LNG: Intercontinental to inter-regional?
Price differentials are threatening the economics underlying global LNG arbitrage. But the lower prices may unlock competition within regions
It was all going rather well for efficient global LNG trade. The associated gas boom that accompanied the US shale oil revolution drove Henry Hub prices to bargain-basement levels just at a time when the country was developing its first wave of liquefaction and export capacity, most of it linked to those Louisiana prices.
An Asian market with an increasing thirst for gas, particularly in China, provided an obvious outlet for these volumes, particularly because the economics worked. As soon as the Opec+ deal in the second half of 2016 pushed oil prices upwards from their sub-$30/bl lows, Asian gas prices—linked largely to oil—decoupled on the upside from global gas supply-demand fundamentals.
Even allowing for the logistical costs of liquefaction and shipping from the US Gulf Coast to Asia, the price premium of the benchmark East Asian JKM index more than covered costs. Asian buyers that could fit spot LNG into their portfolio happily did so, while those locked into largely inflexible, oil-indexed long-term contracts were less happy and sought—sometimes successfully—concessions from their sellers.
The impact of the Covid-19 pandemic has thrown global gas pricing out of this pattern of relative efficiency
Europe was largely on the sidelines of the action at first. As long as Asian demand and prices were robust enough to soak up the flexible global LNG supply, volumes beyond contractual and cool-down deliveries rarely had a material impact on the European market. But it remained part of the story of ever-increasing global price interconnectedness, with Asian prices setting a ceiling above which Europe could not rise without attracting LNG deliveries in preference to the long voyage east.
That changed in early 2019, as a combination of mild winters in both East Asia and Europe, more new liquefaction in the US and elsewhere and—crucially—a slowdown in the rate of Chinese demand growth finally coalesced to produce an oft-predicted LNG ‘glut’.
Europe started getting a trickle, which soon grew into a flood, of LNG that Asia could not absorb. But the economics still, largely, worked. Henry Hub prices remained the lowest, while European and Asian prices lined up to reflect the costs of transporting LNG to both markets and not a lot else.
The impact of the Covid-19 pandemic has thrown global gas pricing out of this pattern of relative efficiency, however. Asia, the world’s traditional premium market, took a hit as the initial epicentre of the outbreak, as well as through its greater exposure to the oil price tumble first precipitated by Opec+ breaking asunder, then by coronavirus going global. The import-dependent market requiring a price incentive to attract distant supply was briefly the cheapest.
Europe was already facing a question over what to do with onshore storage capacity that was uncomfortably full coming out of winter 2019-20 when it comes to absorbing yet more LNG during its traditional summer injection season. The lockdown-related slump in demand has only exacerbated this problem.
Conversely, the US, while also facing demand destruction due to the economic constraints of the pandemic, faces a supply hit too. The oil price slump, combined with physical limitations on oil production due to evacuation and storage issues, will have a knock-on effect on associated gas output. The Henry Hub, a US domestic benchmark not unlike the WTI at Cushing, has gained a certain level of support from lower supply.
As it stands, global LNG arbitrage is broken. The Henry Hub stands at c.$1.70/mn Btu. JKM levels are higher, at c.$2.45/mn Btu, but that is a premium that does not cover transport costs. European prices are at a trans-Atlantic discount, at c.$1.50/mn Btu for the UK’s NBP and just above $1.65/mn Btu for the Dutch TTF.
$1.70/mn Btu Henry Hub price
Nor is the LNG market as well placed as its crude counterpart to weather a temporary dislocation of arbitrage. While liquidity has improved massively, it is still a far shallower pool.
And the logistics are against it. Onshore gas storage is much more specialised than storage for crude and oil products and is woefully inadequate outside of the US and Europe. There is also no mothballed, rarely used or geographically inconvenient capacity that can be temporarily called upon, as in the liquids space. And, as we have touched on, European storage is already creaking.
LNG storage in tanks at terminals is even more limited. Floating storage is possible, but the LNG fleet again suffers from greater specialisation than clean or dirty tankers, with an inevitable impact on spare capacity. And, while huge advances have been made in terms of on reducing boil-off from ships, it remains an inescapable chemical fact that LNG is constantly striving to return to its gaseous state, at which point it quickly needs to be released from storage.
The prospect, therefore, of a disruption to the global LNG market—most likely via a significant shut-in of US capacity that cannot compete in the current price structure—looks imminent. And the return to efficient arbitrage and smooth intercontinental LNG trade flows as a significant, never mind healthily growing element, of the world’s major gas markets may be some time away.
But it is not all doom and gloom for LNG competing on price in an economically efficient manner. While intercontinental flows may be disrupted, the lower gas prices offer a substantial inter-regional opportunity for small-scale LNG to compete against coal and oil products in areas not covered by gas grids.
$1.50/mn Btu NBP price
While LNG containers have a cost increase of c.$2/mn Btu compared with large-scale conventional LNG shipping, in Europe at present that is still going to add up to less than $4/mn Btu all-in. Thus, be it either by break-bulk at the continent’s regasification terminals or smallscale grid-to-LNG liquefaction plants, Europe’s transport sector and chemical feedstock and industrial fuel buyers should begin to find small-scale LNG increasingly competitive compared with their current options. And this is true not just in Europe. Consultancy IHS Markit has observed growing Chinese demand for small-scale LNG as well as the conventional form of the fuel. And, the more widespread small-scale LNG technology becomes, the more its costs should fall.
So, while the price spreads that facilitate an efficient global gas market may remain elusive for a while yet, the calculations on how small-scale LNG measures up against competing fuels may make for more logical changes in how energy moves around regions.
Andrei Belyi is an adjunct professor at the University of Eastern Finland and member of the Board of energy consulting firm Balesene.