Arb windows closing

Published at 16:15 6 Jun 2019 by . Last edited 11:18 22 Aug 2019.

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Falling TTF prices—below $4.00/mmbtu for both Jul-19 and Aug-19—have shut the TTF-Henry Hub arb for the start of Q3 19. Lifting decisions for US cargoes must be made two months in advance, meaning August is the earliest US LNG would be shut in. However, this would not preclude all US cargoes from reaching Europe. Market players may have hedged cargoes. Given Southern European gas trades at a premium, that arb remains open. Spain is likely to take a few additional US cargoes given its 3.5 bcf/d of spare regas capacity, though limited storage availability will hinder its role as an LNG sink. The Sep-19 TTF-Henry Hub arb is open for now, though Europe will need to trim its current 840 bcf y/y storage overhang to keep that contract from sinking further (and closing) too. The Sep-19 JKM-HH arb remains open as well, though lower Asian demand is possible given forecasts for a mild Asian summer that could lower prices enough to place trans-Pacific US cargoes at risk.

The TTF-Henry Hub arb for Jul-19 has closed, as TTF prices are winning the race to the bottom by falling to $3.82/mmbtu for the month as of 5 June. With the LNG market on an M+2 schedule, lifting decisions have already been made for June and July, meaning the August arb is a more relevant concern for cargoes that might not be lifted. The TTF Aug-19 contracts at $3.87/mmbtu mean that the August arb for US LNG to Europe is currently a few cents out of the money, even as Henry Hub prices for that month plumb two-year lows below $2.40/mmbtu (see E-mail alert: Arb for US freedom gas to Europe for late summer delivery may close, 3 June 2019).

Even if the TTF-Henry Hub arb does close for August, it will not necessarily spell doom for all US cargoes heading to Europe. Some cargoes have likely been earlier hedged at a spread that will cover the variable costs of trade and some of the fixed cost. Some market participants will also have lower fixed costs through securing daily freight rates via long-term contracts or ownership of LNG tankers. Only the most marginal of cargoes are likely to be affected by the shut arb windows. We do not envision a US train shutting down, but feedgas volumes could come in lower than current run rates, impacting the amount of cargoes sent up in a given month.

While NW Europe hubs trade in close proximity to the TTF, Southern European markets remain in the money for US gas due to the larger premiums found in the region. While Italy’s three regas terminals were running near capacity in May, Spain has 3.5 bcf/d (2.3 Mt) of spare capacity despite importing a seven-year high of 2.2 bcf/d (1.4 Mt) in LNG last month. Even with this spare capacity, Spain is unlikely to act as a sink for spare US LNG. The country only has approximately 35 bcf of spare storage space, placing a cap on the upside for imports. If higher volumes of US gas head to Spain—only three of over 20 May cargoes were US-sourced—that market would have to balance by reducing either Algerian or French pipeline imports. Either scenario would suggest that the spreads between Spain and its neighbours would narrow, eliminating the attractive netbacks for US cargoes. We forecast Spain could see power burn grow by a maximum of 0.4 bcf/d y/y due to coal-to-gas switching in Q3 19 (assuming normal hydro-generation)

While the Sep-19 TTF contract still holds $0.30/mmbtu of contango, Europe’s continued inability to bring down its storage levels could narrow that premium substantially. The continent’s inventory overhang stands at 840 bcf y/y (23.8 bcm), down by just 65 bcf from an early May maximum. The y/y surplus needs to pare down to 420 bcf by end-October for the market to end the injection season within physical capacity limits. If Europe does not begin to shave its excess stocks soon, then Sep-19 prices could begin to fall as well. This would put another month of US LNG cargoes at risk at the height of the shoulder season, when sentiment for the US market at an already robust projected 3.71 tcf storage carryout could be even less supportive.

TTF prices this low should help push more gas into the power sector to help the European market balance. The parity fuel-switch trigger—where gas-fired plants with no efficiency advantage over coal-fired generation are still economical—currently sits at $3.35/mmbtu (€10.2/MWh). However, that level may fall as well, given recent drops in Cif ARA coal prices and steady declines in EU carbon pricing on concerns over global economic growth. Still, TTF prices could plunge to hit that low fuel-switch parity trigger, which would help add as much as 2.6 bcf/d of added demand in Q3 19, although not all of that is realisable.

A decline in European pipeline flows does not look as certain to help ease the supply overload. We expect Q3 19 declines from Algerian imports of 1.2 bcf/d y/y and of 0.8 bcf/d from Russian flows. We also project a 2.0 bcf/d y/y drop in production from the EU and Norway in Q3 19. The timing of those declines is important, as Norwegian maintenance is scheduled to be flat for the next month. For now, with pipes into Europe indicating no reduction in flows, summer contracts are going to be pushed further down without a greater near-term pullback in supply. This would put September US LNG cargo loadings at risk.

Sep-19 gas contracts in Asia should see more support than the TTF, indicating the possibility that the cross-Pacific arb will stay open throughout Q3 19. The Sep-19 JKM contract is currently trading at $4.82/mmbtu, nearly $0.60/mmbtu higher than the same month’s TTF. There are bearish risks for Asia demand materialising though. The Japan Meteorological Agency’s forecast indicates cooler-than-average weather in July and August, which could hinder incremental buying for restocking in advance of the coming winter. Even as Chinese LNG imports grew y/y, April end-user demand in the country fell y/y, the first month that has happened since 2017. The decline was attributed to weak industrial demand. The ongoing trade war that has effectively closed off China for US LNG is also likely artificially keeping the JKM market weaker. The impact of the new tariff regime means incremental cargoes will not head to China, but those cargoes can be swapped with Qatari or Australian cargoes. While the JKM-Henry Hub arb remains open for Sep-19 for now, it is by no means assured given the current looseness of the global market.

Fig 1: US LNG exports by destination, bcf/d Fig 2: European gas storage, bcm
Source: Bloomberg, Energy Aspects Source: GIE, system operators, Energy Aspects

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