ICE: A Global Natural Gas Market Forms
Europe and Asia take center stage
By Gordon Bennett, Managing Director, Utility Markets
Natural gas markets face rapid change - with North America, Europe and Asia becoming increasingly interconnected, amid the formation of a truly global gas market. Underpinning this is the liberalization of LNG, driven by new supply and demand forces. So could we see the emergence of a truly global natural gas benchmark? And what are the implications for traders?
Market structure disrupted
The market structure of LNG is moving from a procurement dynamic, to one that is market-based. Driving this on the demand side is the unwinding of legacy LNG contracts, which means key Asian buyers are no longer tied to destination-specific take or pay contracts. China has also overtaken South Korea as the second largest importer of LNG, with its new environmental policy expected to continue supporting demand for renewables and natural gas.
On the supply side, the shale gas revolution has turned the United States into a net exporter of natural gas. The long-anticipated glut of LNG supply arrived in late 2018/ early 2019, and has seen international natural gas prices drop to their lowest level in several years, supporting higher consumption, especially for electricity generation. Developing countries throughout Asia - particularly China - are expected to drive gas demand in the medium term, as they look to meet the challenges of growing energy demand, cleaner air, and a smaller carbon footprint. In addition, lower global gas prices will continue to drive gas-on-gas indexation throughout Asia.
"the commoditization of LNG has connected markets that were once regional. This has enabled the creation of the first Asian natural gas benchmark.”
More broadly, the evolving globalization of natural gas has triggered its second secular shift in pricing since commercial LNG was established 60 years ago. As the first market to commoditize, oil provided the legacy pricing structure for commercial natural gas and LNG. The subsequent liberalization of natural gas markets in North America and Europe provides robust hub pricing and has fed increasing linkage to natural gas indexation in natural gas contracts. In the U.S. and North West Europe, the transition is almost complete. And in Asia, the establishment of JKM as a natural gas benchmark should see this phenomenon repeated, with oil indexation diminishing in natural gas pricing. Amid a backdrop of lower natural gas prices, LNG buyers in Asia will have more bargaining power, speeding up the gas market transition.
New pricing structure
The relationship between Europe and Asia is taking center stage in gas price formation. Europe’s contribution to the changing LNG landscape continues to be the flexibility of its gas trading hubs, which offer reliable pricing and absorb surplus LNG. European LNG imports rose close to 76m tonnes in 2019 - by far the highest ever recorded - while the continent absorbed over 21% of LNG produced globally. With Asia as the key buyer of global LNG, it’s the interplay between Europe’s TTF natural gas benchmark with Asia’s JKM benchmark that will drive the pricing formation for global natural gas.
North American gas plays a less prominent role in global gas price formation, though its status as a key exporter will feed demand for a market-based pricing mechanism. As one of many significant exporters, the U.S. is arguably no more likely than Australia or Qatar to develop a key export benchmark. Instead, European benchmarks are rising in prominence.
As the first U.S. company to export LNG, Cheniere Energy exclusively used Henry Hub indexation before 2015 in their take or pay style, sale and purchase agreement. The indexation to Henry provided a perfect hedge for Cheniere’s feed gas exposure, whilst fixed capacity payments provided revenue certainty to finance the expansion of Cheniere’s liquefaction facilities. In late 2015 however, Cheniere started to enter deals with the large European utilities EDF and ENGIE, utilising European benchmarks such as TTF.
In addition, the use of Henry Hub pre-dates a global natural gas market, where there was clear margin differential between it and natural gas markers in Europe and Asia; providing a compelling price advantage for buyers to take Henry indexed contracts whilst providing an effective hedging marker for U.S. exporters. Now, low global natural gas prices driven by a healthy supply of LNG from around the world, means tighter margins and a buyer’s market. New export facilities in the U.S. will find it more challenging to tie themselves to the Louisiana marker.
In June 2019, we saw further evolution in global natural gas dynamics impacting contract structure -with the announcement of Cheniere and Apache’s long term gas supply agreement, which will be indexed to global LNG prices. This is potentially significant in two respects: instead of Cheniere back to backing its feed gas exposure through a risk transfer to the buyer of LNG, it is now managing its feed gas exposure through a risk transfer to the seller of the feed gas. So while the end buyer of LNG may be more reticent to accept the risk transfer, the dislocation in price formation within the U.S. between shale basins and Henry Hub - where we have recently seen negative pricing in the Permian Basin - means that U.S. shale exploration and production companies are able to accept this risk transfer, and provide them with more upside to access global natural gas pricing.
Importantly, as LNG demand fluctuates through market cycles, the current supply/demand imbalance of U.S. natural gas may mean it will never be connected to international markets. These dynamics place JKM and TTF in prime position to become global benchmarks, with TTF’s rise set to cement its status as the ‘Brent’ of natural gas.
These dynamics place JKM and TTF in prime position to be global benchmarks; with TTF’s rise set to cement its status as the ‘Brent’ equivalent of natural gas.
For traders used to focusing on regional natural gas markets, these dynamics demand the ability to think globally. European traders must be aware of supply and demand factors in Asia, just as a buyer in China must be cognizant of those in European markets. The globalization of natural gas mean it is ideally placed to meet several challenges: higher energy demand, improved air quality and reduced carbon emissions. And as the world seeks reliable fuels and benchmarks in increasingly volatile markets, natural gas is assured of a central role.
-LNG liberalization (new supply & demand factors) have transforming natural gas from a regionally priced commodity, to one where pricing is increasingly global
-The supply glut of LNG that finally arrived in late 2018, early 2019 has brought with it low international natural gas prices
-As a result, there is increasing demand for gas-on-gas pricing in LNG contracting
-LNG and natural gas will be needed in Asia to meet the dual challenge of increasing energy demand whilst reducing its carbon footprint and improving air quality
-With Europe as the swing buyer of LNG and Asia as the global demand center, the interplay between the two is key to global gas price formation
-Asia’s JKM or Europe’s TTF are poised to become the global benchmark for natural gas