Executive Summary
Almost every LNG conference has on its agenda nowadays the topic of Asian LNG Trading Hubs, and a number of reports have also been published in the last few years. The most advanced hub initiatives are in Singapore, Japan and China. However, each of these locations faces its own set of challenges, and none has so far been successful in establishing market-based gas pricing in Asia, or a trusted pricing benchmark for the global LNG market. Henry Hub in the US and NBP and TTF are held up as examples, but will an Asian LNG trading hub be myth or reality?
The purpose of this paper is to see what might be required to develop a LNG trading hub and if that cannot be easily achieved are there alternatives and if so, what they might be. The paper’s key takeaways are as follows:
• Gas hubs first developed in the US market, operating as physical locations, where multiple pipelines intersect, with Henry Hub being the most famous in the US. In Europe, NBP and TTF are now the most liquid trading hubs, often described as “virtual” hubs, but in essence they are little different to Henry Hub. NBP and TTF are both products of the physical gas transmission systems in the UK and the Netherlands respectively, just as Henry Hub is the product of the physical Sabine Pipeline. All these markets had significant domestic production and gas storage facilities.
• The key prerequisite in the development of the pipeline hubs was the creation of a competitive wholesale natural gas market. In order for the hub to develop, the key elements relate to non-discrimination, through regulated third-party access on the pipeline, and the standardisation of the contractual arrangements for both pipeline transportation (in the US the gas transportation agreements and in Europe through Network Codes) and for the sale and purchase of gas. The contractual arrangements at the hub make it very easy to trade physical gas without actually needing to deliver it.
• On the back of the physical hubs, gas futures markets developed on NYMEX (for Henry Hub) and on the IPE (now ICE) for NBP. The key to a successful futures market is to have an underlying liquid physical market to which the futures market is inextricably linked, and it can bring in a lot of financial players.
• The level of liquidity at hubs is often measured by the churn rate – the volume of trades divided by actual physical flows in the relevant geography. The UK and Dutch churn rates are both over 20 while in the US it is over 60 – all well above the level deemed necessary for a liquid trading market.
• A final key element in the development of hubs is price reporting. Price reporting by the industry to price reporting agencies (PRAs) began as market liberalisation started and even before hubs were properly established and well before futures markets linked to the physical hubs were set up. All the price reporting was actual trades, thereby increasing confidence in the accuracy and transparency of the reported prices.
• Much of the discussion concerning LNG hubs in Asia has focussed around China, Japan and Singapore. However, as yet, none of these countries have really developed a competitive wholesale natural gas market. China still has a long way to go in terms of separation of transport and commercial activities and introducing regulated TPA as well as reducing the level of government control. Japan requires a clearer separation of transport and commercial activities and solving the issue of integrating the network and introducing TPA. Singapore is the most liberalised market but is simply not a big enough domestic market with enough market players to create a truly competitive wholesale market and consequently a hub.
• Governments and regulatory authorities sometimes appear to believe that creating a trading hub will, of itself, lead to a competitive market and a reliable market price; overlooking the fact that the development of a trading hub is the outcome of the liberalization process rather than one of the requirements.
• The ability to create any sort of meaningful churn at a possible LNG hub in Asia Pacific would appear to be fraught with a number of difficulties because of the nature of the LNG market, not least the sheer size of a single cargo of LNG, and the uneven nature of deliveries – pipeline receipts and deliveries are by contrast continuous and almost instantaneous. There is also no clear geographic location in the region where traded LNG would automatically default to delivery if the parties to the trade wished to do so – this is a fundamental feature of pipeline hubs.
• If a true hub cannot be developed easily, that does not mean that a reliable price benchmark for LNG could not be developed. Numerous price benchmarks are available for LNG, especially in the Asian markets, from the main price reporting agencies. However, these benchmark assessments largely reflect possible bids/offers and/or participants views on what the price would be if a trade was done – this is often referred to a “market chatter” or “heards” as in heard on the street. A small futures market around JKM has been developed by ICE but this is a cash settled market and cannot go to physical delivery. Trades at the moment remain at very low levels, although it has grown rapidly in the last year.
• Instead of considering examples from the gas market, other markets, such as oil, might be considered. The Brent oil market developed in the 1980s with spot and physical forward market and then the futures market, directly linked through the settlement price and EFPs to the physical market. Many of the characteristics that led to the development of a liquid trading market for Brent crude are applicable to the LNG market, although Brent is not a hub as such, in the sense of the natural gas pipeline hubs. From the physical trading of Brent crude, a futures market was also developed by the IPE (now ICE).
