Crude oil is not the only hydrocarbon-based fuel to undergo a sharp price decline in the last six months. Spot prices of Asian-traded Liquefied Natural Gas (LNG) are following crude’s downward trend and are now down to around 50 percent of what they were last October. There are a number of factors contributing to the reduction in LNG spot prices, including a slowing Chinese economy, short-term LNG supply outstripping demand and a strong US dollar that makes LNG more expensive. Along with these short-term factors, another key reason Asian LNG prices are falling is that LNG volumes that are sold under long-term supply contracts are indexed to crude oil prices, but tend to lag behind oil price movements by about 3 to 6 months. The sharp decline in crude oil prices over the last six months is now filtering through to the Asian LNG market. (For related reading, see article: What Determines Oil Prices?)

Asian LNG is linked to Crude Oil

The Asian LNG markets are slightly different from the natural gas markets in Europe and North America. In these markets, gas prices are largely determined by benchmark hub prices. In Europe this tends to be the National Balancing Point (NBP), which is a delivery point in the UK. In North America, the price is determined by Henry Hub, which is a distribution hub on the natural gas pipeline system in Erath, Louisiana, owned by a subsidiary of Chevron Corporation, according to Wikipedia. In Asia, however, there is no readily identifiable hub that serves as a regional distribution point where gas pricing can be easily determined, so LNG contract prices are still largely linked to regional crude oil prices that are dropping.

According to Gastech, a gas industry trade organization, the creation of an Asian gas trade hub will take considerable time, since the key elements that would be needed to support it are now largely absent in Asia. For example, they cite the need for more market participants such as commodity traders, harmonized regulatory rules, and the willingness of governments to reduce their controls on the energy industry and accept the increased influence of market forces. These elements are currently lacking in Asia.

Global LNG Supply Growth

Another factor that could put even more downward pressure on near-term Asian LNG prices is the large amount of LNG supply from Australia that is due to come on-stream in 2015. According to Platts, an oil product pricing service, production of about 32.4 million tonnes per annum (mtpa) of LNG is due to start up in Australia in 2015. BG Group, a UK-based oil and gas company, expects Australia to add a total of 58 mtpa of LNG supply capacity by 2019, bringing its total production capacity to 80-85 mtpa. These volumes could be about to hit the Asian market at a time of weaker structural demand resulting from an economic slowdown in a number of key importers like China and South Korea, two of the largest LNG consumers in Asia after Japan.

Australia is not the only country increasing LNG supply capacity. BG goes on to say that capacity of 21 mtpa will start up in the US in 2015, with the first cargo to be exported from the Gulf of Mexico around the end of the year. Furthermore, facilities for the production of a total of 41 mtpa are now under significant construction in the US, with volumes contracted to go to Asia. This added supply is likely to weigh on prices. (To read about the prospects for expansion in production and exportation of US LNG, see article: The LNG Opportunity Keeps Getting Better.)

One factor that could actually slow future supply growth is the falling price for LNG. Both Australia and the US’s LNG volumes are targeted to supply the Asian market and were committed to final investment at a time when spot LNG prices were much higher than they are today. Many of the Australian LNG projects have costs that are over budget, as reported by many media outlets, and were counting on a high LNG price to make the projects economically profitable. Many of these projects could now end up in financial trouble in a lower price environment, which would remove this extra supply that has been expanding the LNG volume in the Asian market. Additionally, new projects are starting to be shelved and this will postpone expected LNG capacity additions. For example, in December 2014, Woodside Petroleum announced that it is postponing its final investment decision on the Browse LNG project until 2016 and Reuters reports BG is pushing back the Lake Charles LNG project to 2016 as well.

It seems only the Russians are continuing to push ahead with their LNG project in spite of the new economic reality. The Yamal LNG project is a $27 billion project that is due to be launched in 2017, according to the project operator Novatek. This project has recently secured funding from the Russian government in order to remain on track following the implementation of sanctions against Novatek last year that prevent it from accessing western capital markets as a result of the conflict in Ukraine. Volumes from this project are also primarily targeted at the Asian market, but lower LNG prices could have a dampening effect on the project's overall profitability once it is eventually brought on stream. (For related reading, see article: How U.S. & European Union Sanctions Impact Russia.)

Japan Nuclear Re-Start Could Dampen Demand

With all its nuclear capacity offline since 2011, Japan received record LNG imports of 89 million tonnes in 2014, or nearly half of all Asian LNG imports, according to BG. In general, Asia accounts for 75% of global LNG imports of around 243 million tonnes.

BG reports that some of Japan’s nuclear power plants could come back on line in 2015. If this happens, Japan’s demand for LNG could begin to drop, since the fuel is primarily used for electricity generation. This would put additional downward pressure on Asian LNG prices. World Nuclear News reports that Japan’s Institute of Energy Economics (IEEJ) published a study in January 2015 in which they favor bringing back 25 percent of Japan’s nuclear power because it "can be regarded as the closest to what should be aimed for considering government policies now in place.” (For related reading, see article: The Economic Reasons Behind Nuclear Power.)

In addition to the drop in Japan's LNG demand as a result of a nuclear re-start, Wood Mackenzie, an energy consulting company, expects that rising coal capacity in South Korea will result in lower LNG demand from that country in 2015. This is significant, because Korea makes up about one-fifth of the Asian LNG market, so a drop in demand from that market in addition to a potential decline in demand from Japan means prices for long-term LNG supply contracts could stay lower for longer, and mirror what has been happening to short-term spot market prices.

The Bottom Line

Asian LNG prices could stay low for an extended period of time. Short-term supply and demand imbalances such as a slowing Chinese economy and a strong US dollar are putting downward pressure on spot LNG prices in Asia. Adding to this low-price environment is a low crude oil price that is used to determine long-term LNG contract prices for Asian buyers. This means the high-cost projects of LNG suppliers, especially in Australia, could struggle to be profitable once they fully come on line in 2015. Other businesses li