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NATURAL GAS PRICING IN AN UNCERTAIN WORLD

A Presentation to Spring Conference of the Association of International Petroleum Negotiators

New Orleans, Louisiana1 May 2009

JAMES T. JENSEN Phone (781) 894 2362 Jensen Associates Fax (781) 894 9130

49 Crescent Street; Weston, MA 02493 U.S.A. E Mail [email protected] Website JAI-Energy.com

THERE ARE NOW FOUR MAJOR REGIONAL GAS PRICING PATTERNS THAT INFLUENCE WORLD

GAS TRADE

They are: North America, the U.K., the European Continent, and Northeast Asia

China and India, Gas Importers with Both Pipelin e and LNG Options, Have Not Yet Developed Consistent Pricing Patterns of Their Own

The Four Major Regions Differ in Their Sources of Gas Supply, Their Reliance on Contracts, and the Extent to Which They Have Liberalized Their Gas Industries

These Factors Have Had a Strong Influence on Price Behavior

THE STRUCTURE OF THE GAS INDUSTRY HAS DEVELOPED MUCH DIFFERENTLY FROM THAT

OF THE OIL INDUSTRY

Two Gas Industry Characteristics are Largely Responsible for the Differences

First, Because Investment in Gas Transportation is Both Highly Capital-Intensive And Front-End Loaded, it Has Relied Heavily on Debt Financing

This Has Usually Required Long-Term Contracts, Both to Guarantee Debt Service and to Share Project Risk Between Buyer and Seller

Second, Despite the Fact That Petroleum Exploration and Development are Not Inherently Monopolistic, Gas is Most Commonly Transported Through Piping Systems, Which Exhibit Strong Natural Monopoly Characteristics

As a Result, Gas Transmission and Distribution Have Traditionally Been Regulated, Either as Public Utilities as in the U.S. and Japan, or as Government Monopoly Companies as in the U.K. or France

For Countries Whose Gas Supply Was Domestic, as Was the Case in the U.S., Canada or the U.K., Downstream Regulatory Jurisdiction at Some Point Raised Issues of Potential Government Price Intervention Upstream

Countries Relying on Imports for Supply Had Little Jurisdiction Over Upstream Pricing and Pricing Terms Were Negotiated Between Buyer and Seller

IT IS THIS DISTINCTION - HISTORIC SUPPLY RELIANCE ON DOMESTIC SOURCES OR ON

IMPORTS - THAT PROBABLY MOST CLEARLY DEFINES CURRENT REGIONAL PRICING

PATTERNS

Importers Have Traditionally Relied on Long Term Contracts Negotiated Between Buyer and Seller; Most of These Contracts Still Remain in Force

The Old Adage, "The Buyer Takes the Volume Risk and the Seller Takes the Price Risk", Led to Take-or-Pay Clauses for Buyers and Price Escalation Clauses for the Sellers

Because of the Limited Influence Importing Governments Had Over Pricing, Early Price Negotiations Between Buyers and Sellers Established Price Precedents

When the First LNG Contracts Were Negotiated with Japanese Buyers, Japanese Power Generation Was Heavily Dependent on Oil Firing, Crude Oil as Well as Heavy Fuel Oil

The Early Pricing Clauses Tied Price Escalation to Crude Oil Prices - The Japanese Customs Clearing Price for Crude Oil - JCC or "The Japanese Crude Cocktail"

This Precedent Was Adopted by Korea and Taiwan, as Well as Some Chinese Contracts

And Although There Have Been Some Modifications Over Time, the Precedent Remains for Northeast Asia and Has Been Hard to Break

Continental European Pricing Precedents Were Effectively Set by the Netherlands in its Pricing Policies for Domestic Gas from its Super Giant Groningen Field in 1962

At the Time the Dutch Government Established a Policy That Gas Should be Valued at the Prices of the Fuels It Competitively Displaced

Thus the Price Escalation Clauses Were Tied to Market Based Percentages of Light Fuel Oil Together With High and Low Sulfur Heavy Fuel Oil and Transferred to the Pricing Clause by Means of "Pass Through Factors"

