Analysis: First Chinese gas contracts linked to international LNG prices signal oil-gas decoupling continues

Singapore — Two pipeline gas contracts agreed this month by Chinese buyers and an international energy major could kick-start a trend of gas-on-gas pricing in the country as the disconnect between oil and gas fundamentals continues, market sources said July 30.

China's Foran Energy signed a regasified natural gas or RLNG contract with BP for the pipeline delivery of up to 600,000 mt over two years on July 21, according to local media reports. The deal finalizes the RLNG contract from an earlier announcement made on April 20. The contract price was linked to the JKM, the benchmark price for spot LNG in Northeast Asia, with a premium attached, although further details could not be verified, according to multiple trading sources.

This comes after BP and ENN signed a deal on July 9 for a similar 300,000 mt/year of regasified LNG for two years via the Guangdong Dapeng LNG terminal, in which BP holds a 30% stake. The deal was widely heard to have been linked to JKM as well, with an approximate premium of $2/MMBtu.

While trucked LNG sales are mostly sold on a spot basis in China, domestic pipeline gas is typically sold on a contract basis with fixed volumes over certain durations. These contracts are typically not linked to any price indices such as Brent or JKM, but are determined on a flat price basis that fluctuates according to seasonality, competitors' prices and city gate prices.

They are also regulated by government agencies like the National Development and Reform Commission under a state-guided pricing mechanism to ensure that gas prices remain competitive.

While pipeline gas contracts based off LNG prices are a new phenomenon in China, there have been instances in other Asian markets. India's Oil and Natural Gas Corporation has previously signed gas supply contracts for 750,000 cu m/d -- 100,000 cu m/d with Hindustan Petroleum Corporation Limited and 650,000 cu m/d with GAIL -- linked to Platts West India Marker, or WIM. Downstream consumers of gas in east coast Australia have also been known to link contracts to JKM.

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Multiple trading sources based in China said the ENN deal was the first time an RLNG contract was priced against an international LNG benchmark.

"Most contracts in China are based off the portfolio cost of the imported LNG [combined long-term and spot volumes], with an additional $2/MMBtu for tolling and regasification fees, which would be typically more expensive than JKM itself since many term contracts had previously been priced against Brent or JCC," a Singapore-based trader said.

A term cargo delivered in July against a Brent-linked contract of 13.5% slope would cost $3.942/MMBtu, while the JKM for July averaged $2.063/MMBtu, a spread of $1.879/MMBtu.

Several Chinese end-users noted that the signing of JKM-linked contracts could be a new trend in the domestic market, especially with JKM languishing at record low levels due to demand destruction amid the global coronavirus pandemic.

The JKM has averaged at $2.817/MMBtu to date in 2020 as of July 28, almost half of the average at $5.591/MMBtu for the same period last year.

"Since these deals have kicked off, other companies will start considering using JKM as well, for short-term contracts," an end-user based in East China said.

"JKM is preferred for new contracts in a market where supply exceeds demand," a source with a Chinese national oil company said.

More sellers would also be open to spot market-based pricing in the global LNG market as buyers gain negotiating power in the oversupplied market, market sources said. This meant that buyers could have a greater say in what pricing basis could be used in their supply contracts. "Sellers may still prefer oil-linkage for contracts, but since it is a buyers' market now, buyers have greater negotiating power," an end-user based South China noted.

The source mentioned added that it could also be beneficial to sellers of downstream gas contracts in terms of cost and profit analysis if a seller imports LNG mostly from the spot market. The decoupling of oil-linked and LNG contract pricing had become increasingly evident, with this disconnect expected to persist.

However, major domestic gas suppliers like the Chinese national oil companies may not follow suit as most legacy contracts are oil-linked and their portfolio cost of imported LNG would typically add up to be considerably more than spot prices, sources said.