LNG Price

NATURAL GAS PRICING GENERAL THEORY AND APPLICATION Page 1 of 16
NATURAL GAS PRICING GENERAL THEOR

AND APPLICATION
Afshin Javan
Senior Expert LNG Marketing and Sales (NIOC)
Introduction-
Natural gas occupies an important position in the international energy world. Like oil, and other
commercial fuel.
This situation will create specific status for gas pricing in next decade.
There is no “World Price” of natural gas but we will see gradually the pricing system for LNG
has been transparent.
Although there must be “An Environmental Premium” attached to gas that is a cleaner fuel
than oil or coal and which is excluded from this study, energy planners should include a
relative environmental costs and Social benefits of gas in project appraisal.
In most cases in gas suppliers; developing countries, systems of producer pricing and taxation
have been borrowed from the oil industry that becomes an obstacle to gas development.
I believe make the price formula is art and different in each country and will complicated
gradually.
In developed countries structure of pricing formula is very important and calculated according
to cost of project but in developing countries Economic price of any good-gas included is
determined by the intersection of its aggregate demand and supply curves and this is concept
of the Open Access Market and this is confliction between two different pricing system.
Framework of gas pricing includes major participants in gas production in upstream side, midstream and
distribution among end users in downstream side.
Upstream gas pricing formulas are discussed to develop minimum supply price Economic
downstream gas pricing normally faced by both social and market forces in developing
mk:@MSITStore:E:\congress.chm::/HWC1400_1.htm 2/24/2004
countries where major gas reserves exist Like Suth Pars in South part of Iran.
Gas tariff system in applied different countries is discussed where three schools can be
followed: cost plus, market value or price of displaced fuel. Challenges for bringing gas pricing
to economic level are shown and discussed. Finally concept of natural gas planning is
illustrated to reach economic and satisfactory prices to all parties concerned.
In this paper I will try introduced bellow part:
1- Pricing Literature for Natural Gas
2- Gas and LNG Pricing formula and international trade
3- Conclusion
1- Pricing Literature for Natural Gas and LNG
There are various method for calculation of gas pricing in the world, in more countries usually
gas or LNG projects are defined integrated and the pricing will be exercised for value chain; in
other word according to commodity sales and purchases considered pricing formula clause.
The pricing article in FOB or CIF mode for Gas or LNG sales and purchases agreement is the
key issues when we explain about pricing formula means the method for pricing and it is not
the single way.
I would like more than explain about this subject; really the negotiation factor is important for
getting best price and these tolls is other key issue.
In negotiation the pricing formula will be adjusted by seller and buyer and create dual profit and
this is the concept of price optimization and that must be acceptable by lender for project
finance.
As above short explanation I would like classified subject of matter:
a- Pricing for Gas or LNG in Integrate Projects -
In this method directly calculate overall project cost and use difference-pricing formula for
calculation.
In this method according to final calculation and with regards to net back method will obtain
feed gas price.
But the main formula for pricing defined for final consumers.
You can observed this case for more LNG producers around the word.
b- Pricing for Gas or LNG in non-Integrate Projects-
In some countries like Iran the concept of gas pricing is different.
The main factor for creating of this situation is relate to contractual concept as you know NIOC
shall be considered Buy-Back contracts for Up-stream and for mid-stream considered Joint
Venture Contract (JVC).
In this situation we must think for two type pricing formula; the first one is related to feed gas
price and will discus in Gas Sales and Purchases Agreements (GSPA) and second one is gas
or LNG sales price that will be considered in LNG sales and Purchases Agreement (LNGSPA).
Gas pricing can be a complex and controversial subject.
Its complexities comes from an array of different considerations in gas value chain:
A- Gas Supply Side:
(i) Setting producer prices high enough to tempt the risk takers into exploration, production,
primary treatment (Sweetening) and compensation of project cost.
(ii) Creaming off some of the resource rent for the government and this is the royalty concept.
(iii) Finding equitable transfer prices between gas producers and utilities or LNG or GTL plant.