In Somewhat Modified Form, These Patterns Were Adopted for Export Contracts

While the Percentages Have Changed and Newer Escalators are Being Introduced - Coal, Electricity Pool Prices - These Pricing Patterns Largely Remain in Force on the Continent Today

Thus Long Term Contracts Are Still Common in Both Northeast Asia and in Continental Europe and are Still Largely Tied to Oil Prices

Pricing in Those Countries That Developed Their Gas Industries Based on Domestic Supplies - The U.S., Canada and the U.K. - Developed in a Very Different Way

All Three Governments Had Intervened in Wellhead Pricing Decisions at Some Point

The U.S. Experiment With Price Controls Created Severe Gas Shortages in the Early 1970s Since They Provided Price Signals to Consumers That Stimulated Demand but Were Inadequate to Provide the Necessary Supply

Although the Issue of Price Deregulation in the U.S. was Politically-Charged, Congress Finally Set the Country on the Course of Gas Industry Liberalization with the Natural Gas Policy Act of 1978

This Was Designed to Let "Gas-to-Gas" Market Competition Establish Gas Prices; Market Liberalization in Now Widely Under Way Throughout the World

Canada Adopted its Liberalization Policies in 1985 and the U.K. Launched Similar Policies by First Privatizing British Gas in 1986

THE FACT THAT THE THREE GOVERNMENTS COULD DIRECTLY ABANDON THEIR PRICE INTERVENTION POLICIES SIMPLIFIED THE

TRANSITION

But the Process Was Far From Painless

In All Three Countries, Governments Effectively Abrogated a Number of Long Term Contracts with Comparatively Inflexible Price and Volume Terms

This Led to Substantial Financial Turmoil With a Number of Bankruptcies or Near Bankruptcies

But When the Turmoil Subsided, the Industry Entered its New Environment With a Relatively Clean Slate

TO BE SUCCESSFUL, GAS INDUSTRY LIBERALIZATION ENTAILS FOUR

PRECONDITIONS

There Must Be Competitive Gas Available to the Market

Customers Must Be Free to Choose Among Suppliers

The Transmission System Must be Open to Shipment by Competitive Suppliers ("Open " or "Third Party Access")

And Pipeline Access Must Be Non-Discriminatory

ALL FOUR STEPS HAVE BEEN SUCCESSFULLY ACHIEVED IN THE U.S., CANADA AND THE U.K.; SHORT TERM COMMODITY TRADING HAS NOW LARGELY REPLACED LONG TERM CONTRACTING

THERE WERE THREE COMMON EARLY ASSUMPTIONS ABOUT A LIBERALIZED GAS INDUSTRY IN GAS-TO-GAS COMPETITION

The Pricing of Other Energy Sources, Such as Oil, Was Largely Irrelevant

The Traditional Long Term Contract With its Oil Price Linkage Could Not Survive Since One Could Not Sell Oil-Linked Gas in a Commodity Market Priced Below Oil

And the Growth of Interregional Gas Trade, Both by Pipeline and as LNG Would Soon Spread Gas-to-Gas Competitive Markets Throughout the World, Thereby Undermining the Traditional Contract System

SO FAR, THE GAS INDUSTRY HAS FAILED TO FOLLOW THAT SCRIPT

THE ONE ASSUMPTION THAT HAS PROVEN TRUE IS THAT LNG WOULD SPREAD GAS PRICE

SIGNALS THROUGHOUT THE WORLD

The Traditional Long-Term Contract Was Comparatively Rigid, Linking Buyer and Seller Often With Dedicated Tankers

It Might be Described as a "Fixed Destination" Contract

LNG Markets are Now More Destination-Flexible and Cargoes Can Go to Markets That Provide the Best Netbacks

There are Several Ways in Which Trades Achieve Destination Flexibility

There is a Small, But Growing Short-Term Market

Some of These Short Term Volumes Come From Capacity That Has Not Yet Been Committed on Contract

But More of the Short Term Volumes Result from the Increasing Flexibility that Buyers and Sellers Have to Divert Gas From Long Term Contract Commitments

