The Asian LNG glut is here

Widening gulf between LNG spot prices and oil-indexed contracts is squeezing sellers | EU LNG Chart Deck: 4-8 Mar 2024

The first indications of oversupply are manifesting in the Asian market for liquefied natural gas (LNG), triggering a shift in market power from sellers to buyers.

Asian buyers are flexing down the volume of LNG they lift under long-term oil-indexed contracts in order to scoop up much cheaper cargoes in the spot market.

This is happening because weak demand is keeping the spot price significantly below LNG contracts that are pegged to the price of crude oil.

Analysis by Energy Flux shows that Asian LNG buyers could save as much as $15 million for every oil-indexed cargo they replace like-for-like in the spot market. The savings come at the expense of sellers.

The precise saving depends on the ‘oil slope’ — the formula used to calculate the price of LNG under the contract. This is a percentage of the relevant crude oil price, usually either Brent or Japan Crude Cocktail (JCC).

This post analyses the oil-LNG price dynamic, and considers what a spot discount could mean for the balance of global LNG trade over the coming months — and the implications for European energy markets.

🧠 I’ve also reintroduced Energised Minds — a section at the end of the newsletter where I highlight a few interesting energy essays, charts and reports on my radar.

Newsletter stats: 2,000 words, 10-min reading time, 9 original charts & graphs

European prices bottom out

First up, let’s catch up on the latest price movements.

Global gas benchmarks didn’t change much since the last EU LNG Chart Deck. The Dutch Title Transfer Facility (TTF, the north-west European benchmark) found support above $8/MMBtu.

Month-ahead TTF (Apr-24) settled on Friday at $8.46/MMBtu, up 3% on the week. Any further gains will be held in check by record high underground storage levels for this time of year.

It’s a similar story with the Japan-Korea Marker (JKM, the Asian spot LNG benchmark). Prompt JKM settled at $8.40/MMBtu, up 0.7% on the week. Inventories are also plentiful across key Asian markets, and that is unlikely to change with warmer weather on the horizon.

Last week’s modest upticks were partially attributed to the perception that Asian spot buying activity is rising (although this sentiment appears misplaced — more on this below).

As a result, the spread between JKM and TTF is now wafer-thin…

…although that looks set to change over the winter months, if futures markets are any indication of where prices are heading.¹

Unravelling the oil-LNG nexus

The following chart will be familiar to regular readers. It shows the recent inflection point when JKM fell below the cost of a typical crude-linked LNG contract.

In this chart, oil-indexed LNG is calculated as 12.5% of the one-month trailing average of Japan Crude Cocktail (JCC) plus a $0.5 constant. With JCC averaging $86/barrel, this gives a price of $11.17/MMBtu — almost $3/MMBtu (33%) more expensive than spot LNG.

Looking out along the forward curve, we can see that the current savings start to fall after April, and will be gone by Christmas. After that, futures markets are pricing in a reversion as colder weather drives spot prices above oil indexation.

What’s interesting here is to see the seasonality: spot prices wax above oil in the northern hemisphere autumn/winter and wane below in the spring/summer.

Not all oil-indexed contracts have the same price formula. The slope can vary from as low as 10% to as high as 14%, which makes a huge difference on the price — and how it compares to spot LNG.

The savings on offer are considerable, as is the variation in savings across different slopes. For a single cargo of 160,000 cubic metres, the spot/oil price difference ranges from $2.4 million per cargo (at 10% slope) to $15 million (at 14% slope). The mid-point saving is $11 million (12.5% slope).

The seasonal variation in savings is also considerable. Spot LNG undercuts expensive oil-indexed contracts (14% slope) for almost every month between now and Aug-27.

But a cheaper contract with a 10% slope will be price-competitive from Aug-24 onwards. The mid-point contract with a 12.5% slope will dip in and out of favour with seasonal swings in LNG demand. Overall, spot savings in future years are unlikely to be as high as they are today.

Sellers squeezed

It is worth noting that oil-indexed LNG contracts are rigid mechanisms, and not all have flexibility clauses (known as downward quantity tolerance, or DQT). Others might penalise the buyer for exercising them, or oblige the buyer to make the up the shortfall later.

Moreover, buyers can’t dial down their contractual commitments at the drop of a hat. DQT negotiations need to start three to six months before the contract year starts, according to SP Global, and if spot futures are high then the buyer is unlikely to invoke its contractual flexibility in time.

Still, the impact on sellers could be significant. LNG export projects whose buyers exercise DQT will have more spare volumes, and these ‘rejected’ cargoes are sold at a discount in the spot market.

SP Global reported that Russia’s Sakhalin Energy offered four spot cargoes for April loading, “even though the company typically offers one to two spot cargoes a month”. Sakhalin reportedly sought to hike its LNG prices from 13% to 14% oil indexation last year.