As explained in above this part is critical point for LNG and GTL projects in Iran.
B-Gas Demand Side:
(i) Devising complex tariff structures to reward large consumers for shifting off peak.
(ii) Protecting small consumers from monopoly exploitation by the utility.
The whole chain of prices, from the gas explorer to the small consumer, must reflect, and
properly distribute, the economic gains from gas development.
Prices set by a central authority are generally based implicitly or explicitly, on three sets of
objectives.
(a) Efficiency of resource allocation, economic efficiency requires that the real cost of energy to
the society is reflected in the prices that guide the decisions of producers and consumers of
that energy. When this principle is violated, energy consumption can rapidly get out of hand,
particularly that of industrial and other large consumers.
(b) The satisfaction of specific financial targets, a financially viable gas utility is one that has
the capacity to finance, through its own resources and its ability to service borrowing, the
expansion of its operation in line with the development of the market. It is usually possible to
devise a set of tariffs whose structure satisfies efficiency criteria and whose average level
meets the financial needs.
(c) Consideration of social welfares, this may be conflicting with previous objectives and may
lead to contradictory results. So it is important to review the relative suitability of gas
tariffication as a tool to achieve each of the three objectives.
Subsides should be the last recourse to correct the deficiencies of direct income transfer
mechanisms and must be rigorously limited in order to safeguard the objective of financial
viability.
The overriding criteria for gas pricing should be economic efficiency the first step in setting or
changing gas prices is to determine the economic price of gas in the particular country or
region on question the economic price of any good-gas included is determined by the
intersection of its aggregate demand and supply curves.
For many goods, that value is simply the price resulting in an open market place through the
bargaining of many buyers and sellers. For goods that are traded internationally such as oil or
wheat, the economic price in a small country is often determined almost independently of the
local demand and supply conditions. Unfortunately there are many reasons why the economic
price of gas generally cannot be so easily observed:
(i) It is not widely traded commodity owing to its high transport costs involved.
(ii) it is not a perfect substitute for all petroleum products, so the fuel oil equivalent price of gas
is not always an appropriate short-cut estimate for the economic price of gas.
(iii) in domestic markets for gas, political and economic factors have generally led to price
regulation because of monopolistic production and distribution.
(iv) it is delectable commodity so depletion premium has to be included in the
opportunity cost.
In developing countries which is owner of large gas reserves, there are many differences
between domestic and international gas pricing policy and I believe the liberalization in gas
markets like EU and US is not good solver for confliction and only consider customer side.
With regards to new changes in gas market it is necessary consider some adjusted clauses in
gas contracts like Profit Sharing …
International gas pricing need international cooperation between Buyer and Seller and this is
the concept of commercial issue in international gas industry.
In South east Asia and specially Japanese case sellers were also concerned about the impact
of the escalating cost of LNG and tackled cost problems vigorously. Today there is
considerably more realism about what prices will be acceptable for new LNG contracts, and
engineers, contractors, and technologies have essentially risen to the cost challenges so that
now there are several new supply sources prepared to offer LNG to the markets at no more
than a modest premium to current price terms. However, because investors in some projects
are clearly concerned about maintaining adequate cash flows during periods of low oil prices,
new LNG projects have departed from traditional pricing formulae by incorporating protections
from low oil prices through floor prices and “S” curves (which exchange reduced downside risk
for a loss of some upside opportunity).
Generally, LNG purchasers’ unwillingness to pay excessive premier has
FIGURE 1 -PRICE COMPARISON IN THE 3 MAIN LNG MARKETS
dovetailed with the increased competition between projects that has emerged over the last
three years. However, we do expect buyers to accept the reality that some projects will need
revenue protection.
2- Gas and LNG Pricing formula and international trade
What is the LNG or Gas price drivers?
(i) Natural gas supply and demand balance

