrumentsthataTSOneedstoguaranteenetworkintegrity.
The natural gas hub will provide balancing incentives through the gas price that stimulates
marketparticipantstoadopttheirsupply/demandpatternsaccordingly.
Awellfunctioningnaturalgashubwillprovideanincentivetoinvestinflexibilityinstruments
considerablevolatilityincertaingasproductsmightsignaltheopportunityforstoragedevelopers
tobuildtherequiredcapacity,forexample.Considerablespreadsbetweensummerandwinter
productsonthefuturesmarketswouldsignalanexpectedshortageinseasonalswinginthe
market.ThissignalwouldprovidetheincentivetodevelopextraseasonalswingthroughUGS
indepletedgasfields.Similarly,considerablevolatilityonthespotmarketshouldprovidean
incentivetodevelopmoreshorttermUGSthroughaquifersandsaltcaverns.
29
Linepack:theabilityofagasnetworktoabsorbpressuredifferencesasaresultofshiftingdemand/supplypatterns.The
biggerthenetworkthebiggerlinepackthatisavailabletoabsorbchanges.
Apricesignalthatshowstheexpectedflexibilityrequirementstomarketparticipantsnotonly
provides an incentive to develop additional UGS, but will also provide financing. A well
functioningnaturalgasexchangewillprovideamoresolidbusinesscaseforfinancialparties
tosupportpartiesthatdevelopUGStosellcapacitytomarketparticipants.However,overall
confidence in the price signal will be crucial for financial parties to support investments in
Page|46 flexibility infrastructure in competitive markets. This makes the participation of financials in
virtualtradingonthespotandfuturesmarketanevenmorecrucialissuetosupporttrustand
furtherfinancialparticipationinthephysicalmarket.
Finally, through the interconnections with other markets and the availability of a price for
transport capacity, parties find that the area serviced by the hub can increase significantly
beyondthenationalboundaryofamarket.Throughseparatingthepriceforcommodityfrom
flexibility, both become available for other parties in a connected market, and if they are
pricedadvantageously,theywillbeintroducedacrossthenationalborder(orcanbeimported
from beyond). In Europe, flexibility products offered from a virtual trading hub can expand
intoageographicareaofroughly1000kilometresindiameter.
Priceinteractionwithothergasmarkets
Asagasmarketmovesfromanoncompetitivetoacompetitivesituation,alternativesourcesof
naturalgaswillbeofferedtowholesaleconsumers(inadditiontolongtermcontractedgas).This
offercanextendtocustomersinconnectedmarkets(unlessexplicitlyforbiddenthroughregulations,
or made very costly through entry/exit requirements). The combination of TPA and physical
connectionswithothermarketareaswillthusspreadcompetitionacrossnationalborders.
Before2009,therehavebeenconsiderablepriceconvergencesacrosstheAtlanticbetweenHenry
Hub and NBP. The United States and United Kingdom both have a clear price level and TPA to
someregasificationterminals,asituationthatprovidedforconsiderablearbitrageopportunities
(IEA,2006).Asaresult,therespectivenaturalgaspricesremainedwithinamarginofUSD2to
USD3/MBtuforalongperiod.Naturalgaspricesstartedtodecoupleonlyaftershalegasvirtually
eliminated demand for LNG in North America and a lack of LNG export capacity in the United
States(withtheexceptionofonesinglefacilityinAlaska)physicallylimitedarbitragewiththerest
oftheworld.
A pipeline connection between markets might be of even greater value than LNG, as it would
generallybelesscostlytomakeuseofarbitrageopportunities(providedcapacityisavailableata
competitiveprice).IntheUnitedStates,arbitrageinthenaturalgasmarkethasshowntobeso
effectivethatdifferencesbetweenvariousphysicalhubspriceshavesimplyreflectedtransportcosts.
Theseexamplesshowthatthesimple existenceof analternativehubincreasestheoptionsfor
regional natural gas consumers, affecting the pricing environment beyond the borders of the
competitivemarket.
It is generally expected that the various hubs developing in Europe today will converge to one
pricelevel,asregulatoryregimesacrossEuropealigninthefuture.Infact,despitethelackofa
welldeveloped network code that describes capacity allocation between national gas markets,
pricesalreadyconvergeconsiderablybetweenvariousEuropeannaturalgasmarkets(EER,2010).
Analysishasshownthattherelativelawofoneprice(LOP)holdsintheNorthwestEuropeangas
market: prices at various European gas hubs move in harmony. This is a consequence of the
alternative supply option that will always loom over a gas market, even if it is not directly
connectedbypipeline(forexample,NBPandNCG,whichareconnectedviatheTTFortheNorwegian
supply system). Systematic price differentials will continue to exist as a result of difference in

transportcostsandcapacityavailability,butarelativeLOPanalysishasshownthatpricesreturn
totheirrelativelevelratherquicklybetweenallNorthwestEuropeanmarkets.30
Figure26PricedevelopmentintheAtlanticBasin,200312
20
Page|47
15
10
USD/MBtu
10
DeltaNBPHH HenryHub(monthlyaverage) NBP(monthlyaverage)

Source:IEAdatabase.
SeveralfactorssupportpricecointegrationbetweennaturalgasmarketsinEurope.First,thereis
a continuous effort to increase the ease by which natural gas can be traded between markets
(althoughitisstillfarfromperfect)(IEA,2012a).Then,thereisthecontinuedintegrationofvarious
national balancing zones, which provides for increasing volumes traded on one single hub and
betterfunctionality.Finally,thereistheexistenceofaflexiblesupplysourceinNorwaythatcan
arbitragebetweenallmajorEuropeanhubsdirectly,allowingpricestoreturnrelativequicklyto
theirrelativepricelevelsonadayaheadbasis.31
ImplicationsforAsiaPacific
Onthewhole,thetransAtlanticandEuropeandevelopmentshaveshownthatnoperfectregulatory
regime needs to be in place and not all markets have to be considered wellfunctioning to
supportapriceeffectbeyondthenationalboundariesoftheareaservicedbyahub.Inthecase
ofAsiaPacific,thiswouldmeanthatifafunctioningwholesalemarketweretoberealised,the
priceeffectwouldbefeltinothermarkets,eveniftheseothermarketswereinadifferentstage
ofdevelopmentwithregardtocompetition.Likewise,ifLNGweretobecomeaflexiblesourceof
supplywitheasyaccesstoallofthevariousnationalmarketsintheAsiaPacificregion,thiscross
bordereffectofcompetitivepricingwouldmostlikelybestrengthened.
30
The markets under review were NBP (United Kingdom), Zeebrugge (Belgium), TTF (Netherlands), PEGNord (France) and
NCGandGaspool(bothinGermany).
31
TheNorwegianpipelinesupplysystemisdirectlyconnectedtothefollowinghubs:NBP,Zeebrugge,PEGNordandGaspool.
Marketmaturity:whenisaliquidgasmarkettrulyliquid?
As outlined above, increasing competition among natural gas suppliers and consumers in a
marketareaiskeytoestablishingafunctioningwholesalemarket.Theeffectivefunctioningofa
competitivetradinghubwillresultinthehighconfidenceamongmarketparticipants,indicated
Page|48 byincreasedusageofthemarketastheprimaryplatformfornaturalgasexchange.
After the outlined institutional and structural reforms begin to take place, will a functioning
wholesale market emerge? Will the absence of a move towards a more functioning wholesale
marketconfirmthattheliberalisationprocesswasflawed,orwouldotherstructuralissuesbeto
blame? In general, two factors need to be considered very carefully before judging gas market
reformasuccess:confidenceandtiming.
Several factors could influence market parties willingness to switch from the old natural gas
markettothenewcompetitivenaturalgasmarket.Anexamplewouldbegovernmentpressure,
wherebythegovernmentinessencemandatespartiestostarttradingthroughagashub.Although
this would be a fast way to force parties to use the natural gas hub, it would hardly create
favourableconditionsforsustainablemarketdevelopment.Thiswouldmostlikelyincurconsiderable
commerciallitigationandeventualpenaltiesforcommercialpartiesinvolvedthatwouldinterfere
withtheirexistingcontractualobligations.Itisunlikelythatdirectgovernmentpressureonmarket
partieswouldleadtoasustainablecompetitivegasmarket.
Agovernmentwouldbemorelikelytoinspireconfidenceifitmettheinstitutionalandstructural
requirements,andmadeanaturalgashubasattractiveaspossiblebyloweringbarrierstoentry
(costs, infrastructure, bureaucracy) and increasing overall transparency (market data publicly
available). The liquidity of a market is generally considered a fair indicator of market parties
confidenceinthefunctioningofahubanditsabilitytogeneratearepresentativeprice.
Generally, market liquidity is referring to the easiness to trade an asset. However, it is nearly
impossible to express a level of liquidity in one allencompassing indicator that accounts for
marketsize,numberofmarketparticipants,churnfactor,numberofproductsoffered,andthe
bidask spread. In addition, all indicators represent the current state of affairs, and do not
necessarilydenotefuturedevelopment.
Different indicators are used to indicate a markets ability to function and set a reliable price.
Eachhasitsdrawbacks.
Nominatedvolumestoahub:thisindicatorwouldcompileallthenominatedvolumesona
hub as published by the TSO to show usage of the hub in the gas market. The value of this
indicator would depend considerably on the practice and methodology of the TSO and thus
wouldnotprovideanundisputedmeasureforhubattractiveness.
Volumestradedonexchange(supplementedwithOTC):thiswouldgiveanindicationofthe
usage of the hub in the future, as the exchangetraded volumes are also traded on the
forward curve. However, as these volumes do not include OTC trades, which might be a far
moresuccessfulmethodoftradingonahub(duetolowercostsformarketparticipants),this
indicatorwouldreflectthetradingrealityforboththespotandfuturesmarkets.Asignificant
drawback,however,isthatdataonOTCtradesisgenerallyspecialiseddataonlyavailablefor
marketparties,whichthuslimitsitsgeneralandwidespreadapplicability.
Churn rate: the most basic measurement of the liquidity in a spot market is measuring the
churnrate,thetradedvolumeofnaturalgasdividedbythephysicalvolumeofgasdelivered
atthehub.Thebiggestuncertaintyinusingchurnasameasureforliquidityisthesubjectivity
of the number, as there is considerable debate on the methodology and which churn rate
actuallyrepresentsaliquidmarket.

Tradehorizon:anotherindicatorwouldbethetimehorizononwhichproductscanbetraded
onthefuturesmarket.Increasedtradeinproductslaterinthefutureshouldindicatethata
market is moving away from the balancing function and has the ability to generate a price
signal for delivery of gas in the future. However, a longer time horizon says little about the
marketdepthandtradabilityoftheproductsonthecurve.Byitself,itisgenerallyconsidered
ameaninglessindicator. Page|49
Bidaskspreads:measuringthebidofferspreadforaproductwouldindicatethetradability
of individual products. The smaller the spread between the bid and ask prices, the better
supplyanddemandarealigned.Measuringthebidaskspreadisfrequentlyusedtocompilea
tradabilityindexthatcomparesthenumberofproductsonthecurveandtheirrespectivespread.
Despitetheinsightthisprovidesonproductavailabilityonthecurveandtheperformanceof
one market versus another, it does not provide a clear definition of what level of spread is
consideredtomarkaliquidproduct(exceptassmallaspossible).
Otherqualityindicatorsinclude:supportoftheincumbents,marketmakers,timetomarket,level
ofcompetitionbetweenOTCbrokers,thenumberofregisteredmembers,qualityofthemarket
model,qualityofservicesandoverallsystemcosts(Powernext,2011). Itisclearthatnoneofthe
indicatorsonitsownwillexpressoverallconfidenceforallmarketparties.
It will be the overall package that will persuade market parties (both physical and financial) to
support the ongoing process of increasing competition. Confidence in the continuity of this
process should be nourished and supported by increased transparency in the gas market. The
timely publication of relevant and consistent data on the natural gas market by the exchange
operator, TSO and regulator is essential for increasing transparency. The relevance of the data
thatispublishedshouldbesecuredthroughregulardebatebetweenmarketparties,TSO(s)and
regulator(s)(Heather,2012).
Settingthepaceofchange:theroleofaregulator
Onefinalimportantissueinamarketthatisdevelopingintoacompetitivemarketisthechanging
roleoftheregulator,whichiscloselylinkedtotheexpectedpaceofreform.Agovernmentsrole
in a developing market will change from being a market participant (through its stateowned
entities), to a market authority (monitoring market development and enforcing competitive
behaviour)andwillfinallycreatearoleforfinancialauthorities,aswell.
As this process frequently starts with a deliberate decision from the government to open up a
marketforcompetition,itisregularlyexpectedthattheresultofthisprocesswilllookacertain
way (in the case of Europe, the United States is frequently taken as an example) (EER, 2012).
Theseexpectationsareusuallytranslatedintoexpectationsonhowanyoftheindicatorsoutlined
abovewilldevelop.Answeringthequestionsofwhenatradinghubisliquidandwhetherahubis
workingwelldependslargelyontheseexpectedresults.However,theambitionofregulatorsto
deliveronexpectationsisalsoaconsiderableregulatoryriskformarketparties.
A regulator might be persuaded to reregulate when an outcome is not what was initially
desired,increasingregulatoryuncertaintyformarketparticipants.Therefore,thetimeframethat
a regulator sets itself to further market reform is critical for the overall process. Frequent
changesinmarketrulestoachieveadesiredresultmorequicklymightdeterfurtherparticipation
from market parties, defeating the regulators overall objective. Both the industry and the
governmentneedarealisticexpectationonthetimeframeinwhichresultscanbeexpected.
Aclearpacesetterforgasmarketliberalisationisthescaleoffinancialliabilitiesthatwillneedto
beunwoundintheprocess.Anefficient,economicpathneedstobeestablishedbecauseforced
change to contractual structures carries significant financial risks for both companies and
economies.AsshowninChapter2,adaptinggeneralcontractstonewmarketcircumstancestook
aboutadecadeintheUnitedStatesandtheUnitedKingdom.Foraregionalsystemsuchasthe
EuropeanUnion,whichwouldinvolveevenmoregovernments,regulators,TSOsandcommercial
parties,itislikelytotakelonger(SternandRogers,2012).
Future(regional)Asiantradinghubsandtheirregulatorswillthereforehavetotakeintoaccount
Page|50 that increasing competitiveness in a natural gas market will take time, and will in all likelihood
takemoretimewhenmoregovernmentsareinvolved.Arealistictimeframeinthegovernments
and/orregulatorsconveyedexpectationstoallowcompetitiontodevelopwillreduceregulatory
uncertaintyandbenefitthetransitionprocesstowardsamorecompetitivenaturalgasmarket.
Atransparentandcompetitivepricefornaturalgas
The main requirement for a transparent natural gas price is the introduction of competition in
themarket,therebymovingfromanoncompetitivemarkettoacompetitivenaturalgasmarket
at the wholesale level.32 An increase in competition among suppliers and consumers requires
institutionalchangesinitiatedbygovernment,andmonitoredandenforcedbythegovernment/
regulator.
Acompetitivewholesale marketrequiresahubto facilitateownershipexchangeofnaturalgas
betweenmarketparties,bothspotandfuture.Theintroductionofexchangebasedtradingwill
likelyincreasethefinancialisationofnaturalgastrade,makingnaturalgasafinancialderivative
as well as a physical product. The resulting market price should reflect both the physical and
financialmarketplayersexpectationsofthepricelevelamarketismovingtowardsatacertain
timeinthefuture,thusreflectingcurrentandfuturesupplyanddemandinthatmarket.
Theimpactofanaturalgastradinghubisfeltinthebroadernaturalgasmarket,asitrequires
bothconsumersandsupplierstoreview,revalue,andultimatelyrewritebusinesspracticesashas
been(frequently)donesincetheinventionoftheindustry.Generally,ashiftfromlongtermto
short(er)term focus of the business will emerge, with adapting contractual and investment
schemeslikelytofollow.Thisprocessmaytakeatleastadecadefornationalmarketswithaclear
regulatoryauthorityandlongerformoreregionalinitiatives,duetotheincreasednumberof
stakeholdersinvolved.
Whenproperlysetup,gastogaspricinginamarketcandelivertransparencyonthestateofthe
market and its investment requirements that is unsurpassed by oilindexed alternatives for gas
pricing.Thisconfidenceliesultimatelyinthelongtermresolveofgovernmentstoallowmarkets
to determine a natural gas price without letting political considerations get in the way in the
shortterm.Strengtheningtheroleofa(preferablyindependent)regulatorwithaclearlydefined
antitrustmandateinboththefinancialandphysicalareaofthenaturalgasmarketwillincrease
confidenceofmarketpartiesandtheirwillingnesstoplayafullpartinthemarket.

