Japan’s liquefied natural gas industry, the world’s largest, is starting to move away from using crude oil-linked contracts and is instead partially pricing agreements to US gas quotes – a critical step towards the creation of a truly global natural gas market.

Until now, the global natural gas market has been largely split into isolated regional hubs, with prices at different levels and little trade in between.

The shift in Japan comes as many of the country’s existing LNG contracts, which date from the 1970s and 1980s, are set to expire over the next decade, providing importers with a rare opportunity to renegotiate the terms of the supply agreements.

Kansai Electric Power last month became the latest buyer to sign an innovative long term agreement where LNG prices are linked to daily settlements at Henry Hub in Louisiana, the US gas futures pricing point.

Kepco’s move, which could lead to a 30 per cent reduction in LNG import costs, follows similar deals by Japanese utilities including Tokyo Gas, Osaka Gas and Chubu Electric Power and trading houses Mitsui, Mitsubishi and Sumitomo.

“These agreements will help Japanese utilities reduce their fuel costs,” Bob Takai, head of energy at Sumitomo, one of the country’s top trading houses, told the Financial Times.

The move away from oil-linked contracts is already well under way in the European gas market, where German utilities in particular have demanded more flexible prices and contract terms from Gazprom, the Russian gas producer. Javier Diaz, analyst at gas consultants Bentek Energy, said: “Asia can learn lessons from Europe.”

Gazprom has been forced to de-link its prices from the oil market, lowering cost for Germany’s Eon and RWE, Italy’s Eni, and France’s Gaz de France, and Poland.

US natural gas prices had dropped this year to the lowest levels in a decade, fluctuating around $3 and $4 per million British thermal units, because of booming production on the back of the shale revolution. But the price that Japanese importers paid for cargos of LNG – supercooled gas turned into a liquid so it can be shipped – has remained high at about $16 to $17 per mBtu because most of the 30-year-old contracts are linked to the price of oil.

The shale gas boom in the US has freed up supplies of natural gas in the country and Washington is now weighing up whether to allow limited LNG exports. The latest US government-commissioned study, which concluded the economic benefits of unlimited gas exports would be worth the costs, could accelerate approvals for export projects.

With the push among both European and Japanese to negotiate more flexible gas contracts, the link to US natural gas prices is going to accelerate, said Tilak Doshi of the Energy Studies Institute in Singapore. “Convergence [among regional markets] will happen a lot faster than people expect,” he says.

In the medium term, assuming that US natural gas prices will rise to about $5 per mBtu, Mr Takai believes that gas prices, including LNG, could “eventually converge to about $10-$12 per mBtu”.

Additional reporting by Ben McLannahan in Tokyo

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