Tokyo Gas signs gas deal linked to coal prices

  • In this Nov. 3, 2015, photo, smoke and steam rise from the smokestack of a coal-fired power plant near Ordos in northern China’s Inner Mongolia Autonomous Region. Tokyo Gas Co. has signed the first LNG contract linked to coal prices in what is believed to be the first deal of its kind, and China has cleared the way for 11 provinces to begin constructing coal-fired power plants even as it seeks cleaner fuel alternatives such as natural gas. (Photo/File/AP)

Natural gas is increasingly promoted as a cleaner-burning option to coal for power generation, and liquefied natural gas is the answer for buyers without access to gas pipelines. Which makes it ironic — but sensible in a competitive energy market — that a long-term LNG contract would be linked to coal prices.

Tokyo Gas this month signed a heads of agreement with Shell for a 10-year supply of LNG starting in 2020, at 500,000 tonnes per year. That’s about seven or eight full cargoes per year in conventional LNG carriers. Some of that supply — the companies are not saying how much — will be indexed to coal prices.

It appears it’s the first time a Japanese buyer is using a coal-based pricing index in an LNG contract, Reuters reported. The explanation is that Japan’s second-biggest LNG buyer is stepping up its efforts to diversify supply sources and pricing while it works to reduce costs.

The volume not based on coal will be priced to conventional gas- and oil-linked indexes, a Tokyo Gas spokesman said April 5.

Traditional oil-linked LNG pricing, which goes back decades, is roughly based on the energy-equivalency of gas to oil. Burn one or the other, the price is similar.

It’s the same logic for coal-indexed LNG pricing.

“Coal indexation in LNG contracts will be particularly relevant for Japanese buyers, not least because coal is an integral part of Japan’s power-generation mix,” Abhishek Kumar, head of analytics at Interfax Energy in London, told Reuters.

Integral and equal to gas in market share, the target for the country’s 2030 energy mix is 26 percent coal and 27 percent LNG, according to Japan’s Ministry of Energy, Trade and Industry.

“Coal remains the largest competitor to gas in the power sector in Asia. If the index is competitive, this could be an important step for enabling LNG and utilities to better compete with coal,” Nicholas Browne, a Wood Mackenzie analyst, told Reuters.

Coal-indexed LNG pricing is a smart “risk management strategy” for a company that competes with coal-fired generation, said Christopher Goncalves, chair of the energy practice at Berkeley Research Group.

The Tokyo Gas deal with Shell underscores how Asian buyers are pushing hard for price diversification, which will increasingly influence LNG contract negotiations and renegotiations, S&P Global Platts reported.

“We are in a stage of experimentation with non-oil indexation,” Craig Pirrong, professor of finance at the University of Houston, was quoted by Platts.

The traditional oil indexation is one of three fronts in LNG contracts on which Asian LNG buyers have pushed back in recent years. The other two being destination restrictions to prevent buyers from redirecting or reselling cargoes, and contract durations. Japan’s energy ministry has advocated for abolishment of destination clauses for years.

Asian buyers have also gained traction in cutting contract durations, with the market structure moving in favor of shorter-term contracts. Oil indexation, however, has been tougher to dislodge. The deal with Shell “is an example of diversification of pricing, in line with Tokyo Gas’ previously stated strategy,” Hiroshi Hashimoto, senior gas group analyst at the Institute of Energy Economics of Japan, told S&P Platts.

But some analysts see the coal-linked deal as not that big of a deal.

It’s a long-overdue step but unlikely to represent a major shift in the market, a Reuters’ columnist reported April 10.

Buyers and sellers could easily see oil market pricing, and it made sense over the years to stick with that proven formula to provide a reasonable level of revenue certainty for developers of multibillion-dollar LNG export projects, columnist Clyde Russell said: “Crude also made more sense than coal, given that 40 years ago the crude futures market was significantly more advanced — and still is — than the market for trading thermal coal.”

The Tokyo Gas deal makes sense in Japan, where LNG and coal are effectively competing fuels, Russell said. By linking the prices, Tokyo Gas can hedge against competitors that use coal for power generation. “While this recent innovation makes sense in Japan, it may not have too much relevance in other countries in the region,” the April 11 column said.

Spot-market pricing or short-term deals linked to LNG or natural gas indexes are likely to hold more appeal outside Japan than coal-indexed pricing, Russell said. Those other pricing mechanisms offer enough flexibility and don’t require strong knowledge of the workings of coal markets.

Regardless whether the Tokyo Gas deal with Shell is a trendsetter or just an outlier, coal still is a big player in Asia’s energy mix. China has decided to allow 11 provinces and regions to resume building coal-fired power plants. It’s a clear sign that the world’s largest energy user is far from finished with the most-polluting fossil fuel.

Bloomberg News reported April 19 that China’s National Energy Administration forecasts that the 11 provinces — which previously had been labeled as overcapacity for power generation — no longer have too much capacity and can now start adding new coal plants.

The decision underscores how dependent the world’s second-largest economy still is on coal, Bloomberg reported, even as China invests hundreds of billions of dollars in cleaner energy sources such as natural gas, wind turbines and solar panels.

And while coal’s share of China’s energy consumption fell slightly last year, the volume of coal burned increased as the country’s total energy demand grew.

China is not alone in keeping coal around. Pakistan has fired up its first major power plant fueled by one of the world’s 20 largest coal reserves, the country’s Thar desert, S&P Global Platts reported. The new power plant will allow coal to compete head on with imported LNG in the country’s power mix.

Pakistan has battled severe power shortages for years and expects to ramp up the share of coal in its electricity mix to 30 percent by 2030 from as little as 1 percent in 2014, driven mainly by its Thar coal fields, S&P Platts reported.

Larry Persily is a former Alaska journalist, state and federal official who has long tracked oil and gas markets and projects worldwide.

04/24/2019 - 8:14am