What about Oil-linked contracts?

In the past, many long term gas supply contracts have been priced using an "oil-equivalent" formula. This arose because of the illiquidity of gas markets at the time (c.f. oil markets) and gave a sound basis to forward price these contracts for both supplier and buyer. As with any commodity, the supplier is seeking to get the highest price possible and the buyer is looking to secure the lowest price.


In more recent times the huge amount of gas unlocked by the US Shale plays and other sources of unconventional gas, has substantially increased the amount of domestic gas available, driving down the price of Henry Hub Gas prices in the US. As a result many long term gas contracts are now much more expensive than spot Hub prices, causing consternation from those who have locked in gas prices at higher levels. Inevitably this has led to much talk during the past few years about de-linking the gas price from the traditional oil-linked mechanism.


But a glut of gas in the US doesn't necessarily translate into available supplies in the countries that need it. The gas still needs to be liquified and transported. There will also be a large lead time required to build liquefaction facilities, which require billions of dollars in capital. Several companies (twenty four as of July 2013) in the US have applied for LNG export licences, but without reducing the domestic supplies of gas, there is little scope for huge supplies of LNG from there. The US Energy Infomation Administration (EIA) is forecasting US exports to begin in 2016 at a rate of about 5 million tonnes per annum, increasing to 18 mpta by 2023. These figures may be revised upwards if economic growth exceeds the 2.5% used in forecasts.


If the price of oil begins to be driven by scarcity of oil, then a different mechanism may be justified. However the expansion of US gas supplies has been accompanied by an expansion of oil supplies as well, so this may be some way off yet.