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Natural Gas Market & Pricing

Natural Gas Market

There is currently a long-term trend towards a more integrated and inter-related global gas market due to LNG becoming more abundant and affordable. In essence, the abundance of new upcoming natural gas supply, combined with the flourishing LNG industry, are transforming the natural gas market, and adding to its growth and diversification with new trading routes and importers.

Natural gas is traded globally in both pipeline and liquid forms, on a spot, short-term, mid-term and long-term basis. The natural gas trade is mainly structured along existing and planned transportation and storage capacities. European, North American, and Central and South American have already developed and amortised most international pipeline networks. Due to geographical constraints, the Asian market gas trade is pre-dominantly seaborne. Moreover, the global natural gas market consists of several regional segments that are not connected by pipelines. 

The four main regional gas markets are Asian, European, North American, and Central and South (Latin) American. There are significant economic barriers to a free flow of natural gas molecules between those regions due to the marginal costs to transport natural gas in liquid form from one regional pipeline system to another.

How is the Natural Gas priced?

Historically, the only method to determine the price of natural gas exports was long-term take-or-pay bilateral sale and purchase agreements (SPAs) between producer and consumer, which were indexed to crude oil and oil products to guarantee a return on investment in complex and costly transportation and storage infrastructure. On a national level, most governments have regulated natural gas prices (tariffs) based on functional use, type of customer and region. 

As the gas industry developed with the introduction of LNG trade, the number of producers and consumers has been increasing in national and international markets. Since then, new forms of gas trade, contracting and pricing emerged. 

The gas is traded on spot basis in the U.S., based on Henry Hub (HH) gas hub, while in Europe it is traded mainly using the virtual gas hubs such as the National Balancing Point (NBP) in the UK and Title Transfer Facility (TTF) in the Netherlands, which is the main European hub allocating over two-third of all relevant trades.

The most widely used gas price formation mechanisms are as follows:

  1. Oil Indexation: the gas price is linked to crude oil or oil products with provision for the base price and escalation clauses. This pricing mechanism is most often used for international gas trade, especially in LNG. 
  2. Gas-on-Gas Competition: the gas price is determined by the dynamics of supply and demand within a defined market, typically a virtual gas hub.
  3. Regulated Gas Pricing: the gas price is set by the regulatory body using a non-market approach (such as "cost plus"). This mechanism is widely used in domestic markets. Price regulation is often segmented by customer type and demand sector (i.e. domestic vs industrial use) to boost national competitiveness and/or support the social wellbeing of the population. 
  4. End-Product Netback Pricing: the gas price received by the gas supplier is linked to the products which the buyer is producing and is typically applied when the gas is used as a raw material e.g. fertilizer production.
  5. Hybrid pricing. Complex formulas to price natural gas are increasingly used in international gas trade to apply additional flexibility. The components can include prices for substitute energy products, such as crude oil and oil products, coal and electricity, as well as relevant gas market price indices (such as HH or TTF).

One important feature of natural gas markets is the lack of long-term storage capacity with the most developed infrastructure used only to balance seasonal consumption patterns. Along with persistent liquidity constraints, this makes the spot natural gas markets prone to sharp swings in price that can only be mitigated by gas exporters providing the security of supply.

What are the major uses of Natural Gas?

  1. Electric power generation.
  2. Space and water heating in residential and commercial sector as well as other applications like cooking.
  3. Energy fuel for furnaces and boilers in a variety of energy-intensive and manufacturing industries.
  4. Feedstock for gas-to-chemicals, petrochemicals, fertilizer plants etc.
  5. Blue hydrogen generation – a relatively new gas demand centre due to nascent trend to use low-carbon hydrogen for decarbonising hard-to-abate sectors.
  6. Land and marine transport, particularly a fuel for natural gas vehicles in the form of CNG/LNG and the use of LNG as a bunker fuel.

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