LNG demand is a tricky beast, and liable to defy expectations. Last winter, higher than anticipated demand drove JKM prices to $11.35/MMBtu in early January as Asian buyers struggled to attract cargoes in the face of rising Chinese imports. It was the highest Asian spot prices had risen in over three years, and there was every reason to suppose that this winter would see a repeat occurrence. In fact, buyers were betting on it.
Things haven’t quite worked out that way. In expectation of high winter demand, China, Japan and South Korea all shifted their LNG purchases to earlier in the year, pushing up prices in the shoulder months. As of mid-September, however, LNG prices at European gas hubs and the major Asian benchmarks have been falling. Storage capacity filling earlier in the year has inverted the typical pattern of LNG demand, allowing prices to sink just as colder weather starts to kick in.
There are other factors at work too. One is that China has run into a wall with capacity constraints. The country’s limited LNG storage infrastructure is full, but demand may still rise later in the season as storage volumes begin to deplete.
Another cause has to do with the availability of supply. Speaking at the LNG Global Congress in London late last month, Port of Corpus Christi CEO Sean Strawbridge announced that Cheniere would be shipping its first LNG cargo from the terminal on November 15th, months ahead of schedule. This came after the first shipment from INPEX’s Icthys LNG project in Australia on October 30th. The fifth train at Cheniere’s Sabine Pass export terminal may also start before the season’s end.
Weather is playing a role in distorting demand patterns as well. A heatwave in July and August drove up Japanese air-conditioner usage, placing upwards pressure on spot LNG prices as gas-fired power plants stepped into to provide additional power. But possible El Nino conditions this winter may make for milder weather in the East, weighting the seasonal pricing spread towards the summer months.
Finally, sinking oil prices as fears ease about the supply ramifications of Iranian sanctions have also had an impact. Because cargoes purchased on the spot market compete with cargoes delivered under oil-indexed long-term supply agreements, lower oil prices also tend to depress LNG spot prices.
An unusual winter
What can these short-term distortions in the expected pricing characteristics of LNG in Asia tell us about demand over the long-term? Is this winter shaping up to be an outlier, or are there lessons to be learned from recent events that may be applicable further down the line?
It turns out that there are a few conclusions that can be drawn from falling Asian spot prices in Q4 2018. One is that buyers tend to react strongly to demand forecasts – and if enough of them do so, that can undermine the assumptions on which such forecasts are based. The expectation that prices would rise in the final quarter is the very reason buyers chose to stock up early.
Another is that cross-commodity risk will still play a decisive role in the LNG industry for quite some time. Although the proportion of oil-indexed supply contracts is decreasing, the trend is still far from being sufficient to effectively insulate LNG against fluctuations in the price of oil. With three new pipelines due to link the key US shale oil producing region of the Permian basin with ports on the east coast next year, the global market could be flooded with an additional 2 million barrels of US oil a day in 2019. Sustained low prices may reduce the sense of urgency among buyers to diversify away from oil-indexed contracts.
Moreover, no matter how closely supply is calibrated to the expected level of demand, meteorological uncertainty will put paid to any complacency that emerges in the market. The climate isn’t just getting warmer; it’s also getting more volatile. That means more hot summers, more sudden cold spells, and more seasonal temperature swings that just fail to materialise. That uncertainty will feed through into the LNG market, volatile temperatures driving volatility in LNG pricing.
Long-term impactors
Many of the factors that shaped Asian demand this winter won’t stick around for the long-term, however. For instance, the capacity constraints that have prevented China from importing LNG at economically optimal volumes are unlikely to persist. “Given the importance of gas to China we expect that such constraints would last for only a couple years,” says Trevor Sikorski, Head of Natural Gas and Carbon Research at Energy Aspects.
Likewise, buyers’ overcompensation for expected Chinese demand will become less heavy handed as the country’s seasonal demand profile becomes more apparent. Some analysts earlier in the year had expressed concerns that the extent of the overall increase in demand from China masked intra-annual variations, making seasonality difficult to predict with any accuracy. As the market adapts to China’s new role as the world’s largest importer of LNG (as it is expected to become next year), these variations will become easier to discern.
Better understanding the Chinese market could be helped through the creation of a Chinese LNG trading hub, able to provide price signals which more closely reflect the supply-demand balance in the region. Sikorski’s opinion is that “a liquid Chinese gas hub would be a much better pricing point than JKM,” but that creating one will “need much greater gas market liberalisation and much more faith by businesses in Chinese legal rights.” His assessment of recent attempts to create such a hub in Shanghai and Chonquing is that though contracts may be easy to list, getting them traded will prove more of a challenge.
Another unique characteristic of this winter is that price convergence will be the exception, rather than the rule, so long as Asian LNG demand growth outpaces additions in export capacity. With the start-up of new liquefaction trains this winter, and rising LNG shipping rates, the arbitrage between Asian spot prices and European hub prices has melted away in the latter months of the year after freight costs have been factored in.
But as the market tightens, probably in the early 2020’s, the opposite outcome is more probable. Asian LNG demand “is, at least for peak periods, driving wider differentials between the main global pricing hubs,” says Sikorski. “Both US gas and Yamal gas requires wider spreads to get sent to Asia, and that has been happening again, and more consistently.”
