The simple answer to that question is that there is no simple answer.
Historically, LNG prices were linked to oil because LNG was displacing oil and that practice continued until US LNG export projects were proposed. Buyers from the US export projects will get LNG based on Henry Hub gas prices because in most cases they will be responsible for buying US gas and transporting it by pipeline to their contracted export projects to be liquefied.
That access to those Henry Hub-priced supplies has spurred buyers to seek gas-indexed prices in their new purchase contracts, displacing traditional oil-indexed prices.
A number of buyers, especially in Japan, are pushing proposed British Columbia export projects to use the US benchmark Henry Hub gas price as the index for LNG.
“The aim is to link 100% to Henry Hub prices, rather than JCC [Japan Customs Cleared] as has been the custom globally,” Hiroshi Hashimoto, a senior gas analyst with the Institute of Energy Economics of Japan said on the sideline of the CERI 2014 Natural Gas Conference this week in Calgary. “But there will be some options offered to Canadian and US producers of linking 20% of that price to crude oil and the remaining 80% being still linked to gas.”
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An informal round-table discussion Wednesday at the IHS CERAWeek conference in Houston included more varied opinions on the future of oil-indexed prices. The discussion group included LNG buyers, sellers and a ministry official from a government that has several proposed export projects.
Buyers want prices indexed to the Henry Hub because they think they’re paying too much for LNG. Japan, for example, was already the largest LNG market in the world before shutting all its nuclear power plants after the Fukushima nuclear plant disaster in 2011. Japan then needed to boost its LNG purchases to make up for the lost nuclear generating capacity and incurred its first trade deficit in more than 30 years, which has continued to grow since.
But linking LNG prices to Henry Hub prices won’t guarantee prices lower than oil-indexed prices. It depends on the oil price, the percentage of the oil price used as an index, and the Henry Hub gas price.
If LNG is indexed to gas at 12.5% to 13.5%, the delivered price can compete with the delivered LNG price of US Gulf Coast LNG indexed to the Henry Hub price, depending on the oil and Henry Hub prices, said Wolfgang Moehler, IHS Director of Global LNG. Others have pointed out that LNG indexed to Henry Hub prices of $6/MMBtu would be equal to LNG indexed to oil at $80/barrel.
Volatility is also an issue when choosing a price index. Henry Hub gas prices can be more volatile than oil prices. Last month, Henry Hub prices went from less than $4.80/MMBtu to more than $6/MMBtu and then dropped lower than $4.60/MMBtu again in about two weeks.
Buyers must also remember that an export project will not be built unless the developers have already sold most of the capacity under long-term deals with prices high enough to pay for the multi-billion-dollar projects, whether those prices are indexed to oil or gas.
So the bottom line is: buyers have to pay if they want to play.