32
Introducingcompetitiondowntotheretaillevelisnotstrictlynecessaryforareliablepricesignalonnaturalgastrading
hubs,butitwillgiveresidentialconsumersthebenefitofchoice.

4.PerspectivesonAsiangashubdevelopment
Theabilityofnaturalgastoeffectivelycompeteinanenergymixwouldbegreatlyenhancedifthe
price setting were competitive. However, because most Asian nations have, or will have, a
considerableimportdependencyitfrequentlyoccursthatoverallsecurityofsupplyconsiderations
takepriorityoverpriceconsiderationsinenergypolicymaking. Page|51
Overcomingthesecurityofsupplyrationalethatdrivescompaniestopayoilindexedpricesfor
theirlongtermsupplieswillbeachallenge.Asglobalnaturalmarketsareforecasttotightenin
theshortterm,governmentswillexperienceincreasedurgencytosecurevolumesofnaturalgas
fortheirrespectiveeconomies.33Thiszerosumgamereflexhassofarlimitedafurtherdriveto
increasecompetitioninthesewholesalenaturalgasmarkets.
Futurechallengestotheenergysectorasawholemightgiveanimpetustocompetition,asthe
main role of natural gas in the energy mix of several Asian nations might be flexibility. Several
economiesintheAsiaPacificregionwillhavetoadjusttonewrealitiesintheirenergymixinthe
near future. Although the challenges differ broadly among AsianPacific nations (e.g. reducing
coalconsumption,replacingnuclearpower,orfacilitatingimportstopropupthesupply/demand
balance),alltheambitionscriticallyhingeontheabilityofnaturalgastoprovideaflexiblesource
ofenergy.
Astheoutlooksforvariousscenariosdependgreatlyongovernment decisions,energymarkets
are not likely to develop in a smooth fashion. On the contrary, it seems far more likely that
energymixesacrosstheworldwillexperienceconsiderableshocksinducedbyshiftinggovernment
priorities. Trading hubs for natural gas can be used as a source of flexibility in the Asian gas
markets,allowingforcosteffectiveadaptationofcompaniesportfoliostomitigatetheimpactof
external(governmentpolicyinducedorother)shockstotheenergymix.
As described in Chapter 3, creating a competitive natural gas market will involve a rigorous
process that demands fundamental change from both industry and government actors in the
naturalgassector,aswellasattractingnewparticipants.Astherearenofunctioningwholesale
naturalgasmarketsinthenetimportingnationsoftheAsiaPacificregiontoday,perspectivesfor
such competitive markets to emerge will be assessed at the level of the institutional and
structuralrequirementsforacompetitivenaturalgasmarketsetoutinChapter3.34
Perspectives:consumersinAsiaPacific
As AsiaPacific is a region that encompasses various national gas markets in various stages of
development(nomarket,developingandmature),thisworkingpaperpresentsanalysesoffour
economiesintheregionthatarebroadlyrepresentativeofthechallengesthatvariouseconomies
faceincreatingasecure,affordableanenvironmentallyfriendlyenergysupply.
TheAsianPacificmarketisapatchworkofdiverseeconomieswithsimilarlydiversenaturalgas
markets and overall energy sectors. This analysis will limit itself to Korea, Japan, China and
Singapore, but the range of issues explored below is representative to varying degrees of the
othercountriesinthemarket.
33
InIEA(2012a),theglobalgasmarketistighteningintheshortterm,whileawaveofAustraliansupplyisexpectedtoloosen
globalmarketsbeyond2015.
34
Sixrequirements:ahandsoffgovernmentapproach,separationoftransportandcommercialactivities,pricederegulation
at the wholesale level, sufficient network capacity and nondiscriminatory access to networks, a competitive number of
marketparticipants,andtheinvolvementoffinancialinstitutions.
Japan
Japan was traditionally the largest natural gasconsuming market in AsiaPacific, only recently
overtakenbyChina.ItwillremainthelargestLNGimportingeconomyfortheforeseeablefuture,
as it is an island economy with very limited domestic production and without pipeline
connectionstoothermarkets.TheMarch2011EastJapanearthquakeandsubsequentFukushima
Page|52
nuclear accident created considerable security of supply concerns about the Japanese nuclear
focusedenergypolicy.35
As a consequence of the Fukushima accident, the outlook for natural gas demand in Japan
dependsheavilyonhowmuchofthenowidlenuclearcapacity(ifany)willbeallowedtocome
back online in the future. With discussions on a new energy policy for Japan ongoing, overall
energypolicydevelopmentinJapanismostlikelytobedefinedintermsofapreFukushimaand
apostFukushimaera.
Whatever the outcome of the current policy debate, it will have a significant impact on the
natural gas sector, as carbon constraints will likely allow only low carbon energy sources to
replacenuclearpowergeneration.ArecentlypublishedanalysisoftheeffectsofFukushimaon
Japanese LNG demand beyond 2012 modelled a spread of around 10.6milliontonnes of LNG
(14.4bcm)betweenarenuclearisationanddenuclearisationscenario.Theeffectofthissingle
policydecisionwould(despitenationalenergyconservationefforts)haveaneffectamountingto
15%oftotalLNGconsumedinJapaninthepreFukushimaera(i.e.69.8milliontonnesoraround
95bcmofLNGin2010)(Miyamoto,IshiguroandNakamura,2012).
BeforetheFukushimaaccident,Japanwasconsideredamaturenaturalgasmarket,asJapanese
LNGimportswereexpectedtograduallydeclinetowardstheyear2030.Increasingcompetition
would then most likely create considerable benefits, as infrastructure investments have been
amortised. The Fukushima accident made it likely that natural gas demand will increase
considerablyinthemediumterm,whichwillrequireconsiderableinvestmentsinJapansnatural
gasinfrastructure.
Before Fukushima, the power sector represented 60% of total natural gas demand. This is
estimated to have increased to around 65% in 2011. Given this important share of demand,
changesonthegasmarketwillbeconsiderablyhinderedifcompetitionisnotintroducedinthe
powersector.ExperiencewiththeopeningoftheEuropeanpowerandgasmarketssuggeststhat
vertical integration of power generation is a very important new source of competition in gas
markets.Likewise,wellfunctioningcompetitivewholesaleelectricitymarketscreatepressurefor
thegasmarketsaswell,throughtheneedtoreducecosts.Moreover,electricityorgasutilities
withpreexistingretailportfoliosarewellpositionedtobypasstheentrybarriersthatexistatthe
retaillevel;consequently,awellfunctioningcompetitiveelectricitymarketwouldgreatlyenhance
thechancesofestablishingaliquidgashub.
Ahandsoffgovernmentapproach?
In parallel with the debate on the Japanese postFukushima energy policy, the role of the
governmentintheJapaneseenergysectorwillinalllikelihoodbereassessed.Additionalimpetus
tothisdiscussionisprovidedbythedefactonationalisation(fortenyearsinitially)ofthepower
company Tepco in the wake of the Fukushima accident; as well as the company running
Fukushima,TepcoisaconsiderableLNGimporterforitspowerplants.Itiscurrentlyveryunlikely
thattheJapanesegovernmentsinvolvementinthepowersectorwillrecede(Miyamoto,Ishiguro

35
ForadetailedaccountofJapansnaturalgasmarketandpoliciesbefore2011,see:Miyamoto(2008).

andNakamura,2012).Thisincreasedinvolvementindownstreampowermarketswillundoubtedly
spilloverintothegasmarket,asthepowersectorhadbeenconsumingabout60%oftotalgas
consumptionbeforetheFukushimaaccident(IEA,2011b).
Similarly,thetraditionalfocusofgovernmentpolicyonsupplysecurityin energypolicy making
hasledtogovernmentinvolvementinaccessingupstreamdevelopmentthroughthestateowned
JapanOil,GasandMetalsNationalCorporation(JOGMEC).JOGMECismainlyagovernmentvehicle Page|53
forJapanesecompaniestoreduceexposuretoexplorationrisk:itseekstocreateastablesupply
ofnaturalresourcesforJapan(JOGMEC,2012).
The Japanese government actively encourages utilities to leverage buying power on the global
LNGmarketthoughcombinedprocurementoflongtermLNGsupplies;apartnershipwithKoreas
KOGASisperiodicallyconsidered(WGI,2011a).AlthoughthisisfrequentlyresistedbylargeLNG
importers because it does not increase their domestic competiveness (due to the enduser
pricingscheme),36itdoessignifythegovernmentscontinuedcommitmenttoinvolvementinthe
supplyofnaturalgastoJapanateverylevelofthevaluechain(WGI,2011b).Despitepastefforts
toliberalisethegassectordomestically,theaftermathoftheFukushimaaccidentwillmostlikely
deteranyfurthereffortsinthenearfuture.
Separationoftransportandcommercialactivities?
The Japanese natural gas transport and distribution infrastructure is owned and operated by
vertically integrated private gas and power companies. Although a functional unbundling is
required under Japans Gas Business Act of 2004, the regime has been lenient compared with
EuropeanandUnitedStatesregulations,asnolegalunbundlingisrequired.Thishashadlimited
effectonseparatingdecisionmakingfortransportandsales.
Moreover,thereisnomandatoryfunctionalunbundlingforLNGinfrastructure.Thisfurtherlimits
theseparationofactivitiestothedomestictrunkpipelinesanddistributionsectorsinthevalue
chain(MingZhiGao,2010).SomeLNGisredistributedtosatelliteterminalsbydomesticLNGvessels
that improve regional distribution of LNG in Japan. However, this makes regional distribution
companies considerably more dependent on supply from bigger utilities. This, in turn, makes
overalldistributionevenmoredependentonthecommercialactivitiesofafewLNGimporters.
Pricederegulationatthewholesalelevel?
Since 1955, the Japanese government has set its natural gas sector on a trajectory towards
wholesalepricederegulation.Thegovernmentintroducedlegislationforboththepowerandgas
industriestoincreasefreedomofchoiceforconsumers.Thishasresultedinthegradualintroduction
of freedom of choice for big consumers (>2mcm/annum) in 1995, for consumers larger than
1mcmperannumin1999,largerthan0.5mcmperannumin2004andlargerthan0.1mcmper
annumin2007.Ineffect,wholesalepricederegulationhasbeenestablishedinJapan.
In November 2012, the Japanese government announced that it proposes to create an LNG
futuresmarketthatsetsapricebasedonsupply/demandfactors(Shimbun,2012).TheJapanese
MinistryofEconomy,TradeandIndustry(METI)istoconsultwith18companies(powerandgas
utilities,tradingcompaniesandfinancials)toestablishafuturesmarketthatallowscompaniesto
hedgeagainstfuturepricefluctuations.TheconsultationshouldbefinishedbeforeMarch2013,
whilelistingonacommodityexchangeshouldstartasearlyasApril2014.
36
Foraretailpricingregime,acostplusprofitschemesetsprocurementcostsofnaturalgasattheaverageimportcostsfor
LNG for all Japanese utilities. This has generally provided an incentive not to engage in consortium buying with other
companies,asthiswouldreducetheabilitytogainacompetitivepriceadvantageinrelationtoothergascompanies.
Although the outcome and final structure are currently unclear, METIs decision is a very
encouragingsign.AwholesaleLNGpricereflectingsupply/demandinamarketthesizeofJapans
wouldhave considerableimpactonnaturalgaspricingin theregion.Itwouldalsoconstitutea
break with the traditional Japanese focus on longterm supply contracts with oil indexation.
However, the current focus on the price level of imported LNG (especially on lowering prices
Page|54 towards European and United States price levels) could lead to disappointment with policy
makers,asinacompetitivemarket,lowerpricesareneverguaranteed.Thefocusonpricelevel
seemstoneglectthebenefitsofapricesettingmechanismthatcouldcreategreatertransparency
andefficiencyforthematureJapanesenaturalgasmarket.
Inthepowersector,despitethe1995ElectricityBusinessActandthesubsequentintroductionof
freedomofchoicefornearly60%ofthemarket,theincumbentpowercompanieshaveretained
nearmonopolies in their generation and retailing businesses. As highlighted in Japans Energy
Policy Review in 2008, Japan has undertaken a stepwise approach to market reform. But
competitive pricing is the cornerstone in an incentivebased market framework and it is the
feature that allows market participants to communicate and interact in a way that delivers
optimaloutcomespricingistheglueofcompetitivemarkets(IEA,2008b).
Sufficientnetworkcapacityandnondiscriminatoryaccesstonetworks?
Currently Japan has an annual import capacity of around 250bcm compared to natural gas
demandof123bcmin2011.Thirdpartyaccesstotrunkpipelinesanddistributionnetworkswas
introducedin2004andistobeindividuallynegotiatedbypartiesproposingtosupplycustomers.
However, for LNG terminals, the requirement for TPA is deemed only desirable, limiting the
obligationforcompaniestoengageinnegotiatedTPA.Somecompanieshavedevelopedguidelines,
but in general it has proven difficult to establish TPA at LNG import terminals, as these are
developed to fit an importers specific supply portfolio and subsequently the sales portfolio
requirementsinthehinterland.Thelackofinterconnectionsbetweenregionsthenfurtherlimits
theabilitytoincreasecompetitionthroughTPA.
Numberofmarketparticipants?
The Japanese natural gas market has a considerable number of LNG importers (seven power
companies,eightgascompaniesandseveralindustrialimporters).LNGimportsaredominatedby
powercompaniesthatmainlyuseLNGtosupplypowerstations(62%oftotalLNGimportsin2010).
Gascompaniesimported34%oftotalLNGsupplies,whilelargeindustriesimportedaround4%
of total deliveries. There are around 200 local gas utilities active in selling natural gas to end
consumersintheJapanesecitygasindustry.
However, these companies purchase their gas from the larger gas and power companies that
importLNG.Asfourmajorgasutilities(TokyoGas,Tepco,OsakaGasandChubuElectric)imported
nearly71%oftotalLNGdeliveriesin2010,theirpricesettingabilityisconsiderable.Despitethe
largevolumeofnaturalgasannuallyconsumedinJapanandtheconsiderablenumberofparties
active in the sector, the lack of an interconnected pipeline infrastructure and limited, non
discriminatoryTPAonLNGimportterminalslimitthemarketscompetitiveness.
Involvementoffinancialinstitutions?
Japanhascurrentlynotradinghubonwhichnaturalgascompaniescanbuyandsellnaturalgas;
therefore,therearenonaturalgasderivativesthatfinancialcompaniescantradeoneitheraspot
orfuturesmarket.AlthoughtheJapanesegovernmenthassignalledtheintenttocreateafutures
market with the specific aim to provide tools to manage commodity volatility, it is currently
unclearhowthismechanismwouldfunctionandwhetherfinancialinstitutionswouldparticipate.