• While there is no LNG hub as yet, there also does not appear to be a truly reliable price benchmark either, around which there is a lot of physical and futures trading. There are five key elements necessary to create a reliable price benchmark in LNG; these cover pricing transparency, market diversity and size, access to infrastructure, standardisation of contractual arrangements and a physical delivery point at which all trades could be delivered.
• Out of all the markets in Asia, Japan appears the most likely market in which a reliable price benchmark could be developed. METI is actively promoting pricing transparency and the market is large with reasonable diversity of players. Integrating the pipeline infrastructure for the whole of Japan may be a problem, but possibly much easier for Central Japan, where almost 80% of Japan’s LNG is consumed. Non-discriminatory open access to all the regasification terminals and the pipeline system would be required, preferably with all the infrastructure (regas terminals and pipelines) being combined in one system with an independent system operator. It may then be possible to trade LNG as it enters the storage facilities at each regas terminal, making it much simpler to introduce a short, standardised contract for “in-storage LNG”. The ability to trade smaller volumes should promote trading and improve price reporting and transparency, promoting a reliable price benchmark.
Introduction
Almost every LNG conference has on its agenda nowadays the topic of Asian LNG Trading Hubs. Governments, regulatory authorities, academics and market participants are all presenting on how a hub might be developed in Asia. There have also been a number of reports published in the last few years on the development of hubs in Asia.
The most advanced hub initiatives are in Singapore, Japan and China. However, each of these locations faces its own set of challenges, and none has so far been successful in establishing market-based gas pricing in Asia, or a trusted pricing benchmark for the global LNG market. Are the aspirations of these countries realistic? Is there a good understanding of what is required to create a hub? Adapting the concept of a gas hub—which developed in onshore locations with abundant pipeline interconnections in Europe and North America—and implementing it in the context of the global LNG market is challenging in its own right.
Much of the motivation for a hub seems to be premised on the fact that Henry Hub works in the US, NBP and TTF work in Europe so why not establish one or more in Asia and then we will have a market with prices determined by supply and demand . However, there doesn’t seem to be have been much detailed work published on what the real function of a hub is and what does it achieve, let alone whether there are alternatives which may be more realistic in the Asian LNG market.
The purpose of this paper is to assess whether an Asian LNG trading hub is a myth or reality. The author believes there is a need to go back to the basics of how pipeline hubs were formed in order to really understand if a LNG hub can be modelled on pipeline hubs This is reviewed and discussed in Section 1, which will consider existing hubs, where are they, how they work, what do they do and how were they formed? This section will also look at hub liquidity and price reporting which are key elements in the hub development process.
Having reviewed the existing hubs, we can turn our attention to what is, or is not happening in Asia, especially in respect of LNG. Section 2 will look at the progress on creating LNG hubs in Asia, focussing on China, Japan and Singapore, the possible motives of governments in wanting a hub and the progress on creating the necessary conditions for the development of a hub. In addition, the section will also consider how liquidity might be created in the LNG market.
If the development of a hub for LNG is not possible, then what might the alternatives be to promote trading and get reliable price signals. Section 3 will firstly review the many price references and benchmarks that have developed in recent years and consider how robust these are before exploring possible alternatives to an Asian LNG hub, including looking outside the gas market for examples, particularly in the oil market. The section will also look at the possible growth in spot and flexible cargoes and whether this might help promote trading.
Section 4 moves on to look at the prospects of creating a reliable price benchmark, which may or may not be linked to a hub, including the key elements required. It will also consider whether these key elements can be implemented in any Asian country, with a focus on Japan, which in the author’s view, has the greates potential.
Section 5 will cover the conclusions.
It is not the intention of this paper to repeat at length the excellent work that has already been done in this area nor to reinvent the wheel on all of this. However, we will draw on and reference relevant papers and reports, notably from the International Energy Agency (IEA) , the Oxford Institute for Energy Studies (OIES) and, more recently, the US Energy Information Administration (EIA) , since they cover comprehensively many of the fundamental issues to be addressed. We hope to go further, however, in considering alternatives to a LNG hub which would lead to a trading market and reliable and transparent pricing.
Existing Gas Hubs
What does a hub do and how do they work?
The concept of a hub is widely used in the airline industry with many airlines operating a hub and spoke operation. In the gas industry, hubs first developed in the US market, operating as physical locations, usually where multiple pipelines intersect, often close to storage facilities, and looked very much like the airline model. Henry Hub was one of the first hubs and is the most famous. This section will consider Henry Hub and how it works and then look at the UK’s National Balancing Point (NBP) and the Netherlands Title Transfer Facility (TTF), which are the primary European gas hubs.
