Things have gone extremely bearish in the global gas markets, with the JKM May-19 price dropping below the TTF equivalent by 22 cents/mmbtu at Friday’s close (22 March). While May-19 is the outlier with the JKM at a discount, the Jun-19 and Jul-19 spreads also fell below the level where we estimate the JKM-TTF spread needs to be to keep the netback for US cargoes to Asia higher than to Europe. With Q2 19-delivery contracts suggesting US cargoes will go to Europe, the concern for US producers is just how low European prices will go and how low must they go before a TTF-Henry Hub arbitrage trade is uneconomic. Given the precipitous plunge in LNG freight rates, with Fearnleys putting average daily spot tanker rates way down at 30,000 $/d last week, the LNG market is not far from seeing the inaugural closing of the TTF-Henry Hub arb, though the TTF will need to fall to around 4.15 $/mmbtu for that to happen.
Even a few months ago it seemed unthinkable that the LNG market could even contemplate closing the Henry Hub–TTF arb in summer 2019, but that now seems much more likely. The global gas markets are set to face summer 2019 after a mild winter, which has significantly curtailed demand in NE Asia for spot LNG and has consistently pushed more LNG into the European market. Over March so far, NW European markets have seen LNG sendout rise by over 3.3 bcm y/y, while a very mild February and a modestly warmer-than-normal March have kept EU storage high. With only a week to go until the end of the European gas winter, the EU storage carryout looks set to exit March 24 bcm higher y/y. Even if a reasonably conservative view is taken on the volume of LNG that will come into the EU market over the next six months (say, 10 bcm more y/y), the European gas market will be 35 bcm looser y/y over summer 2019.
Global gas markets can try to balance through some avenues in Europe. First, the European markets are likely to fill up all domestic storage sites, with an end-October storage carryout likely to be at least 10 bcm higher y/y. Second, Europe is likely to see some demand-side response, as it has a maximum of 13 bcm of potential added gas demand from pushing hard coal out of merit this summer. While achieving all of that fuel switch will be very difficult due to the need to manage peak demand as well as transmission constraints, 9 bcm of switching is a realistic target. However, gas prices would need to fall in comparison to coal and carbon prices. Looking at the key pricing points at the TTF, the 5% fuel switching trigger (45% efficiency gas-fired plant vs 40% efficient coal-fired plant) is now around 13.6 €/MWh (4.5 $/mmbtu) after last week’s moves in European coal and carbon prices, while the parity trigger is now down at 11.6 €/MWh (3.9 $/mmbtu).
Most of the potential demand-side response should be realised around the 5% trigger in the relevant markets and should be completely achieved at the parity trigger. As most of the fuel switch potential is in markets where prices trade at a premium to the TTF, the TTF will have to move lower than the fuel switch trigger levels to stimulate enough switching in the continental European market.
Third, as the TTF starts ebbing towards the 5% fuel switch trigger level, those lower price points will stimulate lower pipeline flows. We expect to see pipeline flows ease from Norway, the Netherlands and the UK due to a combination of heavier scheduled maintenance, field declines and regulatory limits. We expect flows from the three countries to drop by 6.5 bcm y/y over the coming six months. Flows from Algeria and Russia will need to drop by 8 bcm over the summer if the EU market is to balance. We think Algerian flows are likely to drop by around 5 bcm y/y, and Russian supply could shed some 3 bcm y/y. That Russian number is fairly low—only a 4% y/y drop—as we think that Russia will be actively trying to sustain its market share in the face of much lower customer demand and the competition from LNG.
|Fig 1: JKM – TTF and arb levels, $/mmbtu||Fig 2: European storage and forecast, bcm|
|Source: Refinitiv, Energy Aspects||Note: Cont. = UK, Netherlands, Belgium, France, Spain, Italy, Germany, Austria, Poland, Hungary, Czech Republic, Slovakia
Source: GIE, system operators, Energy Aspects
LNG – any constraints?
The question for the LNG market is, what happens if the growth in supply available to the EU market this summer exceeds the very conservative estimate of 10 bcm y/y? In the absence of greater easing in supply from pipes than previously assumed, it would require the supply of LNG to be choked off, which would likely mean locking in US supply. At what TTF price will LNG supply start to be choked off? In particular, given the comparatively flexible nature of US LNG supply contracts, at what point does it stop being economic to export LNG from the US? As a starting point, the Henry Hub summer 2019 strip is currently around 2.8 $/mmbtu, while freight rates have consistently fallen and are now around 30,000 $/d. Given those current inputs, we estimate the arb will close when European prices dip below 4.15 $/t (12.5 €/MWh), which is the delivered price to NW Europe (TTF) at the Henry Hub price, increased by 15% for liquefaction costs (to 3.2 $/mmbtu) plus transport costs of 0.6 $/mmbtu and regas costs of up to 0.3 $/mmbtu.
The EU fuel switch trigger levels and the LNG arb closing level point to a convergence of equilibrating prices around 4 $/mmbtu, where demand-side increases in power are exhausted and LNG supply into Europe would start to decline. Of course, leaving cargoes in the US is likely to have a bearish impact on Henry Hub prices, although how much of an impact depends on the length of time that arb window is closed. But it does raise the prospect of a global race to the bottom, with the TTF following Henry Hub down while the JKM is pressed into following TTF.
Also, Cove Point is drawing gas from the NE US, which trades at a basis discount to Henry Hub, so choking off cargoes from that terminal would require TTF prices to dip even lower than the cost of choking off the Gulf. Some feedgas to Gulf of Mexico export terminals is sourced at a discount to Henry Hub. While long-term Sabine Pass buyers are linked in to Henry Hub, the actual feedgas might be lower-cost than Henry. Last, the above calculation does include the variable day rate of shipping as a cost, and it is clear much of the trade in LNG is done under long-term charters, so even that component could be fixed, requiring an even narrower TTF-Henry Hub spread to make the trade uneconomic. While this is not a base-case outlook, the market is not particularly far from seeing such a high level of convergence between Henry Hub, the TTF and JKM.