This limits the role of the financial institutions (public and private) to providing capital for
infrastructureinvestment(bothupstreamanddownstream)inthenaturalgassector.
TheRepublicofKorea
NaturalgasconsumptioninKoreahasgrownrapidlyoverthepastdecades,primarilydrivenby
continuous economic growth. Development of the Korean gas sector has been driven by the Page|55
creationofthestatecontrolledKoreanGasCorporation(KOGAS)in1982,whichsetouttodiversify
Koreaseconomyawayfromitsdependenceoncoalandoil.
As a result, the first LNG cargoes arrived in 1986 and natural gas consumption grew at an
impressive14%annually,from3.2bcmin1990tonearly45bcmin2010(IEA,2011b).Thegrowth
innaturalgasconsumptionisprojectedtoslowtoaround1.8%perannumuntil2024,reflecting
theincreasingmaturityoftheKoreannaturalgassector(MKE,2011).Naturalgasconsumptionis
dominatedbythepowersector,with44%ofconsumptionin2010,whiletheresidentialsector
consumedasubstantialshareof28%.
ThisgrowthindemandhasbeenmetbyLNGimportsandasmallvolumeofdomesticproduction
fromthesmalloffshoreDohnghae1gasfielddevelopedandoperatedbytheKoreanNationalOil
Corporation (KNOC). Currently under discussion is the usage of the Dohnghae gas field as an
undergroundstoragesitefrom2017onwards.KoreannaturalgasimportsaredominatedbyLNG
importsbyKOGAS(withoneLNGterminaloperatedbyanothercompany,POSCO).
KoreahasanaturalgasinfrastructurethatissimilartotheEuropeanmarkets,withanintegrated
highpressurepipelinenetworkandconsiderableseasonalflexibilityrequirementsduetotemperature
relatedchangesindemandfromtheresidentialsector.Koreacurrentlylacksundergroundstorage
and pipeline import alternatives to LNG and has to meet its seasonal requirements exclusively
fromtheLNGsupplychain.
KOGAShasseveralflexibilityinstrumentsatitsdisposaltomakesupplymeetseasonaldemand:
highcost,strategiconshorestorage;
spot purchases on the global LNG market. KOGAS is one of the most active buyers on the
globalLNGmarketduringthewinter(Stern,ed.,2008);
LNGcargoswapswithothercompaniesthathavetheoppositeseasonalrequirements,frequently
Japanesepowercompanies(GasMatters,2006a);and
participationinupstreamLNGdevelopments,enablingittomatchtherequiredsupplytothe
domesticmarket.
Although Korea currently lacks the underground storage facilities to accommodate swings in
seasonal demand, it has successfully used its vertically integrated business model to provide
securityofsupply.TheestablishmentoftheKoreangasmarketistheresultofthegovernments
strategic decision to develop a natural gas market in 1982. This has propelled the natural gas
marketbeyondtheintensivegrowthphaseintowhatisnowamaturenaturalgasmarket.
Handsoffgovernmentapproach?
In2001,theKoreangovernmentannouncedaninitiativetosplitupstatecontrolledKOGAS(the
governmentcurrentlyowns26.86%oftheshares)intothreeprivatelyownedmarketingcompanies
and one publicly owned infrastructure company.37 However, since 2002, liberalisation of the
Koreangassectorhasbeenprogressingatasnailspace.
37
TheKoreanElectricPowerCompany(KEPCO)owns24.46%oftheshares,localgovernmentsown9.59%,whiletheother
60%ofthesharesarepubliclylisted.
TheKoreanzealforgasmarketliberalisationwanedaftershortagesintheearly2000sthatwere
blamed on KOGASs inability to conclude longterm import contracts (Stern, ed., 2008). Koreas
government continues to support direct LNG import ventures such as the 2005opened
Gwangyangterminalthatdeliversdirectlytoindustriesandpowercompanies.
However,securityofsupplypolicyremainsatoppriorityforthegovernmentandKOGAStakesa
Page|56 pivotalroleinthispolicy.TheKoreangovernmentsmostrecentlongtermnaturalgassupplyand
demandplancallsformoreaccesstoupstreamnaturalgasproductionandKOGASsleverageof
itsbuyingpoweronworldLNGmarkets(Moonjong,2011).Itisthereforeveryunlikelythatthe
planstoprivatiseKOGASwillberevivedinthenearfuture.Thiswillmeanthatthegovernment
continuestoexertacommandinginfluenceinKoreasnaturalgasindustry.
Separationoftransportandcommercialactivities?
As the sole wholesaler in Korea, statecontrolled KOGAS is in charge of natural gas imports,
storage and transmission. Despite the existence of a fourth LNG import terminal independent
fromKOGAS,thesubsequenttransmissionnetworkisalsoownedbyKOGAS,effectivelyleaving
noroomforseparationofcommercialactivitiesfromtransport.
KOGASandthesubsequentcitygascompaniesthatdistributethenaturalgastocustomersand
industriespassonpricechangeswithatwomonthtimelag.Wholesalepricesforpowercompanies
andcitygasdistributorshavetobeapprovedbytheMinistryofCommerce,IndustryandEnergy
(MOCIE), whereas local prices for end consumers must be approved by regional governments.
This makes the Korean wholesale price scheme an effective Regulation Cost of Service (RCS)
pricingscheme,withnopricederegulationatthewholesalelevel.38
LNGissuppliedbyKOGAS,whichoperatesthethreemainimportterminalswithacombinedimport
capacityofaround100bcmannually.KOGASisrequiredtoreserve22%ofannualconsumption
by2017initsdomesticregasificationterminals(thatleveliscurrently16%).Thisobligationgives
KOGAS a dominant role in guaranteeing sufficient network capacity to accommodate overall
demandandseasonalswingintheKoreangasmarket.
In1999,theKoreangovernmenttriedtointroduceanopenaccessregimefortheKoreannatural
gas network. At first, a regulated TPA regime was considered (under supervision of the Korean
competition authority not MOCIE), but this failed to materialise. Subsequently, a negotiated
TPAregimewasintroducedforcompaniesthatwantedtodirectlyimportLNG(andhadMOCIEs
permissiontodoso)andneeded touseKOGASsfacilities.The companies thatwant toimport
LNG directly can only do so for their own use (and are thus not allowed to resell), must have
adequatestoragecapacityavailableandmusthavecompletednegotiationswithKOGAScovering
useofinfrastructure(MingZhiGao,2010).
TheprocessofnegotiatedTPAhasprovenverycumbersome,asdemonstratedbythesteelcompany
POSCO,whichsoughttoimportLNGforitsownuse.AfterobtainingpermissionfromMOCIE,access
negotiationstoKOGASsLNGterminalsandpipelinesfailedandPOSCOdecidedtobuilditsown
regasificationterminal.In2005,POSCOimporteditsfirstLNGcargosuppliedfromBPsTangguh
projectthroughitsGwangyangterminalthatrepresents2%oftotalKoreanimportcapacityandis
dedicatedtodirectlysupplytwoindustriesandonepowerstation(POSCO,KpowerandGSCaltex).

38
ThemajorexceptionbeingtheindustriesthatpurchaseLNGonworldmarketsthroughtheGwangyangterminal.

In April 2012, the Korean power company Korean Midland Power (Komipo, which is a KEPCO
subsidiary)concludeda0.4mtpatenyearsupplycontractwithtradingcompanyVitoltosupply
itspowerstations.ItwillimportthisvolumethroughthePOSCOterminalbecauseaconsiderable
obstacletoaccessingcapacityatKOGASsterminalswasthatcapacityhastobeappliedforfive
yearsinadvance(WGI,2012).
TheinabilityofcompaniestoreselltheirimportedLNGintheKoreangasmarketandcumbersome Page|57
accessnegotiationsforKOGASsLNGterminalsareconsiderablebarriersfornaturalgassuppliers.
KOGAS has a monopoly on natural gas sales through 98% of LNG import capacity, while the
fourthGwangyangterminalsofarhasonlyfourcustomers(whicharenotallowedtoreselltheir
importedLNG).ThiscurrentlycreatesadefactomonopolyforKOGASasasupplierofnaturalgas
fordistributioncompanies.Therearecurrently30citygascompaniesand14powercompanies
thatbuynaturalgasfromKOGAS.
Koreahascurrentlynotradinghubonwhichcompaniescanbuyandsellwholesalenaturalgas;
therefore,therearenonaturalgasderivativesthatfinancialcompaniescantradeoneitheraspot
or futures market. This limits the role of the financial institutions to provider of finance for
infrastructureinvestment(upstreamanddownstream)inthenaturalgassector.
China
ThestoryofthedevelopingChinesegasmarkethascomeunderintensescrutinyasaChinesegas
marketbarelyexistedtwodecadesago(15bcmin1990).Drivenbyitswelldocumentedeconomic
expansion,naturalgasconsumptionhasincreasedmorethanfivefoldsince2000,growingfrom
around 26bcm in 2000 to around 130bcm in 2011. This makes China the fourth largest gas
market in the world. Natural gas consumption is expected to grow about 13% annually for the
nextfiveyears.
The12thChineseFiveYearPlanpublishedin2010(coveringtheperiod201115)outlinedChinas
goaltosignificantlyincreasegasusageby2015.TheIEAanalysisshowedthattheplannedtarget
might be somewhat overambitious, but estimated that this target (260bcm, twice as much as
Chinasgasconsumptionin2011)couldbemetin2017.Thisambitionismainlyanefforttowean
the overall Chinese economy off its dependence on, coal for environmental reasons. Gasfired
powergenerationcurrentlycomprisesaround2%oftotalpowerproductioninChina.However,
Chinesenaturalgasdemandwillincreaseacrossallsectors(residential,industry,andpower)with
eachsectorconsumingroughlyonethirdofnaturalgasdemandin2017.
In the next five years, natural gas in China will be supplied from three sources: domestic
production,pipelineimportsfromMyanmarandCentralAsia,andtheglobalLNGmarket.Although
naturalgasproductioninChinawillcontinuetomeetthebulkofdemand,itisforecastthatboth
PNGandLNGimportswillincreaseaswell,deliveringslightlylessthanhalfofthetotalChinese
demandin2017(IEA,2012a).
Anextensivepipelinenetworkconnectingdomesticandinternationalproductionwithcentresof
demand on Chinas east coast has already been developed, but is still fragmented. However,
expanding this network to keep up with the projected growth in demand will be challenging.
Both international pipelines connecting Myanmar and Central Asia are ownedand operated by
theChinaNationalPetroleumCompany(CNPC),whichalsooperates90%ofthedomesticnatural
gastransmissionpipelines.ImportterminalsforLNGhavebeenrapidlydevelopedaswellandare
ideallysuitedtosupplynaturalgastotheurbancoastalregions. ChineseLNG import terminals

currently have an import capacity of 29bcm annually, which, together with terminals under
constructionwillincreasecapacitytoover52bcmperannumin2015.
China will encounter considerable challenges for governments and companies to continue to
meettheforecastgrowthandexpandcapacityateverylevelofthevaluechain.39Asthedemand
Page|58 levelbeyond2030isforecasttoreach450bcm,Chinasdemandwillhaveconsiderableimpacton
theAsianPacificandworldgasmarkets.
Handsoffgovernmentapproach?
TheChinesegovernmenthasapivotalroleindevelopingtheChinesenaturalgasmarket,bothat
national and local levels. Overall policy ambitions will be set by the National Development and
ReformCommission(NDRC)andseveralothergovernmentstakeholders.Inaddition,thegovernment
hasadirectstakeineverylevelofthenaturalgasvaluechainthroughthestateownedoilcompanies
(inadditiontoCNPC,theChinaNationalOffshoreOilCompany(CNOOC)andSinopec).Finally,local
governmentsoftenownsharesintheregionalnaturalgasutilitycompaniesthatarealsodirectly
connectedwithinternationalmarketsthroughvariousLNGimportterminalsunderdevelopment.
Although the natural gas market in China has reached an intensive growth phase driven by
government policies that support a diversification away from coal and oil, the government is
already looking beyond a policydriven natural gas sector, experimenting with less government
involvement in pricesetting and opening up technically challenging shale gas resources for
international energy companies. However, despite these experiments with market mechanisms
and market parties in the natural gas sector, the governments pivotal role in the natural gas
sectorremainsfirmlyentrenched.
Separationoftransportandcommercialactivitiesinthenaturalgassector?
As the Chinese natural gas sector is in a phase of intensive growth, the overall focus of the
industryisexpandingitsnaturalgasinfrastructureatanextremelyrapidpacetoaccommodate
currentandfuturedemand.Asaresult,transportinvestmentisintimatelylinkedwithupstream
developmentandsubsequentmarketingactivitiesfromindividualcompanies.Thereiscurrently
no separation between transport and commercial activities, as these are linked through the
activitiesofverticallyintegratednaturalgascompanies,primarilyCNPC.
NaturalgaspricesinChinaareregulatedbycentralandlocalgovernments,whichhavegenerally
favoured households over electricity producers and industrials. On the whole, the government
setspricesfordifferentstagesalongthevaluechain(wellhead,transport,explant/citygate)ona
costplusbasisanddifferentiatesbetweendifferentendconsumers(IEA,2009).Effectively,this
hasledtoanSPRpricingmechanism,whichisfarfromderegulatedpricesatthewholesalelevel.
Natural gas has had difficulty penetrating the various regional markets in China (endangering
government growth targets), as it was frequently considered too expensive compared to the
alternativesofcoalandliquefiedpetroleumgas(LPG)inconsumingsectors.Thispricingissuehas
triggered the government to develop regional market reforms in the Guangdong and Guangxi
provinces.Underthesenewpricingmechanisms,citygatepricesarelinkedtoabasketoffueloil
andLPG.

