Head hunting for LNG traders is on
5 Oct
The birth of liquid international LNG markets
In the second post of our LNG series we focus on the restructuring of LNG markets and how they transform from a rigid, long-term structure dominated by a few incumbents into a flexible and vivid market place.
This restructuring opens doors for new entrants. There will be new buyers without rigid long-term commitments and new traders with less market power. They will distribute LNG towards new markets, even to Hungary. Following our slightly technical post today, next week we will continue our LNG series with focusing on how LNG will penetrate the European markets.
Up until recently LNG trade was very similar to the segmented European gas markets a decade ago. Most contracts were based on long maturity (10-20 years), included final destination restrictions, relied on oil indexation, and to complete the pipeline analogy, most of the LNG tankers were owned by LNG suppliers.
As we presented in the first post of our LNG series, we expect a 50% capacity expansion arriving to the currently rigid market until 2020 that will face difficulties in finding market outlets. It is not easy to forecast what impact the oversupply will exert on the structure of the LNG markets. However, the complete turnaround in the European gas markets, which was also triggered by a similar oversupply situation after the financial crisis, can help us to envisage the forthcoming market developments.
When a business takes off: the rise of the European gas markets
The traditional European gas market became derailed after the global financial crises: demand collapsed, which on the other hand coincided with the commissioning of new regasification terminals in Western Europe. The emerging oversupply depressed prices on the gas markets, which had a fairly low turnover in those years. Let’s imagine a German importer with a long-term gas contract in those days. Looking at his Reuters screen he (it is usually “he”) was confronted with 30% cheaper market prices than his agreed take-or-pay contractual procurements. In addition, he also saw mushrooming of small trading companies that offer the cheap gas for his traditional customers via his pipelines, as he was obliged to provide third party access by European regulators. As a result, the big players have become forced to change their procurement strategies – and managed to persuade their suppliers to change the pricing of the long term contracts as well.
This new situation kick-started the development of the European spot gas markets. Market liquidity is self-reinforcing: the more deals are made, the more potential buyers will trust the market; moreover, it is not necessary to engage in a 20-years contract, because the required volumes can be bought on the market any time. New players boosted liquidity further; reduced transaction costs made the market even more attractive source of gas supply. Besides a few smaller ones, two big and liquid gas hubs emerged: NBP in UK and TTF in the Netherlands.
Big suppliers with long-term contracts also had to adjust their strategies in light of the growing popularity of hub-based gas trading. They gradually abandoned oil indexation and started to offer hub-indexed (i.e. cheaper) gas, modifying long-term contracts. The shift in the pricing pattern was also moved forward by the large European importers calling a European competition procedure against Gazprom for abusing market power. But it was also a sensible move for Gazprom to sustain good relationship with traditional partners and preserve the viability of those who had long-term contracts with it in Europe. The shift in pricing happened only at those areas where markets were accessible for alternative supply (Northwestern Europe). As of today oil indexation still prevails in parts of Eastern Europe. All in all, the share of hub based contracts has increased from 15% to 61% in Europe, while in Western Europe it became the dominant pattern representing 88% of the market share in 2014.
Source: Bloomberg, IMF, Ministry of Industry and Trade, Japan
Play it again: the same might happen to LNG markets
Currently LNG markets are somewhat similar to the European gas markets of 2008. Demand growth of natural gas is significantly slower than it was expected a few years ago, and there is a steady increase in non-contracted and portfolio volumes. Furthermore, in the last half year contracted gas was significantly more expensive than spot cargos and the newly built tankers also eased bottlenecks in transportation. As a result, LNG today can be delivered to the markets offering the best netbacks for suppliers.
If our European analogy works, this is the market constellation that facilitates the development of the liquid LNG market characterized by standardized contracts, fast delivery and availability of price hedging instruments. We expect that oil indexation will be dismantled in long-term contracts as well, especially if the oil price rises again.
Indeed, the easily tradable liquid LNG market has already started to evolve. Free supply is on its way of searching for final destinations: in the next few years non-contracted or portfolio volumes might increase to one third of total LNG supply which makes smaller deliveries also available allowing new entrants to the LNG market. The share of spot and short trading is increasing: short maturity deals (0-5 years) represents a third of total turnover, while the volumes of new long-term contracts have fallen to a quarter of previous volumes. New tenders are continuously published aiming to acquire 2-3 cargos only. The most important proof of the birth of the liquid LNG market is that arbitrage squeezed the wide regional price differences.
Source: Bloomberg, Ministry of Industry and Trade, Japan
LNG market is getting liquid, however, it is far from oil markets in terms of price transparency and product standardization. Nevertheless, market development goes ahead: daily price information became available, and – even if it is self-reported and not real time – it provides the basic orientation about price trends for those less familiar with LNG markets. Three countries, Singapore, Japan and China, have announced their intention to establish an LNG stock exchange where standardized products will be traded and derivatives will be offered to hedge the price risk. Still, a fully-fledged LNG exchange is a remote possibility. In the forthcoming years OTC deals will dominate LNG trade, however, traders will offer relatively cheap cargos for fast delivery.
Central Europe and Hungary can benefit from evolving LNG markets
It is not necessary to have seashore and a regasification terminal to benefit from the developments in LNG markets. If there is a liquid gas market in a country, it is enough to have pipeline connection to those liquid (Western European) hubs where LNG is actively traded. The Central European region has such connections. Recent pipeline capacity extensions have also enhanced Hungary’s integration with the European gas trading centers. As a result, the global LNG oversupply might depress wholesale gas prices in Hungary as well. In the forthcoming posts of our LNG series we will investigate the impact of LNG on the European and regional markets.
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