Henry Hub
Henry Hub is owned and operated by Sabine Pipe Line LLC and its affiliates. It is actually one end of the Sabine Pipeline, which is a bidirectional mainline pipeline that stretches from Port Arthur, Texas, to the Henry Hub. It is an interstate pipeline that is certified as an open-access gas transporter, and it is directly connected to four industrial consumers and one producer. Henry Hub is interconnected to eight interstate and three intrastate pipelines. Henry Hub also has a direct connection to storage facilities. These facilities are salt-dome caverns characterized by high deliverability and high cycling rate, which allow for several withdrawal and injection cycles each year.
Henry Hub is shown, in a simplified schematic, below, showing the pipeline interconnections.
Figure 1 Henry Hub Schematic
Source: RBN Energy LLC
But, in reality, the pipelines are located significant distances apart and connect across the spaghetti bowl of pipelines that crisscross Vermillion Parish in South Louisiana. Figure 2, inside the circle is a more realistic representation of what the Henry Hub looks like – the blue dots are gas processing plants.
Figure 2 – The Real Henry Hub
Source: RBN Energy LLC
Second, for the same reason, the Henry Hub is not all at Henry, LA. In fact, the Henry gas processing plant shut down more than ten years ago, and the hub interconnects to Sabine are scattered across the area around Henry. Thus, the name Henry Hub is more a remnant of its origins and a concept, not a place where a lot of pipelines all connect at a single point. Despite the slight misnomer, the concept does still apply. The Sabine system really does provide interconnects to eleven pipelines designated the Henry interconnects: Columbia Gulf (CGT), Gulf South, Bridgeline Intrastate, NGPL, Sea Robin, Southern Natural (SONAT), Texas Gas, Williams/Transco, Trunkline, Arcadian, Jefferson Island Storage and of course Sabine. And Sabine continues westward, where it connects to another thirteen facilities in Louisiana and nine more in Texas . In addition, as Sabine Pipeline is bi-directional effectively gas delivered into Sabine from a connecting pipeline can be redelivered to any other interconnecting pipeline.
The transfer of gas from one pipeline to another via the Sabine Pipeline / Henry Hub is facilitated by Sabine Hub Services through their IHT (Intra-Hub Transfers) service . IHT is a non-jurisdictional accounting service used to track multiple title transfers of natural gas packages at a market center.
Any party wanting to trade gas through Henry Hub needs to apply to Sabine Hub Services for a IHT number which becomes that party’s unique identifier. After a party trades (buy/sell) natural gas at the Hub, its’ scheduler will submit a nomination to Sabine Hub Services via e-mail or by using the Online Nominations screen on the Sabine Hub Services web site. This nomination will detail all of the IHT purchases (upstream) transactions as well as the IHT sales (downstream) transactions. Each line item on the nomination will have an IHT counterparty number and a volume in Decatherms per day. The total of the upstream transactions will equal the total of the downstream transactions. All counterparties must balance their IHT (upstream = downstream) each day.
Any physical gas entering the Hub to a party’s IHT account must enter the hub via a pipeline transportation agreement. On the IHT nomination, the upstream transaction capturing this transportation of physical gas will detail the pipeline transportation agreement number as well as the volume. Any physical gas exiting your IHT account is "IHT-ed" to the downstream pipeline. On the IHT nomination, the downstream transaction capturing this transportation of physical gas will detail the name of the downstream pipeline point, the pipeline transportation agreement number which will pick up the gas, and the volume.
UK NBP
Unlike Henry Hub, which is a physical point on the Sabine Pipeline system and enables interconnections with multiple pipelines, the NBP or National Balancing Point is what is known as a “virtual” point. Figure 3 is a map of the UK’s gas transmission system, owned and operated by National Grid. The red lines show the gas transmission system and the black triangles the terminals, where pipe gas enters the system and the red squares are the LNG terminals both pipe and LNG, where gas enters the system.
National Grid in the UK operates an entry-exit system for booking and paying for transmission capacity and for the nomination and scheduling of gas flows. The system entry points are largely the terminals shown on the map, while the exit points are offtakes from the national transmission system to local distribution zones or to major offtakers such as power plants. The NBP is effectively the whole of the national transmission system since when gas enters the system it is effectively at the NBP until it exits the transmission system.
