SGX to launch more LNG derivative products in Q2 2017

The Singapore Exchange (SGX), in its bid to gain pricing dominance in liquefied natural gas (LNG), is set to launch more derivative products for the commodity in the second quarter of next year. More transparent pricing for the commodity is critical, to encourage higher demand amid a supply glut, it says.

The new contracts, expected in the second quarter, will be based on its new North Asia price index, its head of oil, power and gas derivatives Lily Chia told The Business Times.

The North Asia Sling (Singapore LNG Index Group), introduced on Monday, is based on LNG cargoes delivered to ports in Japan, Korea, Taiwan and China. These respective economies together account for 60 per cent of global LNG demand.

"After the North Asia Sling has had some time to accumulate more data, we will be looking to introduce swaps and futures (based on the marker) in the second quarter of next year," said Ms Chia.

The new derivatives contracts should stir up more interest in LNG derivatives on the exchange, and will also mean a more complete set of tools for industry participants to use for hedging, she added.

SGX's new North Asia marker is the latest in a string of price indices launched in recent years for the North-east Asia LNG market, as various players vie to create a pricing product that will gain acceptance among LNG players in the Asia-Pacific. Commodity pricing benchmarks are a winner-takes-all game; an established contract would attract even more liquidity.

The North Asia price marker was introduced based on industry feedback calling for the Sling methodology to be extended to the new market, said SGX, adding that the new index will complement the Singapore Sling unveiled in June last year.

"The Singapore Sling will serve as a reference point for the fast-growing and developing South-east Asian LNG market, and the North Asia Sling will serve as a much-needed transparent and representative price for the traditional centre of demand," it said when unveiling the new price marker on Monday.

Like the Singapore index, the North Asia Sling will be based on price quotes submitted by a pool of 22 LNG buyers, producers and traders.

The same players will be involved in contributing their price assessments for both the North Asia and Singapore Slings, said Ms Chia. "They are all actively participating in the physical trade within the whole of Asia, so either index will be relevant for them."

Analysts say while SGX will face competition from these price indices, none of the existing ones are dominant in the market yet, and the exchange's methodology may distinguish itself from the rest.

Wood Mackenzie analyst Chong Zhi Xin said: "It will probably face quite a bit of competition from the established players...which have been around in the industry for a number of years."

Existing price indices include Platts' Japan Korea Marker (JKM) and ICIS' East Asia Index.

Nevertheless, it is a good step by the SGX, he said, adding that the North Asia Sling could emerge as the predominant index if the exchange is able to secure major Japanese utilities, such as Tokyo Gas or Jera on board, as Sling participants. "The only issue is which (price index) the Japanese government wishes to support, and it could be the Tokyo Commodity Exchange."

The existing North-east Asian price indices do not enjoy the same level of liquidity as do the Henry Hub in the US and NBP, giving SGX a shot at success.

Wood Mackenzie's Mr Chong said; "I'd say it's still early days for all these indices. You haven't seen any long-term contract being priced off these contracts as well."

Jason Feer, head of global intelligence and energy and ship brokerage Poten & Partners, said what makes North Asia Sling different is the methodology; the index being constructed by the exchange, as opposed to a price reporting agency, could sit better with some market participants:

"An exchange is a highly regulated entity and that could create the perception that it is more trustworthy or more reliable, and that there's some security in terms of the prices they produce.

"The price reporting agencies have one business model and obviously the SGX has a different business model. That would make them different; some participants might prefer one over another."

Meanwhile, derivatives contracts for the Singapore Sling have only chalked up two buy-and-sell trades, the first between European trading house Trafigura and Singapore-based Pavilion Gas on its launch date in late January.

Asked whether this reflects poor market acceptance, Mr Feer said market players usually prefer to be able to review a "substantial history" of a price index before committing to it, to ensure that it is robust and captures the appropriate price levels.

"Even if people think that a given price index is robust, it'd take some time before you would see widespread adoption," he told BT. "It's not necessarily an indictment of the marker."

In a separate report on Tuesday, SGX said that the active involvement of LNG market participants means that the industry has a stake in the reputation and eventual adoption of Sling for the use of trading.

"This methodology democratises price discovery, where power is shifted towards market participants who have intimate knowledge and understanding of real-time market dynamics."

In the report, SGX also noted that future LNG demand in Asia remains shrouded in uncertainty amid a supply glut, and that LNG's price competitiveness vis-a-vis other fuel sources, as well as policy decisions across the region, will be important swing factors.

SGX's head of commodities research, Adrian Lunt, and its oil, gas and power director, Cheong Jin Yu, wrote: "While there is clear potential for LNG to significantly increase market share in the Asian energy mix, the lack of genuine LNG pricing could in turn hinder the market's ability to compete effectively with other fuel sources for future demand."

Asian buyers have traditionally bought LNG with long-term contracts, using oil or western gas prices.

But oil and LNG prices have diverged significantly this year. SGX said that, as they continue moving apart on differing supply-demand prospects, strains on existing oil-linked pricing mechanisms are bound to intensify.

The SGX report said: "The traditional oil-linked pricing model has essentially decoupled price from both demand and cost in the LNG market, which, over time, could result in the build up of significant supply-demand imbalances in LNG. Ultimately, the persistence of oil-indexation in LNG may merely be setting the stage for a crash scene at a later date."

This article was first published on September 23, 2016.
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