- Created on Tuesday, 11 October 2016 03:33
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(Image Courtesy: Petronet LNG)
Trading, pricing and taxation of Liquefied natural gas (LNG) are grabbing eyeballs across the globe in spite crude price fall-led commodities slump.
Both LNG importing and exporting nations have either crafted or are preparing strategies to make the best out of expanding global LNG market.
“The age of the current LNG market is just dawning,” says Japan, the world’s largest LNG importer in its LNG strategy announced in May 2016. The strategy lists both internal and global reforms to make LNG markets competitive and fair to all stakeholders.
European Union (EU) too is gearing up to shape global LNG market to beef up its energy security.
“A larger and more liquid global LNG market presents an opportunity for the EU. However the globalisation of the LNG market also has an important foreign policy dimension: as a major importer of LNG (the second largest after Japan), the EU has a keen interest in promoting free, liquid and transparent LNG markets around the world,” says European Commission’s (EC’s) strategy for LNG and gas storage unveiled in February 2016.
According to International Gas Union's (IGU’s) World LNG Report 2016, total LNG trade reached 244.8 million tonnes in 2015, up 4.7 MT from 2014. The decline in oil prices and growing weakness in Pacific demand led all global LNG price markers to fall in 2015, from an average $15.60/MMBtu in 2014 to $9.77/MMBtu in 2015.
The number of LNG importing countries has increased from 13 in 2000 to 29 in 2014. The number of exporting countries grew from 12 to 19 during the period, says Australia's gas market report 2015 published in March 2016.
The number on both counts would increase in the coming years, thereby enhancing prospects for widening and deepening of LNG markets.
According to BP Energy Oulook 2016, By 2035, LNG is expected to surpass pipeline imports as the dominant form of traded gas. “The growing importance of LNG trade is likely to cause regional gas prices to become increasingly integrated,” it says.
LNG’s catapult to the centre-stage of global energy dynamics is driven by several factors. A few major are: growing quest for climate change mitigation for which LNG serves as clean fuel & feedstock; realization that LNG helps diversify and strengthen national energy security and recognition of LNG as a major vehicle for creation of wealth, jobs and tax revenue.
With a long and capital-intensive value-chain, LNG offers at least five distinct taxation opportunity right from production of gas in exporting country to delivery of gas in the importing country. Enhanced availability of LNG facilitates increase in tax revenue that accrues from taxation of gas-based manufactured products and services.
Certain other notable causes propelling LNG trade are: shale oil and gas revolution in the United States and the resulting snapping the direct correlation between crude and gas prices; spurt in discovery of conventional and non-conventional sources in several regions across the globe; emergence of floating regasification terminals as cheaper, short-gestation alternatives to onshore terminals for receipt of shipped LNG and gradual development of LNG marketing hubs facilitated by new terminals and pipelines in certain gas markets.
Amidst such market dynamics, free LNG trade has become a pivot of negotiations between the United States and the European Commission over finalization of Transatlantic Trade and Investment Partnership (TTIP).
This is evident from recently leaked documents on hard bargaining over TTIP.
According to EC Directorate-General for Trade's leaked letter dated 20 June 2016 on EU’s proposal for a Chapter on Energy and Raw materials in TTIP, “the Parties must agree on a legally binding commitment to eliminate all existing restrictions on the export of natural gas in trade between them as of the date of entry into force of the Agreement.”
On 24th August, US Vice President Joe Biden stated in Latvia: “We’ve moved from anticipating massive imports of liquefied natural gas to becoming the world’s fastest-growing exporter. For the first time, gas from the United States is being used here in Europe. And every country in Europe can now buy that American resource.”
American LNG would help Europe reduce its dependence on piped gas supplies from Russia and make gas pricing competitive in the Continent.
As put by American Petroleum Institute’s (API’s) Executive Director for Market Development Marty Durbin, “America’s growth in natural gas production means that through LNG exports we can give our allies stability and security in the global natural gas market. America’s shale revolution is growing our economy, spurring environmental improvements and strengthening our own energy security. U.S. LNG will give our allies an opportunity to achieve those some goals.”
This sentiment finds a echo in a Policy Brief titled ‘The Strategic Role of Natural Gas Trade in Transatlantic Relations’ released by Washington-based German Marshall Fund of the United States (GMF) in April 2016.
It says: “Natural gas trade between the United States and Europe offers enormous strategic, commercial, and environmental opportunities. Realizing that potential requires policy changes on both sides of the Atlantic.”
Japan’s Ministry of Economy, Trade and Industry (METI) too has defined agenda for reforms. In its LNG strategy, METI has identified removal of restrictive clause in LNG shipping contracts that are constraining development of markets.
As put by its LNG strategy, “Conventional LNG contracts usually contain a destination clause that somewhat restricts destinations of the relevant LNG cargoes and this practice has hindered free LNG trade. This has long been criticized as problematic, as in Europe, for example, where European Commission confirmed that territorial restrictions infringe EC Treaty under certain circumstances.”
