LNG gets a boost in its largest global market
Earlier this year, Tokyo Gas announced a 10-year deal with Shell to supply LNG from 2020. The project was structured using a coal-linked pricing formula: a rare move that broke the mould of the typical oil-linked contracts that have been used for decades in Japan.
This unusual contract made the headlines earlier this year.
We look at five reasons why this contract is significant for the LNG market.
1. Japan’s changing energy market is driving price innovation
Japan’s energy landscape is in a state of flux. Changing dynamics mean that gas is no longer as competitively priced in comparison to coal, and China is expected to overtake the country as the world’s largest consumer of LNG within the next few years.
Energy market liberalisation has also limited utilities’ ability to pass on fuel costs to consumers.
There’s still a big prize for LNG importers into Japan, but to compete with alternative sources of energy, suppliers need to be innovative.
2. Indexation to coal prices could help gas compete on price
As utilities become increasingly cost-conscious, the need for a competitive electricity generation mix is crucial.
Japan’s market is facing serious overcapacity as nuclear, coal and renewables jostle for position – all challenging the use of gas as a comparatively expensive alternative. Meanwhile, power demand growth will be limited in the face of modest GDP numbers.
With current spot LNG prices trading at US$5/mmbtu, gas is proving competitive against coal in the power sector. But the majority of LNG in Japan is sold in oil-indexed contracts, at an average price of US$9.7/mmbtu – and at this level, LNG can’t compete with coal.
3. Decarbonisation is a priority, but the economics need to make sense
Coal is out of favour as decarbonisation becomes a priority. However, coal holds its own in Asia’s power sector, primarily because it is cheaper than many other alternatives. Although Japanese utilities face policy pressure to reduce their reliance on coal, in the absence of a carbon tax, other incentives need to be in place for gas to become attractive.
Contracts that make use of coal-indexation, such as the Shell/ Tokyo Gas deal, could be an important step to enable gas to better compete with coal-based power generation.
What price is required for LNG to be competitive against coal? And how does this differ for new builds vs existing power plants? Purchase the full insight for an in-depth analysis of coal-to-gas switching economics.
4. Expect more flexible LNG contract structures
Liberalisation has prompted an influx of new suppliers coming to the Japanese market. This will serve to diversify the supply base, but will also add competition from the early 2020s, when demand is already forecast to decline.
Innovative contracts like Shell’s deal with Tokyo Gas are important because they will provide buyers with greater leverage in future price discussions.
As competition increases in the market, we can expect to see contract structures shift significantly, which should provide a boost to LNG.
5. Any changes in Japan could influence wider trends
Not only is Japan the world’s largest market for LNG and the third largest for thermal coal, but it is also the most sought after for both commodities – partly because Japanese buyers are willing to pay a price premium to ensure energy security.
Any changes in this market have the potential to be influential on a broader scale.
Speak to an expert
Prakash Sharma, Research Director, China