39
Acomprehensivereportoutliningthesechallengeswasrecentlypublished:IEA(2012b).

Thishaseffectivelyled tothe introductionofareplacementvaluepricingschemedowntothe

endconsumer level. The scheme is expected to be expanded beyond the current areas to
SichuanandtheShanghaiarea,whereexposuretooilindexednaturalgasimportsishigher(WGI,
2012b). If this scheme were to be extended across China, it would effectively link wholesale
natural gas prices in China to the oil products that they should replace (which would mirror
Europeanpracticesatasimilarmarketdevelopmentstage). Page|59
InDecember2010,theShanghaiPetroleumExchange(SPEX)launchedthefirstLNGspotmarket
inAsia.Thespotmarketwasintendedtohelprelieveatightsupplysituation,whichhadoccurred
intheShanghairegioninwinter2009.Sinceitsintroduction,tradinghasremainedrelativelylow.
Morerecently,SPEXhaslaunchedanaturalgaspeakshavingspotmarkettosecurevolumesof
natural gas for gasfired power plants during peak electricity demand in the summer. This
simultaneouslyprovidesanoutletforcompaniesthathavecontractedrelativelyexpensiveLNG.
Althoughtheinitialvolumetradedduringthesummer(July/September)islimitedto100mcm,it
does show the willingness of the companies and the government to look into marketbased
mechanismstoaddressconstraintsinthenaturalgas(andpower)sector.
Due to the breakneck pace at which Chinas natural gas demand is developing, infrastructure
availabilityisakeyconcernforcompaniesthataspiretoentertheChinesegasmarket.Asthereisno
TPAregimeandnoregulatortomonitortheoverallChinesenaturalgastransportnetwork,individual
companieshavetonegotiateforpipelineaccessandcapacity.Thisseverelylimitstheirabilityto
supplyorprocurenaturalgasfromsourcesotherthantheincumbentproducersandimporters.
Production of natural gas in China is the effective domain of the three big stateowned energy
companies:CNPC,CNOOCandSinopec.Thereareseveralsmallernaturalgasproducersactivein
theregions,buttheydependontransportfacilitiesprovidedbythebigthree(especially,CNPC).
In the area of transmission capacity, CNPC has a nearly complete monopoly, which limits the
optionsforcustomerslookingforcompetitivesupplies.
There are already a considerable number of commercial parties connected to the grid (around
1800companiesaremembersofChinaCityGas),andthisnumberwillcontinuetogrowasthe
marketexpands.40
However, as more regional utilities start to codevelop LNG regasification terminals, this could
increasecompetitionbetweenimportedLNGandcitygatedeliveredgasthroughCNPCspipelines.
ChinaisoneoftheveryfeweconomiesintheAsiaPacificregionthathasPNGandLNGdirectly
competingformarketshare,whichincreasesoverallsupplysecurity,butalsoincreasespossible
competitioninthefuture.
China currently has two spot trading mechanisms, specifically developed to provide a (limited)
optionforcompaniestobalancetheirportfoliosinwinter/summer.Thishassofarnottriggered
financialpartyactivitytofacilitatetradebeyondthespotmarket.Therefore,therearenonatural
gasderivativesthatfinancialcompaniescantradeoneitherspotorfuturesmarkets,asmarket
playeractivityisdecidedlyphysical.
40
Atleast65%ofallurbanisedareasconnectedtothenaturalgasgridby2050,accordingtothe11thFiveYearPlan.
Inaddition,Chinahascurrencyandcapitalcontrolsthatlimitinternationalfinancialpartiesability
to freely convert the Chinese Renminbi, to repatriate profits and to have financial instruments
legallysecured.Thislimitstheroleoftheinternationalfinancialinstitutionsincommoditytrading
inChina.Domesticfinancialinstitutionsplayasignificant(butultimatelyrestricted)roleinfinancing
infrastructureprojects(upstreamanddownstream)inthenaturalgassector.
Page|60
Singapore
AsSingaporestartedtoimportnaturalgasin1992withthecommissioningofthefirstpipeline
connectedtoMalaysia,thecitystatesnaturalgasstoryisoneofgrowthratessimilartoother
developing Asian economies (albeit on a smaller scale). Natural gas consumption grew from
1.3bcmin2000to8.7bcmin2010.ItisforecastbytheIEAtocontinuetogrowbyaround5%
perannumforthenextfiveyears.
Since Singapore has no domestic gas production, any increase in demand for natural gas
simultaneouslycreatesthenecessitytoincreaseimportcapacity.Asof2012,theSingaporeimport
connectionshaveacombinedcapacity9.6bcmperannum(seeChapter2).Thegasdistribution
networkinSingaporeconsistsoftwoseparategaspipelinenetworks:thetowngasnetworkand
the natural gas network. Town gas, which is used for cooking and water heating by residential
and commercial customers, is manufactured from natural gas. The town gas pipeline network
servesabout50%ofthehouseholdsinSingapore.
In2006,theSingaporeangovernmentdecidedtodevelopanLNGterminaltofurtherdiversifythe
states natural gas supply. In 2008, BG Singapore Gas Marketing (BGSGM) was appointed
aggregatortosupplytheinitial3mtpavolumesofLNGfor20yearstotheterminal.InJune2009,
thegovernmentannouncedthatitintendedtotakeoverthedevelopmentandownershipofthe
LNGterminalthroughtheSingaporeLNGCorporationPte.Ltd.(SLNG)todevelop,build,ownand
operatetheterminal.BGGroupwillsourceLNGsupplyforSingaporefromitsportfolio,butitis
expectedthattheQueenslandCurtisLNGprojectwillserveasoneofthemainsourcesofsupply.
In2010,theSingaporeanEnergyMarketAuthority(EMA,2011)announcedtheconstructionofa
third storage tank at the SLNG terminal, as the initial 4.1bcm of annual supply had been fully
contracted by consumers. The capacity will then double to 8.2bcm in 2014, increasing storage
flexibility for LNG traders who want to take advantage of Singapores geographically central
location in the SouthEast Asian gas market. SLNG will be able to accommodate various sized
LNG carriers, from large 265000cubicmetre vessels to small regional carriers of around
10000cubicmetres.Finally,theLNGterminalwillhavereexportingcapabilitiesandwillbeable
toservicethebroaderAsianmarket,ifrequired.
With moderately growing demand, increasing infrastructure capacity and supply secured from
varioussources,Singaporesnaturalgasmarketcanincreasinglybeconsideredamaturemarket
locatedinthecentreofafastgrowingdemandregion.
Ahandsoffgovernmentapproach?
Despitebeingtotallydependentonnaturalgasimports,theSingaporeangovernmenthaschosen
a freemarket approach towards both the power and natural gas markets. Liberalisation of the
electricity sector and natural gas sector are cornerstones of the current Singaporean energy
policy.TheGasActof2001settheSingaporegassectoronafirmcoursetowardsderegulation
with the unbundling of transport and commercial activities, and oversight entrusted to the
independentenergyregulatorEMA.
MorerecentlytheSingaporeanMinistryofTradeandIndustry(MTI)establisheditsPricingEnergy
Right as one of the five key strategies to meet its energy policy objectives. This acknowledged

thatacompetitiveenergymarketwillsetthepricelevelforenergyinSingaporeseconomyand
will provide a signal for investments in infrastructure and energy efficiency measures. The
approach of Singapore towards the natural gas market can be considered as one of the most
handsoffintheAsiaPacificregion.
Separationoftransportandcommercialactivitiesinthenaturalgassector? Page|61
TheSingaporeanGasActof2001separatedcommercialactivitiesfromtransportationactivitiesin
thegassector.Asaconsequence,PowerGasLtd.divesteditscommercialactivitiesin2002.The
commercialgasimportactivitiesweredivestedintoGasSupplyLtd.andnaturalgasretailinginto
CityGasLtd.(bothweretransferredtothestateownedinvestmentcompanyTemasek).In2008,
the network assets of Sembcorp Gas were also transferred to PowerGas Ltd. (Sembcorp Gas
retaineditscommercialimportandsalesactivities).Subsequently,PowerGasLtd.istheTSOthat
owns and operates the natural gas network (natural gas and town gas) in Singapore and is
regulatedbyEMA.PowerGasLtdisnowasubsidiaryofSingaporePower(SP).
Likewise, the LNG terminal currently under construction in Singapore is the first openaccess
terminal in Asia and deliberately separates ownership of the infrastructure from commercial
activities. It is regulated by the independent regulator EMA. This has effectively separated
commercialactivitiesfromanyactivityrelatedtoinfrastructureinSingapore.
Singaporehasderegulatedwholesalenaturalgasprices.However,wholesalepricesdostillreflect
oilpricemovements,aslongtermimportcontractswithIndonesiaandMalaysiaarelinkedtooil.
Thiscorrelationwithoilpricemovementmaychangebeyond2014,whentheexpansionofthe
SLNGterminaliscompletedandLNGpricedatadifferentlevelenterstheSingaporeanmarket,
furtherdilutingtheoilindexedcommoditypricesetbyPNGimports.
Third party access in Singapore is guaranteed in the Gas Network Code (GNC) that went into
effect in 2008, setting set out the rules for the integrated Singaporean gas network. The GNC
establishesaclearframeworkfornetworkoperation,capacityallocationandresponsibilitiesfor
boththeTSOandshippersonthenetwork.Itenablesopenandnondiscriminatoryaccesstothe
gaspipelinenetwork.
ThedecisiontodevelopanLNGterminalinSingaporewillbringSingaporesimportcapacityfar
beyond its current domestic consumption requirements. The initial phase of the LNG terminal
wouldrequire4.1bcmofcontractedcapacitythroughBG;asthiscapacitywasrapidlytakenup,
the government decided to expand capacity. In an 8.7bcm (2010) gas market, the eventual
8.2bcmcapacityofthenewLNGterminalwillprovideaconsiderablesupplycapacityaddition.In
ordertocommerciallyoperatetheLNGterminal,thegovernmentneededawaytoallowLNGto
enterthemarket.
Toachievethisgoal,theSingaporegovernmentintroducedimportcontrolsofPNGtoallowthe
buildup of demand for LNG.Import control on natural gas has been in effect since 2006, and
allowsoldPNGcontractstobehonoured.NewPNGsupplycontractsaresubjecttoEMAapproval
andareonlyallowedfornoncommercialandotherusages.OthernewPNGsuppliesareallowed
to be concluded as a bridging option and will have to terminate before April 2013 (the SLNG
terminalistostartcommercialoperationsinMay2013)(EMA,2011).
A considerable obstacle that remains is how the government will allow gas imports to evolve
after the SLNG terminal has commenced operations. Initially, the limits on PNG imports would
notberevisedaftertheLNGterminalstartedoperating.Thegovernmenthasshownawillingness
tosupportcompetitioninthenaturalgassector,butstatedthatitwilllimitdirect competition
betweenPNGandLNGaslongasthefirstphaseofSLNGwasnotfullycontracted(EMA,2011).
Asthefirstphasewasfullycontractedandconstructionoftheadditionalcapacityofthesecond
phaseisfullyunderway,clarificationonthefutureofthePNGimportrestrictionsisessentialfor
Page|62 market parties to gain confidence in the competitiveness of the Singaporean gas market over
time.IntheSingaporeangasmarketbeyond2013,leavingTPAlimitationsfornewPNGinplace
could potentially render the Singaporean gas market less competitive than it is otherwise
expected to become. Timely disclosure by the government on the capacity allocation for both
newPNGandthesecondphaseoftheSNLGterminalshouldgreatlybenefitconfidencein,and
competitivenessof,themarket.
AstheSingaporeannaturalgasmarketisrathersmall(around10bcm)comparedtosurrounding
naturalgasmarkets,itremainstobeseenwhetherthesaleswouldbeabletogenerateenough
liquiditytodriveanyfuturenaturalgasprice(ifaspotmarketweretobeintroduced).Currently
nineshippersareactiveontheSingaporeannaturalgasmarket,ofwhichsixhavebookedatotal
of2.7bcmcapacityontheSLNGterminal.41TheSingaporeangasmarketwillbesuppliedbyfive
gasimporterswhenSLNGcomesintooperation.
BGSGMwasappointedLNGaggregatorthroughacompetitiverequestforproposaltocarryout
theinitialLNGprocurementforthefirstphaseofSLNG.EMAconcludedanaggregatoragreement
withBGwhichsetsoutthepricingdetailsandothertermsandconditionsforthesupplyofLNG
toSingapore.BGsroleastheLNGAggregatoristoaggregatedemandforregasifiedLNGfromall
endusersofgasinSingaporeandtoprocureLNGsupplyfortheseendusersfromitsownglobal
portfolio.Thishasconsiderablyincreasedthenumberofupstreamsourcesprovidingnaturalgas
toSingapore,andthesubsequentexpansionwillallowmorecompetitivesourcesofLNGtoemerge.
AsmentionedforChina,SingaporehasthecapabilitytofacilitatecompetitionbetweenPNGand
LNG,increasingthenumberofpossibleupstreamcompetitors(ifcurrentimportrestrictionsare
properlyresolved).TheSLNGterminaloffersthepossibilitytoservicenotonlytheSingaporean
market,butthroughitsreexportingcapability,thebroaderAsiaPacificregion(ifeconomicsallow).
As LNG regasification infrastructure is slated to expand in the SouthEast Asian region, this will
increasetherelevantmarketareainwhichSLNGoperatesandthusthenumberofcompetitors
forsupplyanddemand.
Singapore is currently one of the biggest oiltrading hubs in the world, leveraging its central
location in the growing Asian market. It has been the governments longstanding ambition to
becomeAsiasdominantcommoditieshub,attractingcommoditytradersthroughaGlobalTraders
Programme,whichofferstaxincentivesforcompaniestosetuptradingdesksinSingapore.This
hasledtoaconsiderableinflowofenergytradingcompanies.
Natural gas companies have also begun to set up trading desks in Singapore. The presence of
various international oil companies secures the availability of financial services to cater to the
naturalgastradingindustry.FinancialLNGswapswereintroducedbybanksinSingaporein2010.
On the back of an already strong commodity trading infrastructure, Singapore is establishing
itselfasanLNGtradinghubevenbeforethephysicalinfrastructuretoimportLNGisinplace.

