Gas bubble?

Prices rise even as demand falls. Time for a correction? | EU LNG chart deck: 16-27 Oct 2023

European natural gas prices have retreated from recent peaks but remain unsustainably high. The initial shock of events in Israel and the Baltic Sea is giving way to a creeping realisation that gas fundamentals remain weak. European LNG imports have fallen by a third since the summer even as prices rose by the same proportion, suggesting a correction is due. But LNG traders can still make a killing before that happens.

The correction might be underway already. Prices on benchmark TTF fell more than 5% over the last fortnight and even further across the forward curve, eroding the contango that had until recently sustained talk of holding cargoes in floating storage to capture higher winter premiums (see Pushing the boat out — 18 Sept. 2023).

Such talk is positively passé in the current market. The price of winter LNG delivered ex-ship to north-west Europe fell more steeply over the last two weeks than TTF, under pressure from saturated EU gas storage levels and limited terminal capacity…

…widening the winter discount of NWE LNG to TTF.

A broader view highlights the disparity between volume and price. European LNG imports have fallen by 30% since June, even as TTF rose by more than 33% over the same period. LNG imports are still about 28% above the 2015-20 average, but total gas inflows (including by pipeline) are lower than at any point in 2022 and the preceding five years.

It is easy to see why Europe’s LNG imports are tailing off. Industrial demand for gas in Germany fell by 54 TWh over the first six months of the year and shows no signs of recovery. Household gas burn fell by 37 TWh, and power sector consumption fell 4.4 TWh. In total, that’s 9.8 Bcm (billion cubic metres) less gas, equivalent to a -13% reduction in Germany’s entire 2022 gas burn in just six months. At this rate, Europe’s largest gas market will have shrunk by more than a quarter over the full year. The picture looks similar in Italy, the Netherlands, France and other big European gas consuming countries.

Source: Bruegel

Gas is struggling to gain a foothold in the German power sector. Profits have fallen negative for Dec-23 because fuel costs are eroding margins and power prices are softening more quickly than EU carbon prices are falling. Low efficiency coal and lignite power stations are well in the money and crowding out cleaner burning, higher efficiency gas turbines.

So where does that leave the global LNG trade balance as the northern hemisphere heads into winter? Geopolitically-driven price movements in Europe triggered an over-reaction in Asia, where the spot LNG benchmark JKM traded above TTF for most of October.

But sentiment is soft in Asia too. The evolution of the JKM forward curve over the last week speaks for itself.

All of this casts doubt on the sustainability of current LNG profit margins. Cargoes leaving the US Gulf Coast can expect to capture netbacks as high as almost $40 million per vessel¹ after paying for shipping and regasification, which is roughly 30-50% higher than at the start of September.

This remains the case whether US LNG exports head to either Asia or Europe. There’s little to separate the two regions price-wise, so spot cargoes looking for orders will head to destinations that make sense on other factors — such as terminal slot availability, Panama Canal transit capacity or vessel availability.

There is no rush to get the LNG to market because the winter outlook is currently mild. But there could be a rush to capture today’s spot prices for delivery in December, January and February before they deflate. European netbacks over these months remain resilient even as profits in Asia fall back, meaning the market is not currently anticipating a ‘tug-of-war’ for winter cargoes.

A bitter cold snap cannot be ruled out at this stage, but those healthy premiums for gas traders shipping cargoes to Europe won’t last without one. Since these trades are usually settled a month or two in advance, expect those that can to lock in prices for winter delivery now — even while slow-steaming cargoes to their final destination.

Seb Kennedy | Energy Flux | 30th October 2023

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1. Vessel size = 160,000 cubic metres