Sellers May Utilize Volumes During the "Ramp Up" Period of a Contract or Divert Released Buyer Volumes

But Buyers are Increasingly Negotiating Diversion Rights in Their Long-Term Contracts

Figure 1

SHORT-TERM [1] TRADING IN LNGMMT

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

0

50

100

150

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Million Tons

Short TermContract

2.5%

7.5%

11.6%

19.8%

[1] Including Contracts of Three Years or Less

BUT EVEN GREATER FLEXIBILITY IS PROVIDED BY THE TREND TO WHAT MIGHT BE CALLED

"SELF CONTRACTING"

It is Increasingly Difficult to Find Customers in the Liberalized Markets Who Can Commit to the Volume Obligation Without Protecting Themselves with a Gas Market Price Indicator, Such as Henry Hub in the U.S. or the National Balancing Point (NBP) in the U.K.

But Since Buyers Can so Easily Resell Unwanted Volumes Without Loss in a Liquid Trading Market, Their Risk is Reduced; Risk has Migrated Upstream to the Sellers

The Response of Sellers is to Take the Contractual Obligation on Themselves - Self Contracting - Aggregating a Number of Supply Sources and Marketing Directly to Ultimate Customers

For Example, The First Three Trains of Nigeria's Bonny Project Were Traditional Fixed Destination Contracts Written by the Venture, NLNG, with European Buyers

But Trains 4 and 5 Have Contracted with Shell and Total, Two of the NLNG Partners, Which are Now Free to Take Their Volumes Anywhere They See Fit

Self-Contractors Reselling is What Used to be Called a "Warranty Contract", Which Got a Bad Name in the U.S. When a Major Company Could Not Deliver on its Commitments and Was Forced by the FPC to Honor its Obligations with Expensive Gas

Self Contracting Flexibility is Most Pronounced in the Atlantic Basin Where the Liberalized North American and U.K. Markets Predominate

In the Traditional Long-Term Contract, the Buyer Knew Where His Gas Was Coming From and Assumed the Geological and Geopolitical Risk

But in Self-Contracting, Those Risks are Now Assumed by the Aggregating Seller

The Level of Buyer Protection is Different in North America and the U.K. With Their Large Pool of Domestic Gas Than it is for Buyers Solely Dependent on LNG Imports

Buyers in These Markets Must Concern Themselves with the Quality and Diversity of the Suppliers' Portfolio

Thus it is Not Clear that Import-Dependent Markets Will be as Willing to Go the Self-Contractor Supply Route

Figure 2

REGIONAL CONTRACT COMMITMENTS - 2007TRADITIONAL FIXED-DESTINATION CONTRACTS VERSUS FLEXIBLE

DESTINATION VOLUMESMMT

Atlantic Basin

Middle East

Pacific Basin

0 10 20 30 40 50 60 70 80

BCM

Net Contracted [1] NorthAmericaNet Contracted [1] EuropeNet Contracted [1] AsiaDiverted To [2] NorthAmericaDiverted To [2] EuropeDiverted To [2] AsiaSelf ContractedUncommitted

These Volumes are Destination-Flexible

[1] Contract Commitments Stil Dedicated to Market in Qyestion[2] Volumes Committed on Contract But Diverted to Another Market

BUT THE ASSUMPTION THAT LNG TRADE WOULD UNDERMINE OIL-LINKED PRICING

IN TRADITIONAL CONTRACTS HAS NOT WORKED OUT

The Early Price Behavior of Both North American and U.K. Markets Appeared to Confim Those Early Price Expectations

Since Both North America and the U.K. Liberalized When They Had Substantial Supply Surpluses, They Experienced Severe Producer Price Competition and Their Gas Prices Were Indeed Well Below Those of Oil

But Both Regional Commoditized Markets Have Shown that, in Shortage, Interfuel Competition Sets Prices That May be Indirectly Linked to Oil After All

THE DECOUPLING OF OIL AND GAS PRICES IN SURPLUS AND THE RECOUPLING DURING SHORTAGE IS ECONOMICALLY RATIONAL

Economic Theory Outlines the Behavior of Price to Changes in Supply and Demand

But for Gas, Demand is a Function of Its Market Share in Interfuel Competition and Thus is Sensitive to Competitive Fuel Prices Such as Oil