(ii) Infrastructure and market size
(iii) Alternative competing fuels:
(iv) competing source of gas
(v) Seller’s need guarantee of off-take and payment
(vi) Feed gas supply and cost
(vii) Destination characters
(viii) Need for bank ability
Of course there are many other elements that could effect on pricing formula but I will try
introducing some important element.
Above elements are good tools for negotiators for decision-making.
According to these elements the primary shape of the pricing formula will recognize.
We can classify pricing formula in different region:
(i) “Traditional” mode of price that applied in Japan and other Asian Pacific
countries the structure of this formula is:
P=B X JCC + A
B the real variation with the crude price (the Slope)

JCC Japan Crude Cocktail in $/bbl 1-3 months before the month in which the price is
calculated
An Intercept
FIGURE 2- LNG new pricing and contractual trends in ASIA: a case of an S-Curve in Japan
–In Asia LNG is substitution energy for crude oil or oil products
(i) Contracts are signed for large volumes, by important single buyers (Kogas, TEPCO...) or
groups of buyers
(ii) Those buyers are monopolies on their market. Their main objective is to secure volumes.
They are prepared to carry most of the price risk.
(iii) A typical LNG price in Asia:
P = 0.1485 * JCC + b + S
(V)
–The trend is to decrease the price level in relation to crude. But, buyers do not generally ask
sellers to share the downstream market price risk. Price reviews applicable only to b and S.
(Vi) Sellers are only exposed to a typical Crude price risk for LNG in Asia.
At present in Asian Pacific region according to new changes in market the consumers specially
Japan look for new pricing formula with high flexibility that character of this methodology are:
Contract extensions for shorter duration
9 Indonesian contracts have been extended, respectively for 11, 8 et 5 years
Extension of Malaysia-I contract currently under negotiation, with a part of the volumes on
a short term basis (3 to 5 years).
Preference for FOB contracts
9 Indonesian contracts have long been the "FOB exception"
9 Gas companies show a definite interest and have ordered tankers
Part of Malaysia-I extension volumes being negotiated on a FOB basis
9 .
Operational tolerance, free destination
9 Decrease of Take-or-Pay obligation through annual reduction entitlement
9 Price incentives for optional volumes
9 Case by case relaxation of destination clause allowing cargo resale
I would like with regards to importance Japan LNG market more explain about it.
LNG was originally priced in Japan (1969-1973) on what amounted to a cost plus basis, even
though such pricing did not render LNG visibly competitive with other fuels. Prices in the early
Japanese LNG contracts were fixed, unindexed prices. When oil prices rose, however, the
Japanese buyers allowed LNG prices to rise as well, although they were not contractually
obliged to do so. If therefore remained attractive to develop new LNG supplies and producer
governments remained content with the pricing of exported gas reserves. For a long period of
time, LNG-delivered prices were essentially at thermal parity with crude oil prices. When oil
prices fell in 1966, the newer LNG projects, particularly the Australian project, which had been
constructed in the expectation of CIF (cost, insurance, freight i.e. a delivered price) LNG prices
of around $7/MMBTU, were put in some difficulty (although none was threatened with
collapse). After several years of discussion, Japanese LNG buyers generally began to accept
that LNG should be priced a premium (initially around 10%) over thermal parity with crude oil
prices.
The contract prices that were entered into following the drop in oil prices in the late 1980s and
early 1990s, although not all expressed exactly in this form, can be reduced to the following
simplified formula:
P = 14.85 JCC +A
Where P is the price in US cents/MMBTU and JCC (or the “Japan Crude Cocktail” which
represents the weighted average delivered price of the top 20 crude’s by volume imported into
Japan) is in dollars per barrel.
The level of 'A' varied from contract to contract, with newer projects farther from the LNG
buyers having slightly higher prices. Malaysia’s a was 77 cents (though the new MLNG Dua
secured both an 'a' and an additional B). Australia’s 76.8, Abu Dhabi’s 698, and Indonesia’s
(CIF) 59 (although Indonesia always had a different formula, similar to Qatar gas and Ras
Laffan). Brunei and Alaska were 14.65 JCC + 61 and 57, respectively. This was the state of
play in late 1992.
The effect of this standard formula is to give an increasing premium over crude parity at lower
oil prices and a diminishing one at higher oil prices. At around $30/barrel (depending on a) the
formula results in LNG prices that are at parity with crude oil prices. Indonesia has
subsequently achieved steeper slopes, moving the crossover point to higher levels on new
contracts. A straight conversion to crude oil prices would require no and a slope of about
17.25.
The greater the slope, the more upside with high crude prices and, conversely, the more
downside with low crude prices.
The new Indonesian slope is about 15.45, which results in delivered LNG prices being above
crude parity until crude oil reaches a price of around $ 53 per barrel.
In the early 1990, however, there was an honestly and strongly broadcast view by sellers that
CIF LNG prices would have to rise by a dollar or more above the $3.30/MMBTU to
$3.50/MMBTU range that was considered “standard” in order to make new high cost projects
viable. At the time, there were fewer potential new projects than there are today, and much
emphasis was given to the very high cost Natuna project in Indonesia. Japanese buyers were
particularly concerned about this trend and made a significant planning switch away from new
LNG-fired generating plants towards coal-fired generating plants. Japanese buyers made it
clear to the supplying community that such high LNG prices were not realistic. In the light of
LNG’s actual value for new power stations, higher prices might have not been such a problem
for power buyers had they not had a fear that even one new supply at a significantly higher
price would generate demands from existing suppliers to have a similar pricing. The prospect
of sharp ratcheting up of all LNG prices for the sake of one extra supply was too alarming
(ii) “Indonesia” LNG Price formula:

