Continuing our theme of examining the changing landscape of the global LNG industry, in this instalment we go “back to the future” (with apologies to fans of the well-known movie trilogy for the bad pun …) and take a look at the convergence of physical and financial trading of LNG that is contributing to the nascent emergence of LNG as a true global commodity. As reported by the International Gas Union in its 2019 World LNG Report, short and medium-term LNG trade reached 99 million tons in 2018 (an increase of 14.5 million tons over the prior year) comprising approximately 31% of global LNG trade. Of this, according to sources, approximately 79 million tons, or 25% of global LNG trade, comprised volumes delivered on a spot basis (defined as cargoes delivered within 90 days from the transaction date).
We identified the main driving forces behind this development in our prior note appearing in Gastech’s Insights Newsletter (August 20, 2019). To briefly recap, we see the emergence of US LNG, which introduced Henry-Hub based pricing, effectively brought about the de-coupling of LNG from crude oil, and eliminated destination restriction clauses from US LNG SPAs, alongside the emergence of commodity traders and LNG aggregators in the sector and the penetration of FSRUs, as some of the most important drivers in this regard.
Alongside this significant growth in the physical trading and delivery of LNG on a spot basis, the industry is seeing an increase in the development and volume of financial trading of LNG, largely in the form of futures contracts. In its basic form, a commodity futures contract specifies a certain date in the future for delivery by one party (the seller, or “short” position holder) to the other (the buyer, or “long” position holder) of the underlying physical commodity against receipt of a set price. Futures contracts trade on a regulated futures exchange and are cleared through the facilities of a centralized clearing house and a brokerage firm (referred to as a “futures commission merchant,” which is a member of the clearing house). The clearing house guarantees the performance of each clearing member that is a party to a futures contract by, in effect, taking the opposite side of the transaction. Clearing houses do not, however, guarantee the performance by clearing members of their obligations to their customers.
According to the Intercontinental Exchange (ICE; part of ICE-NYSE), it launched the first-ever LNG future contract in 2012, which was a cash-settled future contract based on the Platts Japan/Korea Marker (JKM). The ICE JKM LNG (Platts) Future contract is a monthly cash-settled future based on Platts’ daily assessment price for JKM. The contract size is 10,000 MMBTu, with trading price, settlement price, and minimum price fluctuations all quoted in U.S. Dollars in increments of one-tenth of one cent ($0.001) per MMBTu. Importantly, the ICE JKM LNG (Platts) Future contract cannot be settled by physical delivery, only through final cash settlement.
CME Group, operator of the NYMEX (among other exchanges) has also launched its own LNG JKM (Platts) Future contract trading on NYMEX. The NYMEX LNG JKM (Platts) Future trading unit (or contract quantity) is also 10,000 MMBTu; however, the minimum price fluctuation is $0.005 per MMBTu, except for the final settlement minimum price fluctuation, which is $0.001 per MMBTu. Like the ICE product, the NYMEX LNG JKM (Platts) Future contract cannot be settled by physical delivery, only though final cash settlement.
While these LNG futures contracts have been around for a few years, it is probably the case that meaningful penetration and growth in trading volumes emerged only in 2017 and 2018. CME Group’s Monthly Exchange Volume Report (September 2019) reflects that 2019 YTD volumes for JKM LNG Futures were up by nearly 36% to 12,511 as compared to 9,218 in YTD volumes for 2018. Over 212,000 lots were traded using the ICE JKM LNG (Platts) Future contract in the first half of 2019 alone, already an increase of 46,000 lots as compared to the total amount of lots traded in 2018. This increase in trading volumes and the upcoming rollout of Platts’ eWindow (which already supports Platts’ in its price assessments for key global benchmarks) to the LNG market in partnership with ICE highlight the industry’s appetite for greater efficiency in trading, price transparency and the standardization of LNG futures contracts.
One of the key issues potentially hindering the continued development of LNG as a global commodity has been the lack of physical trading hubs in different regions. While natural gas trades and physically settles at the Henry Hub (and other points) in the U.S., the National Balancing Point (NBP) in the U.K., or the Title Transfer Facility (TTF) in the Netherlands, a true physical trading hub in LNG has yet to develop and emerge in a meaningful way, if at all, despite the efforts of contenders such as Singapore or leading importing countries such as China and Japan. Singapore, which until recently was also vying to develop a liquid financial derivatives trading market in LNG with its SLING (SGX LNG Index Group) spot price index, now seems to have stepped back and abandoned its effort with the announcement earlier this year by the Singapore Exchange that it will stop producing and publishing the spot price index.
In a timely development, coinciding with this article going to print, CME Group on September 4, 2019 announced its new LNG futures contract – the “US LNG Export Futures,” which CME Group indicated will be available for trading on October 14, 2019, pending regulatory review. According to CME Group, the new LNG futures contract will be the first-ever physically delivered LNG contract. Counterparties will be able to take delivery at Cheniere Energy Inc.’s Sabine Pass LNG terminal facility. The Freeport LNG terminal and additional facilities will be included in future delivery months, according to CME Group’s press release. It is expected that the new US LNG Export Futures will be listed with and subject to the rules and regulations of NYMEX.
LNG has particular characteristics that need to be taken into account as a truly robust and liquid derivatives and physical settlement market for the commodity continues to develop. It will be interesting to see, in the coming month, how the CME Group’s new futures contract addresses some of these issues. For example, the trading unit of 10,000 MMBtu used in the JKM futures contracts (consistent with practice in the well-established natural gas futures market) is only a fraction of the volume of an LNG cargo shipment. Generally speaking, LNG vessels have capacities ranging from 150,000 cm to 180,000 cm, while Qatar’s Q-Class fleet offers capacities of up to 266,000 cm. With a physically settled LNG futures contract, if a counterparty is holding an open short or long position that it needs to deliver or take possession of, there will be a physical mismatch between the financial trade and the vessel capacity, perhaps requiring an aggregation to reach an acceptable cargo (or partial cargo) volume. Operational complexities are another characteristic to be considered. Unlike the physical convergence of multiple natural gas pipelines supporting physical trade and settlement at Henry Hub for example (with a constant flow of natural gas on a 24 hours, seven days a week basis), an LNG liquefaction terminal has complex operational requirements in respect of scheduling production and loading of LNG on LNG vessels. Counterparties to the new CME Group LNG futures contract will not necessarily always have capacity and or slots at Sabine Pass (or Freeport or other US Gulf Coast terminals down the road). It would seem, therefore, that such counterparties would need to settle and take delivery through existing customers of a designated LNG terminal. Another consideration for physical settlement of an LNG futures contract is how to address LNG quality specifications, which currently vary between terminals and are often subject of extensive negotiations between buyers and sellers, depending on feedstock gas, destination requirements and other factors. So far, LNG specifications have not formed part of the standardized, cash-settled LNG futures contracts currently available in the market.
At the same time, LNG terminals will need to consider the additional regulatory, commercial and compliance risks that may arise by serving as the physical delivery point for settlement of futures contracts.
With Gastech’s formal opening in Houston just a few days away, it will be interesting to see if more details around the US LNG Export Future contract’s terms are provided and hear the industry’s reaction. Even if we all need to wait for the pending regulatory approval, this is yet another indication that we are undoubtedly in the midst of dramatic change in the global LNG industry.
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