Strike spike
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Nobody should be labouring under the misconception that European energy markets have returned to ‘normal’. The summer lull was punctured by a 30% spike in month-ahead Dutch TTF (Title Transfer Facility, the European gas benchmark) last Wednesday on fears of a possible strike in Australia that threatens to disrupt as much as 10% of global liquefied natural gas (LNG) supply. The fact that TTF saw the strongest price response rather than JKM (Japan-Korea Marker, the Asian LNG benchmark) is yet another indication of the lingering jitteriness of European gas markets.
Australia ships most of its LNG to Asian markets so logic should dictate that any potential supply disruption in this region would be reflected first and foremost on JKM. But gas markets stopped behaving rationally when Russia launched its full assault on Ukraine in February 2022, and events such as this belie any pretence of a return to pre-invasion averages.
The strike threat — and it remains only a threat at this stage — pushed TTF above JKM for the first time since late June. The fact that JKM barely budged even as TTF clung onto these gains heading into the weekend again speaks to a market driven by fear and irrationality, rather than supply-demand fundamentals.
TTF calendar futures were driven higher all along the forward curve, with gains recorded as far out as March 2024. In the absence of a swift resolution to the labour dispute at three Australian LNG megaprojects, the premium for sending spot cargoes to Europe could persist. If so, this would suck more cargoes out of the Atlantic basin and quell appetite to ship LNG to Asia and other regions.
The profitability of shipping a standard cargo from the US Gulf Coast to Europe shot up to more than $25 million after Wednesday’s rally, tipping the economic calculus sharply away from sending marginal cargoes to Asia. And bear in mind that this assumes US LNG cargoes can still traverse the Panama Canal, which is experiencing heightened congestion due to tighter draft limits imposed in response to drought conditions:
However, a broader view tells a different story. We are still a very long way from the (frankly insane) netbacks of 2022, when US LNG spot cargoes captured profits as high as $300 million (!!) after paying for upstream gas, liquefaction, transportation and regasification at a European LNG terminal:
And leaving aside the anomalous TTF premium for September, spot cargo profitability is in fact still fairly balanced between Europe and Asia throughout winter until March 2024 — the ‘shoulder’ month, when storage refilling typically begins:
Currently, the market sees Europe as being amply supplied by gas for the next six months as underground storage facilities are racing towards their technical maximum capacity. Reports of traders sending gas into underground storage in Ukraine supports this narrative. Notwithstanding an intense and prolonged cold snap, there is no decisive price signal to ship spot LNG to Europe until the spring, when depleted gas stocks will need to be replenished.
There are several key indicators to keep an eye on as winter approaches. A less discussed one is the difference between LNG priced on the water in north-west Europe (NWE LNG) and TTF. As Europe pivoted to LNG replace lost Russian pipeline flows, a disconnect emerged between these two price points. And last week’s rally widened the discount:
The NWE LNG discount to TTF is a proxy for the value of EU gas infrastructure. Europe’s LNG pivot placed a premium on regasification terminal slots, while the rush to stock up ahead of winter makes gas held in storage more valuable than LNG on the water. The deeper this discount goes, the stronger the indication that bottlenecks are hampering Europe’s ability to import LNG and refill stocks.
This dynamic is already playing out in the cost of chartering LNG vessels. With demand subdued in both Europe and Asia and the TTF forward curve in contango, freight rates assessed by Spark Commodities are starting to rise as traders hold more LNG on the water in ‘floating storage’. This is a bet on a European winter price rally offsetting the cost of renting vessels for longer periods:
The trouble is that as more traders make this bet, the higher freight rates will rise — increasing the risk that the bet could fail. Also, more expensive shipping erodes margins for sending LNG cargoes over longer distances, further supporting the economic calculus for sending US spot volumes to Europe rather than Asia. The stage is set in the Bay of Biscay for another pile-up of laden vessels awaiting an opportune moment to dock and unload.
Another key indicator is on the power demand side. The ‘clean spark spread’ for gas-fired power generation is currently in the black throughout winter in Germany, Europe’s biggest gas market. But margins are precarious, and any rise in fuel costs would push gas out of the merit order:
The key contract to watch is again March 2024, when the drive to replenish depleted gas stocks could push TTF hub prices higher to lure more cargoes into Europe. This would erode the profitability of gas-fired power and, in an extreme situation, trigger a temporary switch back to coal to balance the grid in the spring months — a period of typically subdued demand and strong renewables generation.
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