The Global LNG Market Is About To Change
“The January LNG price spike in Asia has the market all abuzz. A one-time event? A look at the global supply/demand balance suggests the LNG market is in a transition to tighter market with higher prices. ”
At the turn of the new year, the energy press was alive with stories about the soaring price for natural gas in northern Asia. An early cold snap drove up Asian heating demand. When coupled with several LNG terminals being out of operation and ship congestion at the Panama Canal slowing carrier journeys panic gripped the LNG market driving prices to record levels. A recent story in The Wall Street Journal carried the headline: “Record Liquefied Natural Gas Prices in Asia Won’t Last.” While the headline was meant to be a warning to investors that LNG prices might be at a speculative peak, it actually reflects a truth about commodity markets, especially ones highly dependent on weather. As Mark Twain once said, “If you don’t like the weather in New England now, just wait a few minutes.” In Asia, waiting for a change in high LNG prices may mean waiting a month or two, rather than minutes, but we can safely count on warmer temperatures arriving and dampening heating demand – the timing may be uncertain, however, like day follows night, natural gas prices will come down.
Although LNG prices remain elevated, the global natural gas market is beginning to change. The change will reflect more than temporary warming trends, but rather a markedly different market supply and demand dynamic. The supply/demand dynamics of the next few years will be markedly different from those that have existed in the past few years. The turmoil of 2020 may have masked the arrival of the changes, although it may also have assisted others.
Last year, the pandemic created major dislocations in the LNG market, as demand fell in response to reduced economic activity. In addition, for some regions, the prior winter was warmer than anticipated, which lessened demand. For example, LNG demand in Europe was hurt by the second consecutive warm winter, further bloating the continent’s gas storage and reducing the need to import additional supplies of gas. Then came the arrival of Covid-19 that smothered demand worldwide, and forced many energy market adjustments. With the U.S. often providing the marginal supply of gas, the domestic LNG market was victimized by the global demand changes. The result was somewhere between 165-200 U.S. LNG cargoes were not shipped between late spring and early fall of 2020.
Given all the demand problems in 2020 and continued flows of natural gas output, worldwide LNG prices dropped. Both Asian (JKM) and European (TTF) gas prices dropped to Henry Hub levels of $1.50-$2.00 per million British thermal units (mmBtu) throughout the summer. Even with take-or-pay liquefaction fees of $2.25-$3.50/mmBtu, the loss from cancelling an LNG cargo was less than the loss than would have been incurred had the gas been shipped.
Exhibit 15. Is LNG Price Spike Signaling Market Change? OURCE: S&P Global Platts
This year, things are starting to look different for the LNG market. The global gas demand picture is improving, helped currently by the cold weather in the Northern Hemisphere, but also by the robust economic snapback by China. Gas demand has also been boosted by China’s shift of an estimated 10 million homes from heating with coal to burning natural gas. That shift, which is the equivalent of moving all of Australia’s homes from one fuel to another in the span of one year, contributed to the LNG price spike. Because China had not prepared and built its gas storage inventory sufficiently, the scramble to purchase LNG cargoes at whatever price to meet demand contributed to the market panic. Most LNG is purchased on long-term contract. Therefore, the spot LNG market is highly sensitive incremental purchases. Panic buying drove LNG cargo prices to upwards of $30 to $40/mmBtu, likely setting all-time highs.
With Asian demand powering the market, LNG cargoes heading to Europe were diverted to capitalize on the record gas prices. The shortage of LNG carriers boosted day rates to record levels of upwards of $350,000 per day. Congestion at the Panama Canal either had ships waiting for roughly 14 days to transit, or electing to take longer routes from the Gulf of Mexico to Asian ports, further inflating delivered LNG prices. As fewer LNG cargoes arrived in Europe, the continent has been drawing down its bloated storage to meet heating demand, which helps the LNG market later this year.
Strong Asian demand, China’s continuing trade war with Australia, its source of LNG supply, and Europe consuming more of its storage, suggest that U.S. LNG cargoes will avoid being cancelled this year. While all of these conditions appear to be short-term in nature, they are a reflection of the underlying changes that are beginning to impact the global LNG market for years into the future.
