European gas prices soared earlier this month as workers at three LNG facilities in Australia threatened industrial action.
A strike at one facility was averted, but the threat to the other two remained, keeping gas prices low. But in the last year, there has been an attempt to put a kind of cap on gas prices in Europe, and especially on LNG prices. The effort is starting to pay off.
Until last year, the global LNG market featured long-term contracts in line with crude oil futures prices and spot deals. After Russia invaded Ukraine, the European Union began imposing sanctions and pipeline gas flows began to decline, LNG suddenly became extremely important to Europe. And this prompted a race to reduce pricing risks associated with the state of the LNG market at the time.
That race resulted in the launch of the Northwest European LNG futures contract based on the S&P Global NWM, or Northwest marker. The LNG market matured rapidly. In highly volatile markets, traders can hedge European LNG cargoes.
They couldn’t care less about pipeline gas and its price while trading LNG. The reason was, once again, market disruptions due to the Ukraine conflict, chief among them the disruption of gas flows from Russia, especially after the sabotage of the Nord Stream pipeline.
A mature market is a low-risk market, and this has been happening in the LNG market for the last year and a half. However, this hasn’t really reduced the extent of volatility in that market, as evidenced by the impact of news of potential strikes on Australia’s top three LNG facilities on LNG prices, especially in Europe.
Hedging is important in trading, but when there is a threat of a shortage in supply, all bets are off. And there was a risk of a supply shortfall equivalent to a tenth of total global supply – this is how much the North West Shelf, Gorgon and Wheatstone together produce.
Ultimately, supply and demand are outweighing other factors that traders can use to hedge the risks inherent in the commodity markets.
No doubt, it is good to have a liquid market, and now, due to the rise of the Dutch benchmark TTF at the expense of the UK’s National Balancing Point, LNG traders have such a liquid market. Trade is more active and easier than ever, even intercontinental trade with Asia.
However, at the same time, prices, regardless of the benchmark they are based on, remain highly vulnerable to the threat of a potential cut. The good news is that as the LNG market matures, a repeat of last year’s price hikes may be less likely this year or in the future.
On the other hand, in the event of cold winters in the Northern Hemisphere, a lack of supply can push prices significantly higher during peak demand seasons.
The good news for now is that Europe’s gas storage is more full than usual at this time of year. Thanks to last year’s leftover quantity, which was bought at record prices, and there was no point in reselling them at huge losses, the continent’s storage is now 92.5% full. This can provide a comfortable buffer in the event of an outage, especially if the outage does not last very long.
However, even with this buffer, Europe will remain a major competitor to Asia in LNG cargoes as it has been forced to reduce its reliance on pipeline gas. Demand from Asia is increasing even before the winter season. This season will likely be the first major test for the new, more mature, global LNG market.
By Charles Kennedy for OilPrice.com
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