Last week’s record-high spot prices of liquefied natural gas (LNG) in Asia may not hold for long, but the surge could be a sign of what the future holds for natural gas prices globally.
The growing LNG trade and the growing importance of LNG on the global gas markets have upended the way part of global gas supply is traded and has made regional gas markets more interconnected. When spot LNG prices rally in north Asia, LNG sellers rush to send cargoes there, leaving fewer LNG supply going to Europe, where natural gas prices rise in a generally tighter market.
Gas Markets Increasingly Interconnected
This happened at the start of 2021, when surging spot LNG prices in Asia incentivized cargoes going to the region, instead of to Europe, and sent UK prompt wholesale gas prices to a two-year high amid unusually freezing temperatures across Britain.
The cold snap raised gas demand in the UK, but fewer LNG arrivals tightened the market, sending wholesale gas prices surging.
The cold spell with temperatures below seasonal norms in most of the northern hemisphere, from Madrid to Tokyo, was the main culprit for soaring spot LNG prices. Yet, the rally also showed that regional gas prices are no longer isolated within their respective region. These days with rising LNG trade globally, when Asia sneezes, Europe catches a cold.
To be sure, most of the LNG traded globally is under long-term contracts linked to oil prices.
But this leaves the spot LNG market more vulnerable to price volatility because of the smaller traded volumes and reduced flexibility to respond to market imbalances compared to other energy commodities, as Financial Times’ Energy Editor David Sheppard notes.
Higher Gas Prices Volatility Could Lie Ahead
While last week’s all-time high spot LNG prices in Asia will not last with the coming of warmer weather, the price spike could be a sign of what’s coming for global gas and LNG markets—higher volatility and generally, higher gas prices.
“While contract gas prices have been low and relatively stable in recent years, this is unlikely to last,” Bruce Robertson, Energy Finance Analyst, Gas/LNG, at the Institute for Energy Economics and Financial Analysis (IEEFA), said in a briefing note last week.
“With lower levels of drilling, financial instability in the oil and gas industry, and low levels of industry investment, it is likely that a new era of higher prices and more volatility is upon us,” Robertson added. Related: Why Oil Companies Can’t Replace Oil Profits With Renewable Profits
Reduced drilling in the United States—which is now a major LNG exporter accounting for most of the increased LNG export capacity—and the poor financial state of many oil and gas companies operating in America could unsettle the relative stability of the past three years of the Henry Hub gas prices, the U.S. benchmark, which is the reference to calculate the price of U.S. LNG exports, Robertson notes.
“We may be coming to the end of an era of stable gas prices and the effects of this will reverberate globally as the U.S. is now a major exporter,” the analyst said.
The more volatile and higher gas prices could jeopardize as much as US$50 billion of gas-fired power projects in emerging South Asia LNG markets Pakistan, Vietnam, and Bangladesh, according to Robertson.
IEEFA sees lower investment and reduced drilling activity leading to price spikes and volatility at a higher level than in the last three years.
“Gas customers globally can expect an unpredictable time ahead with substantially higher prices being a distinct possibility,” Robertson wrote in the note.
LNG Trade Will Only Grow In Coming Years
As LNG trade continues to grow, short-term and spot LNG contracts have increased as a share of global LNG flows. Even the long-term LNG contracts are indexed to the price of oil, which, history has shown time and again, is also a highly volatile commodity.
Despite the pandemic, LNG trade increased in 2020 compared to 2019, with volumes rising by 3 percent year over year in the first nine months of 2020, according to the first Annual Short Term Gas Market Report 2020 of the Gas Exporting Countries Forum (GECF), an organization of countries representing 60 percent of the world’s LNG exports and including major gas exporters such as Russia and Qatar.
Spot and short-term LNG trade accounted for 34 percent of global LNG trade in 2019, up from a 31-percent share in 2018, GECF said.
“The higher share was driven by the increasing flexible LNG volumes from the U.S. and an uptick in LNG volumes traded by traders and portfolio players,” GECF says, noting that spot and short-term LNG trade is expected to increase further, driven by increasing flexible volumes from the United States.
The recent record-high spot LNG prices in Asia may have been just a short-lived blip as a result of a ‘perfect storm’ on the market, but growing LNG trade, more flexible contracts, and increasingly interlinked regional markets could put an end to the recent relative stability of global gas prices.
By Tsvetana Paraskova for Oilprice.com
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