JKM globalises the gas market
In Asia, an increasingly liberalised LNG market has enabled the region to mitigate a lack of interconnected pipeline infrastructure
LNG liberalisation—the move from a procurement structure to one that is market-based—has globalised the natural gas market, creating a virtual pipeline between continents.
On the supply side, the shale gas revolution turned the US into a net gas exporter, while independent terminal developer Cheniere’s pioneering business model of selling LNG on a free-on-board (Fob) basis indexed to a gas benchmark is widely credited as a catalyst for the change in market structure. For LNG buyers, the unwinding of long-term legacy LNG contracts and access to US gas that held, initially at least, a large discount to price levels in the demand centres of Europe and Asia further precipitated this development.
In Asia, an increasingly liberalised LNG market has enabled the region to mitigate a lack of an interconnected pipeline infrastructure. And that liberalisation also produced Asia’s first gas benchmark, with LNG contracts settled against the S&P Global Platts’ Japan Korea Marker (JKM) price assessment.
These market structure changes have resulted in strong growth in traded volumes of financial instruments that allow players exposed to JKM indexation to manage these risks. For example, in the fourteen-month period from January 2019 to February 2020, 11 monthly volume records were set on Ice’s JKM futures contract. Open interest has continued to rise this year, with a record of 94,634 lots set on 12 June. Participation is also on a clear uptrend—with a monthly record of 80 companies active in July.
More to come
More broadly, gas’ evolving globalisation has triggered a second secular shift in pricing since commercial LNG was established 60 years ago. As the first market to commoditise, and as a competing fuel for heating and power generation demand, oil provided the legacy pricing structure for wholesale gas and LNG. The subsequent liberalisation of gas markets in North America and Europe provided robust hub pricing and fed increasing gas-on-gas indexation in contracts.
In Asia, an increasingly liberalised LNG market has enabled the region to mitigate a lack of an interconnected pipeline infrastructure
In the US and northwest Europe, the transition is all but complete. And in Asia, the establishment of JKM as a genuine benchmark should play a role in seeing this phenomenon repeated.
JKM futures hit the milestone of a churn rate—the ratio of the derivative market to the underlying physical market—of 1 in 2019, based on the total amount of LNG imported to Japan, Korea, Taiwan and China. Volumes in cargo equivalents also provides some useful context to the growth in JKM futures; average daily volumes (ADV) first hit the cargo/day mark in January 2018, reaching a monthly peak of 12 cargoes/day in February this year. The record number of cargo equivalents traded in one single day was 26 on 23 January.
Comparing JKM futures against another electricity generation fuel, Ice’s globalCoal Fob Newcastle contract—Asia’s most liquid coal future—shows how quickly liquidity in JKM has grown. From a standing start in 2016, JKM overtook Newcastle in both ADV and open interest in 2019 and cemented that lead in 2020.
This trend will be in part driven by the growth of the Asian natural gas spot market and in part by the increasing use of JKM indexation in spot and term contracts. In this way, a virtuous cycle of liquidity will feed both more derivative volume and further use for physical indexation.
Home and abroad
The Ice JKM liquidity pool has also seen a stronger weighting towards Asian-based participation in 2020, which seems to further corroborate its increasing acceptance as Asia’s natural gas benchmark. Interestingly, July saw reports of a first Chinese pipeline gas contract linked to JKM—between BP and two Chinese buyers, Foran Energy and ENN.
11 – Monthly volume records set on Ice’s JKM futures contract, Jan 2019- Feb 2020
JKM’s original link to Europe was perhaps driven more by the location of participants in the liquidity pool than anything else. But recent changes to LNG market structure mean the relationship between Europe and Asia is now far more important.
With Asia as the key buyer of global LNG and Europe as the world’s balancing market, the interplay between Europe’s TTF and JKM underpin pricing formation for global gas. These dynamics provide a symbiotic relationship between JKM and TTF, with TTF as the ‘Brent’ of gas and JKM as both Asian gas benchmark and key location basis indicator. For traders previously used to focusing on regional natural gas markets, these dynamics demand the ability to think globally.
Gordon Bennett is managing director, utility markets at Ice