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The dominance of oil-linked LNG prices is coming to an end...kudos to BHP for recognizing this..and shame on others for not!

After many years of promoting the idea that oil-linked pricing for LNG contracts is a concept that has out-lived its usefulness - and its main reason for continued use is to protect the margins of the large LNG producers, I was pleased to see this article in the Australia Financial Review on October 15 2014.  Kudos to BHP for being the first large company (that I am aware of) that has accepted reality that the days of oil-linked prices should be limited and the future should be one of more transparent prices based on gas-on-gas economics - just like any other commodity!

BHP SPLITS WITH ENERGY PRODUCERS ON GAS PRICING

PUBLISHED: 14 OCT 2014 - Australian Financial Review

BHP Billiton has split from Australian gas producers by pushing for a move away from oil-linked pricing, potentially threatening returns for one of Australia’s largest export earners.

Japanese power companies have campaigned for several years to sever the link between LNG prices and oil prices because it was forcing them to pay more for gas than consumers in Australia and North America.

While gas exporters have opposed such changes because they would likely lead to lower received prices, BHP marketing boss Mike Henry said gas pricing markets were less transparent and liquid than they should be, and a move toward pure market pricing for gas was needed.

Mr Henry said the security of Japan’s energy supply would be improved if gas pricing was not influenced by other commodities. “Support for greater spot market depth and pricing on the basis of LNG fundamentals rather than by way of linkage to other indices will enhance the functioning of the LNG market and hence supply resilience.

“Recent moves by ¬buyers and sellers in that direction are encouraging but need to be accelerated,” he told an audience in Darwin. “BHP believes LNG will be like every other major globally traded commodity in that it will move to pricing on its own dynamics over time and will stop referencing to other commodities.”

HENRY HUB LINKAGE

BHP’s stance on gas prices follows a successful campaign in 2010 to move the iron ore pricing system away from long-term, often yearly contract prices, and replace it with a purer pricing -system based on daily or monthly ¬supply and demand forces. Australian gas exports to Japan have traditionally been referenced to the benchmark oil price because the early use of gas in Japan was as a substitute for oil. But gas has since become a crucial part of Japan’s energy mix after the nation reduced its dependency on nuclear power, and Australian exporters rank among Japan’s biggest suppliers.

Japanese companies have sought to  replace the link to oil prices with a link to the US domestic gas price (known as the Henry Hub), which would ¬create a gas price more than three times cheaper than the prices paid by ¬¬J¬apanese buyers today.

Mr Henry indicated that a shift toward a Henry Hub linkage was not preferable either and a pricing system independent of other commodities was the ideal solution. Santos vice president Peter Cleary conceded the gas pricing system was evolving and the majority of transactions would continue to be linked to oil prices over the next decade.

“We are shifting toward new pricing schemes, but to shift to a commodity pricing scheme as Mike [Henry] said, these shifts don’t happen overnight. They historically take some time before buyers and sellers have confidence in that. If we look at iron ore, the transition from bilateral long-term ¬contracts market to the transparent daily spot market took over a decade,” he said.

“We anticipate the shortened spot market will increase in pace and make an orderly traded market, but we expect to see long-term offtake agreements take 70 per cent [of the market], and those agreements will be based on oil-linked pricing.” Mr Cleary said oil-linked prices gave gas producers the confidence to undertake lengthy and costly projects to grow gas production. “For long-term capacity to be added, sellers require certainty of demand, long-term contracts and a pricing scheme which offers some certainty, such as oil-linked prices,’’ he said.’’ Mr Henry called on Japanese business to join the campaign against introducing protectionist gas policies in Australia.

The Australian Financial Review