price indexed partly to inflation element and typically 90% relate to oil and 10% relate to
inflation.
P=P0 x ( R1 X REP/REP0 + R2 X RP1/RP0)
P0 Base price in certain date

REP Indonesian realized Export price in $/bbl 1-3 months in which the price is
calculated
REP0 base Indonesia realized export price
RP1 Agree inflation index
RP0 Base inflation index
R1 & R2 Weighting applied
A Intercept
(iii) “European “ LNG Price formula:
In Europe LNG is a diversification energy: LNG has to compete with pipe gas from Norway and
Russia.
9 As pipe gas, LNG is indexed on Oil products, coal, and inflation.
9 Consequence of pipe gas competition : prices are lower than in Asia
9 Before the EU directive for gas markets deregulation, LNG was imported by
large monopolies (GdF, ENAGAS…) under classical pricing terms.
FIGURE 3- Europe: LNG prices versus pipe gas prices
9 Since the EU directive many new players are trying to enter the LNG business in
Europe.
9 Power Utilities, or Gas Commercialisation companies targeting to sell to eligible

customers.
9 Purchase smaller volumes : approx 1 Bcm
Do not control their market and have few suppliers, è are not prepared to carry the
entire price risk. They negotiate different price terms to share the market price
risk with sellers:
in this type of formula basket of indices: e.g. Brent, fuel oil , gas oil, inflation and coal and
indexation is based on average – great stability ,but there are lags to market.
The price reviews periodic.
Two type of formula applied in Europe :
First one is Multiplicative model:
P= P0 X (R1X A/A0 +R2 X B/B0+R3XC/C0 +…)
The second one is Additive model:
P= P0 + R1X A/A0 +R2 X B/B0+R3XC/C0 +…
P0 Base price I certain date
A,B,C Moving average prices of oil products or other agreed indices
A0,B0, C0 Base price for the above
R1,R2,R3 Weightings applied to each the above
According to new changes in European market , the European costumers seek net back
calculation method and proposed this method to traditional supplier like Algeria and Russia.
This method according to the LNG project cost probably creates some difficulty for Middle-
East new players.
(V) “USA” LNG price formula:
This formula linked quoted Henry Hub prices.
P=B X HH +/_ A
B rate of variation with the gas price
HH Quoted Henry Hub price at agree date
A Intercept
4- Conclusion-
Pricing is art and this is the precisely activity.
Pricing needs enough time for thinking about different elements for making index and needs
deep study.
Gradually the status of gas increase in consumers energy basket and this is good reason that
we will see in near future price transparency for this commodity and I believe the relation
between Crude oil and other Fuels index decreased.
Probably the Net Back calculation pricing has been good way for getting transparency but at
present could not effective help for new suppliers.
In Middle east Grass root LNG and Gas Projects the Cost compensation is the first aim and
this is logical way for project economy.
Goals of Gas Pricing Policies are to ensure efficiency of resource allocation,
satisfaction of specific target beside consideration of social equity.
Characteristics of Natural Gas as different from liquid crudes and fuels imply its pricing policy
for satisfaction of specific target beside consideration of social equity.
Economic Level of Gas Pricing should be followed to encourage gas exploration and
development. Especially it is an effective way for energy conservation.
We can summarized Key issues as in bellow:
1-The changes in gas market will be happened and create new concept in gas business:
a- Short and mid term contract
b- More flexibility for distance and pricing formula in gas contracts
c- Independency to crude
2- Improvement for international project need more cooperation between gas producer
and gas consumer.
3- with regards to liberalization in market there are some possibility for establishment of gas
union in gas supply for price protection.

