Japan wakes up to US shale revolution Japan has awakened to the US shale revolution. When Japanese Prime Minister Shinzo Abe met President Barack Obama in Washington last week he asked the US to permit exports of its gas to Japan. Tokyo has also announced up to Y1tn ($10.9bn) in credit guarantees to fund investments by Japanese companies in shale gas projects. That Japan is interested in US gas should come as no surprise. Japan is the world's largest buyer of liquefied natural gas, and later this decade the US will start exporting some of its huge surfeit of domestically produced shale gas in the form of LNG. But the possibility of a new east-west trade axis has huge implications for the international gas market. The emergence of US export capacity is leading to a significant rethink of the way gas is priced - a development that is causing ructions throughout the LNG industry, affecting both producers such as ExxonMobil and Royal Dutch Shell and consumers such as Mitsubishi and Tokyo Electric Power, Japan's largest utility. "LNG has become a big political issue," says one Japanese trading house executive. At the heart of the debate is the practice of linking the price of gas in long-term supply contracts to the price of crude oil. Oil-indexed contracts have been a feature of the LNG industry for decades. That is now set to change, industry experts say. "Long-term, we're going to move from oil-indexed to gas-linked contracts," says Dale Nijoka, head of Ernst & Young's global oil and gas practice. It's here - everyone's talking about it. The change has already taken place in Europe. Some of Gazprom's customers have taken the Russian energy group to arbitration, forcing it to introduce more market-linked - and lower - prices into their contracts. Driving much of the change in the gas trade is the North American shale revolution, which saw techniques such as hydraulic fracturing and horizontal drilling open up vast gas reserves previously thought uncommercial. A flurry of projects has now emerged to harness the plentiful supplies of cheap shale gas by selling it on to international markets as LNG. And the exporters are pricing their gas off Henry Hub, the US natural gas benchmark, rather than off Brent or WTI. Henry Hub gas is now selling for about $3 to $4 per million British thermal units, less than a quarter of the price LNG cargoes are sold for in Asia. Japanese, Korean and Chinese buyers have, understandably, been flocking to the US in search of deals. As a consequence, says Professor Jonathan Stern, head of gas research at the Oxford Institute for Energy Studies, Japanese utilities are increasingly reluctant to commit to oil-indexed LNG. "They recognise how dangerous it is to sign up to any contracts on the old formula," he says. They can see the degree of commercial exposure, which is huge. What has spurred the Japanese into action is the way that rising LNG prices have stoked the country's mounting trade deficit and exposed power utilities to big financial losses. Not only is LNG becoming more expensive, Japan has also been importing more of it: with most of the country's nuclear reactors shut down in the wake of the 2011 Fukushima disaster, gas is filling the gap. As its appetite for LNG grows, Japan's interest in US exports has soared. So far, though, there are few potential suppliers. Of the 17 projects that have applied for a permit to export LNG to countries without a free-trade agreement with the US, only one - Cheniere Energy's Sabine Pass venture in Louisiana - has been awarded one. Cheniere has already presold much of its gas to South Korean, British, Indian and Spanish buyers. But the Japanese are also getting in on the act. Tepco announced earlier this month that it had agreed a supply contract with Cameron LNG, another proposed export project in Louisiana backed by Sempra Energy of the US, Mitsui and Mitsubishi of Japan and GDF Suez of France, and also indexed to Henry Hub prices. One of the top priorities of Japanese companies is "to cut the LNG price, alongside diversifying their sources of energy," says Bob Takai, head of energy at Sumitomo Corp, a leading Japanese trading house. Other Japanese gas importers, including Tokyo Gas and Osaka Gas, are also trying to move away from oil-linked prices, even for gas not produced in the US. Kansai Electric Power, for example, signed an innovative long-term agreement where the LNG it buys from BP, sourced from various parts of the world, is linked to daily Henry Hub settlements. Kepco is hoping for a 30 per cent reduction in LNG import costs. But the push for lower costs on the part of Japanese groups is causing problems for the LNG industry, experts say. Developers say they need the security provided by long-term, oil-linked offtake agreements with big buyers to underpin the vast financial outlays required for big LNG projects. "The LNG market can only work if you give the developer certainty on revenues," says an executive at one leading energy group with oil-linked gas projects. Our business, and particularly LNG, is long term. Yet that certainty is becoming hard to find as Japanese buyers wait to see how much Henry Hub-indexed gas will be permitted to flow out of the US. "Clearly, when you have a new development in the market as we've seen in the US, it's perfectly natural for buyers to pause and say "are we seeing an inflection point, and what's the implication?"" says one LNG executive at an oil major. But that means projects are being held up. Mr Nijoka says there are 50 potential gas developments in Australia that could be affected. "I can guarantee you that they won't go forward without certainty on sales," he says. The LNG executive warns there are dangers in the Asians" new caution. "The longer buyers wait, it delays supplies coming to the market, and it causes the pinch and the volatility that you're seeing today," he says. No bank is going to finance these [large LNG projects] unless they have a certainty on revenues. Additional reporting by Ajay Makan