European gas prices spiked earlier this month as workers at three LNG facilities in Australia threatened industrial action.
Strikes were avoided at one of the facilities, but the danger remained for the other two, keeping a floor under gas prices. But over the past year, attempts have been made to put a sort of a ceiling on gas prices in Europe—and more specifically, LNG prices. The effort is beginning to pay off.
Until last year, the global LNG market featured long-term contracts indexed to crude oil futures prices, and spot deals. After Russia invaded Ukraine, the EU started shooting sanctions, and pipeline gas flows began to shrink, LNG suddenly became extremely important for Europe. And that prompted a race to lower the pricing risks associated with the state of the LNG market at the time.
That race resulted in the launch of the Northwest European LNG futures contract based on the S&P Global NWM, or Northwest Marker. The LNG market matured fast. Traders in an extremely volatile market could hedge European LNG cargos.
They could also no longer care so much about pipeline gas and its price when trading LNG. The reason, once again, was the market disruption caused by the Ukraine conflict, chief among them the decimation of gas flows from Russia, especially after the sabotage of the Nord Stream pipeline.
A mature market is a lower-risk market, and this is what has been happening to the LNG market over the past year and a half. This, however, has not really reduced the extent of volatility in that market, as evidenced by the effect that news of the potential strikes at Australia’s top three LNG facilities had on LNG prices, especially in Europe.
Hedging is important in trade, but when there is a danger of a supply shortage, all bets are off. And there was a danger of a supply shortage equal to a tenth of total global supply—this is how much the North West Shelf, Gorgon, and Wheatstone produce together.
Ultimately, supply and demand continue to trump any other factors traders might use to reduce risks inherent in commodity markets.
No doubt, it is good to have a liquid market, and now, thanks to the rise of the Dutch benchmark TTF at the expense of the UK’s National Balancing Point, LNG traders have such a liquid market. Trade is more active than ever and easier than ever, even intercontinental trade with Asia.
At the same time, however, prices, whatever benchmark they are based on, remain supersensitive to the threat of potential outages. The good news is that perhaps a repeat of last year’s price spikes may be less likely this year or in the future because of the maturing LNG market.
On the other hand, tight supply, in case of a cold Northern Hemisphere winter, could push prices significantly higher during peak demand season.
The good news, for now, is that Europe’s gas storage is fuller than usual for this time of the year. Thanks to leftover volumes from last year, which were bought at record prices, and it made no sense to resell them at a huge loss, the continent’s storage is now 92.5% full. This could provide a comfortable buffer in case of an outage, especially if the outage does not last very long.
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Even with this buffer, however, Europe will continue to be a major rival for Asia in LNG cargos as it has been forced to reduce its reliance on pipeline gas. Demand from Asia is already picking up ahead of the winter season. This season will probably be the first big trial for the new, more mature, global LNG market.
By Charles Kennedy for Oilprice.com
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