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Osaka Gas believes that technologies serve as the foundation of corporate competitiveness, and considers R&D to be one of the most important elements in the strategy to make a difference.
For this reason, Osaka Gas works actively on R&D and commercialization of new technologies, as presented below.

Market valuation of LNG price formula through application of financial engineering

Overview

This study defines a novel concept, the market value of price formulas, by applying financial engineering techniques and proposes a technique for objective valuation. More specifically, noticing that cash flows linked with future crude oil prices can be replicated by crude oil derivatives, we defined crude oil derivative market prices as market values of LNG price formulas since future LNG purchasing costs can also be replicated by crude oil derivatives. Furthermore, we studied a valuation methodology in which financial engineering is used to assess the market values of LNG price formulas referring to forward delivery prices of crude oil and option prices.
This methodology enables objectively assessing differences of varying price formulas under defined market value conditions. It becomes also possible to generate multiple price formulas differing in slope or kink point, while they have the same market value as that of a certain price formula. This is the first step toward a totally new framework that allows buyers and sellers to negotiate LNG contracts using a common measure of objective assessment rather than using their respective subjective measures.

Background

The price formula is one of the important determinant factors in LNG contract negotiations. The LNG price formula indexed to crude oil price presents a specific shape known as the S-curve, with low and high price band slopes (proportionals to crude oil price) being milder than middle price band slope (see figure below). Buyers and sellers argue for different formulas during negotiations. However, the relative magnitude relations of price formulas can be reversed depending on the crude oil price level. Consequently, it is difficult to make an objective comparison. As a result, buyers and sellers adhere to subjective arguments, frequently causing negotiations to become deadlocked. Therefore, the establishment of an objective evaluation methodology for the values of price formulas will lead to more efficient negotiations for both buyers and sellers.

 

Effects

The market valuation methodology for LNG price formulas devised in this study improves efficiency in price formula negotiations for LNG contracts. It is also useful for buyers to make a decision on contracts. If there are multiple price formulas for the buyer to reach agreement with the seller, the buyer can select the lowest-cost price formula based on this assessment methodology. Although in this study the focus was placed on price formulas indexed to crude oil price, this methodology is applicable to price formulas indexed to other indicators (e.g., North American gas price).

Links

Paper presented at Japan Society of Energy and Resources conference (94 KB PDF)  
Paper presented as Gastech (264 KB PDF)  

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