41
Theseare:CityGasPteLtd,GasSupplyPteLtd.,KeppelGasPteLtd.,YTLPowerSerayaPteLtd.,SenokoGasSupplyPteLtd.,
SembCorpGasPteLtd.,GMREnergy(Singapore)PteLtd.,TuasPowerGenerationPteLtd.andTuaspringPteLtd.

CreatingcompetitioninAsiaPacificnaturalgasmarkets
That the AsianPacific natural gas market operates within a patchwork of developing and
developed economies presents specific conditions for increasing competition in the natural gas
sector.Twoimportantissuesstandoutwithregardtogovernmentalattitudestowardsnational
involvementinthenaturalgassector.
Page|63
First, in most natural gas markets, the government considers that its most important role is to
guaranteesecurityofsupplyofnaturalgasfortheeconomy.Whileavalidpolicychoice,thiscan
bedetrimentaltoincreasingcompetitioninanaturalgasmarket,asseeninKoreaandJapan.
Second, the role of the government in the natural gas market as a market participant through
verticallyintegratedenergycompaniesdoeslimitcompetitionandtheeconomicefficiencyinwhich
marketscandevelop.ThiscanbeseeninKorea,ChinaandalsoJapan,sincethenationalisationof
Tepco.GovernmentownershipinmatureenergymarketssuchasKoreacreatesconsiderablebarriers
toentryandputsabrakeonanymovetowardacompetitivemarket.Similarbarriersareobserved
in China, although at this phase of market development, it is certainly encouraging to see the
governmentinitiating(limited)marketbasedmeasurestoincreaseflexibilityinthegasmarket.
Even if most natural gas markets discussed above comply to some extent with some of the
requirements to increase competition in a market, the current outlook for the emergence of a
competitive market remains bleak. The most likely candidate to have reformed its natural gas
sectorinsuchawaythatacompetitivemarketwillevolveiscurrentlySingapore,whichcomplies
withnearlyalltheinstitutionalandstructuralrequirementssetoutinChapter3.
Table4Competitivemarketrequirementsinselectedcountries
Institutional/structural requirement Japan Korea China Singapore
Hands-off government approach - - - +
Separation of transport and commercial activities - - - +
Wholesale price deregulation + - +/- +
Sufficient network capacity and non-discriminatory access - - - +
Competitive number of market participants + - + +/-
Involvement of financial institutions +/- - - +
Note:+=currentlycontributingtowardsacompetitivenaturalgasmarket;=currentlynotcontributingtowardsacompetitive
naturalgasmarket;+/=currentlyunclear.
A concerted effort from the government is pushing for increased competition both from the
consumerandsupplierside.TheSingaporeangovernmenthasconsiderableexperienceinregulating
theenergycommoditytradebecauseitisalreadyoneofthemajoroiltradinghubsinAsia.The
mostimportantfactoristhatSingaporehasasupportingsystemtofacilitateatradinghubwith
spotandfuturesmarkets.
However,sofar,noindicationhasbeengivenbytheTSOorregulatorthatdevelopingahubthat
providesbalancingservicesonthespotmarket(andpossiblyafuturesmarket)isbeingconsidered.
TheSingaporeangovernmentconductedaconsultationroundtoassessdifferentmarketmodels
inearly2012;asecondconsultationroundhasbeendelayed,andtheoutcomeisthuscurrently
unclear.TodevelopaSingaporeannaturalgastradinghubandincreaseconfidenceamongmarket
parties will likely require the regulator to revise current import limitations on PNG. It is crucial
thattheseissuesberesolvedinatimelymannerinordertoallowforareliablepricingsignalto
developinthismarket.
Althoughitisquestionablewhetherthevolumeofthemarketissufficienttosupportliquidityon
aspotmarket,ithasbeenobservedinEuropeanmarketsthatevenalimited pricesignalinan
insufficientlyinterconnectedmarketwillprovideanalternativethathasimplicationsbeyondthe
geographicallimitofamarket.Singaporehascertainlypositioneditself(boththroughgeography
andinfrastructure)toexpandtheeffectofaSingaporeannaturalgaspricebeyonditsborders.
However,theinstitutionalandstructuralrequirementstoincreasecompetitionarenotsolelydefined
byagovernmentofanimportingeconomy.Theabilityofacompetitivenaturalgasmarketinthe
Page|64 AsiaPacificregionwillcruciallydependontheabilityoftheglobalLNGmarkettoprovideflexible
andcompetitivesupplies.Thesewillreflectboththechangingnatureofacompetitivespotmarket
with less demand for longterm contractual arrangements and more demand for a shortterm
oriented,diversifiedsupplierbase.However,thesearecircumstancesgenerallybeyondgovernments
controliftheyarenotwillingtoengagedirectlyintheglobalmarket.
ObstaclesinupstreamLNGsupplyflexibility?
Inprinciple,thereshouldbenodifferencebetweenincreasingcompetitioninanaturalgasmarket
primarilysuppliedbyLNGanddoingsooneprimarilysuppliedbypipelines.Inthedownstream
market, this would require the steps set out in Chapter 3. Increasing competition among LNG
suppliers,however,wouldrequireachangeintheglobalLNGmarket,whichisfarmoredifficult
toinfluencebyanyonegovernment.
DespiteagrowingnumberofregionallydispersedLNGsuppliersandthetechnicalabilitytosend
LNG anywhere in the world (provided there is a regasification terminal), the LNG supply chain
itself has considerable rigidities that currently limit the free flow of LNG on world markets
(Zhuravleva,2009).Theavailabilityofshorttermcontractedvolumeshasincreasedconsiderably
overthelastdecade,from5%in2000toabout26%in2011(Figure27).
Figure27LongandshorttermcontractedLNGintheworldandAsiaPacific,200711

350
LNGlongterm LNGshortterm
300
26%
250 19%
200 16%
20% 18%
bcm
24%
150 14%
18% 20% 14%
100
50
0
2007 2008 2009 2010 2011 2007 2008 2009 2010 2011
World AsiaPacific

Sources:GIIGNL,2008;GIIGNL,2009;GIIGNL,2010;GIIGNL,2011;GIIGNL,2012.

The share of spot volume consumed in the AsianPacific market (24% in 2011) lags slightly
compared to global spot consumption worldwide (26% of total consumption). The AsiaPacific
regionhasgenerallyreceivedthelargestshareoftheshorttermcontractedvolumesintheLNG
market. In 2011, 61% of the shortterm contracted cargoes were delivered in the AsiaPacific
region, a 43% increase compared to 2010. AsianPacific shortterm imports increased by 52%
comparedto2010,whichreflectedgreaterJapaneseLNGdemandaftertheFukushimaaccident
andincreasedKoreanandChineseimports(Figure28).

This overall increase in shortterm supplies in world markets reflects a substantial increase in
shorttermtradingintheAtlanticBasin,astheNorthAmericannaturalgasmarketismuchmore
competitive. LNG contracting in the North American natural gas market is far more shortterm
oriented,with44%oftotalLNGsupplyimportedundershorttermcommitmentsin2011.
Figure28ShorttermcontractedLNGintheworldandAsiaPacific,200711
Page|65
90
Restofworld AsiaPacific
80
70
60
50
bcm
40
30
61%
20
61% 78%
10 52% 43%
0
2007 2008 2009 2010 2011

Sources:GIIGNL,2008;GIIGNL,2009;GIIGNL,2010;GIIGNL,2011;GIIGNL,2012.
Shortterm traded LNG volumes are predicted to increase by 11% annually for the next three
years (Poten, 2012). However, a distinction needs to be made between shortterm and spot
purchases.Thetermshorttermpurchasessignifyvolumescontractedfordeliverywithinoneto
four years into the future.42 Spot purchases usually indicate cargoes that are purchased and
deliveredwithinoneyear.Generallyitisbelievedthatroughlyonethirdofshorttermcontracts
canbeconsideredspot;in2011,thiswasaround8%to10%oftotalimportedLNG,orabout1%
ofglobalnaturalgasproduction.
TheincreaseofavailableshorttermLNGsuppliesisdrivenbyfourfactors:
TheunexpecteddropintheLNGimportrequirementoftheUnitedStatesasaconsequenceof
theshalegasrevolutionprovidedboththeliquefactioncapacityandtransportcapacityinthe
LNG supply chain to significantly increase shortterm available LNG. This also resulted in
increasingLNGreexportsfromtheUnitedStates;
The emergence of selfcontracting portfolio players who sign longterm commitments, but
retain destinationflexibility,allowsforthebestnetbackontheirportfolio.Frequently these
marketing organisations have a global portfolio that enables them to optimise transaction
coststhroughswappingarrangements;
Theemergenceoflargepricedifferentialsthatmakeitattractiveforboththebuyerandthe
seller of LNG to divert cargoes to other markets (mostly Asia), as consent of both parties is
frequentlyrequiredtoengageinarbitrageactivities;and
The number of LNG suppliers has increased and is likely to expand into new frontier areas
(e.g.EastAfrica,theRussianarcticandNorthAmerica).Thiswillprovidemoresupplysecurity
forconsumers,butalsoincreaseopportunitiestoswapcargoes.Itlimitstheoveralldistancethat
LNGhastobetransportedtoreachconsumers,increasingefficiencyoftheglobalsupplychain.
42
ThisfollowsthedefinitionfromtheInternationalGroupofLiquefiedNaturalGasImporters.
Inthenearfuture,anevenmoreshorttermorientedLNGsupplysystemwillbedifficult,asLNG
isacapitalintensiveindustrywhichmakesvolumeriskforproducersanevenbiggerissue,justas
with PNG, since the customer has (potentially) a large number of alternative sources available.
TheinvestmentrequirementsforLNGsupplyareheavilytiltedtowardsupstreamdevelopment
and transport, as a regasification terminal will generally require no more than 10% of total
Page|66 expendituresontheLNGsupplychain(dependingonupstreamdevelopmentcost).
Toovercometheinherentdemandinsecurity,LNG supplyisgenerallyconducted throughlong
term, oilindexed contracts that have even more stringent takeorpay conditions than PNG
contracts.InadditiontoallthetechnicalandeconomicrestrictionsonLNGsupplyflexibility,the
currentcontractualstructureoftheLNGbusinessstandsoutasaconsiderablebarriertoincreased
shorttermtradingofLNG.43
LNGcontractstructure
Increasing flexibility in the LNG supply system would ideally result in a freely floating supply
source for markets that would immediately respond to price differentials via swap and spot
transactionsamongmarketparties(suppliers,tradersandconsumers),allowingthemostefficient
supplyroutestoservicedemand.ToenablethecurrentpipelinestructureinLNGcontracts,better
support for competitive natural gas markets in Asia would require the reduction of transaction
costs in shortterm contracts and adaptation of current contractual arrangements in longterm
supplycontractstoallowformoreflexibility.
Shorttermsupplycontracts
IfacompetitivenaturalgasmarketinAsiaweretosucceed,amoreresponsiveLNGsupplysystem
wouldbecrucialtoattractsuppliestothemarket,thusincreasingoverallliquidity.Asoutlinedin
Chapter3,thiswouldalsoreducetheconsumersneedforlongtermcontractsduetothesupply
securityprovidedthroughthespotmarketandlowertransactioncosts.
Currently,shorttermtransactionsintheglobalLNGmarketareindividuallynegotiatedcontracts
thatdonotgivepartiesthebenefitoflowertransactioncosts,becauseproductsaredifficultto
separatefromflexibilityrequirements,asshippingavailabilityisanindispensablerequirement.In
essence,thelackofaregional/globalregulatoryregime(asLNGisstillabulkcargobusiness)to
coordinatetransportcapacityandthesheersizeofLNGcargoesmakesitverydifficulttocreatea
standard product in which a considerable number of companies can easily trade. This is even
more complicated by technical requirements (the quality of LNG, the sort of tanker, etc.) that
furtherimpedethedevelopmentofstandardisedproductsforshorttermtransactions.
Asoutlinedabove,shorttermtransactionsinanLNGmarketarequitedifferentfromshortterm
transactionsinaninterconnectedpipelinesystemsuchasintheUnitedStates.Currently,short
termcontractingconsistsofroughlyfourtypesoftransactions:
Shorttermsupplycontracts:onetofouryearsupplybilateralcontractswhichdonotdiffer
markedlyfromlongtermsupplydeals,buthavenooptionforpricerenegotiation(seelong
termcontractsbelow);
Portfolio optimisation: a company makes longterm commitments for supply, but retains
destinationflexibility,allowingforthebestnetbackonitsportfolio.Thiswouldfrequentlystill
involveshorttermtransactions,breakingup(several)longtermcontract(s)intoshorterterm
contractstooptimisetransportcostsinfaceofsupplyobligations;

43
TheOxfordInstituteforEnergyStudieshasdistinguished12barrierstoarbitrage:lackofapricedifferential,lackofLNGsupply,
lackofinformationonmarkets,lackofpricetransparency,lackofspecialisttraders,contractuallimitations,technicalrestrictions,
regulatoryandmarketrestrictions,lackofshippingcapacity,lackofregasificationcapacity,andinefficienthedginginstruments.