If the project’s Japanese offtakers agreed to the higher price and are now rejecting two or three oil-pegged cargoes in April, then Sakhalin could end up losing as much as $30 million or $45 million in revenue for every month that this situation continues.

Net zero physical impact

Any LNG buyer with a contract that includes a DQT clause is probably trying to exercise their right to buy less, and make up the difference in the spot market.

It is not inconceivable that a buyer might end up re-buying the very same DQT cargo in the spot market, and bag a saving of $10 million or so (at the seller’s expense).

The net impact on physical LNG balances is zero, all else being equal. The same amount of LNG is being produced, loaded and bought — just under different terms and at (lower) prices.

The gas still needs to go somewhere and these cargoes are still profitable, just less so, which means the plant won’t be shut in (although the operator might choose to schedule maintenance at this time).

Misplaced sentiment

There has definitely been an uptick in LNG spot market activity in Asia, driven primarily by Chinese buying activity. It is likely that rejected DQT cargoes do not account for all of these spot deals, but certainly some of them do.

While the precise proportion is unknown, it raises the possibility that any upward price movements based on reports of ‘Asian LNG spot buying’ do not take into account the fact that the net amount of LNG changing hands has not necessarily increased by much, if at all.

For this reason, last week’s uptick on Dutch TTF — which was attributed to rising Asian demand — could be a case of misplaced sentiment.

Signalling error

Long-term contracts distort market signals. When JKM falls low enough, DQT cargoes move out of oil-indexation and into the spot market, increasing spot liquidity. The opposite is also true: when spot prices rise, more LNG is traded under long-term contracts, and spot liquidity falls.

The inverse correlation between prices and liquidity increases volatility. The dominance of oil-indexed contracts in Asian LNG trade means that liquidity falls when prices rise above the oil slope threshold, stoking volatility at a time when buyers are already scrambling to acquire a tightening pool of spare supply.

The corollary of this is greater security for long-term contract holders. The LNG market has just emerged from a period of extreme volatility, which saw obscene profits made on spot sales in late 2021 and throughout 2022. Buyers with oil-indexed contracts were shielded from giddying price gyrations, and incentivised to resell cheap contract volumes into red-hot spot markets.

Market power shifting

Now that we are entering a period of oversupply, the attractiveness of oil indexation has diminished. This will put pressure on sellers to lower the oil slope on new contracts, or prevent them from raising slopes on existing contracts that are coming up for price review.

Price-sensitive buyers in countries such as India and Pakistan are unlikely to sign long-term deals if they feel confident they can dip into the spot market to pick up extra volumes when needed.

This is an awkward reality for QatarEnergy, which must market a huge slab of uncontracted capacity over the next couple of years. The same is true for any US LNG project seeking to pre-sell volumes to secure debt finance.

Plain sailing… for now

For Europe, a liquid and loose LNG spot market is overwhelmingly good news. European utilities and industrials are constrained in their ability to sign long-term LNG contracts due to decarbonisation targets and tightening climate policies, so access to cheap spot cargoes is quite handy.

The unanswered question is: what happens after the glut? Once the coming wave of new supply is absorbed by the market, to what extent will European gas demand have fallen? Will the region use the intervening ‘calm years’ to get its energy house in order?

This is a topic I intend to explore in a forthcoming Energy Flux deep dive (if you have strong views or insightful data on this, feel free to reach out). In the meantime, European energy markets seem to be facing a prolonged period of plain sailing. Let’s hope it’s not squandered by a fit of complacency.

Seb Kennedy | Energy Flux | 11 March 2024

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🧠 Energised minds

— Critical thinking on crucial energy issues —

• Nat Bullard’s annual presentation on the state of decarbonisation is a datavis-rich joy to peruse. Many of the 200-odd slides jump out; this one in particular caught my eye:

• All US upstream gas producers are losing money — even EQT, which has the lowest breakeven cost. Little wonder they are cutting production, says analyst Jeff Krimmel. Remember, these guys need to be profitable and in growth mode to meet the coming surge in US LNG exports. That means Henry Hub must rise as liquefaction capacity grows:

• “[An] irrational level of gas over-production puts the [US gas] industry’s obsession with LNG export into perspective. Unable to control themselves, they need to send some of the excess to foreign markets so prices don’t drop toward zero.” Art Berman never minces his words:

• Germany would need 84% less natural gas-fired power had it not decommissioned nuclear, according to JP Morgan’s epic Electravision report:

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More from Energy Flux:

1. Futures prices are not a forecast, rather they merely reflect how traders are weighing up supply/demand balances and market risk at any given moment. But in lieu of a forecast, they are the best guide we have.