The bearishness of summer 2019 shows no signs of abating as the very loose European market entered free fall, chased downwards by reductions in coal and carbon as bearish developments spread through the complex. The end of last week saw the August TTF-Henry Hub spread fall to the level that suggests the arb window between the two hubs is about to close, with August the first month where LNG loading could be influenced by that window closing. While there is still plenty of contango between August and September, the TTF’s summer weakness could see the latter contract also fall to those lower levels. In the absence of a hot June and July in NE Asia, a falling TTF could drag the JKM down with it, closing the global arb windows for US LNG exports.
The European gas market has been bearish for months, but the end of last week was one of the first times we saw near-curve contracts drop to fuel switch parity. While not falling that low, all the forward contracts tumbled heavily for a second straight week as the market continues to fail in its attempts to slow storage injections. While the prompt levels signal the point where the TTF is looking to maximise the amount of coal-to-gas switch it can realise, the drop in the July TTF contract to 3.85 $/mmbtu also signalled for the first time that the TTF-HH arb for July has closed, even with Henry Hub plumbing sub 2.40 $/mmbtu lows.
The closing of that TTF-HH arbitrage window at the near end of the curve is possibly less supportive than it appears. The LNG market is a M+2 market, so LNG lifting and shipping decisions for June and July have already been made, and most of the cargoes destined for Europe should already be hedged. Regarding August loadings, offtakers at Cheniere’s Sabine Pass and Corpus Christi terminals have until June 20 to cancel lifting a US cargo for that month. The earliest we might see some pullback on US supply into the global market would be for that August contract. At Friday’s close, the August TTF contract was at 11.9 €/MWh—3.92 $/mmbtu, which was providing a netback to producers of 2.45 $/mmbtu—still open on the arb, given that the Henry Hub curve Aug-19 contract had softened down to a similar level. With Aug-19 trading down to 11.7 €/MWh in early Monday trade, that arb window is open a crack (just 10 cents). Given how weak the European market looks, that August window is expected to close sooner rather than later. The TTF Sep-19 contract was still in deep contango of 1.2 €/MWh (0.4 $/mmbtu) at Monday's close, meaning that September arb window will stay open for longer, although it could fall as the near-term curves dip further
Spanish LNG – not that much of a sink
While the other NW European hubs trade reasonably close to the TTF, the southern markets trade at a bigger premium to TTF, and the arb to Spain and Italy remains wide open even out to the M+3 contract. While the southern markets still have an open arb window across their curves, there are limits to what can be imported even at the current attractive (and open) netback. Of those southern markets, Spain looks the market of choice based on spare regas capacity, with 2018 imports leaving some 21 Mt of potential additions through 2019. For the remaining summer months, we estimate spare regas capacity is a whopping 2.3 Mt/m higher y/y.
However, Spain’s ability to import higher levels of LNG is limited, as it has only about 1.0 bcm of empty storage capacity to inject into before those facilities are full. The Spanish market will absorb most of the incremental supply through coal-to-gas fuel switching, as we forecast power sector gas burn increasing by 0.8 bcm y/y in Q3 19. The PVB is now trading at a level which we expect will prevail in the Spanish market this summer, as it is where the bulk of the coal-to-gas switch in that country should be realised. A further softening of the PVB below that level provides only modest upside to our figures, as full coal-to-gas switching in the Iberian power sector would translate into a total 1.2 bcm y/y gain in power sector gas burn through Q3 19 given normal hydro generation. Under such a scenario, should all incremental supply come from LNG, it would only add 0.3 Mt/m of additional Spanish imports to our forecasted 1.2 Mt/m for Q3 19.
If higher volumes of LNG head to Spain, the Iberian market will only balance if it reduces Algerian imports or imports from France. The latter outcome suggests that spreads between Spain and France will need to narrow, and even then, the Iberian arb window would likely shut.
Will JKM keep the Pacific arb open?
Even if the HH-TTF arbs close for the Aug-19 and Sep-19 contracts, there has been a long period for expected cargoes to be hedged at a spread that covers variable costs and some part of the fixed costs. Only the most marginal of cargoes are likely to be affected by those arb windows closing. Some market participants will have lower fixed costs, given daily freight rates could be considered fixed by any participants with a fleet of boats owned or used under a longer-term contract. Cheniere could be sourcing feedgas at a discount to Henry Hub, again lowering the price that the TTF would have to go to before the arb window would completely close.
Last, Sep-19 Asian gas contracts should see better support than the TTF, suggesting a widening of the TTF-JKM spread and opening up the possibility that the cross-Atlantic trade arb will be closed, but the cross-Pacific arb could stay open. The likelihood of the Pacific arb staying open will be improved by a hot June and July in NE Asia, which would drive incremental buying as the region would start restocking for the coming winter. As it is, even Sep-19 on the JKM has been following the TTF down, and at just a 69-cent spread, it is almost at the level where it is pushing US marginal cargoes to Europe. With weather forecasts for Japan in July to be mild, even that restocking buying could be modest, suggesting that even the Sep-19 JKM contract could come under pressure to close.
|Fig 1: HH to JKM and TTF Arb level and forwards, $/mmbtu||Fig 2: Henry Hub LNG netbacks, $/mmbtu|
|Source: Refinitiv, Energy Aspects||Source: Refinitiv, Energy Aspects|