LNGspotdeals:thesaleofcargoesthatarenotdedicatedtoanyspecificmarketisfrequently
made through competitive tenders, brokered trades, cargoes sold in longer trading chains,
andspeculativetradingpositionstakenupbynontraditionalparticipants(e.g.banks);and
LNGarbitration:wherea(longtermorshortterm)transactionalreadyinplaceismodifiedto
createvalueforboththeoriginalsellerandbuyerandacargoissubsequentlydeliveredtoa
thirdparty. Page|67
Box2TheJapan/KoreaMarker
TheJapan/KoreaMarkerisaspotassessmentpricepublisheddailybytheenergyconsultantPlatts.It
provides a spot price for traded LNG in the AsiaPacific market and facilitates swap and spot deal
making. It has a limited trade horizon into the future, as the prices assessed are reported for the
third,fourth,fifthandsixthhalfmonthinthefuture(maximumdeliveryhorizonofthreemonths).
Launched in February 2009, the JKM is used as a reference price for swap and spot deals by large
producersandconsumerswhothusengageinwhatmightequatetopipelinetopipelinecompetition
on the high seas. In January 2010, the JKM started to be published as a single value assessment
insteadofatradablerange.
Theassessmentpriceisaresultofeditorialengagementwithmarketparticipants(producers,consumers,
traders,brokers,shippersandother)byPlatts.Pricesoftradesincludedintheassessmentaredelivered
(exship)inaregionspanningseveralportsinJapanandKorea.CargoesdeliveredinChineseTaipei
and China are included in a normalised way, corrected for assessed deviation costs (Platts, 2012).
Standardcargoesof135000to175000m3sizeareconsideredintheassessment.
TheJKMhasbecomethemainalternativeAsianpricingindicatorforpartiesengagedinglobalLNG
trade. In June 2012, Platts launched a JKMswap assessment derived from JKM, which is assessed
(usingthesamemethodologyasJKM)forthreemonthsintothefuture.TheJKMswapiseffectively
thefirstLNGderivativewithsizesthataresetatastandardof10000MBtu.InSeptember2012,the
first200000MBtuJKMswapwasclearedbyICEEurope,signallingtheemerginginterestoffinancial
serviceprovidersintheLNGtrade,althoughoverallactivityfromfinancialpartieshasbeenlimited.
TwomajorpointsofconcernstandoutwhenregardingJKMasatransparentandrepresentativeprice
signalfortheAsiannaturalgasmarket.
Liquidity: considering the size of a 140000m3LNG carrier, this would roughly translate into a
USD45000000 transaction (at USD14/MBtu). To participate in LNG spot trade would thus
require access to considerable financial reserves and riskmitigating instruments. This financial
threshold limits the number of market participants and the liquidity that underpin the JKM
assessment. The minimum size of a product on spot markets in the United States and Europe
wouldbeconsiderablysmaller(evencomparedtotheJKMswapsizeof10000MBtu).
Transparency: despite the liquidity issues described above, the establishment of JKM as the
internationalbenchmarkdoessignalthecontinuedneedforsuchanAsianmarkeringlobalLNG
trade. However, the method used to assess the JKM price cannot be considered transparent
when compared to a possible functioning wholesale market, as JKM price discovery does not
evolvethroughdirectcompetitionforsupply/demandonaspotmarketorexchange.
JKM is most certainly an important addition to the available international price indices (with
considerablepricedevelopmentinthelastthreeyears)andassuch,supportstheemergenceofan
efficientglobalLNGmarket.However,itremainsthebestalternativeavailableonlyaslongasthereis
noAsiannaturalgaspricederivedfromtransparentandcompetitivepricediscovery.
The LNG spot and arbitration deals can require considerable timeconsuming negotiations
betweensellerandbuyer(incaseofarbitrationbetweenseller,buyerandthirdpartiesinvolved).
To facilitate trade and increase legal security (for both seller and buyer), master sale and
purchaseagreements(MPSA)havebeendeveloped.
The European Federation of Energy Traders (EFET) LNG Master Agreement launched in 2010 is
increasingly used in Europe and has been used in some deals in AsiaPacific.44 The EFET LNG
contract is generally simpler, shorter and easier to use for all parties than the traditional LNG
MPSA.Similarly,theInternationalGroupofLiquefiedNaturalGasImporters(GIIGNL)hasupdated
their standard MPSAs to reflect changes in the global market in 2011.45 In a response to an
Page|68 increase in shortterm supplies, the Association of International Petroleum Negotiators (AIPN)
has also recently (2012) updated its standard MPSA. These changes in MPSAs further facilitate
trade,simplifyincreasinglycomplicatedtransactionsandpotentiallyreducetransactioncostsand
increaseliquidityontheinternationalLNGmarket.
Inadditiontocontractualdetails,themainnegotiationissueforanyMPSAwouldbethepricefor
whichtheLNGistobesold.ForsuppliersandsellerstotheAsiaPacificregion,thispricewould
currently reflect the buyers and sellers urgency to conclude negotiations and an experts
estimate of the value of a cargo in the AsianPacific market. No transparent reference pricing
point currently exists (although JKM is an alternative increasingly used for this purpose); the
introduction of one would considerably speed up this negotiation process, further increasing
liquidityintheglobalLNGmarket.
Longtermcontracts:destinationclausesinLNG
In essence, a longterm LNG supply contract is still a shipping contract with features similar to
that for other bulk commodities traded on international maritime trade routes. However, LNG
traderequiresaverycapitalintensiveandspecialisedsupplyinfrastructurethatisquitedifferent
from other globally traded energy commodities (e.g. coal and oil). This has led parties (both
buyerandseller)toorganisetheLNGsupplychaininsuchawaythatitcouldberegardedasa
pipelineconnectingsupplyanddemandcentres.
InatraditionallongtermMPSA,abuyercommitstoofftakeapredeterminedvolumeofLNG(or
numberofcargoes)overasettimeframe,withagreedlimitsonshorttermfluctuationsandonly
asmalldownwardtolerancebeforeriskingavolumetakeorpaypenalty.ThustheLNGproducer
shouldersthepricerisk,whiletheLNGbuyeriscommittedtostricttakeorpayobligationsand
shouldersthevolumerisk(Zhuravleva,2009).
Longterm supplies are generally still delivered freeonboard (FOB) or delivered exship (DES).
This reflects standard international commercial practices and derives from the fact that LNG
tradeisinessenceinternationalbulkcommoditytrade,whichrequiresinsuranceandshipping.46
FreeonBoard(FOB):thetransferofriskoccurswhenLNGpassestheship'srailattheportof
shipment,afterwhichallcostandliabilityoftransportingtheLNGtotheportofdestination
will transfer to the buyer. FOB means that a buyer has higher flexibility with regard to
destination.However,thisincreasesprocurementcostforthebuyerasithastoprovidefor
shipping,insurance,regasificationcapacityandothercosts.BuyerswillmostlikelychooseFOB
delivery if it has optionsavailable that reduce insurance and transport costs compared with
exshipdeliveryintheportofdestination.
DeliveredExShip(DES): thetransferofriskdoesnotoccuruntiltheshiphasarrivedatthe
named port of destination and the LNG is made available for unloading to the buyer. The
sellerhasagreedtobearnotonlyfreightandinsurancecosts,butalsoriskandtitleuptothe

44
TheEFETLNGMPSAcanbeaccessedat:www.efet.org.
45
TheGIIGNLMPSAisavailableat:www.giignl.org.
46
Market parties are increasingly considering alternative delivery arrangements such as CIF or regional delivery points
(sometimesonthehighseas)suchastheJKMdeliverypoint.

arrivalofthevesselatthenamedport.Costsforunloadingthegoods,additionalduties,and
taxesareforthebuyer.47
Figure29LongtermcontractedLNGdeliveredFOBorDESin2011
Page|69

Source:GIIGNL,2012.
In2011,aconsiderableshareofglobalLNGdeliverieswasDES(61%),withtheAsiaPacificregion
takingthebiggestshareoflongtermcontractedsuppliesasDES(64%).Deliveryexshipusually
provideslessroomforreselling,asthecargoisdeliveredatport.Toredirectacargowouldthus
eitherinvolveLNGarbitrationwiththesellerorincurreloadingandshippingcostattheportof
delivery. Both options would require a price spread between markets to make either practice
profitable. UsuallyLNGbuyersin the AsiaPacificregionare utilitieswithasupplyobligationto
customers(afixedsalesportfolio)andthereforegenerallylimitedneedtodivertcargoes.
Historically,longtermLNGcontractpriceswerenegotiatedatalevelthatwouldreflectthevalue
ofnaturalgasinthe(electricity)marketwhereitwouldbedelivered.Alongtermcontractwas
thus also a considerable tool for arbitrage if natural gas was valued at a different level in a
connected (or geographically close) market. In a way similar to the European longterm supply
contracts,acontractualrestrictionwasneededtolimitabusethrougharbitragebyeitherpartyin
thecontract.Subsequently,destinationclauseswereaddedtolongtermLNGcontractsstipulating
towhichmarketacontractedLNGneededtobedelivered(whichtakeorpayclausescouldnot
provideasLNGcanbeshippedaroundtheglobe).
DestinationclausesinlongtermLNGsupplycontractsforbidbuyerstoresellacargooutsidethe
countrywheretheyareestablished,whichtherebyguaranteestheselleraformofprotectionof
competitioninothermarkets.Thedestinationclauseshavehelpedtomaintainpricedifferentials
acrossdifferentregionalmarketsandaremainlyusedbylargeMiddleEasternproducers,asthey
are geographically conveniently located to arbitrage between the markets in the Atlantic and
Pacificbasins.
Destinationclauseshavesincethenservedasatoolofsecurityofsupplyanddemandonwhich
supplychainsanddistributionsystemsintargetmarketsweredevelopedandamortised.Destination
47
InIncoterms2010(published1January2011)DESwasreplacedbyDeliveredatTerminal(DAT).
clausescantakevariouslegalshapesandformsandtherestrictionsneednotbeasexplicitasan
outrightbanonreselling,butcanraisethearbitragethresholdtoadefactoprohibitivelevel.
In the Atlantic Basin, destination clauses have come under considerable pressure. In the 2003
secondEuropeangasDirective,theEuropeanCommissionforbadedestinationclauses(forboth
PNGanLNG),astheyare consideredtobemarketpartitioning devicesforexporters.Although
Page|70 the United States government has taken a more lenient approach, new contracts have been
draftedthatincreasecontractualflexibilityintheAtlanticBasin.
Overall,thereductionofdestinationclausesintheAtlanticBasinhasledtoincreaseddestination
flexibilityfromproducersinthisarea,mainlyNigeria,EquatorialGuinea,andEgypt,sincethefirst
quarterof2012.Subsequently,anumberofsellershavestartedtoselfcontractcargoes,selling
directly in the downstream market, thus reducing offtake risk. Currently this has increased
destinationflexibilityandledtoanincreasingamountofLNGthatisexportedtowardsthehigher
pricedAsiaPacificbasin(seeChapter2).
However,thisdevelopmenthaslaggedforproducersintheAsiaPacificbasin,wheredestination
clausesarestillregardedasawaytoprovidesupply/demandguaranteesforbuyers/sellers(itis
also not likely that under current contractual obligations, LNG supplies for AsiaPacific markets
can easily be diverted towards for the Atlantic Basin even if prices did allow). However, the
increased availability of flexible LNG from the Atlantic Basin is putting pressure on flexibility
provided by longterm LNG contracts. This in turn will put considerable pressure on producers
andconsumersintheAsiaPacificbasintonewfindwaystodividerisksinLNGsupplycontracts.
PricereviewinlongtermLNGcontracts
As longterm PNG and LNG contracts span more than a decade, they need to include regular
contractreviewstorecalibratethecontracttooverallmarketconditions.Buyersandsellerswill
looktoreducethecoststhateitherpartycanincurfromthepricedisparitiesbetweenthelong
termcontractpriceandthepriceofthemostlikelyalternative(inanoncompetitivemarket)or
an alternative source of natural gas (in a more competitive market). Any price review in long
termLNGcontractswillhavetobeconductedthroughcommercialnegotiations.
TheapproachtopricerenegotiationclausesinlongtermLNGsupplycontractsisgenerallyoneof
fourdifferenttypes:
noclauseonrenegotiationisincluded;
pricesshallbereviewedeverythreetofiveyears;
pricesmaybereviewedeverythreetofiveyearsifbuyer(s)orseller(s)wishtodoso;and
aspecificintervalisnotincludedinthecontract,butapricemaybereviewedifbuyer(s)or
seller(s)wishtodoso.
Longtermcontractswithoutarenegotiationclausearerare,asthiswouldrepresentconsiderable
risktothebuyerand/orseller.Generally,thelatterthreecontractsrepresentroughlythesame
renegotiationonpricewithadifferenttriggertostartrenegotiations.
Thescopeofthecontractreviewisgenerallylimitedtotheissueofprice.Intheoilindexeddominated
supplycontractsoftheAsianPacificregion,thiswouldentailadiscussionontheslopeoftheprice
relationshipbetweenoilandLNG,butacompletereviewofthepricestructureisnotexplicitlydenied
inmostrenegotiationclauses.Thismeansthatasignificantpricereviewbeyondthechangeofthe
slope of the Scurve is usually an option. This would provide the opportunity for LNG suppliers/
consumerstoadaptthepricingsystemtoincludeanalternativeregionalpricingsignalinthefuture.
AsopposedtolongtermPNGcontractsinEurope,renegotiationsforLNGsupplydonotdiscuss
contractconditionssuchasindexation,destinationflexibilityandtakeorpaylevel.Longtermcontracts

