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Analysis: Pakistan warns LNG importers against oil-linked contracts

Highlights

Competition watchdog advises importers to renegotiate contracts

Recommends alternative pricing indexations like NBP, HH, JKM

Singapore — Pakistan's competition watchdog has advised domestic LNG importers to renegotiate their long-term contracts, and warned them against crude oil price indexation, as the price disparity between oil-linked contractual supplies and prevailing LNG spot market values widens.

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The warning came as LNG spot prices have fallen below long-term oil-linked contract parity ahead of Asia's peak winter season, an unseasonal trend driven by comfortable Asian stocks, lower-than-expected Chinese demand and additional supplies from Ichthys and Corpus Christi, two new megaprojects that are ramping up right on time for the winter buying spree.

In a preliminary assessment issued last week, the Competition Commission of Pakistan (CCP) advised its domestic LNG importers to both renegotiate existing contract and revise their LNG supply negotiation strategies looking forward.

It invited stakeholders to consider alternative pricing indexations like NBP, Henry Hub and JKM, introduce floor and ceiling prices to protect buyers against oil volatility, and reduce the price review period from the current 10 years to lessen the disparity between contract and spot prices.

"The emergence of spot [benchmarks] and established gas hubs like Henry Hub and NBP has thrown a spanner in the works," a CCP spokesman told S&P Global earlier this week. "The JKM, although not a hub, does represent a potential option as far as pricing is concerned. Falling Asian spot market prices strengthen the case for indices like the JKM."

The recommendation follows an assessment aimed at identifying vulnerabilities and promoting competition in Pakistan's economic activity. The assessment concluded that there are barriers to competition across all levels of the LNG value chain.

NO RISK-FREE OIL LINKAGE

Since Pakistan's first contract with Qatar was signed in early 2016, the country's LNG importers have said that as long as LNG is priced at a low slope to crude oil, it would guarantee the competitiveness of LNG versus other oil products in the power sector -- LNG imports are part of the country's plan to change its electricity feedstock landscape by replacing gasoil and fuel oil with regasified LNG to reduce the country's electricity bill and improve its air quality.

But this argument has failed to acknowledge the inherent risk that the unpredictable disparity between oil and international LNG prices places on both buyers and sellers, especially at a time when pressure to liberalize gas and power markets in Asia is forcing LNG importers to prioritize price competitiveness and market risk over long-term supply security.

Long-term contracts signed on an oil-linked or gas-hub-linked basis create a disparity between expected delivered prices when the contracts are originally signed, and LNG market-based pricing when deliveries begin. This risk is exacerbated by Pakistan's acutely price-sensitive gas market, due to heavily regulated domestic prices and the financial weakness of its power distribution companies.

This issue is not exclusive to Pakistani importers. The risk of pricing LNG against a different commodity has resulted in numerous contract disputes between its neighboring Indian buyers and international suppliers QatarGas, ExxonMobil and Gazprom, as well as the high-profile price review arbitration case between South Korea's Kogas and Australia's North West Shelf earlier this year.

Pakistan has oil-linked term supply contracts worth more than 10 million mt/year with Qatargas, Italy's Eni, Shell and Swiss trader Gunvor.

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CCP also recommends more competitive tolling tariffs and port charges in order to increase the competitiveness of regasified LNG. Port Qasim charges $600,000 per vessel, while tolling tariffs are at $0.479/MMBtu for Engro Elengy terminal and $0.4177/MMBtu for Pakistan Gasport, which adds up to approximately $250,000/day.

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The study also urges gas transmission and distribution companies - SSGCL and SNGPL - to improve their distribution pipeline network for greater efficiency in the handling of regasified LNG.

The preliminary assessment is seeking comments from stakeholders and the general public before December 15.

Pakistan's LNG imports are expected to grow exponentially, from 4.9 million mt of LNG in 2017 to nearly 24 million mt/year by 2023, according to S&P Global Platts Analytics, as the country faces declining gas reserves and rising consumption.

--Abache Abreu, abache.abreu@spglobal.com

--Haris Zamir, newsdesk@spglobal.com

--Edited by Jonathan Fox, newsdesk@spglobal.com