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NATURAL GAS PRICING GENERAL THEORY AND APPLICATION Page 1 of 16

NATURAL GAS PRICING GENERAL THEOR

Senior Expert LNG Marketing and Sales (NIOC)

In this paper I will try introduced bellow part:

1- Pricing Literature for Natural Gas

2- Gas and LNG Pricing formula and international trade

1- Pricing Literature for Natural Gas and LNG

As above short explanation I would like classified subject of matter:

a- Pricing for Gas or LNG in Integrate Projects -

b- Pricing for Gas or LNG in non-Integrate Projects-

In some countries like Iran the concept of gas pricing is different.

Gas pricing can be a complex and controversial subject.

A- Gas Supply Side:

B-Gas Demand Side:

(ii) Protecting small consumers from monopoly exploitation by the utility.

properly distribute, the economic gains from gas development.

(iv) it is delectable commodity so depletion premium has to be included in the

Generally, LNG purchasers’ unwillingness to pay excessive premier has

FIGURE 1 -PRICE COMPARISON IN THE 3 MAIN LNG MARKETS

2- Gas and LNG Pricing formula and international trade

What is the LNG or Gas price drivers?

(i) Natural gas supply and demand balance

B the real variation with the crude price (the Slope)

(iii) A typical LNG price in Asia:

Contract extensions for shorter duration

9 Indonesian contracts have been extended, respectively for 11, 8 et 5 years

Preference for FOB contracts

9 Indonesian contracts have long been the "FOB exception"

9 Gas companies show a definite interest and have ordered tankers

Part of Malaysia-I extension volumes being negotiated on a FOB basis

Operational tolerance, free destination

9 Decrease of Take-or-Pay obligation through annual reduction entitlement

9 Price incentives for optional volumes

9 Case by case relaxation of destination clause allowing cargo resale

(ii) “Indonesia” LNG Price formula:

P=P0 x ( R1 X REP/REP0 + R2 X RP1/RP0)

P0 Base price in certain date

(iii) “European “ LNG Price formula:

9 As pipe gas, LNG is indexed on Oil products, coal, and inflation.

9 Consequence of pipe gas competition : prices are lower than in Asia

FIGURE 3- Europe: LNG prices versus pipe gas prices

9 Power Utilities, or Gas Commercialisation companies targeting to sell to eligible

9 Purchase smaller volumes : approx 1 Bcm

The price reviews periodic.

Two type of formula applied in Europe :

First one is Multiplicative model:

P= P0 X (R1X A/A0 +R2 X B/B0+R3XC/C0 +…)

The second one is Additive model:

P= P0 + R1X A/A0 +R2 X B/B0+R3XC/C0 +…

P0 Base price I certain date

A,B,C Moving average prices of oil products or other agreed indices

A0,B0, C0 Base price for the above

R1,R2,R3 Weightings applied to each the above

(V) “USA” LNG price formula:

This formula linked quoted Henry Hub prices.

B rate of variation with the gas price

HH Quoted Henry Hub price at agree date

Pricing is art and this is the precisely activity.