While Henry Hub and the Sabine Pipeline allows for the transfer of gas between many different interconnecting pipeline, in the UK there is only one transmission pipeline system. Apart from that there is great similarity between the way the Sabine Hub Services IHT works and the way the UK system works through the nominations process.
The UK gas system is governed by the Uniform Network Code – essentially a gas transportation agreement. The NBP was established in the original network code as the balancing point – hence the name – at which all shippers on the system had to balance their gas flows, with gas entering the system being balanced with gas exiting the system. The NBP was never intended as a “trading” point or hub at which gas could be traded but the way the network code was drafted allowed trading to develop. Shippers on the system are required to make Input Nominations for gas entering the system at entry points and Output nominations for gas exiting the system at exit points. The Code allows that the sum of input nominations on any one day need not be equal to the sum of output nominations on that day . In addition to Input and Output nominations, Shippers can also make Trade Nominations under the Code. The Trade nominations can either be a “Disposing Trade Nomination” – a sale – or an “Acquiring Trade Nomination” – a purchase. Under the Code the sum of Disposing Trade Nominations on any one day must equal the sum of Acquiring Trade Nominations on that day.
It was this provision in the Code allowing trade nominations which promoted the use of NBP as the trading hub in the UK and for a long time the primary trading hub in Europe. All any party has to do to trade gas was to apply to become a Shipper to the pipeline and to the regulator OFGEM (Office for Gas and Electricity Markets), which was not a particularly difficult process. Once a Shipper licence was granted, the party could then easily trade gas at the NBP using the trade nominations process. The Shipper didn’t even have to bring gas into the system through the entry points or take gas off the system at the exit points to trade gas, since they could just use the trade nomination process, which many early participants did. In many respects the virtual hub structure in the UK allows for the trading of physical gas in a simpler manner than in the US at say Henry Hub, where the hub is set up to actually move physical gas from one interconnecting pipeline to another. This requires participants to enter into multiple transportation agreements and physically actually move the gas on these pipelines and so be involved in the gas industry. Under the UK system a party can trade physical gas with no supply, no customers but just with other counterparties.
Figure 3 Map of UK Gas Transmission System
Source: International Energy Agency and Department of Business, Energy and Industrial Strategy
Netherlands TTF
In many respects the Netherlands TTF is much the same as the UK NBP in that it is a virtual balancing point on the Gasunie Transport Services system shown in Figure 4 below. It is important to distinguish between Gasunie Transport Services (GTS), which is the transmission system operator, and Gasunie. The former balances the grid and manages TTF, whereas the latter also has interests in the GATE LNG terminal in Rotterdam, storage capacity in Zuidwending, the BBL pipeline to the United Kingdom, a part of the German transmission grid, and Nord Stream 1. There is a Chinese Wall between GTS and Gasunie.
Figure 4 Netherlands Transmission System
Source: International Energy Agency
The system is very similar to the UK system with entry points at the borders and exit points to the Dutch distribution system and power plants, but the Gasunie system also has multiple exit points at borders to other countries.
Gasunie set up TTF in 2003 and it was modelled on the NBP, but Gasunie set it up as a hub immediately and it was no “accident” like NBP. TTF is a virtual market place, where gas is being traded that has already been introduced into the transport system, which makes it easily tradeable. The gas is registered by means of a ‘nomination’ from certified shippers. Nominations are electronic notifications stating the volume of gas transferred, the period, the quality of the gas and the buying and selling parties. Even though this trade in gas is a mutual process between Gasunie customers, they need to notify Gasunie of these transactions. This way, Gasunie always know who owns the gas, and can balance the system. TTF, however, only deals with gas which is already in the system or “entry-paid” gas and as such mirrors the trade nomination process in the UK Uniform Network Code.
The creation of TTF was part of an effort to liberalize natural gas markets that was dictated by the European Commission in Brussels. It is worth noting that the European Commission published various legislative proposals which indicated that physical and legal unbundling of public and commercial activities was the best means to create competitive markets. The Minister of Economic Affairs at the time (Brinkhorst) was a fervent supporter of this doctrine, and consequently the Netherlands went further in implementing this then most member states (with notably the United Kingdom leading the way). In essence, the Dutch state purchased the transportation assets, deemed key to preserve public interests, from its owners (collectively organized in the so-called Gasgebouw), and created a new legal entity to operate them. Somewhat confusingly the name ‘Gasunie’ migrated with this new entity, and the remaining commercial activities had to be carried out by a company that required a new name (GasTerra) which remained part of the Gasgebouw.
