The natural gas market is entering a golden age on the back of increasing global demand. So proclaims the International Energy Agency, the western countries’ watchdog. But the natural gas pricing system remains, for now, largely in the dark ages.

Unlike oil, the cost of natural gas varies substantially around the world. In the US natural gas prices are below $5 per millon British thermal units, but in continental Europe they are near $10 per mBtu and in Asia are more than $12 per mBtu.

The IEA believes that the commodity will take steps towards becoming a truly global market over the next two decades. But pure globalisation is far away.

“Natural gas markets are becoming more global and regional prices are expected to show signs of increased convergence, but the market does not become truly globalised,” the IEA says in a study titled Are We Entering a Golden Age of Gas?, part of its forthcoming World Energy Outlook 2011.

The price of the commodity in key regions, including much of Europe and Asia, will remain anchored in decades-old practices: long-term contracts indexed to the cost of oil or refined oil products. As such, natural gas prices do not reflect the supply and demand fundamentals for that commodity, but rather those of the oil market.

The IEA believes that the regional price gap will have narrowed by 2030, but prices will nonetheless remain far apart. It sees natural gas prices in real terms (adjusted for inflation) at $7 per mBtu in the US, just above $10 in Europe and $12 in Japan.

The persistence of the old practices – firmly supported by producers such as Gazprom of Russia, Sonatrach of Algeria or Qatargas – is a pity, as it will hamper the development of the market. Using oil as the base to price natural gas is particularly anachronistic given the growing use of gas in power generation, where oil has played virtually no role since the 1980s.

Over the last decade the natural gas market has moved towards so-called gas-to-gas pricing, in which the commodity is priced against its own spot market rather than against the cost of oil or fuel oil.

Gas-to-gas is the pricing mechanism of choice for much of North America, the UK and Australia. In total, it accounts for about a third of global natural gas supplies. But the rest is sold largely based on oil prices, in spite of demand for reform from European importers. In Asian nations such as Japan, however, the pressure to reform the pricing system is significantly less.

Yet the growing role of liquefied natural gas, or super-cooled gas ready to ship by tanker over large distances, could help to create a truly global natural gas market. That is particularly true as new LNG importers in Asia seek more flexible arrangements than those used by the traditional importers of South Korea and Japan.

India, for example, bought several spot LNG cargos last year linked to the price of the US spot market of Henry Hub, a pipeline interchange in Louisiana. Pakistan has been buying natural gas on a medium-term contract also based on the Henry Hub price.

Those initial steps towards gas-to-gas pricing are welcome, but more effort is needed. Let us not forget that oil prices were fixed by Opec until just three decades ago and today crude oil is the most liquid and traded commodity in the world.