were structured to provide maximum supply/demand security and therefore are very strict in
theirtakeorpayobligationscomparedtolongtermPNGcontracts.48Thustheabilitytosignificantly
changethevolumeobligationsorflexibilityclausesinlongtermLNGcontractsisverylimited.
Changesinvolumeand/orflexibility(ifnotcausedbyaforcemajeure)aregenerallypossibleonly
when contracts come up for renewal. By 2017, nearly 50% of the volume currently supplied
under contract will have been terminated.49 This will mean that a considerable amount of LNG Page|71
supplywillbereplaced(thisisalreadyhappening). Therehasbeenarecenttrendoflongterm
LNG buyers looking for shorterterm contracts and considering increased supply flexibility a
specialpointofinterest(ArgusGlobalLNG,2012).
Perspectivesforchangeincontracts
Despite contractual, technical and transport rigidities, the physical flow of natural gas remains
crucial for any spot market development. The existence of a spot market will not necessarily
undermine the rationale for longterm supply contracts, as sellers are likely to still value the
abilitytoconcludealongtermagreement.
AflexibleLNGsupplychainwouldbothbenefitfromandsupportspotmarketdevelopment.The
establishmentofareliabletradinghubinAsiaPacificwouldinduceachangeinpricesettingfor
longtermcontractsandthesortofcontractsthatareofferedtobuyers.Thequestionwouldthen
be: what developments on the global LNG market could impede or support a more flexible
systemofLNGsupply?
Changeinshippingavailability
Currentexpansioninthenumberofmarketpartieswithoutupstreamaccess(nearly50%ofships
onorderarenotdedicatedtoanyupstreamproject)willincreasethenumberofnoncontracted
LNGcarrierstonearly10%oftotalshipsinoperation.Areinforcementofthistrendwillnotonly
showincreasedconfidencefrommarketpartiesintheirabilitytomakemoneyinLNGshipping,
butwillalsosupportincreasingflexibilityoftheLNGsupplychain.
Changeinregasificationcapacityavailability
ThirdpartyaccesstoLNGregasificationterminalsintheAsiaPacificregionisextremelylimited,
duetoregulatoryhurdlesandthefactthatterminalsaregenerallypurposebuilt.Withonlyone
openaccess terminal currently under development in Singapore, the immediate prospect of
moreTPAregasificationcapacitycomingavailableintheregion,withoutgovernmentaction,remains
rather bleak. Expanding TPA in the AsiaPacific region will require substantial changes of policy
amonggovernments,eithertocreateafavourableinvestmentclimateinadditionalTPAregasification
capacity,ortorequireincumbentcompaniestoreducebarrierstoentry.
Marketpartiesinvolved
Thenumberofcompaniesthatusetheirportfoliotosupplycustomerswithshort(er)termLNG
volumeshasbeenincreasing.Thisisaconsiderablegamechanger,asthesecompaniesusetheir
globalupstreamportfoliotoarbitragebetweenmarketsandoptimiseshippingrouteswithinthe
portfolio. These companies are frequently international oil and gas companies (IOGC) that not
onlyhaveupstreamaccess,butalsoregasificationcapacityavailableindifferentregions,which
alwaysprovidesthemwithanoutletfortheirnaturalgas.
48
LongtermPNGcontractsfrequentlyhaveapredeterminedbandwidththatprovidesconsiderableflexibilitywithregardto
theACQ,withthepossibilitytousecarryforwardandmakeupvolume.
49
FromIEAdatabases.
ArelativelynewphenomenonintheAsiaPacificLNGmarketwillbedevelopingimportrequirements
fromLNGexportinggiantssuchasstatenaturalgascompanyPetronasinMalaysiaandPertamina
inIndonesia.Aspricinginthedomesticmarketisfrequentlybelowcost,thishasdrivendomestic
consumption to levels that domestic production cannot sustain without compromising export
commitments. Consequently, both companies will become considerable portfolio players with
Page|72 longterm,oilindexedexportcommitmentsandanincreasingvolumeofoilindexed/spotimport
commitments.
InMalaysia,atargetdatehasbeenannouncedbywhichdomesticgaspricesshouldreachmarket
parity. Although this should have an encouraging effect on energy efficiency, it is not likely to
solve Malaysias longterm challenge of increasing imports. This could provide an incentive for
Petronastostartlookingatalternativeshorttermsupplysourcesfromthespotmarketandways
toaccuratelypricenaturalgasintheregion,asthiswouldreducepriceriskforthecompany.A
functioningtradinghubintheregionimprovesthenumberoftoolsavailabletomanageportfolio
risksforcompaniesthatfocusoncreatingamargin.
In addition, financial players such as banks have made inroads in LNG trading by focusing on
hedgingopportunitiesformarketpartiesandtradingphysicalcargoesthemselves.However,physical
traderemainslimited,asthevalueofacargoboughtintheAtlanticBasinanddestinedforAsia
wouldbevaluedaroundUSD45million.50Effectively,withoutregasificationcapacitycontracted,
orasizeableendconsumerportfoliotosupply,oracompetitivewholesalemarketavailablethat
canabsorbsuchavolume,suchacargowouldbeaconsiderableunhedgedposition,arisknotall
financial players are comfortable with. So far, the specialist nature of the LNG trade and the
limitedavailabilityoffinancialhedgingfacilitieshaverestrictedfinancialpartiesparticipationin
theglobalLNGmarket(WGI,2012d).
Newflexiblesupplies:NorthAmericaandEastAfrica
TherehasrecentlybeenconsiderablespeculationaboutthepotentialofnewLNGproducersto
delivervolumestomarketbeyond2017.Inthemediumterm,Australianproductionisexpected
todeliversizeablevolumes,butthiswillnotincreasemarketflexibility,as91%ofitislongterm
contracted,thusleavingabout9bcmnotcontracted.
ThissecondwaveofLNGisexpectedtooriginatefromliquefactionterminalsbuiltintheUnited
StatesandCanada,andfromrecentlydiscoverednaturalgasdepositsinEastAfrica.Chenieres
SabinePassterminalphaseI(intheUnitedStates)wasthefirstterminaltoreceiveaFinalInvestment
Decision(FID)andwillbebuiltonanewbusinessmodelthatindexedLNGtospotmarketprices
(inthiscase,115%HenryHub,whichcoversenergyusageduringliquefactionandtradingoverhead
tooffloadthevolumesincasetheyarenotlifted)andleviesaseparateuseitorloseitchargeof
betweenUSD2.25andUSD3.00/MBtu(dependingoncontract)forliquefaction.The21.9bcmof
LNGsupplyislongtermcontractedbut(unliketheAustralianexampleabove)soldwithcomplete
destinationflexibility.InitialcontractingpartiesareBG,GasNatural,GailandKOGAS.
AlthoughthepricingonHenryHubiscurrentlycompetitivewithAsianoilindexedvolumes,this
mightsignificantlychangeinthefuture.ItisthereforecurrentlyunlikelythatHHindexationwill
makeasignificantimpactonoilindexedpricing,asthevolumesoldfromSabinePassaloneisnot
enough.Moreover,thesevolumesfromNorthAmericawillalsonotcontributetoatransparent
pricingsignalrepresentingsupply/demandintheAsiaPacificregion,asHHindexationresponds
to supply/demand in North America. However, considerable impact might be felt through the
moreflexiblecontractarrangements,aslowerdevelopmentcostsallowforlessstringentvolume
requirements(suchasauseitorloseitfee).

50
Cargoof140000m3atUSD14/MBtu.

IntheUnitedStates,atotalof302bcmofLNGexportcapacityiscurrentlyproposed(asofend
December 2012), part of which could come on stream beyond 2017. In addition, Canada could
addanother42bcmby2017.51TheproposedKitimat13.6bcmLNGliquefactionproject(developed
byEncanaandEOGresources)isestimatedtobeverycompetitive,especiallyconsideringthatits
western location is close to AsianPacific markets. However, it is questionable whether freely
availableLNGwillbeavailablefromCanada,asthemainpartnersindevelopingotherterminals Page|73
(PetroChina,KOGASandMitsubishi)havededicatedmarketsforsalesinAsia.Meanwhile,several
issues, such as domestic transport capacity, need to be ironed out before LNG could leave the
westernCanadianshores(WGI,2012c).
Figure30ConstructioncostsforvariousLNGprojects
4500
4048
4000
3258
3500 3256
USD/tonnesofproduction
2867
3000 2778
2 500 2273
2500
2083
2000 1850
1731
1500
1500 1026
1000 940 1000
800
500

Notes:greenunderconstruction,blueisproducing,redisproposed.SabinePassisFIDphaseone.PLNGisPapuaNewGuineaLNG.
EastAfricaProjectcostsareestimated.
Sources:IEAdatabase;variouscompanieswebsites.
InEastAfrica,MozambiqueLNGisthemostrecentlyproposeddevelopment,afterconsiderable
finds were announced by Anadarko and ENI. Both companies are moving towards developing
LNGexportcapacityandnegotiatingtermsandconditionswiththegovernment.Severalsignificant
discoverieshavealsobeenmadeinTanzania.Asexplorationiscurrentlyunderwayintheregion,
with several IOGCs vying for acreage and takeover opportunities, the full scale of EastAfrican
reserves will become apparent over the next few years. A current estimate is that at expected
production costs of between USD1500/tonne and USD2500/tonne, EastAfrican LNG fits well
withintheglobalLNGportfolio.
SeveralofthecompaniesinvolvedaremajorportfolioLNGmarketers(suchasENIandBG),which
increasesthelikelihoodthatthedevelopmentofthesereserveswillincrease theavailableLNG
flowswithoutaspecificcommitmenttoamarket.Inaddition,theLNGfacilitythatwouldbebuilt
oneither MozambiquesorTanzanias coastwould beideallylocatedtoarbitragebetweenthe
AtlanticandPacificbasins,increasingthescopeofcompetitionforLNGpowerhouseQatar.
It seems likely that natural gas developments in North America and East Africa will increase
overallflexibilitytotheLNGsupplychain.ThismighthaveanimpactonoverallLNGcontracting,
making destination flexibility a key issue for LNG procurement, as LNG producers will have to
providemoreflexibletermsiftheywanttosellvolumetocustomers.
51
DerivedfromIEAdatabases.
LNGasalinkbetweenmarkets?
TheLNGsupplychaincangenerallyprovideflexibilityinboththelongandshortterm.Longterm
flexibilityisderivedthroughinvestmentsintheoverallsupplychain.Shorttermcontractingand
portfoliomanagementwillreducetraveldistance,increaseflexibilityandoptimiserevenuesfor
thepartiesinvolved.ThereareseveralencouragingsignsthattheLNGsupplychainisbecoming
Page|74
moreresponsivetoshiftsinglobaldemandthroughincreasingdestinationflexibility.
However,eveninthetheoreticalandhighlyunlikelysituationwithuniversalthirdpartyaccessfor
supplierstoLNGimportterminalsandnoflexibilityrestrictionsinsupplycontracts,theabilityofan
LNGcarrierwillmostlikelyneverbeasresponsiveasadirectupstreamconnectionviaapipeline.
Shorttermfluctuationsindemandwillalwayshavetobemetbytheregasificationterminal,flexibility
frompipelineimports,additionalstoragewithdrawalsandlinepackinthedistributionsystem.
Theoretically, in an AsiaPacific natural gas market with several transparent pricing hubs, LNG
couldreducepricingsignalsbetweenmarketsinasimilarwaytothatobservedinEurope.Witha
flexible source of supply, it is possible to send natural gas to where it is most advantageously
pricedinaregionthatwouldhaveseveralpricingpoints.Althoughthishasresultedinconsiderable
convergence of prices on the spot market in Europe, it is unlikely that (without a more
interconnected pipeline network) this will be the case in Asia. However, LNG trade is able to
createapriceconvergencebetweenfuturesmarkets(monthaheadandbeyond)ifthesedevelop,
whichwouldlimitpricedifferentialsintheAsiaPacificregion.
Ashocktothesystem?
Despite the growing demand for natural gas in AsiaPacific energy markets, perspectives for a
functioning wholesale gas market remain currently limited. This is a result of governmental
policiesthatvaluesecurityofsupplyovereconomicobjectivesinthemorematureAsianmarkets;
andthedifferentstagesofdevelopmentofthenaturalgasmarkets.
Security of supply considerations have resulted in considerable government interference along
thenaturalgasvaluechaininmatureAsianeconomies.Governmentinterferenceindeveloping
economies might be a reflection of the overall developmental stage of the market, something
thatcanchangebutwillrequiretime.
Onthesupplyside,contractuallimitationsrestrictLNGsflexibilitytoserveasamarketarbitrator
andsupplythemarketwithaneffectivepriceincentive.ThisishamperingLNGsabilitytoprovide
the flexibility needed to support a competitive natural gas market which inspires confidence in
spot/futureprices.WhiletheglobalLNGmarkethasbecomedecidedlymoreshorttermoverthe
pastdecade,theAsianmarkethasbenefitedlessfromthisdevelopment.
Longterm supply contracts generally have price renegotiation clauses that allow for price
adaptationstochangesinthemarket.However,volumeordestinationclausesaregenerallynot
partofrenegotiations.IncreasingvolumeanddestinationflexibilityinLNGsupplycontractswill
thereforerequireachangeintheoverallmarketthatwillincreasethesefeaturesinnewcontracts.
Currently,changesinthemarketlookpromisingonseveralaspects,namelytheincreasingroleof
portfolioplayersandtheexpecteddestinationfreevolumesfromNorthAmericaandEastAfrica
thatwillarriveafter2017.
As LNG is increasingly allowed to be shipped destination free, it is likely that its arbitrage role
between competitive markets will increase and price movements will likely cointegrate (if a
competitivemarketisavailable).Butitisliabletoperformthisroleonthefuturesmarketandnot
necessarilyonthespotmarket,asthephysicalresponsivenessofLNGsupplyislikelytoalways
lagbehindpipelinesupplies.

