Peer reviewed analysis from world leading experts

Is LNG the new fuel for the global economy?

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A LNG tanker is seen behind a port in Yokohama, south of Tokyo, Japan, 4 September, 2015. (Photo: Reuters/Yuya Shino).

In Brief

During this year’s G7 summit, Japan announced its vision of creating a LNG market to meet increasing energy demand. Natural resource markets are a foundation for trade and economic development.

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What is less well known is the close link between the natural resource markets and the currency markets.

LNG was first imported to Japan by the Tokyo Electric Power Company and Tokyo Gas in 1969. Since then, the market has grown substantially and financing large LNG projects has become possible. But the LNG market is much smaller and geographically dispersed than the crude oil market. Developing the market further requires a spot market, and there are three main requirements that need to be overcome to make the most of this opportunity.

First, storage capacity must grow. The storability of crude oil makes adjusting supply possible — essential for a spot market. Likewise, more LNG tanks must be built so that supply can respond to price changes. It is commonly assumed that storing LNG is difficult due to extreme temperature requirements. But, just like crude oil, LNG storage is feasible if investment in suitable infrastructure is made.

Second, producers and suppliers must be able to trade LNG. The clauses restricting destinations that can be delivered to should be abolished or at least made more flexible. Transportation infrastructure should also expand to allow for changing demand.

Lastly, financial institutions must provide liquidity to facilitate transactions and a means to hedge risks. The construction of a LNG production base requires large investments and most LNG trade is based on a long-term contract with the oil price as a benchmark. The involvement of major electricity and gas companies made financing big LNG related investment possible. When the oil price was high, many new projects began. So the rising oil price was the major impetus for the expansion of the LNG production. But the expansion of the market calls for the creation of a LNG price index, which reflects demand and supply globally.

The companies dominating the oil industry predominantly use the US dollar and changing the trading currency would require an appropriate market for risk hedging. LNG sales contracts are linked with the oil price and have served the industry well as the US dollar and the oil price are negatively correlated, providing a natural hedge. But the current low oil price creates a huge gap between the future forecasts of sellers and buyers. Sellers typically anticipate the low price to continue but buyers do not. So contract negotiations based on the link to oil have become harder to conclude.

Delinking LNG from oil will be useful for new projects and will also result in delinking from the US dollar. Multiple currencies should be used since contractors and oil companies are exposed to foreign exchange risk from construction activities. If the revenue stream can be matched with its underlying cost, risks can be further mitigated.

Natural gas is typically found in rural areas. To avoid the abundance of resources hindering industrial development — the so called ‘resource curse’ — governments must solve problems associated with oligopoly and diversify the industrial base by global value chain upgrading. Such initiatives require large infrastructure projects with long life cycles, and infrastructure finance is often a bottleneck for sustainable development.

For this reason, most countries welcome foreign capital. LNG exporters can secure the revenue flow for foreign loan repayment. Given that Japan, South Korea and China are the major LNG importers, the Japanese yen, South Korean won and Chinese yuan should play a bigger role in matching the demands for infrastructure investment and LNG trade.

US consumption has contributed to world economic growth for decades. But the US growth engine has relied on the reserve currency status of the US dollar and a current account deficit supported by US Treasury bond investors such as China, Japan and South Korea. As they transition to more consumption-driven economies and serve as a new engine of growth for the world economy, their currencies must also gain reserve currency status.

Japan, China and South Korea have a common interest, and responsibility, to establish a LNG spot market to meet future energy demand. In doing so, they may also contribute to sustainable industrial development through infrastructure investment in many parts of the world and ensure future growth for the world economy.

Tomoo Kikuchi is a senior research fellow at the Centre on Asia and Globalisation, Lee Kuan Yew School of Public Policy.

Yohei Tanaka is an assistant manager at the America and Africa Project Division, INPEX, the Japan-based oil and gas exploration and production company.

4 responses to “Is LNG the new fuel for the global economy?”

  1. Thanks for an informative analysis of the economics of the use of LNG. The currency aspects are an aspect of this fuel’s market which I knew nothing about before.

    It should be noted, however, that natural gas is not a ready made, simple solution to the environmental problems which coal and oil present to the world. Methane is actually a much more powerful greenhouse gas than carbon dioxide is. The Nat gas industry claims that the leaks of this gas during exploration and transportation are very low. But independent research has found that the industry’s estimates of less than 4% are grossly lower than what actually occurs. Aging exploration, storage, and transportation facilities mean that the leakage is closer to 7-8%. At this rate, the so called advantages of ‘clean’Nat gas over other fossil fuels are nonexistent.

    If Japan, S Korea, and China are serious about doing something to mitigate climate change on a world wide basis, they should be very careful about how they try to integrate LNG into their economies. Renewable sources of energy, such as wind, solar, and hydro, offer much less impact on the environment than Nat gas does.

    • Appreciate your comments and getting into currency aspects..

      I’d agree LNG=clean can’t be concluded easily and requires further examination on an integrated basis from exploration to fired plant. Not too familiar with transportation aspects, but yes, native CO2 varies depends on source gas and construction includes massive activities and energy usage. And shale production adds further footprint. So it really varies depends on project and not all seems to be a good emission figures.

      Cautiously consider “how to integrate LNG into its economy” is a question that I still ask myself. Increasing of LNG may not happen as people expected, for some countries it is not that affordable, and simply LNG is not the only source of energy. And scientists and the industry may prove and agree carbon dioxide vs methane effect. From currency standpoint, LNG seemed to fit well, but could be other transaction.

      Thinking on a “worldwide basis” is quite profound as this would be my next theme to consider. Japan particular being aging society and energy consumption figures are decreasing, our facilities could be rather overcapacity (depends on nuclear). In this circumstance, for instance emissions tax may not necessary change our energy structure efficiently.
      Japan has less wind and sun compared to other countries, and hydro was built massively in the early years and any new hydro dam requires migrating villages in recent days.

      Like we have transformed our energy mix over the past 100 years, I think how we can contribute to the transition on a worldwide basis, mostly by introducing clean energy in developing countries. While domestically trying to balance usage of existing facility and transition to a better emissions.

      • Thank you both for your follow up to my comments.

        Denmark, in particular, and Germany, to a lesser extent, are demonstrating that wind can be a viable source of a significant amount of their energy needs. As Japan has long coastlines along its 4 major islands there must be places where the wind blows with enough strength and consistency to make it a viable source of energy.

        I agree that Japan’s demographics will probably mean a long term decline in demand for energy….unless PM Abe and his successors can find politically palatable ways to reverse these trends. THAT is the subject for another series of articles, however!!

        As for nuclear power, that is another very complex ‘ball of wax,’ as the expression goes.

        Very GOOD point that Japan, with its technological and engineering sophistication, can assist via the introduction of clean energy in developing countries around the world. I hope it will do so for a variety of reasons.

        THANKS again!

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