Short Term Demand Can be Quite Inelastic - With Volatile Pricing - When Oil Has Been Displaced From Dual-Fired Boiler Markets, and Relatively Elastic - With Stable Pricing When Limited Gas Supply Forces Dual Fuel Customers to Switch to Oil

Figure 3

THE THEORETICAL BEHAVIOR OF SUPPLY, DEMAND AND PRICE ACCORDING TO "ECONOMICS 101"

Increasing Volume

Increasing Price

Supply Increases With Price

Demand Decreases With Price

Market Clearing Price

Market Clearing VolumeJensen

Increasing Ratio of Gas Prices to Oil Prices

Figure 4

A MORE REALISTIC SHORT TERM GAS SUPPLY/DEMAND CURVEA MARKET IN GAS-TO-GAS COMPETITION

Increasing Volume

Inelastic Premium Demand

Elastic Gas Demand in Competition with Residual Oil in Switchable Boilers

Inelastic Load Building

Inelastic Short Term Supply

In Surplus, Oil and Gas Prices Are Decoupled - Resulting in "Gas-to-Gas" Competition - Prices Are Volatile

The "Cusp" Where Gas Prices Become Decoupled from Oil

Discounted Prices

Jensen

Increasing Ratio of Gas Prices to Oil Prices

Figure 5

ANOTHER SHORT TERM GAS SUPPLY/DEMAND CURVE - TWO MARKETS WITH GAS-TO-OIL COMPETITION RESTORED

Increasing Volume

Inelastic Load Building

Oil and Gas Prices Still Coupled But With Higher-Priced Distillate, Rather Than Residual Fuel, Competition

Oil and Gas Prices Recoupled - Resid Prices Set a Cap On Gas Prices - Prices May Be More Stable But Are Exposed to Oil Price Risks

1

2

Elastic Gas Demand in Competition with Residual Oil in Switchable Boilers

Elastic Gas Demand in Competition with DistillateOil in Switchable Boilers

Inelastic Short Term Supply

Inelastic Short Term Supply 1

2

1

2

Jensen

Both the U.S. and U.K. Recent Experience with Oil and Gas Prices Illustrate the Economic Driving Forces on Price

Both Regions Started With Decoupling, But Both Have Experienced Prices that are Higher Than Oil Prices

Both Regions Have Been in Gas-to-Gas Competition and Thus in a Position to Threaten the Oil-Linked Contractual Markets with Price Competition, But Recently Oil Prices Have Fallen Faster Than NBP in the U.K.

There is Also Seems to be Decreasing Liquidity in the NBP Market, Suggesting Less Decoupled Gas-to-Gas Competition in the Future, Now That the U.K. is a Net Importer from the Continent

Figure 6

HENRY HUB GAS PRICES RELATIVE TO WTI CRUDE OIL PRICES (THREE MONTH MOVING AVERAGE)

Jan

91

Jan

92

Jan

93

Jan

94

Jan

95

Jan

96

Jan

97

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99

Jan

00

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09

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

$16.00

$18.00

$20.00

$22.00

$/MMBtu

Henry Hub

WTI PricesThe Gas "Price Shock" of 2000/2001

Hurricane Katrina

The "Gas-to-Gas" Competitive Period

"Gas-to-Gas" Competition Returns

Oil Linkage

Average Percent of WTI Jan 91/Nov 00 - 63.5% Feb 03/Dec 05 - 92.0% Jan 06/Dec 08 - 59.1%

Figure 7

THE RELATIONSHIP BETWEEN BRENT CRUDEOIL PRICES AND U.K. GAS PRICES AT THE NATIONAL BALANCING POINT (NBP)

(THREE MONTH MOVING AVERAGE)

Jan

01

Jan

02

Jan

03

Jan

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Jan

05

Jan

06

Jan

07

Jan

08

Jan

09

$0.00

$2.50

$5.00

$7.50

$10.00

$12.50

$15.00

$17.50

$20.00

$22.50

Price - $/MMBtu

Brent Crude $/MMBtu

NBP $/MMBtuThe U.K. as a Net Gas Exporter is in Surplus "Gas-to-Gas" Competition

New Pipelines and LNG Terminals Restore Surplus and "Gas-to-Gas" Competition Returns

