Gordon Bennett
Managing Director, Utility Markets
Natural gas markets face rapid change - with North America, Europe and Asia becoming interconnected, amid the formation of a truly global gas market. Underpinning this is the liberalization of LNG, driven by new supply and demand forces. So could we see the emergence of a truly global natural gas benchmark? And what are the implications for traders?
The market structure of LNG is moving from a procurement dynamic, to one that is market-based. Driving this on the demand side is the unwinding of legacy LNG contracts, which means key Asian buyers are no longer tied to destination-specific take or pay contracts. China has also overtaken South Korea as the second largest importer of LNG, with its new environmental policy expected to continue supporting demand for renewables and natural gas.
On the supply side, the shale gas revolution has turned the United States into a net exporter of natural gas. Despite concerns of a LNG glut, this prospect was offset by rising Chinese demand until late 2018. Other supply shifts include Australia usurping Qatar as the largest exporter of LNG, while Russia has also boosted LNG exports.
Importantly, the commoditisation of LNG has connected markets that were once regional - overcoming physical and market infrastructure constraints as it acts like a virtual pipeline between continents. This has enabled the creation of the first Asian natural gas benchmark (the Platts JKM contract) which is establishing credibility amid increased use for spot cargo and derivatives contract pricing, helping to feed a virtuous cycle of liquidity.
More broadly, the evolving globalization of natural gas has triggered its second secular shift in pricing since commercial LNG was established 60 years ago. As the first market to commoditize, oil provided the legacy pricing structure for commercial natural gas and LNG. The subsequent liberalization of natural gas markets in North America and Europe provides robust hub pricing and has fed increasing linkage to natural gas indexation in natural gas contracts. In the U.S. and North West Europe, the transition is almost complete. And in Asia, the establishment of JKM as a natural gas benchmark should see this phenomenon repeated, with oil indexation diminishing in natural gas pricing.
The relationship between Europe and Asia is taking center stage in gas price formation. Europe’s contribution to the changing LNG landscape continues to be the flexibility of its gas trading hubs, which offer reliable pricing and absorb surplus LNG. With Asia as the key buyer of global LNG, it’s the interplay between Europe’s TTF natural gas benchmark with Asia’s JKM benchmark that will drive the pricing formation for global natural gas.
While North American gas plays a less prominent role in global gas price formation, its status as a key exporter will feed demand for a market-based pricing mechanism. Yet as one of many significant exporters, the U.S. is arguably no more likely than Australia or Qatar to develop a key export benchmark. Instead, the recent MOU between Tellurian Trading UK and Vitol highlights the rising prominence of JKM in global gas markets: a 15-year LNG contract where a U.S. exporter pegged its transaction price to the Asian benchmark, citing its liquidity and transparency.
In addition, there is less correlation between U.S. natural gas prices and those in Europe or Asia. This is because the U.S. Gulf Coast is not a key pricing point, but one of many sources of natural gas and LNG. Other pricing points have equally strategic value - Cove Point is closer to the Atlantic Basin route to Europe, while future Canadian LNG is closer to the Pacific Basin route to Asia. In addition, the route for Russian LNG (Yamal) has advantages over U.S. LNG for Europe and Asia, while Qatar offers easy access to Europe and Asia with ultra-competitive feed gas prices.
These dynamics place JKM and TTF in prime position to become global benchmarks for natural gas; potentially the ‘Brent’ equivalent of natural gas.
For traders used to focusing on regional natural gas markets, these new dynamics demand the ability to think globally. European traders must be aware of supply and demand factors in Asia, just as a buyer in China must be cognizant of those in European markets. And against this backdrop, the globalization of natural gas is helping elevate its status as a clean, flexible, and cost-efficient fuel - arguably the most important global commodity.