Javier Blas is commodities editor at The Financial Times
The natural gas market is entering a golden age on the back of increasing global demand. So proclaims the International Energy Agency, the western countries’ watchdog. But the natural gas pricing system remains, for now, largely in the dark ages.
The cost of natural gas varies substantially from geography to geography. While in the U.S. natural gas prices are below $5 per millon British thermal units, in continental Europe they are near $10 per mBtu and in Asia are above $12 per mBtu. The natural gas market differs from the oil market, as it is fragmented in regions rather than global.
The International Energy Agency believes that the commodity will take some steps towards becoming a truly global market over the next two decades. But a pure globalization is far away.
“Natural gas markets are becoming more global and regional prices are expected to show signs of increased convergence, but the market does not become truly globalized,” the IEA says in its study Are We Entering a Golden Age of Gas, part of its forthcoming World Energy Outlook 2011.
The price of the commodity in key geographies, including much of Europe and Asia, will remain anchored in decade-old practices: long-term contracts indexed to the cost of oil or refined oil products. As such, natural gas prices do not reflect the supply and demand fundamentals of the commodity, but rather those of the oil market.
By 2030, the IEA believes that the regional price gap will have narrowed, but prices will remain, nonetheless, apart. It sees natural gas prices in real terms, adjusted by inflation, at $7 per mBtu in the U.S.; just above $10 in Europe, and above $12 in Japan.
The persistence of the old practices -- firmly supported by Gazprom of Russia, Sonatrach of Algeria or Qatargas -- is a pity as it will hamper the development of the market. The use of oil as the base to price natural gas is particularly anachronistic taking into account the growing use of gas in power generation, where oil has played virtually no-role since the 1980s.
Over the last decade the natural gas market has moved towards the so-called gas-to-gas pricing, in which the commodity is priced against its own spot market, rather than against the cost of oil or fuel-oil. Gas-to-gas is the pricing mechanism of choice for much of North America, the U.K. and Australia. In total, it accounts for around a third of global natural gas supplies. But the rest is sold largely based on oil prices in spite of demand for reform from European importers over the last two years. In Asian nations such as Japan, however, the pressure to reform the pricing system is significantly small.
Yet, the growing role of liquefied natural gas (LNG), or super-cooled gas ready to ship by tanker over large distances, could help to create a truly global natural gas market. That is particularly true as new LNG importers in Asia look for more flexible arrangements to those used by the traditional importers of South Korea and Japan.
India, for example, bought several spot LNG cargos last year linked to the price of the U.S. spot market of Henry Hub, a pipeline interchange in Louisiana. And Pakistan has been buying natural gas on a medium-term contract based on the price of Henry Hub too.
These initial steps towards gas-to-gas pricing are welcome, but much more effort is needed. Let us not forget that oil prices were fixed by OPEC until just three decades ago, and today crude oil is the most liquid and traded commodity in the world.