The LNG industry is on the verge of a radical transformation to a more liquid and flexible market from the opaque, oil-indexed bilateral exchange of cargoes for the past two decades. Various indexes and exchanges are jostling to position themselves as the hedging solution for the new LNG trader, although opinions are divided as to just how far commoditisation can go in this high capital-intensive, conservative sector.
JKM is becoming the Asian natural gas benchmark. More and more cargoes are indexed to JKM and liquidity is developing quickly in the JKM futures, which becomes self-fulfilling. As more participants index to JKM, there is more demand for JKM futures to hedge the position and as liquidity increases in the futures contract, more participants get comfortable that there is a hedging tool available and so more indexation to JKM occurs.
This is being driven by the liberalisation of the LNG value chain; a phenomenon caused by the shale gas revolution providing destination free LNG at the same time legacy long-term LNG contracts are unwinding. The Japanese energy market is changing but very slowly. With the Fuel Adjustment Pricing System there is less incentive to hedge, but when the energy market in Japan liberalises completely it will be a game changer. The game is already changing without this liberalisation in full flow.
JKM derivatives are used by a broad and diverse pool of participants, including utilities, oil and gas companies, banks and non-bank financials. About 30-40 companies actively trade in JKM futures each month on ICE and a total of 60 years to date in 2018. More than 20 new participants have joined this year and there are new additions to the liquidity pool on almost a monthly basis, says Gordon Bennett of ICE.
Both CME Group and ICE have launched new products this year to allow participants to hedge LNG more easily. CME Group added JKM options products in August and plans to launch front-month and back-month futures in November, subject to regulatory approval. “We are very bullish on the future development of the JKM marker and have been steadily rolling out new instruments to support its development,” said Owain Johnson, CME’s managing director for energy research.
ICE has launched a suite of North West Europe (“NWE”) $mmBtu contracts to provide LNG participants standardised pricing tools; the NBP and TTF 1st Line Financial Futures were introduced as a hedging tool for LNG cargoes and NBP and TTF Last Day Financial Futures were introduced to simplify access to the Atlantic spread against Henry Financial Futures. ‘We will continue to evolve our global natural gas portfolio to meet the needs of natural gas participants,’ Bennett said.
‘About 70% of LNG goes to Asia and this will continue for the foreseeable future. Buyers may favour JKM but NWE is the balancing market for LNG and therefore liquid trading hubs such as the UK’s NBP and the Netherlands’ TTF are key tools in optimising LNG portfolios. We can see this in the correlation between our JKM and GCM LNG futures contracts and our leading European benchmark futures contracts. Currently, Henry Hub seems dislocated from other natural gas benchmarks and it will be interesting to see how North American natural gas benchmarks evolve since Cove Point entered commercial activity earlier this year and with the recent positive FID for LNG Canada,’ Bennett said.
Singapore is a strong contender to become the Asian hub due to its geographical location, trading infrastructure and established business environment. The Singapore Exchange (SGX) launched the SGX LNG Index Group or SLInG in 2014. But Singapore itself has limited demand and trade volume on the SGX is correspondingly small, while Japan and China are pinning their hopes on their own exchanges.
Some observers say LNG should be priced FOB at the point of delivery rather than destination, similar to the coal markets. For the US, Henry Hub is by far the most important benchmark and looks set to become the key reference for new exports. Henry Hub trading accounts today for the overwhelming majority of all global trading in natural gas, dwarfing the European and Asian benchmarks. Henry Hub has been criticised as a US domestic benchmark but the growth of LNG exports from the US has ensured that Henry pricing has become very relevant to the global markets. Cheniere, the first to bring US export terminals online, references front-month Henry in its contracts.
“We can see the changing environment for global gas very clearly in the international participation rates for Henry Hub,” CME’s Johnson said. “A few years ago, virtually every Henry Hub trader was based in the US, whereas now we see around 7% of Henry Hub volume traded during the Asian day and more still in Europe. That’s a hugely significant change.”
But physical liquidity has declined at Henry Hub since production boomed in prolific shale basins such as the Marcellus, Permian and Haynesville. The hub is running at only about 10% of its capacity, with 60-80% of nominated deliveries going to Sabine Pass through NGPL pipeline, says Brad Leach, Principal at Connecticut-based Energy Advisory Services. The Platts monthly index liquidity indicator showed zero trades at Henry for August, meaning its value was based on an assessment rather than actual deals done, with only two or three for the previous two months and six and five in September and October respectively.
CME announced in the summer it will launch the first physically delivered LNG futures contract, to Cheniere's Sabine Pass terminal on the US Gulf Coast. CME says there is no update on the timing of the launch, which will be challenging due to the complex physical nature of LNG trading.
Other LNG terminals may also vie with Cheniere to host the benchmark reference price. Facilities in the Northeast near the Marcellus could look to Dominion South, the market location with the highest physical trades in Appalachia and even some proposed Texas facilities are closer to the Permian supply source than is Henry Hub, and so could argue their contract prices should be based on Waha. Both Dominion South and Waha are trading at a significant discount to Henry due to inadequate pipeline capacity to take away the nearby shale gas.
The lack of consensus around benchmarks, varying needs of buyers and sellers in different parts of the world, differing geographical logistics and uncorrelated developments in domestic markets mean it is unlikely there will ever be one global price reference for LNG. But this is good news for market participation as traders are required to straddle these diverging interests and provide a link to a more connected global gas flow.
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