More than a balancer: the role of Europe in LNG
With extensive regasification and storage capacity, flexible demand and well-connected, liquid trading hubs, Europe is establishing itself as more than just a global LNG balancer.
The conversation around LNG in Europe has, in no uncertain terms, shifted.
Boasting over 100 Bcm of storage capacity, more than 20 LNG regasification terminals with over 220 Bcm/year of send-out capacity, a deep coal-to-gas switching channel, and well-connected, liquid trading hubs, Europe is steadily cementing a key role for itself in global LNG markets, one of global balancer, price anchor and demand hub in its own right.
Whereas the bulk of LNG contracts for delivery into Asia remain oil-indexed, in Europe a period of contract revisions starting in around 2007 meant gas — much of which was piped in from Russia and oil-indexed – has become increasingly hub-indexed.
By 2019, over 70% of Europe’s gas supply is assumed to be linked to hub prices, primarily to the UK NBP or Dutch TTF, on a direct or hybrid basis, according to S&P Global Platts Analytics.
This connection to hub prices has fed liquidity on both the NBP and TTF, with the latter cementing itself as the primary hub for long-term gas indexation and hedging.
This has largely been driven by the TTF’s location close to Europe’s largest markets, proximity to both supply from Norway and the UK, and access to significant storage facilities, all of which are accessible to the majority of market participants.
Reflecting these dynamics, the TTF’s churn rate — the number of times a unit of gas is financially transacted before delivery — has consistently fluctuated between 25 and 70, depending on the contract month.
While this is on the whole lower than the annual churn rate of the US Henry Hub of more than 55, no index representing either LNG or pipeline gas in Asia has achieved a churn rate of above one yet.
That said, starting in 2018, JKM’s churn rate has been accelerating, averaging just under 0.3 in 2018, and breaching 0.5 in various single months in the first half of 2019.
For now though, the TTF remains the most readily applicable financial tool in the global gas market to hedge against financial and physical price exposure, reflecting the downside risk for LNG price dynamics more accurately than Henry Hub or oil, especially in times of oversupply.
A ‘put option’ at play
Europe’s extensive regasification capacity, storage space, flexible demand and liquid trading options also make it the global LNG market’s natural “put option”, because of its ability to absorb surplus volumes in times of oversupply.
This dynamic was clearly at play in Winter 2015 and Winter 2018 — both periods of weak LNG demand. In Winter 2018, markets in northwest Europe (UK, France, Belgium, Netherlands) imported roughly 28 Bcm (around 150 million cu m/d), equating to a regional capacity utilization of nearly 50%, its highest level in the modern LNG era, Platts Analytics data shows.
Underlining this connection between global LNG and European gas, the price correlation between JKM and TTF was a nearly perfect 1:1 through Winter 2018, while the relationship each benchmark held with oil fell below negative 0.2.
This clearly demonstrated Europe’s ability to efficiently absorb and disperse LNG at times of market glut and led to all of Europe’s “put option” components being brought into play.
Storage was driven to record levels and hub liquidity skyrocketed, even in traditionally less liquid southern European hubs like Spain’s PVB and Italy’s PSV where price transparency and infrastructure accessibility remain more opaque.
Many LNG players with market length already use Europe as their financial and physical balancer. An example of how this “put option” functions practically can be seen in the case of Qatar, which utilizes its ownership stake in the UK’s South Hook regasi cation terminal to secure capacity for its marginal, swing cargoes when Asian demand is too weak to absorb incremental flows.
Using JKM as a proxy for Asian demand, Platts Analytics data shows that when Qatar’s netbacks to JKM fall below that of TTF, Qatari exports to South Hook surge, while conversely, in times of a notable JKM premium to TTF, Qatar’s exports to South Hook dry up.