The Transition to Net Importer

Brent Now Dropping Faster Than NBP

THE ORIGINAL CONTRACT LINKAGES BETWEEN OIL AND GAS PRICES HAVE BEEN MODIFIED IN BOTH NORTHEAST ASIA AND

EUROPE TO LESSEN THE IMPACT OF OIL PRICE VOLATILITY

In Northeast Asia, This Has Largely Been Through Price Caps and "S Curves" That Limit the Price Response in Times When Oil Prices Fall Outside Set Limits

At High Prices These Have Had the Effect of Decoupling Oil and Gas Prices and Have Been Contested by Suppliers Who Argued - Before the Recent Price Collapse - that High Oil Prices are the New Norm

The Price Decoupling Allowed Northeast Asia to Cross-Subsidize Spot Cargo Purchases of LNG in Competition with Atlantic Basin Customers

In the Recent Seller's Market, Suppliers Have Been Trying to Renegotiate the S Curves Out of Existing Contracts Where They Have the Leverage to Reopen Them or Take Them to Arbitration

An Exception Has Been Some of the Australian Contracts Where Suppliers Want to Retain Floors to Protect a High Cost Structure

But it Appears That Many of the S Curves Have Been Removed, Ironically Just as Oil Prices Have Collapsed

Figure 8

AN "S CURVE" ILLUSTRATEDBASIC SLOPE - 0.1485, PIVOT POINTS @ $25 AND $50

10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100

Oil Price - $/BBl

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

$9.00

$10.00

$11.00

$12.00

Gas Price - $/MMBtu

Basic SlopePivot Point

Moderated Slope

Pivot Point

Figure 9

THE DECOUPLING OF JAPANESE LNG AND CRUDE OIL PRICES THROUGH "S CURVES" AND PRICE CAPS AT HIGH OIL PRICES

(JCC) - A COMPARISON OF OIL AND LNG PRICES INCLUDING SPOT CARGOES FROM THE ATLANTIC BASIN

$0.00

$2.50

$5.00

$7.50

$10.00

$12.50

$15.00

$17.50

$20.00

$22.50

Price - $/MMBtu

JCC $/MMBtu

Total LNG$/MMBtu

Spot LNG$/MMBtu

"S Curves" and Price Caps Decouple LNG and JCC Prices

'S Curves" and Price Caps are Being Negotiated Out, Oil Prices are Now Falling Faster Than Gas Prices

Spot Cargoes from the Atlantic Basin Priced Near or Above Oil

Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09

The Principal European Price Moderators Have Been a Reduction in Pass Through Factors (a Reduced Percentage of the Oil Price Change Passed Through to Gas) and the Lag Times Between Observing and Applying Oil Price Escalators

But the Effect in Both Market Regions Has Been to Change the Linkage Between Oil and Gas Prices

Thus the Price Advantage Has Not Always Been in Favor of the Commoditized Markets, and it Has Proved Difficult for Them to Undermine the Traditional Contract System

The Fault Line Between the Two Systems - Liberalized Commodity Trading and Contract-Dependency - Lies in the English Channel Between the U.K. and the Low Countries and at the Atlantic Regasification Terminal Outlets on the Continent

Figure 10

BRENT CRUDEOIL PRICES COMPARED WITH GERMAN AND SPANISH BORDER PRICES

(THREE MONTH MOVING AVERAGE)

Jan

01

Jan

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Jan

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$0.00

$2.50

$5.00

$7.50

$10.00

$12.50

$15.00

$17.50

$20.00

$22.50

Price - $/MMBtu

Brent Crude$/MMBtu

German Border$/MMBtu

Spanish Border$/MMBtu

Reduced Pass Through Factors Together With Lags and Some "S Curves" Decouple Border Prices From Oil Prices

Now Oil Prices are Falling Faster Than Gas Prices

OVER THE PAST DECADE PRICING AND CONTRACTING BEHAVIOR HAS BEEN SHAPED BY THE MOVE TO MARKET LIBERALIZATION

AND THE RAPID GROWTH OF LNG TRADE

During the Period LNG Markets Have Functioned in an Environment Which Has Included:

The Acceleration of LNG Growth Rates Under the Influence of New Atlantic Basin Demand From North America, Spain and the U.K.

