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.