European predicament puts further pull pressure on LNG markets
The contest between Europe and Asia for global LNG supplies has so far remained muted but will intensify later this year, as the fuel will remain in demand among European countries weaning themselves off Russian gas while energy-hungry Asian buyers will soon start building stocks for the winter demand season.
After a robust 2021 when LNG demand increased by 8% year/year, Asia-Pacific’s growth is now a shadow of its former self. Imports in the first quarter (Q1) of 2022 fell by 8% to levels not seen since 2020 due to milder winter weather and greater use of coal and oil as spot LNG prices soared.
Europe, however, has emerged as the premium market for LNG amid the ongoing war in Ukraine, with inflows surging by 70% year/year in Q1 compared with a 4% decline for all of 2021. The magnitude of the Asian demand slump in response to Europe’s aggressive bidding for cargoes has underlined a sensitivity not previously seen to this degree.
Russia’s stuttering invasion of its neighbour has fundamentally reshaped the outlook for European LNG, compelling Brussels and other continental capitals to shift away from Russian pipeline gas and towards LNG, with the US seemingly best-placed as supplier.
Russia supplied 155bn m³ of gas to Europe last year – roughly one-third of the continent’s gas demand – that comprised 142bn m³ of pipeline gas and 14bn m³ of LNG. Replacing this volume with LNG from other sources would lift Europe’s LNG demand by 114mn metric tons/year – equivalent to 30% of the global LNG market last year, as estimated by Shell.
The European Commission’s RePowerEU plan in early March seeks to replace 100bn m³/year of gas demand this year, equivalent to 73.5mn mt/year of LNG and nearly two-thirds of the 155bn m³ imported from Russia. This would be mostly achieved via by diversifying gas supplies through additional LNG imports and pipeline imports from non-Russian suppliers such as Norway and Azerbaijan, with the remainder made up by energy efficiency, heat pumps, and renewables.
Some options proposed by RePowerEU make sense, but displacement through heat pumps and energy efficiency appears unrealistic. Displacing such an enormous volume of Russian gas this year, while simultaneously ensuring EU member states fill up underground gas storage to at least 80% of capacity by the end of October, will depend heavily on Europe’s ability to source additional LNG this year. This means benchmark European gas prices at the TTF will need to outbid the JKM for supply.
European demand in full force
It is unclear if Brussels’s envisaged scale of supply increase is realistic. But so far Europe has been able to attract a greater share of cargoes, taking volumes from Asia. European inflows topped 11.5mn mt in April, which would be the strongest month since January, while Asia’s imports were forecast to be the lowest since June 2020 at 20.55mn mt, according to commodity analysts Kpler.
The scale of unloadings at European terminals is such that the continent is increasingly struggling to absorb these cargoes owing to infrastructure constraints. Lone unloading slots on the secondary market are reportedly being sold at more than $7/mn Btu amid the intense competition for using European unloading infrastructure.
This congestion will be exacerbated as Western European gas demand slackens seasonally into the summer, barring strong cooling demand in the Mediterranean. Maximising the use of import capacity outside of Northwest Europe – such as Greece’s Revithoussa and Poland’s Świnoujście import terminals – will help ease some of the snarl-ups, while new capacity targeted for commissioning this winter will help too.
The question is how long European buyers will continue to have the upper hand over their Asian peers. Consultancy Rystad Energy believes price signals on the TTF are likely to far exceed Asian spot prices this year. Even a relatively small substitution of any Russian gas shortfall in Europe with spot LNG has potential to squeeze spot supplies in Asia, in turn leading to massive rises in competition for remaining cargoes and risks of further price spikes.
This would exacerbate Asia’s already high spot prices that have remained elevated due to fundamental and geopolitical factors. Regional spot prices averaged $30.4/mn Btu in Q1 of this year, up by more than threefold from $8.9/mn Btu in the same period of 2021 and an eightfold jump from $3.7/mn Btu in 2020. The higher prices have resulted in demand destruction in Asia that has balanced the global market, allowing European buyers to step in.
