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LNG trade needs greater liquidity to counter volatility

Many have questioned the efficacy of the Asia JKM benchmark, which has long been regarded as a barometer of the LNG market. But the more pertinent issue is whether trade in the commodity has achieved the required liquidity to support a global price benchmark

LNG demand is predominantly still tied to power generation, which subjects trade in the commodity to the vagaries of the weather, particularly during the winter season in North Asia. While the market turned against buyers during this year’s cold snap, it could just as easily have gone the other way

ONE leading liquefied natural gas price benchmark used to hedge cargo and freight positions, has faced renewed heat regarding its efficacy as a reference for pricing term supply deals.

The JKM benchmark for cargo trades in Northeast Asia, a region that is home to the world’s top LNG importers, surged past $30 per million British thermal unit last week, easily more than doubling previous winter highs.

S&P Global Platts, the agency behind JKM pricing assessments, had flagged three deals reflected in its daily trading window from January 8 to January 13 that were priced above $30 during a press briefing held last Friday.

While its analysts also emphasised that JKM spot prices would not stay at these levels, noting that February cargoes were fixed at below $30, that has not fully appeased buyers. 

Importers in China and India have shunned spot cargo buys. Meanwhile in Australia, industrial gas users have pushed for government support towards a reference to the US Henry Hub benchmark in domestic supply agreements.

Save for spikes in 2005 and 2008, US Henry Hub has consistently traded at below $10 per mmBtu for over two decades.

This regional benchmark is more commonly used as a reference for exports from projects in the US, which have also been subject to price volatility this winter season.

Congestion at the Panama Canal since October has forced many tankers carrying US LNG to sail via a much longer route via the Cape of Good Hope in South Africa to get to markets in Asia, increasing tonne-mile and squeezing already tight supply.

Platts estimated as of January 14 that this adds $3.55 per mmBtu to freight costs, driving up the overall prices of US origin cargoes.

But freight costs have also soared as spot prices climbed in Asia in early January, with BP said to have been behind a tanker charter priced at a record $350,000 per day.

These factors illustrate the intricate correlation between LNG cargo trade and the shipping market, which sets the commodity apart from oil and oil products.

Latching on the recent volatility in freight rates, one promoter of a US LNG project, counter-argued for the case of term supply contracts.

The shipping costs for cargoes tied to such deals would not have jumped so drastically as freight would probably have been negotiated along with the term offtake, he suggested.

Yet, what prompted buyers to hold back from committing to term offtake over the past 12 months was precisely the perceived availability of spot cargoes at very low prices following a macro-economic slowdown triggered by the coronavirus pandemic.

Critics may argue these developments, coinciding with the worst pandemic in recent memory, nonetheless demonstrate the fallacy of pegging term offtake to a spot trade-linked index like JKM.

Still, this argument precisely holds true because LNG as a commodity is far less liquid than crude and many oil products.

Its demand is predominantly tied to the need for power generation needs, which are inelastic yet heavily dependent on uncontrollable swings in weather conditions across continents.

Liquidity in the LNG market has certainly picked up with spot cargoes seen accounting for more than a third of overall trade volume in 2019.

But until this cleaner burning fossil fuel gains more clout in transport and other sectors, its cargo prices and associated freight rates may well remain subject to the whims of mother nature with the accompanying inherent volatility.

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