Timera Energy, a power, gas and LNG consultancy, has prepared a report showing the structural changes underway in the global LNG market, at least as it relates to the non-Europe sector. The reason for this focus is that Europe has become the balancing point for the global LNG market. Therefore, what happens to supply/demand balances in the Asian, Middle East/North Africa (MENA), and Latin American markets will impact the European gas market and set the marginal price for LNG. That is why one needs to study the supply/demand balance for the non-European markets.
Timera’s conclusions are summarized in a series of charts. The first shows, in a bar chart, the history of non-European LNG supply and demand for the past five years. Only in 2018 did supply growth match demand growth. In the other four years, supply exceeded demand growth. That market condition was especially significant during the past two years, both of which reported the largest annual supply increases of the five-year span. Adding to the market’s problem is that the last two years experienced declines in demand.
Exhibit 16. Why LNG Prices Have Been Weak SOURCE: Timera Energy
Another way of displaying the market’s dynamics for this period is to plot the supply growth against demand growth. In such a chart, it can become obvious which force – supply or demand – is the stronger. For the 2016-2020 period, the supply/demand ratio puts it in the sector of oversupply. That would translate into a market with little pricing power. Using this plotting technique, we can easily see how devastating the 2019 and 2020 non-European markets were for global LNG business.
Exhibit 17. Oversupplied LNG Market Of The Past SOURCE: Timera Energy
The LNG market conditions participants have come to expect during the past five years include the following, as summarized by Timera:
Lower absolute price levels.
Lower inter-regional price spreads (e.g., JKM vs TTF – Asia vs Europe), with higher correlations.
Lower volatility of price spreads.
Higher LNG imports into Europe, with strong JKM/TTF relationship.
Lower vessel charter rates.
Stronger influence of Henry Hub prices (given US shut-in dynamics).
However, when the bar chart is extended to include a forecast for the next five years (2021-2025), one can see how the oversupply era will rapidly be replaced by an undersupplied market. It is important to understand that we know future supply growth due to the long construction cycles for liquefaction plants. While many LNG terminal final investment decisions (FIDs) anticipated during 2020 were delayed, plants already under construction continued. Therefore, the near-term supply growth is fairly assured, but longer-term supply growth may be less certain. Timera assumes that all current FIDs are completed on time, including the possible 2025 arrival of additional capacity from Qatar. Despite that latter assumption, the next four years are projected to show less supply growth than demand. Although the forecast calls for an oversupply in 2025, that might change if the Qatari capacity addition is delayed.
Exhibit 18. How LNG Market Is Poised To Change SOURCE: Timera Energy
Again, when the next five years supply/demand ratio is plotted on the graph of market balance, the imbalance of demand over supply is dramatically shown by the fact that all the 2021-2024 bubbles are positioned well above the marking a balanced market.
Exhibit 19. Global LNG Moving Into Supply Shortage SOURCE: Timera Energy
Timera summarized its view of how the global LNG market will change in the coming years – something gas buyers and sellers will need to adjust to. It sees the future as including:
Higher absolute price levels.
Higher & more seasonal inter-regional price spreads (e.g., JKM vs TTF), with lower correlations.
Higher volatility of price spreads and greater frequency of price spikes (e.g., Jan 2021).
Lower LNG imports into Europe, with Asia pulling gas away.
Higher vessel charter rates (longer average voyages).
Reduced influence of Henry Hub prices as TTF/JKM diverge.
There is another European natural gas market dynamic at work that could further upset the global LNG market.That is the role of Russian gas supply.As many people know, Russia is building a second Nord Stream gas pipeline under the Baltic Sea to Germany.Nord Stream 2 has been the target of many of the U.S. sanctions against Russia put into place by the Trump administration in retaliation for undesirable antics such as election meddling, activity in Syria, and poisoning political dissidents.Many of these sanctions were viewed unfavorably on the European continent, and especially by Germany who is the primary beneficiary of the additional gas supply. The pipeline is now a target of attack by the European Commission following the Russian government, at the direction of President Vladimir Putin, arresting dissident Aleksei Navalny upon his return to Moscow after recovering from a poisoning incident. The Nord Stream 2 is nearly complete, but EU lawmakers are calling for sanctions to prevent it from being finished.
Plans call for the EU lawmakers to discuss the sanctions during the last week of January. It will require unanimous agreement among the 27 EU members. Germany, the beneficiary of the doubling of the Nord Stream gas pipeline deliverability, has said it has no intention of halting the construction work. An additional complicating factor for the EU is its desire to await the completion of the Russian legal process for Mr. Navalny after his arrest, which could delay the sanctions decision until after the pipeline in completed.