The sense among LNG analysts in China and Singapore surveyed by Gas in Transition is that Asia will outbid Europe for marginal cargoes over the remainder of 2022, sourcing the bulk of volumes from the US as structural demand returns. This implies the Northeast Asian spot market will maintain a premium to the TTF that covers the additional cost of shipping to Northeast Asia.
But it is unclear if this will be reflected by the JKM paper market given the extreme price volatility in Europe and extremely thin liquidity in JKM trading – particularly as Asian buyers are pivoting as much as possible to long-term contract takes.
“The Russian invasion of Ukraine has had a dramatic impact on long-term LNG contracts. Many traditional LNG buyers will neither procure spot gas or LNG nor renew or sign additional LNG contracts with Russian sellers,” said Wood Mackenzie principal analyst Daniel Toleman.
“Spot prices have also been high and volatile, pushing many buyers towards long-term contracts. Additionally, some buyers are returning to long-term contracting on behalf of governments to protect national energy security.”
Asian buyers have some ability to outbid Europe for cargoes as their spot price exposure is very low as a share of aggregate demand. Buyers have been actively signing long-term contracts over the last year – China contracted close to 23mn mt/year of term LNG in 2021 and has already signed up more than 16mn mt/year to date this year.
Fellow regional buyers Japan, South Korea and Taiwan have also increased their long-term contract coverage, outpacing growth in their LNG import demand. The expectation is that this gives the Northeast Asian market a 90% contract coverage, making trade flows to Asia sticky and hard to redirect to Europe.
Asian buyers still have to source spot cargoes and bid them away from Europe, but these will be a relatively small expenditure on their balance sheets compared with European buyers.
Long-term contracts on a typical oil-indexed basis to Japan and South Korea are expected to average $9.6/mn Btu for the rest of this year compared with a JKM price of $22.59/mmbtu earlier this week. Spot purchases can therefore be averaged out with this cheap supply – as was demonstrated in South Korea last year, when independent power producers shunned the spot LNG market in favour of increased purchases from state-owned LNG importer Kogas.
Similar dynamics could play out with some of China’s second-tier importers that are more exposed to the spot market. They may opt to buy LNG from state-owned importers CNOOC, PetroChina and Sinopec, which can offer a mixture of long-term contract and spot prices.
US to the rescue
The global LNG market has pulled almost every short-term lever for increasing supply and decreasing demand, and Europe therefore has reduced flexibility to raise LNG shipments further.
“There simply is not enough LNG around to meet demand. In the short term this will make for a hard winter in Europe. For producers, it suggests the next LNG boom is here, but it will arrive too late to meet the sharp spike in demand,” said Kaushal Ramesh, senior analyst for gas and LNG at Rystad Energy.
LNG export projects in the US and Australia have been operating at nameplate capacity since March, leaving little scope for a further surge in output. Similarly, price-sensitive drivers of Asian demand have already largely been priced out of the market – these include India’s power and industrial sectors cutting LNG consumption, substitution of gas with high sulphur fuel oil in Pakistan and Bangladesh, and Japan burning more oil for power.
The US is the most obvious supplier of incremental LNG, as it can add liquefaction trains quicker than any other country, is physically closer to European gas markets than Asia and the Middle East, and is aligned geopolitically with the bloc. Qatar has the upstream resources to expand but there are limits as Qatargas already has six trains under construction, while Australasia is possible but has longer time scales.
If the US moves to fill in the gap in European demand created by the withdrawal of Russian gas, then it would put the American industry on course to overtake Australia as the largest global exporter by 2025, according to Bernstein Research. By the end of this decade the US could have 200mn mt/year of LNG export capacity compared with 100mn mt/year at present.
The anticipated growth in global LNG demand due to Europe means as much as 120mn mt/year of new LNG capacity will need to be sanctioned by the middle of this decade. US projects are in pole position – a reversal in fortune as a number of them lay dormant waiting for demand to rise, and have now been given new life.
The most commercially-viable capacity in the US includes Cheniere’s Corpus Christi Stage 3 and Venture Global LNG’s Plaquemines LNG developments, but projects previously on ice such as Energy Transfer’s Lake Charles and NextDecade’s Rio Grande have reported 9.45mn mt/year worth of deals recently.