The European Parliament’s promulgation of the first Gas Directive (Directive 98/30/CE) in 1998 heralded a new era for Europe’s gas markets. The onset of liberalisation resulted in a transition from markets traditionally composed of monopoly/monopsony incumbents to a system of competitive markets composed of buyers and sellers from around the world.
No similar overarching legislation has been passed in Asia. However, the Asian gas markets (like the European gas markets more than a decade before) may now be on the precipice of a significant change. How sellers and buyers in this market respond will shape the future of the market for years to come.
The Japan Customs-cleared Crude (otherwise known as JCC or Japanese Crude Cocktail), a basket of oil prices, has long been the favourite pricing mechanism for long-term LNG sales agreements in Asia. Given the limited competition in these individual Asian gas markets there has been little need for parties to depart from the traditional oil-indexation model, resulting in limited uncertainty for both buyers and sellers. Where any differences did arise, they were amicably resolved through commercial negotiations and parties rarely ever resorted to international arbitration.
However, as was recently reported by Platts, some Asian gas buyers are increasingly including partial indexation to the US Henry Hub spot gas price in their long-term gas supply agreement price formulae. This represents a departure from the more traditionally favoured oil-indexation model.
This change in indexation reflects other changes in the market. It likely stems from the increased possibility of stable North American exports. Additionally, the global gas glut, coupled with increased Asian demand for natural gas, has sparked increased activity and more market players trading in Asian LNG.
More sellers, with an increased supply of gas, will have an impact on the structure of the Asian gas markets and, potentially, on future price reviews in Asia. Concerns about security of supply may diminish if the importance of price and margin increases. As the long-standing discomfort with international arbitration abates throughout Asia, more long-term commercial relationships may be resolved by international arbitration.
The situation is similar to Europe in the late 1990’s, as it began to liberalise through a series of EU directives. Gradually, through the increased use of trading hubs, interconnected markets and a greater number of buyers and sellers, the conditions of the European gas market changed. As a result, high-value, high-risk price review negotiations and arbitrations became common for both buyers and sellers.
This is not to say that the Asian gas markets may liberalise in the same way that European gas markets have. Changes in indexation may not mark a wholesale departure from traditional pricing methods. Many Asian buyers may take a more cautious approach. Conversations with some Asian buyers reveal a continued preference for JCC indexed prices, largely based on concerns about the unpredictability of US exports and hub-based prices in distant markets (e.g. that regional events impacting the hub price may affect the price of gas in an entirely different market). Oil-indexation in high-volume, long-term price formulae may remain unchanged.
Amid this uncertainty, buyers and sellers in the Asian gas markets have an opportunity to learn from previous European experience. Some of the lessons learned – namely, how to tailor price review provisions and price formulae for a changing market – came at a severe price for some companies. By recognizing the potential for changing market conditions and planning in advance, participants in the Asian gas markets and their legal advisors can adapt price review provisions and be better able to resolve potential future disputes about gas prices.