Dynamics of Natural Gas Pricing: The Critical Need for a Natural Gas Hub in South Asia

By Kamal, Maha | Journal of International Affairs, Fall-Winter 2015 | Go to article overview

Dynamics of Natural Gas Pricing: The Critical Need for a Natural Gas Hub in South Asia


Kamal, Maha, Journal of International Affairs


This paper will examine three main pricing mechanisms for gas contracts: oil-indexation, gas-gas competition and netback from final product (e.g. prices linked to Ammonia etc.) in light of the gas contracts in this region that are oil-indexed or linked to oil prices. It will analyze the long term viability and competitiveness of this mechanism for South Asia and discuss natural gas demand in South Asia, conventional and unconventional sources of Natural Gas, as well as the effects of geopolitics in the region on Natural Gas contracts. Remaining cognizant of these developments, this paper proposes the creation of a new natural gas trading hub in South Asia.

Introduction

The natural gas market in the Asia-Pacific region is seeing great changes, as markets like Japan and South Korea mature and newer markets like India look towards different gas pricing mechanisms. As new players enter the market, existing literature on the subject indicates the need for greater competition and a break from old pricing mechanisms linked to oil. One of the most prolific experts on international gas pricing, Jonathan Stern, wrote that while hub pricing may be a solution for some markets, this solution may be unique for different countries: "In Asia, there is no reason to expect China and India to adopt price mechanisms identical to those of Japan and Korea." Similarly, the International Energy Agency proposed a new gas pricing hub in Asia, saying that a mature natural gas market may need more transparency.

The global natural gas market has seen many changes that have influenced the supply of natural gas, such as the Shale Gas Revolution in North America, the Fukishima disaster, Japan's increased demand for liquefied natural gas (LNG), and new entrants in the natural gas market through unconventional gas (shale gas, tight gas, coal bed methane etc.). While the Henry Hub in the U.S. is seeing prices in the range of $2-4 per MMbtu (million British thermal units, a unit for the heating value of natural gas), LNG prices in Asia have been as high as $18 per MMbtu in peak demand seasons. As global oil prices fell from their peak price of $115 per barrel in June 2014, the volatility of the oil market has been greater than the natural gas market. As the natural gas market continues to diverge from the oil market, oil-indexed contracts no longer reflect the realities of the natural gas market.

This paper examines the pricing mechanisms in Europe and the Asia-Pacific region, and analyzes oil-indexed contracts in comparison to gas-on-gas trade. It will then analyze the long-term viability and competitiveness of this mechanism for South Asia, and discuss natural gas demand in India and Pakistan, the two biggest natural gas markets in South Asia. Lastly, it looks at the geopolitics of natural gas for South Asia and the impact of some interesting changes that have not yet been explored in the literature.

This paper proposes the creation of a new natural gas trading hub in South Asia, to promote the liberalization of natural gas markets in South Asia, particularly in light of new political factors such as the Iran nuclear deal of 2015, the China-Pakistan Economic Corridor (CPEC) and the U.S. exit from Afghanistan.

It concludes that this may conservatively take more than a decade to develop since the evolution of natural gas pricing mechanisms took more than five years in Europe, and are projected to be longer for more mature Asian markets. South Asia as a whole is still a new entrant in the global natural gas market, and regional politics greatly influences infrastructure developments. However, this paper will argue for South Asian nations to work towards the creation of this natural gas trading hub, in order to a) reduce the impact of oil price volatility on South Asian economies; b) increase competition in the natural gas market; and c) promote regional integration through greater trade.

Global natural gas markets are changing

As global oil prices fell from their peak price of $115 per barrel in June 2014 (see figure 1), importing natural gas indexed to oil could not remain economically viable for oil-importing countries. …

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