The effects of Japan’s push for greater LNG market flexibility on LNG pricing and destination restrictions

Abstract

Two defining characteristics of the current liquefied natural gas (LNG) markets are increased diversification and fragmentation as they become more liquid. While Japan has traditionally sourced its LNG from long-term contracts with producers in the Middle East, it is now sourcing a greater amount of LNG intra-regionally. In parallel with shifts in sourcing, Japan is also now less reliant on long-term bilateral contracts, with more of its LNG purchases coming from short-term and spot contracts. Based on these trends, traditional bilateral contract provisions hinder liberalization by preventing the free-flow of LNG. Unsurprisingly, two recent developments in Japanese policy have sought to address this challenge, with a marked effect on traditional long-term contracting practices. First, Japan is moving away from crude-oil based pricing to more diverse LNG price structuring, rendered effective through changes in domestic gas and electricity markets. Secondly, Japanese purchasers are no longer accepting uncompetitive destination restrictions in their contracts. In short, supply security as a goal is best met by complementing long-term supply with a portfolio of short-term suppliers.