METI has also pointed out the constraints imposed by destination clauses in LNG contracts at LNG Producer-Consumer Conference meetings and on other occasions, and the recognition has been shared at G7 Energy Ministers meetings and G7 Summit meetings, it adds.
METI believes that easing or elimination of destination clauses is indispensable for achieving a flexible and liquid LNG market. It will thus continue to strive for reforms at G7 meetings and LNG Producer-Consumer Conference meetings. It intends to strengthen collaboration with major LNG consumers to press for global LNG reforms.
A major reform proposal calls for changes in LNG pricing process. METI has pointed out that LNG was often linked to crude price in fixed-term contracts over the decades. Such Link-up is no longer necessarily justifiable due to diversified use of LNG.
It is here pertinent to note that market dynamics has already snapped this link in the US, where shale revolution has empowered gas to dislodge coal as primary fuel for base-load power generation. In certain markets, piped gas and LNG prices are competing well. Moreover, emergence of surplus LNG regassification capacity is fuelling the growth of spot market for LNG.
Says METI, “The establishment of price indices which accurately reflect the supply and demand of LNG itself will not only facilitate spot trading but also contribute to stabilizing import prices through immediately helping to diversify price formulae, which used to be mainly linked to crude oil prices.”
It adds: “In order to establish price indices which reflect the supply and demand of LNG itself, it is necessary to increase spot trading to enhance the reliability of spot price indices, and make a shift, also in fixed-term contracts, to a new system linked to gas price indices from the current pricing system linked to crude oil prices.”
Australia's Gas Market Report 2015 shares similar perception. It says: “There is a growing desire for more flexible contracting arrangements, and the global LNG trading environment has become increasingly more complex. The growing flexibility in long term LNG contracts over the past decade is illustrated by the relaxation of destination clauses in contracts, an increase in the use of FOB sales contracts rather than DES, and less onerous take or pay commitments. Both buyers and sellers are seeking more options for pricing, which until recently has been dominated by oil-linked pricing. These options include linkages to hub-based prices, such as the Henry Hub in Louisiana, and hybrids involving a mix of indexes including power generation prices.”
The Report published by Australia's Department of Industry, Innovation and Science, observes: “For there to be a ‘golden age of gas’, it will be important that the price settles into a ‘Goldilocks zone’, a ‘just right’ price that encourages growth in demand and the supply required to meet it. If prices are too high, customers will turn to other energy sources and moderate their gas demand. If prices are too low, investors will not see attractive returns to motivate investment in future capacity. We are currently experiencing prices in the latter category.”
European gas markets continue to move towards a gas hub based model at the expense of the traditional role of long-term bilateral contracts, notes a recent report jointly published by Agency for the Cooperation of Energy Regulators (ACER) & Council of European Energy Regulators (CEER).
ACER-CEER Annual Report on the Results of Monitoring the Internal Natural Gas Markets in 2015 says: “Upstream producers are forced to increasingly incorporate gas hub (price) elements in their long-term contracts price indexation formulas. They have an incentive also to actively trade on hubs in the hope of influencing price formation as this affects their bilateral long-term contracts.”
Keeping in view pricing-taxation interface, Asia-Pacific Economic Cooperation (APEC), in its report captioned ‘APEC Energy Demand and Supply Outlook 2016’, has pitched for governments’ intervention.
It suggests: “To accelerate gas trade, governments could consider reducing tariffs and provide economic incentives to private developers across the value chain of the natural gas industry.”
Canada last year toed this investment-simulation strategy. In February 2015, it decided to provide accelerated capital cost allowance to LNG plants and thus forgo certain potential income tax revenue. Such tax incentives are crucial to attract investments in new LNG gasification terminals across the world that have come to halt in 2016 due to depressed LNG prices.
Australian Petroleum Production & Exploration Association (APPEA) also favours improvement in investment-related tax incentive to stimulate investment in new LNG projects.
In a submission to Australia's Tax White Paper Task Force in June 2015, APPEA stated: “The existing depreciation provisions have been an important factor that has allowed Australia to attract the investment funds necessary to expand our natural gas export capability to a world class scale. Not only do these provisions need to be retained, they arguably need to be further shortened if Australia is to attract the next wave of investment in this critical export industry.”
It is, however, difficult to discern a pattern in the taxation of different segments of LNG value chain. Tax relief for established LNG players is, thus, hard to come by. They run the risk of taxed more by exporting countries battling fall in revenue due to slump in prices of oil and gas. Oman thus decided to hike corporate tax on LNG firms to 55% from 15% in May 2016.
KPMG foresees additional tax complexities for international investors keeping in view imminent alignment of local tax laws with OECD’s BEPS guidelines.
In a report titled ‘Managing tax in the LNG and FLNG industry: Lessons from the front lines’, KPMG notes that “Some tax issues are common to other international oil and gas projects, while others are unique to the industry or to the project’s location.”
The key challenge for all exporting and importing countries is to ensure that any harsh taxation or abrupt withdrawal of any tax incentive at any component of LNG chain does not lead to demand-supply imbalances.
LNG’s true disruptive potential in the energy markets can be realized only by enlightened policy and regulatory environment across the world.
Published by taxindiainternational.com on 7th October 2016