Europe, the LNG sponge

Published at 18:26 5 Mar 2019 by . Last edited 11:18 22 Aug 2019.

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Rising US LNG export capacity and warm winters in Asia and Europe have left gas inventories high around the world. In Asia, we project Japan will see flat y/y imports this summer, while South Korea will take 0.2 bcf/d (1.1 Mtpa) less LNG y/y, as both countries have high inventories and stronger scheduled nuclear availability through Q3 19. We project 0.9 bcf/d (6.2 Mtpa) in y/y import gains from China, though much depends on how the central government navigates industrial fuel-switching targets, meant to improve air quality, in the face of slowing economic growth. A very warm February means we now project a 700 bcf (+20 bcm) y/y end-March storage overhang in Europe, which has pushed prices down across the continent. Coal-to-gas switching will be critical for Europe to balance that excess supply, particularly in light of our projection for European imports to increase by 425 bcf (12 bcm) y/y this summer. TTF prices for summer 2019 delivery, at around $6.00/mmbtu, have room for further downside, particularly if coal and carbon prices also fall. Limited European gas power demand this summer could stifle US deliveries across the Atlantic, although that is not in our base case.

Europe, the LNG sponge

US LNG export capacity is set to double by year-end, with feedgas demand rising to 7.4 bcf/d (53 Mtpa), raising the question of how much the global market can absorb. In summer 2019, we anticipate all US gas will find a home despite a warm Q1 19 in both Asia and Europe, which has left storage levels high. But that swelling of supply is manifesting itself in weak prices. High Asian storage will lead to lower spot purchases in spring, but we still anticipate demand will be robust this summer, albeit lower than initially expected on potential weakness in the Chinese economy. Europe—itself dealing with a massive projected y/y overhang by end-March of 700 bcf (+20 bcm), more than double last year’s carryout—remains the destination for incremental cargoes.

That excess supply will push down prices, keeping European gas markets loose and encouraging gas to compete for market share in the power sector. Any revisions to supply hitting Europe—whether it be pipeline imports, LNG or domestic production—will lead to adjustments to demand forecasts, specifically the degree of coal-to-gas substitution necessary to keep the market balanced.

Underlying Asian demand will grow by 1.5 bcf/d (10.4 Mtpa) y/y this summer. Japanese demand will be flat to slightly up, with any growth only in Q3 19, when the impacts of nuclear restarts and high end-of-winter storage levels evaporate. South Korean demand is expected to be weaker by 0.2 bcf/d y/y (1.1 Mtpa), similarly due to higher nuclear availability and high storage levels. Demand growth will be strong in emerging Asia, with China up by 0.9 bcf/d y/y (6.2 Mtpa).

For China, there remains a risk that industrial gas demand could underwhelm due to a slowing economy. Additionally, the government has yet to issue its 2019 coal-to-gas switching target as economic concerns could lead it to ease the pace of industrial fuel switching this year. Still, any downside to demand growth should be limited by regional authorities issuing their own fuel-switching targets, while Chinese distribution companies will still be actively seeking new connections/expanding their networks. Furthermore, Beijing has introduced support measures for industry—including tax breaks and larger credit facilities—in order to cushion the impact of the US-China trade spat.

Europe’s LNG imports this winter have included healthy US deliveries and have driven the continent’s 700 bcf y/y (+20 bcm) inventory overhang expected for end-March. While Sabine Pass sent 37 cargoes to Europe in 2018 (13 of which were in December), 2019 so far has already seen 23 cargoes from the terminal come ashore across the Atlantic. This increase in imports has been particularly acute in the UK, which has been a favoured destination for spot cargoes. A positive NBP-TTF spread has encouraged 137 bcf (3.9 bcm) more LNG imports to the UK y/y over the last four months. As a case in point for the impact of higher imports, UK consumption in January was up by 21 bcf (0.6 bcm), driven by a colder month y/y, but LNG sendout was up by a massive 50 bcf (1.4 bcm) y/y to 56 bcf.

UK LNG imports are likely to remain strong. We forecast LNG imports in summer 2019 to be up by 0.15 bcf/d y/y, or 40% (1 Mt). Since the closure of the 125 bcf (3.5 bcm) Rough facility in 2017, British storage capacity is now just over 50 bcf (1.5 bcm), so there is only limited injection requirement in this market over summers. There is a low base of coal-fired generation—2.6 GWh (equivalent to 0.3 bcf/d in gas demand) in summer 2018—and even if that output was to be fully replaced with gas-fired generation over the entire summer, the impact would be minimal. The NBP will likely need to move to a discount to the TTF to encourage UK exports to continental Europe.

Still, continental Europe is the larger market. There is more potential for coal-to-gas switching there and getting the power sector to shift generation fuels will be essential for Europe to balance. Our global balances suggest that Europe will take 425 bcf (12 bcm) more LNG y/y this summer. European end-user gas demand will be higher by 260 bcf y/y (7.4 bcm) due to coal-to-gas fuel switching as gas prices move down to a lower fuel switch trigger on average.

We forecast that Europe will end summer 2019 with over 3.3 tcf (95 bcm) in storage, up by 320 bcf (9 bcm) y/y to a new five-year high. Such high inventories are a key reason that TTF prices for summer 2019 delivery currently average $6.00/mmbtu, down by $1.68/mmbtu y/y from 2018 actuals. With the TTF already pricing low in relative terms, downside to TTF pricing this summer is only likely to come if European coal and carbon prices drop as well, with the fuels chasing each other downwards in competition for power sector demand.

For US-sourced LNG, the JKM-TTF spread will be the fundamental factor driving gas to either Asia or Europe. With freight rates currently just below $50,000/day, the difference in shipping costs to Northeast Asia and Northwest Europe is around 70 cents/mmbtu, above where the JKM-TTF spread is currently trading for Q2 19-delivery contracts and just below where Q3 18 is trading. While the warm winter in Northeast Asia has seen JKM prices slide along with LNG sendout due to low demand, Asian deliveries will more palatable for US producers should TTF prices see additional weakness this summer. Given Europe’s high LNG imports this winter, it is possible that the European demand sponge will be full saturated by the end of summer 2019.

Fig 1: NBP-TTF, $/mmbtu Fig 2: UK LNG imports, Mt
Source: Refinitiv, Energy Aspects Source: Bloomberg, Kpler, Energy Aspects

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