Initially, support for TTF was, understandably, not overwhelming. At that time, Zeebrugge was the emerging trading hub in Continental Europe, but it was physical and quite closely linked to NBP. By requiring trade to go through the new exchange rather than on the border, incumbents lost a significant revenue stream, and initially fought it. The independent regulatory authority Nederlandse Mededingsautoriteit demanded that GTS used an entry-exit model, as in operation in the United Kingdom. There were concerns at the time, for instance that the Dutch network had been designed to market the specific low calorific Groningen gas rather than facilitate competition, but in the end, and with expansion of the domestic network and nitrogen capacity , the market accepted the new direction. It is worth noting that there were tensions between existing players, legal requirements in the form of European directives, and the interpretation thereof by the independent regulatory authority (which in this case arguably was strictly legal, even though the Dutch state lost a revenue stream over this).
Once TTF was created in 2003 it took time to get used to this new model. The newly named GasTerra was assumed to offer commodity on the newly created exchange, but on the other hand there was concern that, given its dominance on the local market, the regulatory authority would intervene. Major shareholders in GasTerra likely also had strong views on the path forward. One could argue that without liquidity, and limited price transparency, it was difficult for market actors to purchase additional natural gas, or sell excess commodity. In other words, the relevant legislation might have been in place, but the market needed maturing. A specific initial complication in the case of the Netherlands was that trade initially was essentially split up, in low calorific and high calorific natural gas, with quality conversion as an added service. In the end, a compromise agreement was reached (or forced by the regulatory authority), and GasTerra started trading various products on TTF, notably by 2005.In January 2009 the costs of quality conversion were socialized, and from then onward trade on TTF could take place in MWh. In 2011, GasTerra started offering within day and day ahead products on TTF to further incentivize wholesale trade.
Hubs Comparison
Even though Henry Hub is a physical hub and NBP and TTF “virtual” hubs, they essentially serve the same purpose in that they are all “meeting points” or market centers at which parties can buy and sell gas with the title transferring between them under agreements put in place by the hub or pipeline operators, using the nominations processes. While NBP and TTF are described as virtual hubs, they are in essence little different to Henry Hub . NBP and TTF are virtual in the sense that there is no exact physical location on a map where they can be identified. However, they are both products of the physical gas transmission systems in the UK and the Netherlands respectively, just as Henry Hub is the product of the physical Sabine Pipeline. NBP and TTF physically represent the entirety of the UK and Netherlands gas transmission systems in that as soon as gas enters each of those systems it is “at” NBP or TTF until the gas exits those systems.
In some respects, the trade nominations process with NBP and TTF makes trading somewhat easier than at Henry Hub, promoting multiple trades of the same molecules of gas. However, this can also be achieved at Henry Hub if the parties nominating under the IHT can net off flows. For example, if a party is delivering 100 units of gas to interconnection pipeline A but also receiving 60 units of gas from interconnection pipeline A, then the party only needs to deliver 40 units of gas on a net basis to balance its flows under the IHT.
All three hubs were also in countries with significant domestic production and gas storage facilities.
Hub development and market liberalisation
Creating a wholesale natural gas market
The IEA paper concluded that there were a number of institutional and structural requirements needed to create a competitive wholesale natural gas market . The institutional requirements were:
• A hands‐off government approach to natural gas markets: this implies a shift from direct policy making and market involvement to market monitoring through an independent anti‐trust agency.
• Separation of transport and commercial activities: vertically integrated supply systems need to be broken up, either through full ownership unbundling or through financial separation, as long as commercial and transport activities are run as separate entities.
• Wholesale price deregulation: letting the market set the wholesale price level for natural gas, breaking the former bundled, regulated, natural gas price into a transmission price and a wholesale price that includes commodity, services and a profit margin.
The structural requirements were:
• Sufficient network capacity and non‐discriminatory access to networks: Non‐discriminatory access will increase the number of market participants, while sufficient network capacity will ensure that there are no bottlenecks and fragmented markets that behave according to their own supply/demand dynamics. An independent transmission system operator (TSO), either divested or functionally separated is preferable together with a well‐developed network code (set of rules).
• Competitive number of market participants: A genuinely competitive gas market requires a number of gas suppliers and traders with competitive market shares along with multiple producers and buyers of gas.
• Involvement of financial institutions: a competitive natural gas market will also need financial parties that are willing to cover financial/operational risks for parties involved in the natural gas trade, and also participate as traders.