Snapping a Crude Link

America’s gas renaissance could spell cheaper gas for energy-starved economies even in Asia
Energy
HENRY HUB This distribution point for a vast gas pipeline network in America has assumed global importance

The International Energy Agency’s latest World Energy Outlook report has brought cheer to energy-starved parts of Asia. For, among other things, it highlights a rising probability of natural gas evolving its own pricing mechanism—finally severing its traditional link with crude oil prices.

The report speaks of plentiful global reserves of gas, likely to last for well over two centuries. This was common knowledge. What comes as reassurance for Asian economies is the prospect of getting it cheap, thanks to its abundance in the US, where companies have mastered the art of extracting unconventional shale gas. America’s recent spurt in gas output is expected to lower prices of this natural resource elsewhere on the globe as well. The US has its own price discovery model, the Henry Hub, a trading platform for domestic gas. Specifically, this is the New York Mercantile Exchange’s platform for contracts of gas futures, and it takes its name from an actual distribution network hub in Lousiana. The point, however, is that Henry Hub prices are set by local demand and supply. They are not dictated by crude oil. This means that gas buyers in the US pay only a quarter of what buyers do in Asia, where oil-linked prices still prevail.

The price differential is so wide that America now plans to liquefy and export surplus gas to Asia. “Natural gas exports from the US and Canada could help erode oil-linked formulas in Europe and Asia,” agrees Bob McNally, president of Rapidan Group, a US-based energy consultancy, “We are already seeing this in Europe, where [Russia’s] Gazprom has sold some gas on a spot-linked basis [at a discount].” Oil-indexation has not been abandoned, but it is significant that discounts are being offered by suppliers to stay globally competitive. ‘Though no alternative pricing method has been established yet, the overall global tendency is to move away from oil indexation towards more flexible, or hub based pricing,’ says an IEA spokesperson, in an email response to Open.

But Asian buyers should resist over-optimism. As the IEA cautions, while oil-linked prices are very high, they tend to be more stable and predictable. Also, as McNally says, final independence of gas from oil depends on “shale gas going global”, which requires broader acceptance of hydraulic fracturing (or ‘fracking’, used to extract shale gas), a technique seen as eco-hazardous by many countries.

The IEA estimates the landed cost of American gas in India to be upwards of $10 per unit, which is more than twice what the country’s power and fertiliser sectors currently pay for Reliance’s KG Basin supplies. But if the price of KG gas is revised sharply upwards in 2014, when it is next due for a reset, American gas could prove cheaper.