Why BHP wants to change LNG pricing

They did it with coal and with iron ore. Now the world's largest miner, BHP Billiton, wants to change the way LNG is priced. The head of BHP's marketing division says he favours a system where LNG trades on its own fundamentals rather than being linked to the oil price.

Customers of LNG, especially the Japanese, have been increasingly vocal in their support and they have a point. There is no rational reason why LNG prices should be linked to oil. It is the result of a historical quirk. The two fuels aren't competitors: LNG is a generation fuel and oil is a transport fuel. Each has different economics and different production characteristics.

A more liquid spot market, which is what BHP wants for all its output, will mean fluctuations in the supply and demand for LNG are reflected in the price. If it had its way, BHP would abolish the oil price link and long term contracts and have all LNG sold on spot markets in a similar way to iron ore or coal.

Producers of LNG largely favour the existing system for two reasons. One is that for the past decade oil prices have been persistently high and being linked to oil prices generates higher revenues. Producers also say that long term contracts are vital to encourage new investment. A decent sized LNG project will typically cost about $20bn.

Without long term contracts, typically 20 years, few producers would front up that amount of capital and fewer projects would be built. And therein lies the reason for BHPs support.

As the world's largest miner, it can marshal resources that competitors can't. BHP isn't being benevolent when it argues for a pricing revolution. A change of the sort it seeks will mean a decline in new projects and, possibly, higher profits for incumbents. The company has overturned commodity pricing before and stands a decent chance of doing so again. LNG hopefuls should be worried.