The United States, under Mr. Trump, and other countries who supported his sanctions against Russia, were concerned about the increased power Russia will have over energy supplies to the European continent. The most recent statistics from Eurostat for 2018 and 2019 show that Russia is only the number three gas supplier to the EU. Those statistics are misleading once one understands that substantially all the gas volumes flowing from Ukraine and Belarus are originating in Russia.
Exhibit 20. Russia Actually Is Major EU Gas Supplier SOURCE: Eurostat
As the Eurostat chart shows, Russia accounted for approximately 19% of the gas imported into the EU in 2019. Ukraine was tied with Russia, while Belarus provided nearly 10% of the 2019 supplies. Collectively, Russia et al represented 48% of the gas flow into the EU, about twice the volume of gas coming from Norway.
The past decade has highlighted the importance of Russian gas getting to Europe, as part of its political influencing strategy. At one point, Russia supplied almost all of the gas going to Ukraine, besides the volumes transiting to the EU. The same was true with Belarus. A recent paper by academics at the Baker Institute discussing the future for Ukraine natural gas contained a chart showing the history of gas exports from Ukraine. While the volumes flowing recently are lower than those shipped during the 1990s and early 2000s, Ukraine still exports substantial volumes, virtually all going to the EU. The fees derived from this transit activity in 2019 accounted for nearly 16% of the government’s finances.
Exhibit 21. Despite Falloff, Ukraine Still Big EU Gas Supplier SOURCE: Baker Institute
Belarus is in a similar situation as Ukraine with respect to Russian natural gas. Gazprom, Russia’s leading gas producer and a source of significant revenues for the Russian government, has had contentious financial dealings with Belarus, as well as Ukraine. Gazprom has negotiated high-priced gas contracts with both countries, which became particularly onerous last year when global natural gas prices collapsed below $2/mmBtus, and gas demand fell in response to the economic lockdowns. These political battles spotlight why completion of Nord Stream 2 is important for Russia to ensure a steady flow of gas to the EU, and a steady flow of revenue to the government. The startup of the new pipeline will enable Russia to take harder stances against Belarus and Ukraine over their gas transit arrangements, since starving them of gas in order to secure higher gas prices will become easier, as it has done in the past during periods of political tension.
From the perspective of the global LNG market, not only is Russia become a bigger exporter giving it potentially greater political power, but the price of its gas influences the TTF (Title Transfer Facility) gas price that establishes the continent’s gas pricing structure, much as Henry Hub does in the U.S. market. A reason why LNG cargoes diverted from Europe when Asian LNG prices spiked was that the TTF only rose slightly, creating a huge arbitrage profit for cargoes even with additional transit costs. Whether Gazprom could create a more flexible pricing scheme is unknown (most of its sales are on long-term contracts), but strategic supply “outages” could throw the European gas market into serious shock, as well as harm the economies and citizens. One should not underestimate the potential for economic/political mischief by the Kremlin powers.
At the same time Russia is increasing its influence in the European gas market, it is also expanding its pipeline and LNG supplies to China. Hereto, Russia could use its gas supply power to influence competitive prices for delivered LNG into China, Japan and South Korea. It is a given that Russia would disavow any intent to use its growing economic leverage due to greater control over gas supplies for political purposes, but thinking about possible Black Swans for global energy markets means this potential must be on people’s radar screens. The growth of pipeline gas exports from Russia can become an unsettling force in global gas markets, and a powerful political influencer via manipulation of supplies, just as the world is evolving a global natural gas market.
Russian gas and LNG flowing to China will be an important supply force impacting Asia, as it has now become the primary driver for global gas consumption. As pointed out above, the shift from coal to gas for heating Chinese homes contributed to the recent spike in LNG prices. This is not the first time China has suffered economic harm by switching from coal to gas. An earlier switch contributed to an electricity shortage as China had not constructed sufficient power transmission capacity to handle the switch. The current cold weather had driven LNG cargoes to $40/mmBtu prices with LNG carriers earning upwards of $350,000 per day, more than double pre-panic rates. These prices connote signs of a bubble in the global gas market. Yes, record LNG prices in Asia won’t last. However, fundamental changes underway suggest the LNG market will be different in the future than it has been. More gas price spikes and Asia having a greater say in the LNG market should be expected, and market participants need to be prepared.