APERC Workshop at EWG52

Moscow, Russia, 18 October, 2016

3-2. LNG in the Asia-PacificFavoring trade and rational market development

Kirsten SmithResearcher, APERC

Report Highlights

3

LNG in Asia-Pacific: Favoring trade and rational market development

Report Highlights

Popular pricing mechanisms in the Asia-Pacific disadvantage natural gas and LNG

The region has been shocked by high natural gas prices that have fueled energy security concerns

Oil-linked pricing has created excessive volatility and has driven market imbalances that distort the normal investment cycle

Long-term contracts have been used to reduce investment uncertainty at the expensive of market flexibility

Shocks in the oil market are unrelated to natural gas market balances

4

LNG in Asia-Pacific: Favoring trade and rational market development

Report Highlights

Major challenges exist in expanding the use of natural gas and LNG

An ambiguous role in the transition to a low-carbon economy

Declining domestic production in the Asia-Pacific increases energy security concerns for importers

Lack of convergence in opposing stakeholders’ expectations without an appropriate pricing mechanism to align interests

5

LNG in Asia-Pacific: Favoring trade and rational market development

Current market conditions present an opportunity to direct structural change in order to encourage a more liquid and rational LNG market over future business cycles

Global demand will be driven by Asian economies, but domestic supply will fall short

Negotiating power has shifted away from one extreme with the emergence of a buyers market

Report Highlights

0

100

200

300

400

500

600Planned projects

Divertable supplies from Europe

New projects

Existing projects

High demand

Low demand

MT

2010 2015 2020 2025 2030

LNG trade balance in APEC

LNG markets

7

Major worldwide LNG trade flows, 2014

Major LNG trade flows have historically kept the international market

divided on a regional basis

Natural gas has competed in separate isolated markets

8

Worldwide LNG imports by region, 2000-2014

APEC has 14 out of 20 import terminals and 27 out of 28 export terminals

expected to begin construction before 2019

Growth in LNG demand has come from Asia

North American LNG Export Terminals Approved

0

50

100

150

200

250

300

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

Middle East

Americas

Europe

Asia

MT

9

Natural gas import prices and spot LNG prices for northeast Asia, 2001-2015

When global oil prices increased, regional natural gas prices diverged

because of differences in pricing mechanisms

The Asian Premium has driven energy security concerns

0

5

10

15

20

25

20

15

20

15

20

14

20

13

20

12

20

11

20

10

20

09

20

08

20

07

20

06

20

05

20

04

20

03

20

02

20

01

Japan

JKM

UK

USA

$/MMBtu

2016

Outlook

11

Natural gas demand and supply outlook in APEC, 2013 and 2040 (Bcm)

Natural gas is expected to be the fastest growing fossil fuel

2040

156

439

678

188

17638

146

678

492

1068

211

338

65318

China

Russia

United States

Other north-east Asia

Other Americas

Oceania

South-East Asia

2013

Demand

385

699

1109

4

419

125168

2040

2013

112

626

630

4

204

63190

Supply

Strong supply growth in

the US, China and Other Americas

Strong demand growth in the US, China and SE Asia

Note: Oceania (Australia, New Zealand and PNG), Other Americas (Canada, Chile, Mexico and Peru), Other northeast Asia (Hong Kong,

Japan, Korea and Chinese Taipei), South-East Asia (Brunei Darussalam, Indonesia, Malaysia, Philippines, Singapore, Thailand and Viet Nam)

12

APEC natural gas net exports by region, 2013 and 2040

Production in Asia is not expected to meet forecast demand growth,

which will mean increasing import dependency

Asia will continue to rely on natural gas imports

-400

-300

-200

-100

0

100

200

300

China Russia United States Other north-east

Asia

Other Americas Oceania South-East Asia

2013

2040

Bcm

Net importer

Note: Oceania (Australia, New Zealand and PNG), Other Americas (Canada, Chile, Mexico and Peru), Other northeast Asia (Hong Kong,

Japan, Korea and Chinese Taipei), South-East Asia (Brunei Darussalam, Indonesia, Malaysia, Philippines, Singapore, Thailand and Viet Nam)

Net exporter

Pricing and contracts

14

Oil Price Escalation (OPE)

Price is linked, usually through a base price and an indexation clause, to competing fuels, typically crude oil, gas oil and/or fuel oil.

Originated in Europe in the 1960s when NAM (a joint venture between ExxonMobil and Shell) and the Dutch government introduced it with the intention of giving natural gas a price advantage to incentivize its use over other oil-based fuels.

Gas-on-Gas Competition (GOG)

The price is determined by the interplay of supply and demand and is traded over a variety of different periods.

Trading takes place at physical or virtual hubs and it is likely to occur in developed futures markets.

Increasingly seen as the competitive market ideal.

Most common market-based mechanisms for price setting

15

GOG = Gas-on-gas competition, OPE = oil price escalation

Worldwide natural gas imports by market price mechanism

Gas on gas competition dominates in North America

and has increased in popularity as utilities have been unbundled in Europe

Most common market-based mechanisms for price setting

0

50

100

150

200

250

300

350

400

North America Europe Asia Asia-Pacific Latin America Former Soviet

Union

Africa Middle East

GOG

OPE

Bcm

APEC seeks to increase GOG competition to encourage market pricing linked to gas fundamentals

rather than oil prices

16

LNG spot and short-term deals, 2000-2014

The oversupplied market has led to increased bargaining power for buyers

and more flexible contracting arrangements

Contract structures are becoming more flexible

Old Model• Long-term (~20 years)• Destination restrictions• Take-or-pay• FOB shipping responsibility

New Model(s)• Spot, short-term or long-term• Tolling structures• Resale flexibility

Typical contract specifications

0%

5%

10%

15%

20%

25%

30%

35%

0

10

20

30

40

50

60

70

80

2000 2002 2004 2006 2008 2010 2012 2014

Middle EastLatin AmericaNorth AmericaEuropeOther AsiaChinaIndiaTaiwanKoreaJapanShare of spot and short-term deals

MT Share of spot and short-term deals

Policy recommendations

18

Define the role of natural gas in energy and climate policies

Transitioning toward a low carbon economy

Policy recommendations

0

100

200

300

400

1990 2000 2010 2020 2030 2040

China

Japan

Korea

Chinese Taipei

Thailand

Malaysia

Viet Nam

Mtoe Projected net coal imports for selected APEC economies

The extensive use of coal in Asia offers remarkable potential to expand the primary demand of natural gas

in APEC in the form of LNG

Enforce fiscal and investment frameworks that facilitate gas upstream projects

Promote financing alternatives for LNG projects

19

Acknowledge the critical role of LNG infrastructure for energy security

Policy recommendations

Support the development of gas price hubs

Explore alternative LNG business models

Advance new LNG contract features

Natural gas import sources in APEC

0.0

0.2

0.4

0.6

0.8

1.0

0%

20%

40%

60%

80%

100%

2000 2005 2010 2013

Others

Turkmenistan

Australia

Qatar

USA

Indonesia

Malaysia

Canada

Share of Intra-APEC imports

Gas import diversity (RHS)

Bett

er

Wors

e

20

Use collective power to encourage more balanced interactions and discussions

Policy recommendations

Engage stakeholders in LNG projects

Foster regional cooperative activities

APEC is an excellent forum to discuss mechanisms that facilitate an

accelerated LNG trade that leverages the dialogue and collaboration of producers and buyers across member economies.

http://aperc.ieej.or.jp/

Thank you for your kind attention