European storage is set to be full in September and this is pressuring the price of contracts at global hubs for delivery up to Q4 19. The TTF Q1-20 contract is being buoyed by the risk that Russia and Ukraine may not reach an agreement on transit flows beyond 1 January 2020, resulting in a wide contango along the TTF and JKM curves and thus supporting the use of floating storage. Otherwise, rising LNG supply globally should lead to low global gas prices and narrow Henry Hub spreads to global markets until at least late 2021. Indeed, we expect the Henry Hub-TTF arb could close for Sum-20.
Europe imported 6.1 bcf/d (0.17 bcm/d) more LNG y/y in Q2 19, which added gas to an oversupplied market. Gas was injected into storage at a high rate, despite a y/y storage surplus that stood near 880 bcf (25 bcm) from early April to late June. By end-July, storage hit 2.9 tcf, nearing the 3.5 tcf tank tops level. We expect around 318 bcf to be injected in August, leaving little room left in September, so the injection rate should progressively slow in August.
Rapidly filling storage is weighing on the TTF prompt and this pressure will only increase as stocks near capacity, all coal-to-gas fuel switching in power is realised, and the European market realises it must curtail supply. As such, prompts and near curves at the TTF and even hubs in southern Europe are pricing to encourage all potential fuel switching, with the TTF trading below the fuel switch parity trigger of $3.79/mmbtu (11.5 €/MWh) from 18 July to 2 August. The need to reduce supply promises very low TTF prices, potentially as low as $3.00/mmbtu, which is the point where some Russian gas could fail to cover variable costs and this will drag down the JKM to sub-$4/mmbtu. Total Russian flows to Europe dropped by 0.8 bcf/d y/y in July and we think a drop by at least the same amount is needed in August for the market to balance.
Low September prompt prices could further pressure Oct-19 and even Q4-19 at the TTF and JKM. The TTF Q4-19 contracts are trading well below Sum-20. This sort of contango is unusual, but the Q1-20 and Sum-20 contracts are being supported by the risk of the Russia-Ukraine transit agreement expiring on 1 January 2020 without a new deal. If a new transit agreement is not reached, Ukraine has said that Russian gas will not transit the country, locking the gas out of southern European markets. The loss of that much supply—potentially 640 bcf in Q1 20—would cause a run on European gas in storage and push TTF prices up quickly, and the JKM up with it.
Russia offered to roll over the current transit agreement on existing terms for 2020, according to reports last week, which puts pressure on Ukraine to accept that proposal while negotiations on a longer-term agreement continue. Our base case still assumes that an agreement will be reached to allow Ukrainian transit flows to continue next year. If an agreement is reached for transit in 2020, the risk premium should exit the Q1-20 contract and the TTF premium to Henry Hub should narrow for that quarter. Furthermore, the fundamentals suggest that the TTF Sum-20 contracts are highly overpriced given we expect strong incremental LNG supply in summer 2020 and a Ukrainian transit deal to be reached for 2020. We think Sum-20 prices should be as low as this summer if not lower.
Given the current narrowness in the spreads between the TTF and JKM for both Oct-19 and Nov-19, the JKM is likely to get dragged down with the TTF. Near-average temperatures in winter 2019-20 would leave global balances loose, leading to continuing incremental LNG supply to Europe and more gas in storage y/y there, and Sum-20 contracts would come under pressure to fall. Price weakness would then extend to contracts for delivery in winter 2019-20. A y/y drop in LNG supply into Europe is only likely from Q4 21, so there is a very real probability that low global gas prices are going to be sustained for winter 2019-20 through to summer 2021. These loose market balances mean that JKM-TTF spreads will stay narrow, and TTF-Henry Hub spreads for Sum-20 may need to drop to the point where they close the arbitrage window.
For 2019, peak summer has almost passed with only the occasional Northeast Asian hot spell so far, although August is looking hotter y/y in Japan. So far this summer, the market for top-up spot cargoes has been stuck in the doldrums. However, the failure of the TTF-Henry Hub arb window to close for September ahead of the 60-day deadline for lifting cargoes suggests exports from the US will continue through Q3 19, even though variable cost margins are narrow.
The level of seasonal contango—both at the TTF and the JKM—should support the use of floating storage this year. We put the necessary spread between one monthly contract and the following monthly contract at around $0.60/mmbtu for floating storage to be profitable. With the JKM Sep-19–Dec-19 spread at $2.60/mmbtu, the curve has plenty of contango to make that trade work. A rise in the use of floating storage will tie up ships and tighten the freight market, weighing on the economics of the trade though. Freight rates topped out at $200,000/d in 2018. At that rate, the cost of a monthly float would increase to $1.90/mmbtu, which would be prohibitive for floating storage given the prevailing contango in the curve.
|Fig 1: European gas storage, tcf||Fig 2: Total Russian flows to EU, chg. y/y, bcf|
|Source: GIE, system operators, Energy Aspects||Source: Eustream, NET4GAS, NEL, OPAL, GAZ SYSTEM, Energy Aspects, Energy Aspects|
|Fig 3: Global gas hub curves, $/mmbtu||Fig 4: Total sendout in EU, bcf|
|Source: CME, Energy Aspects||Source: SO data, Energy Aspects|