By Alex Calvo

SNA (Tokyo) — Japan is completing steps to launch a derivatives market for Liquefied Natural Gas (LNG). While oil has long been traded in both spot and future markets, LNG remains very much the province of long-term fixed-price contracts. Japan is one of the biggest consumers, accounting for some 40% of world imports. Tokyo’s faith in nuclear energy was shattered by Fukushima and LNG is one of the key components of the new energy mix.

When Tokyo’s plans come to fruition, this will be the first LNG futures organized market in the world. Citing Japan’s trade minister, Reuters reported that the idea was to get it up and running by March 2015. The market would be located at the Tokyo Commodity Exchange. Some reports have referred to an over-the-counter market; that is one where futures are negotiated and drafted on an individual basis, while some experts point out that we are more likely to see an organized market emerge from day one — a market where standard “off the shelf” contracts are traded. In these markets, participants discuss the price of a contract but not its main characteristics, which have been decided and are publicly available before hand.

According to government sources, the goal would be to provide LNG importers, including utilities and suppliers to households and industries, the possibility of hedging risks, while moving away from oil-linked contracts. Currently, it is common to lay down the price of LNG as a formula of that of oil.

Japanese authorities would like to see similar markets emerge in other countries, and contacts with Singapore and the United States have been reported. A second step may be a futures market with physical settlement; that is ultimate delivery of the natural gas being traded. Before that, a preliminary goal would be to set an LNG spot reference price. That is a publicly known price for immediate delivery, resulting from a sufficiently high number of trades. This could act as a reference for contracts, replacing the price of oil.

Ryo Minami, oil and natural gas director at the Ministry of Economy, Trade and Industry (METI), explained, “What we are seeking is reliable market influence on LNG prices.”

Platts, an energy data company, currently provides the “Japan Korea Marker,” the benchmark LNG spot price index. It compiles it from data on Japan and South Korea-bound physical cargoes. Takashi Ishizaki, commerce, distribution and industrial safety policy group director at METI, believes that the new spot reference price will complement that of Platts. He explained that the Japanese authorities were already “collecting data as a test” and that they would require Japanese buyers to report the prices paid, from which METI would calculate the new spot index.

Japan’s bill for imported energy is high and rising. Furthermore, Japanese utilities are paying up to four times ($16-$18 per million British thermal unit) the US domestic natural gas price. In the two years since Fukushima, Japan’s LNG imports have risen by 23%. According to official statistics, in the year to March 2013 it imported 87 million metric tons, at a price tag of 6.2 trillion yen, or some US$60 billion. Over the same period, import prices paid by the Japanese have gone up by 76%, in part fueled by a weaker yen. This is one of the major factors behind the country’s trade deficit.

Tokyo is eagerly awaiting the completion of export facilities in the United States and the expansion of the Panama Canal.

Japan is also counting on additional imports from Russia, while Moscow is very much interested in diversifying away from Europe while avoiding overreliance on the Chinese market. In the past, Moscow has tended to rely on pipelines and fixed or oil-related price contracts. However, Russian authorities have realized the significance of LNG and want to make sure they do not miss the action. Now that Moscow feels much more confident in geopolitical terms than some years ago, having managed to consolidate a sphere of influence and to recover part of its lost influence, the stage may be set for deeper cooperation with Japan in, among others, energy matters. Despite outstanding issues, relations between Moscow and Tokyo seem to be based on pragmatism and an acknowledgment of overlapping interests. Thus, Japan’s move to set up an LNG futures market is likely to be followed carefully by Moscow, which may try to get involved in order to reinforce its own plans and to avoid being sidelined.

Launching an LNG futures market deserves attention as it is part of Tokyo’s drive to cut down its energy import bill, to move to a new energy mix, and to reinforce its energy security through diversification.

Alex Calvo is a guest professor at Nagoya University.