The LNG sector has not been without its drama in 2017, with Hurricane Harvey, the Qatari diplomatic crisis and Australia’s decision to regulate LNG exports keeping the market on its toes despite significant export capacity expansions.
But while there has been some fretting over possible LNG supply disruption, it remains a buyer’s market, thanks to growing flexible volumes, slowing demand from LNG’s legacy markets in Northeast Asia and the expiry of sizeable long-term contracts.
And it is this new shift toward a more customer-focused market that has set LNG on the path to becoming a more fungible global commodity.
The Japan Fair Trade Commission’s finding in June that LNG destination clauses are likely anticompetitive was a game-changing step toward a more flexible global LNG market. It could mark the start of a round of similar regulatory activity on LNG resales across Asia that would benefit large buyers faced with a combination of contractual surplus and downstream deregulation.
Significant volumes of LNG could burst onto the market as a result—boosting spot competition, portfolio optimization and global interconnectivity—as cargoes are directed to the premium buyer.
The Japanese ruling was well received in the Atlantic Basin—the EU in July agreed to cooperate with Tokyo to phase out territorial restrictions on resales, already illegal under EU competition law, and promote “liquidity, flexibility and transparency in the global LNG market.”
In Europe, there could be more seasonal spot LNG activity given Centrica’s decision to permanently close Rough, the UK’s largest gas storage facility, and resilient gas demand in the power and industrial sectors.
Europe’s main contribution to the changing global LNG landscape will continue to come from the unique flexible capabilities of its gas trading hubs, offering reliable pricing points and absorbing surplus LNG in its role as the world’s market of last resort.
LNG supply outlook
The LNG supply outlook is also staggering. More than 100 million mt/year of new liquefaction capacity is expected to come onstream in the period 2017-2020, mainly from Australia and the US, where innovative approaches to contracting, pricing and marketing are building on a wave of liberalization in global LNG trade.
And those hoping the market would rebalance before the mid-2020s had their hopes seemingly dashed by Qatar’s July announcement that it would expand the country’s LNG liquefaction capacity, already the world’s largest, by 30% to 100 million mt/year by 2023.
With slowing growth from its traditional customers, demand uncertainty in the Middle East and growing diplomatic isolation from its neighbors, Qatar is facing growing pressure to offer more contract flexibility, especially as long-term contracts for close to 9 million mt/year of LNG are due to expire by 2021.
Legacy and emerging exporters in Southeast Asia and Australia are also adjusting their business models and entering the spot market, adding competition to a growing community of traders and portfolio aggregators.
Traders have stormed the LNG markets.
Their innovative commercial strategies, ability to take risks and customer-focused business approach have played a pivotal role in transforming the LNG landscape, and that trend is set to continue.
In a bold move to fuel liquidity growth and address a lack of standard terms and conditions for LNG trading, Swiss trader Trafigura has proposed its own standard master sales and purchase agreement as a template for the LNG industry. If successful, the initiative could lead to greater trading efficiency and transparency, and fewer barriers to new market entrants.
On the financial side, lenders have been used to funding projects supported by rigid oil-linked contracts supplying regulated market monopolies. With that old world order ebbing, LNG sector finance will largely depend on acceptance of the increasingly pivotal role of spot markets, with improved operational efficiencies supporting LNG economics and more robust pricing benchmarks strengthening the market’s hedging capabilities.
Growth in swaps
Growth in the Platts JKM swaps LNG derivatives market has been explosive. A total of 6,720 lots of the JKM swaps – the equivalent of more than 18 full-size LNG cargoes – changed hands and were cleared through an exchange in August, the highest number of lots in a given month.
The stage is all set. The reconfiguration of supply and demand in the LNG industry is on course to change the nature of global trading drastically and permanently.
The traditional ways of doing business, based on destination-restricted, oil-indexed long-term contracts are disappearing, making room for enhanced flexibility and interconnectivity, promoting a more liquid, competitive and transparent marketplace.
Nearly a third of global LNG transactions are now conducted outside of the long-term contract framework and the share is set to rise, driven by regulatory changes, growing flexible supplies, the need to optimize portfolios to protect netbacks in a lower price environment, and an increasing number of players acquiring trading skills.
Suppliers, challenged with existing production costs or waiting to come onstream as the surplus erodes and prices recover, may see this as negative. But new opportunities are also up for grabs for those able to respond quickly to those changes.