Long-term LNG contracts with price review clauses continue to dominate the Asian LNG market. The pricing in those contracts remains predominantly oil-based. The evident reason for that is the absence of a reliable price signal for LNG itself in Asia. However, several countries in Asia are setting up LNG trading hubs in various forms. Those hubs, once trading, will provide some type of price signal for LNG. A key question is facing the market is when and how that price signal will start to have a meaningful effect on existing long-term LNG contracts through price reviews.

This issue involves the past, present and future.

Past: A historical perspective sets the scene. The question is what conditions are necessary for a hub price signal to affect pricing under long-term LNG contracts? The most comparable historical model is the European gas market over the last twenty years. The European experience reveals that gas hub price signals were used commercially before the hubs reached a significant level of liquidity. This was for many reasons – for one thing, the mere existence of a price signal in the market created ‘winners’ and ‘losers’. This in itself changed the market dynamic.

Present: Three countries compete to develop Asia’s first real gas hub – China, Japan and Singapore. Each country is making efforts, but also faces challenges. For example, Singapore has many natural advantages as a gas hub, particularly for South Asia, but is hampered by low domestic consumption. Japan, by contrast, has enormous domestic consumption, but physical constraints to allowing consistent and coherent third-party access (a necessary part of true market liberalization).

Future: The real question for market participants is where things will go from here. How will emerging hub prices be used to trigger price reviews under long-term LNG agreements? And how they might be used to justify price changes under price review clauses?

Market players will need to take into account various factors, such as:

• The relationship between the hub’s liquidity, and the resulting price’s use in the market.
• The “ripple” effect of a new price signal.
• The complexity of calculating the value of diversion rights/flexibility.
• The role of “in any case” or “market competitively” clauses.
• The value to the seller of take-or-pay commitments v the value to buyers of security of supply.
• What role, if any, that destination clauses play.

Price review clauses in long-term LNG SPAs typically have a two-step nature. They normally provide for negotiations with the fall-back possibility of resorting to arbitration. Both stages involve different considerations when it comes to using emerging price signals.

In sum, Asian LNG hubs are on the horizon. It’s only a matter of time before they provide a meaningful price signal for long-term LNG contracts. The question is how, and when, that signal will effect long-term LNG contracts.
Source: White & Case LLP