Conclusion:chickenoregg?
Among the major gasconsuming regions, the fully functioning North American and quickly
improvingEuropeanwholesalenaturalgasmarketsbothreflectpricesthatcloselycorrespondto
regionalsupplyanddemand.AthirdpricebenchmarkinthedevelopingAsiannaturalgasmarket
wouldmakesenseforlongtermAsianeconomiccompetitivenessandthefutureofgasintheregion. Page|75
TheAsiannaturalgasmarketisthefastestgrowingmarketandisexpectedtobecomethesecond
largest gas market by 2015, with 790bcm of natural gas demand. However, the entire Asian
Pacificregionlacksatradingplatformtofacilitatetheexchangeofnaturalgasandconsequently
apricesignalthatisabletosteerinvestmentsinnaturalgasinfrastructures.
Asgovernmentslooktoanincreasedshareofnaturalgasinpowergeneration(forsecurityand
environmentalconsiderations),gaswillfrequentlyneedtocompetewithdomesticallyproduced
coal.Tocompeteefficientlyintheelectricitymix,naturalgaswillneedtobepricednotagainst
theoilmarket(asoilhasaverylimitedroleinpowergeneration),butondemandandsupplyfor
thegasitself.
This issue has come to the forefront in the aftermath of the Fukushima accident. Asian LNG
import prices were pushed to record highs as a result of oil price developments rather than
demand/supplyofgas.Indeed,theflexiblegassuppliesdrawninfromtheAtlanticBasintomeet
theextraJapanesedemandwerenotablycheaper.Inacompetitivenaturalgasmarket,otherwise
competitiveLNGwouldnotberendereddearthankstopricingtrendsofanaltogetherseparate
commodityinadifferentmarket.
Creatingacompetitivegasmarket
Gettingtothatmarketmodelstartsbyincreasingcompetitionbetweensuppliers(andconsumers)
at the wholesale level. The final objective in natural gas market liberalisation would be the
establishmentofatradinghubwithanaturalgasexchangeprovidingareliablepriceforfuture
delivery.
Governments will need to take a different role than is now common among developing Asian
Pacificmarkets,adaptingtotheroleofregulatorandultimatelythatofarbitratorviacompetition
authorities.Thiswillrequireaconsistentmindsettowardincreasingcompetitionandsurrendering
controlofwhatisoften considereda strategicsectoroftheeconomy. Thatissomething many
governmentswillfinddifficulttodo.Andyetitwillbenecessarytoinstilthenecessaryconfidence
todrawinnewparticipants(especiallyfinancialparties),andformarketplayerstostartusingthe
hubtobalancetheirportfolios.
Institutionally,thatmeansahandsoffgovernmentapproach,separationoftransportandcommercial
activities,andpricederegulationatthewholesalelevel.Subsequently,threestructuralrequirements
have been identified: sufficient network capacity and nondiscriminatory access, a competitive
numberofmarketparticipants,andthelongterminvolvementoffinancialinstitutions.
Thecreationofanaturalgasmarketwillinfluencethewaynaturalgaschangeshands,asphysical
and financial trading worlds will meet on the gas hub. First, OTC trading will be supplemented
withexchangebasedtrading,whichrequiresmuchmoreriskmitigationthroughfinancialinstitutions.
This financialisation will attract an increasing number of players other than traditional physical
portfolio players. The resulting price for natural gas should reflect expectations of all market
players,includingcurrentandfuturesupply/demandinamarket.
Theimpactofanaturalgastradinghubistypicallyfeltinthebroadernaturalgasmarket,asit
requiresbothconsumersandsupplierstoreview,revalueandultimatelyrewritebusinesspractices.
Mostlikely,ashiftinfocusfromlongtermtoshort(er)termwillemerge,anddifferentormodified
contractualandinvestmentschemeswillfollow.Thisprocesswillprobablytakeatleastadecade
fornationalmarketswithaclearregulatoryauthorityandlongerformoreregionalinitiatives,
Page|76 duetotheincreasednumberofstakeholdersinvolved.
Theinstitutionalandstructuralrequirementsforacompetitivegasmarket(setoutinChapter3)
shouldenableatransparentandlevelplayingfieldformarketplayers.Acompetitivenaturalgas
marketcanprovidebetterinformationonthestatusofthemarket,somethingthatoilindexation
cannot.Necessaryinvestmentsinthenaturalgasindustryrelyonconfidenceincompetitivegas
prices.Thisconfidencecanbederivedfrommarketarrangements,butwillultimatelycomefrom
governmentsdemonstrableintenttoletmarketforcesdetermineanoutcome.Confidencealso
requiresastrongandpreferablyindependentregulatorwithaclearlydefinedantitrustmandate
inboththefinancialandphysicalareasofthenaturalgasmarket.
Theintroductionofcompetitionaimstomaketheprocurementofnaturalgasbygascompanies
moreefficient,andinvestmentneedsmoretransparent.Thiswillnotmean,however,thatnatural
gas is automatically priced lower than oilindexed equivalent volumes. It will mean that, when
properlysetup,themarketwillpricenaturalgasatitsrelativevalueinaspecificenergymix.
ProspectsforacompetitivegasmarketinAsiaPacific
Currently,prospectsforafunctioningwholesalenaturalgasmarketremainlimited.Eveninthe
morematureAsianPacificmarkets,thebasicrequirementsforawholesalemarketarenotcurrently
in place, since governments continue to put an emphasis on security objectives over economic
ones.Inaddition,severalgovernmentshavedevelopedandkeepinplacepreferentialpricesetting
regimesthatlimitcompetitioninthenaturalgasmarket.
Security of supply considerations have resulted in considerable government interference along
thenaturalgasvaluechaininmatureAsianmarketssuchasKoreaandJapan.Althoughthepolicy
emphasis on security of supply is an entirely legitimate one, the result is ongoing government
interferenceandresistancetomoredownstreamcompetition.
InChina,themarketisdevelopingfast,withintensedemandgrowth.Suchenormousinvestment
requirementsreducethescopeforcompetition.Consequently,theChinesegovernmenthaslooked
atwaystointroducemoreflexiblepricingschemesinsomedevelopedgasmarketareasonthe
eastcoast.
Currently,Singaporeseemsthebestsuitedcandidateforaregionalnaturalgastradinghub,asits
governmenthasadistinctlyhandsoffapproachtomarkets.Thegovernmenthasalsointroduced
wholesale pricing for natural gas and effectively unbundled both the power and natural gas
infrastructure. An openaccess regime will be established for the future SLNG terminal, and
financial parties serving global commodity markets are already in place and wellpositioned to
serveemergingnaturalgastrade.Singaporeitselfisarelativelysmallmarket,whichcouldlimit
thenumberofplayersinthewholesalemarket,butawellconnectedhubcouldservetheregion
wellbeyondthecitystate.
ObstaclestoacompetitivegasmarketinAsiaPacific
A unique characteristic of natural gas trade in AsiaPacific is the limited amount of gas that is
tradedviainternationalpipelinesonlyabout10%oftradedvolumeintheregion.

AnincreasinglyflexiblesupplychainwillrequireacontinuedincreaseofLNGshippingavailability
and thirdparty access on Asian regasification terminals. Usually such terminals are built with
capacity dedicated to LNGimporting companies (frequently dominant national or regional
organisations),leavinglittle(ifany)sparecapacityforcompetitors.Increasingcompetitionbetween
LNGsuppliersformarketshareinseveralAsianmarkets(beyondSingapore)willthereforebea
verydifficultprocessfromaregulatory,technicalandcommercialperspective. Page|77
Inaddition,destinationclauseswhichwereintroducedtoreinforceinvestmentsecurityhavethe
unfortunateknockoneffectofcreatingmarketsegmentationandstiffeningtheoverallsupplychain.
Chickenoregg?
It is clear that the possible development of a competitive natural gas market that ultimately
generates a reliable price signal in any Asian market will not happen overnight, and will not
necessarily lead to lower prices in most markets (as some protagonists frequently assume). It
doeshowevergivetheAsianPacificeconomiesanopportunitytoincreasesupplyflexibilityand
overalleconomicefficiencytomeettheirgrowingdemandforenergy.
Themovetowardsacompetitivenaturalgastradinghubcannotdependsolelyonexternalshocks
intheglobalmarket.Governmentswillneedtosignalwhethertheywouldacceptsuchachange
tohappen.
In the very long term, as markets in the AsiaPacific region mature and infrastructures are
in place and amortised, a likely outcome might be that multiple pricing areas will develop.
Japan/Korea,China,andespeciallySingaporestandoutforthisonthebasisoftheircurrentand
futuremarketstructuredemand.
Inthemediumterm,thisistrulyachickenoreggdiscussion.AmoredestinationflexibleLNG
supplyisneededtodrivethemomentumtowardsagastradinghubinAsia,butwithoutinitial
steps towards such a hub, flexible LNG would not have a haven in Asia at which to arrive.
ASingaporeanmovetowardacompetitivenaturalgasmarketmightnotimmediatelyleadtoa
competitiveAsianPacificpricingsignal,butitisaveryimportantandremarkablefirststep.

Acronyms,abbreviationsandunitsofmeasure
Acronymsandabbreviations
ACQ annualcontractquantity
Page|78 AIPN AssociationofInternationalPetroleumNegotiators
ASEAN AssociationofSouthEastAsianNations
BGSGM BGSingaporeGasMarketing
BM bilateralmonopoly
BOW balanceofweek
CEER CouncilofEuropeanEnergyRegulators
CH clearinghouse
CM clearingmember
CNOOC ChinaNationalOffshoreOilCompany
CNPC ChinaNationalPetroleumCompany
CO2 carbondioxide
DA dayahead
DAT deliveredatterminal
DES deliveredexship
EMA (Singapore)EnergyMarketAuthority
EU EuropeanUnion
FERC FederalEnergyRegulatoryCommission
FID finalinvestmentdecision
FMA financialmarketauthority
FOB freeonboard
FSU FormerSovietUnion
GECF GasExportingCountriesForum
GIIGNL InternationalGroupofLiquefiedNaturalGasImporters
GNC gasnetworkcode
GSP governmentsellingprice
HH HenryHub
HHI HerfindahlHirschmanIndex
ICE IntercontinentalExchange
IGU InternationalGasUnion
IOGC InternationalOilandGasCompany
JCC JapanCustomsCleared(oilprice)orJapanCrudeCocktail
JKM Japan/KoreaMarker
JOGMEC JapanOil,GasandMetalsNationalCorporation
KNOC KoreanNationalOilCorporation
KOGAS KoreanGasCorporation
LNG liquefiednaturalgas
LOP lawofoneprice
LPG liquefiedpetroleumgas
METI (Japanese)MinistryofEconomy,TradeandIndustry
MOCIE (Korean)MinistryofCommerce,EnergyandIndustry
MPSA mastersaleandpurchaseagreement
MTI (Singaporean)MinistryofTradeandIndustry
NBP nationalbalancingpoint
NCM nonclearingmember
NDRC (Chinese)NationalDevelopmentandReformCommission

NP noprice
NYMEX NewYorkMercantileExchange
OECD OrganisationforEconomicCooperationandDevelopment
OPEC OrganisationofPetroleumExportingCountries
OTC overthecounter
PNG pipelinenaturalgas Page|79
RBC regulationbelowcost
RCS regulationcostofservice
SLNG SingaporeLiquefiedNaturalGas
SP SingaporePower
SPA salesandpurchaseagreement
SPEX ShanghaiPetroleumExchange
SPR socialandpoliticalregulation
TAGP TransASEANGasPipelinesystem
TPA thirdpartyaccess
TSO transmissionsystemoperator
TTF TitleTransferFacility
UGS undergroundgasstorage
WA weekendahead
WD withinday
YA yearahead
Unitsofmeasure
Bcm billioncubicmetres(40MJ/m3)
Gtoe gigatonnesofoilequivalent
GW gigawatt
MBtu millionBritishthermalunits
Mcm millioncubicmetres(40MJ/m3)
MJ megajoule
MT megatonne
Mtpa milliontonnesperannum
MWh megawatthour
TWh terawatthour
USD UnitedStatesdollar
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ThispaperreflectstheviewsoftheIEASecretariatbutdoesnotnecessarilyreflectthoseof
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respectofthePartnerCountriesseriescontents(includingitscompletenessoraccuracy)and
shallnotberesponsibleforanyuseof,orrelianceonthePartnerCountriesseries.
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Developing
a Natural Gas
Trading Hub in Asia
Obstacles and
Opportunities
The market for natural gas in Asia is dominated by long-term contracts in which the price of gas is linked, or indexed,
to that of oil. In recent years, this has helped keep Asian gas prices much higher than those in other parts of the
world, leading to serious questions about whether such a system is sustainable. In this report, the IEA shows what
it would take to create a regional natural gas trading hub in which prices arent indexed to those of oil but rather
reflect local supply and demand fundamentals.
Long-term contracts can play a beneficial role in providing investment security, but their current pricing does not
take into account fundamentals and the competitiveness of gas within the energy mix of the mature economies
where the gas is consumed. Moreover, without a competitive spot market for natural gas one that supports and
encourages price discovery there is little incentive and little scope to change current commercial practices. This
leaves both consumers and producers with insufficient room to explore different options, which limits the degree
to which natural gas can serve as a flexible source of energy for both growing and mature economies.
Developing a natural gas trading hub in Asia aims to provide stakeholders with insights on the changes that are
required in the Asia-Pacific natural gas sector both downstream and upstream to allow a competitive natural
gas price to emerge. Building on OECD Europe and OECD America experiences, this report sets out to assess
perspectives for these changes in the Asia-Pacific natural gas markets. It identifies obstacles and opportunities for
a competitive natural gas price in the Asian economies to emerge.

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PARTNER COUNTRY SERIES

Warner ten Kate

51% 53% 50% 52%

In the AsianPacific region government regulations to a large extent continue to determine

PricerangeLNGpurchase LNGatJCCparity JapanLNGaverage

development has significantly redressed LNGs competitive environment in power generation

Spot% JapanimportLNGlongterm JapanimportLNGspot

Operational Underconstruction Planned LNGimportAsiaPacific

USLNG UKLNG AsiaLNG JCC Asiancoalmarker

Noncompetitive Competitive Page|33

Thirdpartyaccess ThirdPartyAccess ThirdPartyAccess

Wholesaleprice WholesalePrice WholesalePrice

Handsoffattitude HandsOffAttitude HandsOffAttitude

Spot market Futures market

Non clearing Clearing Exchange

Optional risk mitigation available through brokers

Non clearing Clearing Clearing Exchange

Spot market Futures market

Trader/financial party activity

Shipper/trader activity (physical)

Time of delivery in future

Spot market Futures market

YA YA+2 YA+3 YA+

QA Q+2 Q+3 Q+4

NBP flexibility reach

TTF flexibility reach

NCG flexibility reach

DeltaNBPHH HenryHub(monthlyaverage) NBP(monthlyaverage)

ideallysuitedtosupplynaturalgastotheurbancoastalregions. ChineseLNG import terminals

Thishaseffectivelyled tothe introductionofareplacementvaluepricingschemedowntothe

PDF versions available

A number of books printed before January 2012

are now available free of charge in pdf format

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