As demand for natural gas dwindles, traders are creatively looking at their options
A variety of intermediaries and contract terms allow traders to swap cargoes with each other, divert shipments or even take longer routes to optimise returns
London/New York — The golden age of trading in the world’s natural gas market has ended, and it was bound to happen even before the coronavirus struck.
Two warm winters in a row in addition to the health crisis have gutted demand for the fuel used for everything from home heating to power generation. That’s left inventories brimming during a season when they’re usually drained.
A decade ago, the industry was still developing. That kept hefty premiums for shipping liquefied natural gas (LNG) by tanker to places such as Asia far from pipeline networks. These days, LNG has grown into a global industry allowing gas to flow freely around the world. That and the demand slump is gutting the margins on once-lucrative shipping routes.
“I joined LNG when there was a $3 dollar margin” on every million British thermal unit of gas shipped, Sarah Behbehani, a senior vice-president of LNG at Jera Global Markets who has two decades of experience in energy trading, said in February when she predicted the worst year ever for the fuel. “Now we scramble for 2c.”
As recently as two years ago, traders could depend on gas prices of $4 in the US, $8 in Europe and $11 in Japan and South Korea. Today there’s less than 25c difference between the rates in those regions.
That’s a far cry from the boom years for traders in 2011. When an earthquake in Japan caused the worst nuclear disaster since Chernobyl, that nation shut down its reactors and scrambled for gas to keep the lights on. Royal Dutch Shell diverted nine ships full of LNG, each worth tens of millions of dollars, from Brunei, Russia and Nigeria to Japan.
That episode sent fuel prices and shipping rates higher, underscoring the competition for prized LNG cargoes and helping foster a global trading network. After years of investment in ports to handle the fuel which is chilled to -162°C, LNG has become the fastest-growing energy commodity.
Margins to ship the fuel have been narrowing for almost a year, starting with an unusually warm winter in Europe and Asia in 2019 that cut the need for fuel during the heating season. The Covid-19 pandemic drew more life out of the market, causing storage tanks to fill well beyond seasonal norms.
With no end in sight to those trends, margins narrowed, reducing the incentive for US exporters to send gas to Asia. Atlantic cargoes are staying in the Atlantic and the same is happening in the Pacific basin, according to brokerage Tullett Prebon Energy (Singapore).
Traders have to be quick to make money. Instead of months where an arbitrage would open between regions, the incentive to ship appears rarely for a week or so.
In March, Asian rates rose briefly as European nations halted activity because of the health scare. Cargoes started flowing from the Atlantic to the Pacific, but only until India imposed its own lockdown, which sent Asian prices to fresh lows. Today, there’s little incentive to ship LNG, and traders are watching for signs that buyers will cancel cargoes they have pledged to order.
“The arb is closed,” said Tobias Davis, head of Asia LNG at Tullett Prebon. “We are in a unique trading environment.”
The growth of the global trade also complicated the LNG business, favouring sophisticated traders and the biggest companies with the most clout. No longer is the business dominated by long-term contracts arranged between gas producers and consumers.
Now, a growing array of intermediaries and contract terms allow traders to swap cargoes with each other, divert shipments or even take longer routes to optimise returns. And as vessels become more efficient, they can act as long-term storage facilities holding cargoes until prices improve.
“The market is really developing and the tools are more readily available,” Peter Abdo, MD and head of global origination and LNG at Uniper’s trading unit, said at the Bloomberg Commodity Investor Forum late in 2019.
Here’s what LNG traders can do when the Atlantic-Pacific arbitrage window is closed:
Location and time swaps
LNG traders engineer swaps when both benefit from using the other’s cargo, usually because of location. For instance, someone with a shipment in Europe but a buyer in Asia could switch with a trader in the opposite situation, thereby saving on transport costs. Swaps can also be done in time, not just location.
Traders such as Gunvor, which is set to receive a new LNG vessel that loses less of its cargo per journey, can benefit from so-called floating storage. That’s a strategy when price signals indicate it’s better to let the cargo sit on board until the approaching heating season boosts prices. Securing a vessel now when rates are relatively low helps.
LNG shipping costs are falling on weaker commodity markets and a lack of arbitrage, according to the Spark30 Atlantic June index compiled by Spark Commodities in Singapore, which takes assessments from LNG shipbrokers. Both May and July contracts also fell on the back of depressed demand, said Tim Mendelssohn, Spark’s MD in Singapore.
Traders can take advantage of lower shipping costs and move cargoes, for example, from the US to northern Asia via a longer route via the Cape of Good Hope, avoiding fees transiting the Panama Canal. Such a longer journey can take a month or more and could mean prices are higher on arrival. It’s not unknown for vessels to take as long as two months in longer routes.
Focus on local markets
One consequence of the closed Atlantic-Pacific arbitrage is that cargoes from the Yamal LNG project in the Russian Arctic are remaining in northwest Europe, with ships transferring their loads in Belgium or off northern Norway.
While such intraregional saturation can push prices lower, it can also bolster the development of small-scale deliveries deeper into downstream markets, for example as a cleaner fuel for use in transport, said Andrei Belyi, the owner of energy consultancy firm Balesene OU.
“In the context of oversupply we observe an increasing dynamic of small-scale deliveries within each region, which creates a basis for regional LNG markets and small scale deliveries,” said Belyi, who is also an adjunct professor at the University of Eastern Finland.