Using the over-the-counter markets to navigate the shifting LNG landscape
The considerable disruption in today’s natural gas markets should come as no surprise. The geopolitical environment in which Russia has progressively cut gas flows to the West has put increasing pressure on the natural gas market, with European countries rushing to secure enough gas stocks to make it through the winter. A backlog of ships is waiting to offload liquified natural gas (LNG) to European ports, further impacting prices due to the lack of storage infrastructure on the continent.
The geopolitical situation has revealed clear frailties in the LNG market structure, prompting the industry to explore whether it is time to overhaul the entire market as natural gas transitions from several sizeable independent markets to a truly global market.
The market structure. Given that natural gas has previously been difficult to transport, prices are typically set locally or regionally rather than globally, like some commodities (e.g., oil). Most traded natural gas is transported by pipeline in local regions, allowing prices to be set by negotiation, regulation or open-market trading mechanisms.
However, with the creation of the LNG market, most cargoes are sold on a long-term contractual basis at prices either indexed to the cost of the feed gas, the floating price in the destination market or indexed to other commodities. This means that in deregulated markets (e.g., the U.S., Europe), prices are set by traders that price gas at location-specific hubs.
However, in other parts of the world (e.g., Singapore, China, India), suppliers and buyers outside the local market are unlikely to want to trade on the hub prices. Therefore, the pricing model has been completely upended with companies and countries fighting for the best and most accurate LNG price.
Globalization of the natural gas markets. The lack of a global pricing model has led to skyrocketing gas prices driven by concerns about the curtailment of gas flows from Russia into Europe.
Across Europe, roughly 80% of the continent’s gas has previously come from Russia. With the taps being shut off, Europe is shifting its focus globally to find new gas imports. This sudden surge in LNG appetite is driving a substantial price divergence—even across European gas hubs—given the sudden shift in gas import flows from Russia in eastern Europe to LNG in western Europe.
Europe, and by extension other global regions in the U.S. and Asia-Pacific (APAC), must change how they calculate the price of LNG. Questions are being asked about Title Transfer Facility (TTF) and if it works as an LNG price indicator. While TTF has all the qualities of a global commodity benchmark in Europe due to vast amounts of liquidity, supporting quick exports and onshore trade, it has never been used in this context.
TTF entirely dominates the Europe, Middle East and Africa (EMEA) landscape. Comparable indexes such as The Hub Europe and the Spanish PVB produce notably less liquidity. Rather than fully reinventing LNG indexes throughout Europe, an easier solution could be to create the appropriate instruments to manage the balance between regions similar to West Texas Intermediate (WTI)-Brent, Brent-Dubai and WTI-Dubai.
Evidence of this is already clear with the Japan-Korea Marker (JKM) and TTF trading on the increase and the gradual translation to US$ for TTF. The U.S. export pricing will need reform to better reflect U.S. onshore pricing. If this can be achieved, it will give the LNG basis contracts the instruments necessary to push natural gas to a fully global state and bring quicker balance.
This sudden surge in LNG appetite is driving a substantial price divergence, even across European gas hubs, given the sudden shift in gas import flows from Russia in eastern Europe to LNG in western Europe.
Other issues. In addition to addressing the pricing structure, a massive infrastructure issue must be addressed if the continent is to boost its LNG usage. Europe has fewer LNG terminals than the UK does on its own—these are essential to store LNG.
Furthermore, as part of the energy transition, companies are coming under greater pressure internally and from external stakeholders to rapidly move away from fossil fuels. Companies must have the correct and detailed information and indexes to manage where gas and energy are coming from and the implications of what is happening on a global scale, and this is only possible with a precise pricing index that provides accurate data consistently.
Looking ahead. It is not surprising that the LNG markets are transitioning from large regional hubs to one global market to meet the rising demand. This is having a significant impact on the way the LNG and natural gas markets are traded and priced.
Instruments for price discovery and protection must be updated to better reflect global markets. Traders now need global instruments that provide the right price perspective of the main regional prices in global terms, as they can no longer rely on regional prices to reflect the price accurately, and these prices are not fit-for-purpose in markets without hubs.
The market has begun coalescing around a global pricing opportunity. Coupled with changing trade routes, the energy transition and the geopolitical environment, gas has become a globalized commodity and must be indexed as such.
Europe, the U.S. and APAC must start changing how they calculate the price of LNG. The solution lies in creating a suite of global indices that can help the market balance between major markets and regions (e.g., Henry Hub–U.S./TTF, EMEA/JKM and APAC) as this new truly global natural gas market takes shape. GP
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Matthew Joy is the Head of Energy and Commodities Data Products for Parameta Solutions, the data and analytics brand of interdealer broker TP-ICAP. He has worked within the TP-ICAP group for more than 20 yr. Joy has extensive experience in the financial sector and in a range of markets including government debt, commodities, repo, credit default swap and foreign exchange.
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