ALREADY considered one of the most important trading hubs for liquefied natural gas (LNG) in the world, Singapore in 2016 will look to entrench the position by aiming to become a pricing hub for the fuel.
This comes as the market faces a glut of supply as well as waning demand - set to change everything from how LNG is bought and sold to how it is priced.
The Singapore Exchange will on Jan 25 launch contracts for LNG futures and swaps. The futures and swaps contracts, with a size of 1,000 mmBtu and 10,000 mmBtu respectively, will be cash-settled.
They will be based on the weekly price index - named Singapore Sling after the country's famous cocktail - which the exchange publishes based on prices submitted by 20 major physical LNG players.
"That's going to be a milestone of sorts," said SGX head of commodities product management Lily Chia.
"But it will really be part of a longer journey of seeing the market develop and being available to serve the market with the risk management products that we'll be putting out."
In doing so, the exchange will be vying with others in Tokyo and Shanghai to create a pricing product that will gain acceptance among LNG players in Asia-Pacific, which make up three quarters of the global LNG trade.
This comes amid accelerating times of change for the sector.
Global export capacity of LNG is expected to grow 44 per cent over the next five years to an unprecedented 135 million tonnes a year, with most of the supply coming from new players Australia and the US.
Investments in the Australian liquefaction plants had been sanctioned between 2009-2011, when the industry was expecting LNG demand to double between 2010 and 2020, said Tony Regan, Platts LNG Business Development Manager for Asia-Pacific. Since the recession, however, demand growth for LNG has ground to a halt.
"Now these plants are coming on into a much weaker market than was envisaged," he said. While some 80 per cent of the additional production from Australia has already been locked into long-term contracts, lower than expected demand in the largest buyers - Japan, South Korea and China - means that they, too, will be looking to resell volumes they have bought.
"This is going to be a game changer because it means we're going to see a lot of LNG being put onto the spot market over the next few years," said Mr Regan.
The lopsided market has given more power to buyers, who are now requesting for contracts that have shorter terms, destination flexibility, and hybrid pricing models.
Because of the huge costs involved in developing liquefaction and gasification plants, LNG contracts have traditionally lasted for 20 to 30 years, with strict terms committing a particular buyer to certain amounts of LNG or to pay a penalty otherwise, also known as "take or pay" clauses.
The contracts have also been indexed to oil prices. While the current lower oil prices have brought delight to LNG buyers, many at the same time still remember when they had to pay more for LNG imports because of higher crude oil prices.
The rise of a more liquid spot market now brings a greater impetus for a benchmark that is more representative of LNG supply and demand, observers say.
"With more liquidity that's coming out from Australia and the US, Asia continues to be a destination point for all these uncontracted supplies," said Wood Mackenzie analyst Chong Zhi Xin.
"Pricing these supplies off Henry Hub (the US natural gas price) or NBP (the UK natural gas price) doesn't accurately reflect the market conditions in Asia."
Pavilion Energy, owned by Temasek Holdings, has been a vociferous supporter of Sling, and said in late October that it plans to start placing trades on the price index within the next few years once the SGX swap products are ready.
Others are more tentative.
"We don't see it as a our natural role to be one of the front runners to test out and have blind faith in the workings of this," Statoil senior vice-president for marketing and trading Tor Martin Anfinnsen told BT in an earlier interview.
For any index to succeed, he added, it would need to have transparency, liquidity, resiliency as well as the trust of market participants.
SGX itself recognises the uphill task ahead. When asked whether the exchange has secured any market makers for the new contracts, Ms Chia was cautious in her reply.
"Because this market is still a very new one and even the physical market itself is fairly illiquid with only a few trades a month, it is still quite an early stage," she said.
"So to be able to find even one or two active market makers is quite challenging. We'll do our best but we're not looking at big numbers here."
Some question whether Singapore will be able to succeed in establishing a price reflective of the Asia-Pacific LNG market, given its restricted imports of the fuel.
"Singapore's on the right track but while that develops, China will continue to be the main driver ... it has the critical sources of supply and demand and therefore more balanced pricing," said Tan Lian Yok, a lawyer specialising in commodities at K&L Gates.
"A hub price will lean towards China at this time."
Asked about this, SGX's Ms Chia said that Sling - based on cargoes in the vicinity of Singapore - is relevant even for cargoes that head to Shanghai.
"It can be used with a simple freight adjustment from Singapore to Shanghai. It's how hub pricing should be formed - from that one price, anyone can use it as a floating basis for whatever physical transaction they wish to transact in, from whatever origin to whatever destination."
She added: "Our index should survive the different trade flows that ebb and flow."
Amid the competition, geopolitics might hold sway. Some believe that the US, expected to become the third largest exporter of LNG, would prefer that the LNG price not be dictated by a dominant market player like China.
In any case, the road to any successful pricing model for LNG in Asia is expected to be a long one.
Mr Anfinnsen, noting how the established gas hubs in the UK and US have evolved, expects the process to take at least five years "before you have something that will start to evolve by its own volition" - even with large buyers and sellers committed to it.
Though it is still uncertain whether the market would have an appetite for LNG derivative products, SGX says it is choosing to launch the products now to allow market participants to use Sling together with a hedged position, rather than to wait till the market matures further.
"So we decided on earlier rather than later, but we're patient with seeing it grow progressively," said Ms Chia.
"We will spare no efforts to grow the liquidity and enhance the product, but we can only grow in step with the market, and as to how quickly the market will develop is really anyone's guess."
This article was first published on January 22, 2016.
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