Will Japanese LNG futures be able to succeed?

Japanese government plans to launch the world first liquefied natural gas futures by the end of March 2015. It aims to cut Asian LNG prices that are currently set based on crude oil prices. Will the intention be achieved?

Japan imported 87.3 million metric tonnes of LNG in 2012, according to the customs data. Of which 60 million tonnes are bought under long-term contracts, therefore, about 27 million tonnes were urgently secured in order to make up for electricity supply shortage due to the nuclear outage.

World natural gas supply exceeded consumption by 49.2 million oil equivalent tonnes in 2011, according to BP. Since massive North American shale gas supply depresses gas prices in the region, Asian gas price are nearly four times higher than North American price.

However, does oversupply of natural gas also mean ample LNG supply as well?
Current global LNG supply capacity is at about 280 million tonnes per annum, while world LNG trade was 240 million tonnes in 2011, according to the International Gas Union. Utilization rate was 86%.

In 2012, Japanese LNG demand increased by 3 million tonnes on year, and demand by other consumers were also estimated higher. Meanwhile, growth of global LNG supply capacity is expected to be lower until 2015.

In other words, global LNG supply and demand are going to be tight.
In the global market, natural gas is oversupply, crude oil is in balanced supply and demand but LNG is in supply shortage in the near term. If pricing of LNG will be changed from current crude oil based scheme to LNG's supply and demand based scheme, Asian LNG prices might be more expensive.

On the other hand, LNG futures market on the Tokyo Commodity Exchange is unlikely to attract enough participants. TOCOM has failed to grow its Middle East crude oil futures. TOCOM crude oil futures have recorded sluggish trading since launched in 2001. Its daily trading volume is less than 5,000 contracts, that is far lower compared to more than 500,000 of NYMEX WTI's daily trading volume.

Japanese commodity futures market does not have enough appeal to attract investors. Its liquidity stays in very sluggish level, so financial institutes and hedgers are hesitant to use Japanese commodity futures market.

What will affect TOCOM LNG prices is not clear. There is a natural gas futures market on NYMEX, but North American gas market and Asian LNG market do not have enough direct relationship.

North American natural gas can be transported to Asia as LNG with the cost of $460 per tonne. However, it is just a theoretical calculation. Arbitrage trading will not occur without enough gas-liquefy and shipment capacity.

If TOCOM launches LNG futures within two years, prices could trace the crude oil market rather than NYMEX natural gas. Japan's average crude oil import price that is currently used for Asian LNG price benchmark will be likely to continue affect LNG futures.

Japan accounted for only 3.3% of global natural gas consumption in 2011, according to BP. Chinese consumption was also only 4.0% of global demand. East Asia has not been a major player in the world gas market yet compared to the US and Russia.

But LNG market is dominated by those minor players -- Japan, South Korea, China and Taiwan. East Asia accounted for 60% of world LNG demand. Therefore, international interest in the LNG market is likely not so strong.

US crude oil imports to fall more on limited storage capacity

US Energy Information Administration recently reported that domestic crude oil production in the United States is expected to exceed imports by the end of this year.

Meanwhile, net petroleum imports in the US have been already less than domestic production since early February. The latest figures in the EIA weekly statistics showed net petroleum imports fell below 6 million barrels per day compared to 7.15 million bpd of crude oil production.

Since petroleum demand in the US is the lowest level in the past 20 years, the country's dependence on imported petroleum is getting smaller.
Net petroleum imports by China are quite close to the US, Chinese buying seems to be bigger than the US in the near future.

The reason of decreasing US petroleum imports is of course higher crude oil outputs in the north America triggered by the Shale Revolution.
Increasing supply from Canada and North Dakota pushes up crude oil inventories in the US Midwest region. Current inventory level in the area is close to the  working storage capacity limit of 120 million barrels.

Crude oil stocks level at Cushing of Oklahoma reached to above 51 million barrels in early this year. The critical inventory level at the physical delivery point of NYMEX crude oil futures was close to the maximum capacity of 64 million barrel, and led Brent premium against WTI to over $20 per barrel.

However, crude oil inventory in the US Midwest has been close to the maximum level. Therefore, absence of further increase of Midwest inventory level is likely to limit Brent premium against WTI in the future.

On the other hand, current working crude oil storage level at the Gulf of Mexico region is about 270 million barrels. The latest inventory level of 180 million barrels is 67% utilization. It is much higher level compared to 53% as of the end of September 2012.

Crude oil supply from Canada and domestic inland oil fields that are not able to store in the Midwest region are being sent to the Gulf of Mexico area through the Seaway Pipeline. As long as domestic petroleum demand does not recover significantly, the US is likely to reduce crude oil imports into the Gulf of Mexico region further in order to avoid the inventory to reach the critical level.

China's Jan-Feb energy demand is slowing down

Although energy demand surged in the fourth quarter 2012, the consumption has been slowing down significantly since the beginning of this year.
Crude oil processed by Chinese refineries in January-February rose 3.0% on year to 1 million barrels per day, according to the National Bureau of Statistics.

The processing volume still remained above the 1 million bpd level, however, the growth rate was lower than 3.7% that is the average of 2012. Moreover, the January-February growth was much lower than 8.1% which was scored in Q4 2012.

Electricity output shows similar tendency. Power generation by Chinese utility firms in the first two months was 757.3 billion kilowatt-hour. The year-on-year growth was 3.7%. It was slower than the 2012 average of 4.7% and significantly lower than the last Q4 average of 8.1%.

Meanwhile, the National Bureau of Statistics says the country's industrial output rose 9.9% on year in the January-February period. The growth value is close to the average of 10.0% recorded both in whole year 2012 and the last Q4.

Since electricity cannot keep in stock like petroleum, slow growth of power demand seems to show recent actual lower demand of energy in China.
 Is China able to achieve 7.5% growth of gross domestic product as planned?

Is natural gas able to ease China's air pollution?

Consumption of natural gas is rapidly growing in China. Year-on-year growth of natural gas demand in 2012 was 12.8%, much higher than below 5% of coal and petroleum. It was tenth consecutive two digits growth.

Since coal and petroleum are said to be causing recent severe air pollution, growth of environmental friendly natural gas use may ease the problem.

China is anticipated to keep increasing natural gas consumption in the future, while the International Energy Agency estimates the country has the world biggest shale gas reserves of 1.3 quadrillion cubic feet.

However, it is not so simple matter.
First, despite the higher growth rate, current gap of consumption amount between coal and natural gas in China is still far wide.

The below chart converts each fuels amount into tonne oil equivalent. It describes that coal consumption in 2012 was 12.8 times bigger than natural gas and petroleum was 3.3 times larger than gas.

In China, nearly half of coal is estimated to be used for electricity generation. Thermal power is account for 80% of the nation's total electricity supply, hydroelectricity supplies 15% and nuclear etc provide rest of 5%.

Most Chinese thermal power plants burn coal. On the other hand, natural gas is account for 55% of Japanese thermal power plants' fuel, petroleum is 20% and coal is burned to generate 25% of total power supply.

Because of existing big difference of usage between coal and gas in China, it is quite difficult to shift thermal power fuel to natural gas immediately.

Majority of Chinese thermal power plants are constructed recently in order to meet surging electricity demand. It also seems to make power companies hesitate to change their facilities.

The following chart shows trends of electricity and coal demand in China. Consumption in 1995 was set at 100 and the lines indicate every year's growth. The chart suggests that efficiency of coal consumption to generate power is improving year by year. It is likely to be due to install of advanced facilities.

Since fuel efficiency directly affects on costs, Chinese utility firms seems to pay much efforts, but environmental measures which reduce profits do not attract their attention.