September 19, 2012
In the wake of the March 11, 2011, earthquake and tsunami and the shutdown of the country’s nuclear power plants, LNG imports to Japan continue to increase — with close to 50 percent of the country’s power now being generated from LNG. At the same time, production of shale gas has changed the market for natural gas in the United States, shifting the supply of natural gas from a position of shortage to one of excess. The resulting decrease in the pricing of the US Henry hub indexed gas price has led to a large price gap in LNG prices between the two countries.
Latham & Watkins partners William Voge and Joe Bevash discuss the dramatically lower pricing of the US Henry hub indexed gas prices in comparison to the prices that have prevailed in Japan under the Japan Crude Cocktail (JCC) index.
What is the difference between the Henry hub and the JCC price indices?
Bevash: The Henry hub price is dictated by US supply and demand for natural gas. Henry hub doesn’t track petroleum prices, unlike the JCC price index and, to some extent, the European gas price indices. The current price differential between Henry hub and JCC is unprecedented — the spread is between US$14 and US$16 dollars per million BTU.
There is less of a differential between the Henry hub and the European indices. The European gas prices have a natural cap on them because LNG competes in price with the more conventional piped gas that comes from Russia — piped gas having a much lower transport cost than LNG.
Will this price differential create an opportunity for Japan, as the world’s top LNG importer, to lower its costs for securing strategic supplies of fuel?
Bevash: Assuming that the price differential continues to apply, and taking into account liquefaction and shipping costs, the landed price of LNG in Japan originating from the United States is estimated to be between US$6 and US$10 per million BTU below the landed price from other LNG suppliers whose cost is based on the JCC index. That should create an opportunity for Japan to obtain LNG on a long-term basis at a lower cost.
Will there be sufficient LNG development in the United States to put price pressure on other LNG sale and purchase agreements (SPAs) that no longer will be linked entirely to JCC prices?
Voge: One of the hot topics that is being discussed around the world is whether or not the JCC index price for LNG in Japan might change over time as more gas comes from the United States. Each of the first four LNG SPAs for LNG being produced in the United States that is known publicly is indexed to the Henry hub price.
The notion that is being explored is whether there will be sufficient LNG coming from the United States into Japan based on Henry hub pricing that will result in reducing JCC indexed gas price. If the JCC index price for gas reduces in response to the pressure of Henry hub indexed LNG SPAs, then the contract price for LNG under existing LNG SPAs and new LNG SPAs that are linked to the JCC index will reduce as well.
The question then would be whether the increase in natural gas production in the United States could put sufficient pressure on JCC index pricing so as to reduce the current pricing differential that exists between the markets. Of course, as the JCC price index is tied to petroleum prices rather than to the market price for natural gas, there likely always will be a price differential between the two indices.
On June 1, 2012, Latham & Watkins hosted a panel discussion entitled “US LNG Exports to Japan: Recent Developments” in Tokyo. Participants from Latham & Watkins included Michael Gergen, Hiroki Kobayashi, Joel Mack, Kenneth Simon, Tom Wilson and Michael Yoshii, as well as Bill Voge and Joe Bevash.