The Inability of LNG Liquefaction Capacity to Keep up with the New Demand, Leading to Chronic Shortages and High LNG Prices

The Impact of High Gas Prices on Demand and on Domestic Supply, Squeezing the Requirement for Interregional Gas Trade

The Dramatic Increase in Oil Prices

WHAT HAS NORTH AMERICA LEARNED FROM THE EXPERIENCE?

The Early Assumption - "All You Need is an LNG Terminal and You're in Business" - Has Been Frustrated by Chronic Supply Problems

The Attempt to Apply Traditional Contracting to a Liberalized Market Substituting Henry Hub for Traditional Oil Indicators Doesn't Seem to Work - Most LNG Supply Will be Marketed as a Part of Self-Contracting Major Companies' North American Supply Portfolios

And Nearly Everyone Has Been Surprised by the Magnitude of the Market Response to Price - Particularly for Non Conventional Gas Supply

WHAT HAS THE U.K. LEARNED FROM THE EXPERIENCE?

The Early Assumption - "The Startup in 1998 of the Interconnector, the Pipeline Linking the U.K. and Belgium Would Export U.K. Surpluses and Gas-to-Gas Competition to the Continent and Force Liberalization" - Hasn't Really Worked Out

While There Has Been Some Price Competition in North Europe, the Difficulty of Acquiring Third Party Access to Pipeline Capacity and the Overhang of Inflexible Contracting Has Limited the Price Effect

And Now That the U.K. Has Become a Net Importer, Will the U.K. Still be the Aggressive Price Setter or Will its Prices be Influenced by Continental Contracting Patterns?

WHAT HAS THE CONTINENTLEARNED FROM THE EXPERIENCE?

The Early Assumption - That the Enthusiastic Embrace of Gas Market Liberalization by the European Community Would Quickly Force Europe to Follow the Lead of North America and Europe - Has Also Moved Very Slowly

Not All European Governments Have Been Eager to Abandon Government Monopolies and Local Regulation

And No One Seems to Have the Authority Nor the Stomach for the Contract Abrogation Which Opened up U.S., Canadian and U.K. to Spot Market Competition

And So, Long-Term Contracts, Usually with Oil Linkage, Still Dominate Continental Gas Markets

WHAT HAS NORTHEAST ASIALEARNED FROM THE EXPERIENCE?

Northeast Asia's Long-Standing Dominance of World LNG Trade Has Been Challenged by the Emergence of Atlantic Basin Demand and the Chronic Shortages of LNG Supply

Northeast Asia's Preference for Crude-Oil-Linked Long Term Contracts (JCC) Looked Dangerous When Oil Price Levels Rose Dramatically, But Some of the Damage was Contained by S Curves and Other Price-Capping Clauses

And Just as Those Protective Clauses Are Being Negotiated Out, the Collapse of Oil Prices Has Spared the Region Further Damage

But What Happens to the Oil Price Linkage in the Longer Term After the Recession Ends?

WE ARE NOW ON THE VERGE OF A SUBSTANTIAL UPHEAVAL IN WORLD GAS AND

LNG MARKETS

The Lagging Startup of New LNG Liquefaction Capacity is Finally Catching up to Demand, Which Would Have Created LNG Surpluses Even Had Market Growth Continued as Expected

But the Financial Recession Has Sharply Reduced Worldwide Gas Demand Growth as Industry and Power Generation Have Been Adversely Affected

And in the U.S., One of the Most Significant Changes is the Somewhat Surprising Growth of Unconventional Shale Gas, Which Has Substantially Increased Domestic Production (Up 7.8% in 2008) and Backed Out LNG

Since North America was Expected to be a Major Growth Market for LNG, the Increased Domestic Production Has a Severe Impact in Expected Future LNG Demand

In LNG, it Has Long Been Assumed That the U.S. is "the Importer of Last Resort"

So What Happens to North American - and Atlantic Basin - Pricing When You Pour Additional LNG into a Market That is Already in Surplus?

We Thus May be On the Verge of a Price War in Which Surplus LNG and Surplus U.S. Domestic Supply Face Each Other in a Liberalized Market with "Gas-to-Gas" Competition

SO WHAT MARKET ENVIRONMENT IS LIKELY TO SHAPE PRICING AND CONTRACTING IN THE

NEXT SEVERAL YEARS?

North American Prices Have Been Well Below Oil Parity Levels for the Last Several Years (59% of WTI Since Early 2006); If Anything, They Will Go Lower Still With the Addition of Surplus LNG

Prices in the Oil-Linked, Contract-Dependent Market Have Been Largely Insulated from North American Price Weakness by a Combination of Tight LNG Supplies and Panic Buying in Northeast Asia

Both of Those Elements are Now Gone and Oil Prices Could Well Recover Before Gas Prices

LNG Cargo Arbitrage Might Then Place Substantial Stress on Traditional Oil-Linked Contracting

PRICES IN THE COMMODITIZED MARKETS OF NORTH AMERICA AND THE U.K. SHOULD

REFLECT GAS-TO-GAS COMPETITION

IN NORTH AMERICA - Price Weakness May Well Continue Until a Combination of the Falloff in Drilling Activity and Field Decline Restores Market Balance

But What Will be the Longer Term Impact on Supply from a Period of Reduced Activity?

IN THE U.K. - The Export of North Sea Surpluses Has Caused Price Competition in North Europe

Now that the U.K. is a Net Importer, Will Atlantic Basin LNG Arbtrage Exported Via Pipeline be Able to Perform a Similar Role?

BUT THE CONTRACT-DEPENDENT MARKETS SHOULD NOW BE FULLY EXPOSED TO LNG PRICE ARBITRAGE PRESSURES - HOW WILL

CONTRACTING RESPOND?

ON THE CONTINENT - Spain's Fully-Liberalized Market Will be the Most Vulnerable But Northern Europe Remains Exposed Through North Sea Pipelines and Increasing LNG Import Capacity

The Extent to Which Other Continental Markets are Affected Will be Determined in Part by How Rapidly the European Community's Push Towards Liberalization Proceeds

But the Inherent Conflict Between Traditional Oil-Linked Pricing Clauses and a Weakened Atlantic Basin LNG Cargo Market Should Finally be Joined

IN NORTHEAST ASIA - For Some Time the Region Has Been the Driving Force in World LNG Pricing

The Emerging LNG Surplus Changes All That at a Time When the Many of Asia's Protective Limits on Oil Prices Have Been Removed

Japan's "Nightmare Scenario" - After the Recovery, Oil Supply Limitations Finally Drive Oil Prices to High Levels as Gas - and LNG - Pricing is Increasingly Decoupled from Oil

Or Will a Failure to Invest in New LNG Capacity During the Downturn Take the Pressure off LNG Competition?

Is the Linkage to JCC Still Viable?

IN CONCLUSION

For Some Time Gas-to-Gas Competitive Commodity Markets in North America and the U.K. Have Coexisted with the More Rigid Oil-Linked, Long-Term Contract Markets on the Continent and Northeast Asia

The Early Assumption of Those Who Favor Liberalization - That International Gas Trade Would Force Liberalization on Traditional Contract-Dependent Markets and Create a World-Wide Commodity Market - Has Not Really Developed

A Combination of Market Conditions - Rapid LNG Demand Growth and Constrained LNG Supply - Has Restricted the Challenge that Commodity Pricing Potentially Poses to Traditional Contracting

But Those Conditions are Now Changing with an Emerging LNG Surplus

Even If the Surplus is Short-Lived, it Will Pose Problems for Traditional Contracting

But it is Apparent That the Long-Term Contract for New LNG and Pipeline Projects Refuses to Die

The Challenge - Adapting Contract Pricing Terms to the World of International Price Arbitrage