Inspiration from LNG spot price fluctuations during the Asian heating season

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Text/Yan Han China International Petrochemical Joint Corporation, Contemporary Petroleum & Petrochemical

The international liquefied natural gas (LNG) market has been volatile since the COVID-19 pandemic in 2020, with the Platts JKM spot price index, which represents the level of the Asian LNG spot price, falling below $2/MMBtu at one point in late May 2020, but soaring to over $32/MMBTU in mid-January 2021. Especially during the 2020-2021 heating season, the large fluctuations in the international LNG market have greatly affected the procurement costs of mainland LNG buyers, posing challenges to the continent's energy security. This article explores the reasons for the abnormal fluctuations in asian LNG spot prices in the 2020–2021 heating season from multiple perspectives, and makes recommendations for future LNG procurement in mainland China.

1 Cause of the LNG spot price anomaly for winter 2020–2021

In the 2020–2021 heating season, multiple factors such as supply and demand in the international LNG market have driven up the rise in Asian LNG spot prices. Platts JKM spot quotes, which reflect Asian LNG spot levels, rose from $6.8/MMBTU in early November 2020 to a maximum of US$32.5/MMBTU in mid-January 2021, with JKM prices exceeding US$30/MMBTU for the first time.

1.1 Multiple upstream projects have failed

According to Reuters, since November 2020, there have been 19 upstream failures by the end of the heating season. In November 2020, the NWS project in Australia, the Freeport project in the United States, the Qatar LNG project and the Nigerian LNG project all failed. Among them, the failure of the Qatar LNG project had a greater impact on the Asian spot market, and the failure lasted for 29 days, resulting in a capacity loss of 7.8 million tons / year, and the long-term contract supply of the project was reduced by 7 to 8 ships. Due to long-term contracts with qatarl LNG projects, some end-users in Japan and South Korea have had to increase spot purchases to compensate for the decline in long-term contract supply. In December, a number of Australian projects such as IchthysLNG, Wheatstone LNG, Gorgon LNG have failed one after another, and the Cameron LNG project in the United States and the MLNG project in Malaysia have also had supply problems, making the original tight supply situation worse. In January 2021, the IchthysLNG projects in Australia and NLNG in Nigeria briefly failed but were quickly repaired. In February, the United States suffered a cold wave, Texas suffered a "big blackout", many projects were affected by this, but soon restarted.

Overall, the number of global LNG project failures and the impact on supply in the 2020-2021 heating season are relatively rare, and the market once had a situation where it was difficult to find goods.

1.2 Extremely cold weather has caused buyer spot demand to rise

1.2.1 Temperatures in Northeast Asia during the 2020–2021 heating season are lower than in previous years

Beginning in December 2020, the Northeast Asian region was hit by a cold wave, and temperatures in Asia's major natural gas importers plummeted below normal levels in previous years. The low temperatures continued until around early January 2021. Specifically, Japan has two periods of obvious temperature decline, one is the second week of December 2020, the average temperature dropped to about 3 °C; the second is the end of December 2020 to the beginning of January 2021, the average temperature dropped to about 2 °C, the temperature plummeted so that Japan has a shortage of natural gas, and it has to increase spot procurement in the international market to ensure domestic natural gas supply. South Korea has cooled more pronouncedly relative to Japan, with average temperatures falling below 0°C in late December 2020 to –7°C in January 2021, 6°C lower than in previous years. Beijing has suffered a historic cold wave, with temperatures reaching –17°C on January 6, 2021, the lowest temperature recorded in the 21st century.

1.2.2 LNG imports of Northeast Asian buyers reached a new high

In the 2020–2021 heating season, LNG imports from the major importing countries in Northeast Asia increased year-on-year. In November 2020, the total imports of China, Japan and South Korea were basically flat year-on-year, but from December 2020 to February 2021, the monthly LNG imports of the three countries increased by an average of about 2 million tons year-on-year, while the total monthly imports in December and January exceeded 20 million tons. Among them, China and Japan have the largest monthly import increase, with China's LNG import volume and use ratio increasing by more than 4 million tons in the 2020-2021 heating season, and Japan increasing by nearly 2 million tons year-on-year. The monthly LNG imports of LNG importers in Northeast Asia are shown in Figure 1.

1.2.3 Japan's electricity prices soared to historical levels

Due to insufficient preparation for extremely cold weather, there will be a shortage of natural gas supply in Japan in the 2020-2021 heating season, and there will be a serious shortage of raw gas for power plants, especially in early January 2021, when Japan's electricity prices soared, and some areas experienced power curtailment. On January 12, the wholesale price of electricity on the Japan Electricity Wholesale Exchange (JEPX) reached 154.57 yen/kWh, an all-time high, more than 20 times the level of trading in early December of the previous year (see Figure 2). In this case, although Asian spot prices are already at a high level, some end-users in Japan still have to enter the market to continue to purchase spot prices, further pushing Asian spot prices to historical highs. In early January 2021, Japan's Kyushu Power purchased a ship of DES spot that arrived at the end of January at a price of nearly $40/million British thermal units. In contrast, the Asian JKM price fell below $2/MMBTU in May 2020.

1.3 The surge in freight rates and congestion of the Panama Canal prevented Atlantic goods from being transported to Asia

In early January 2021, the surge in demand in the Asian natural gas market also tightened the LNG shipping market, and LNG vessel freight rates rose. In fact, the daily rent of LNG spot ships began to rise in July 2020 to about $30,000/day later, and the daily rent of BP and Trafigura ships transporting U.S. cargo ships even reached $350,000/day in January 2021. According to Reuters, unit freight rates from SABINEPASS export projects in the US to China exceeded US$6/MMT in early January 2021, compared to less than US$1/MMBtu in May-June 2020. Overall, the sharp rise in freight rates reduced the economics of Atlantic goods to Asia.

In addition, the congestion of the Panama Canal during the heating season hindered the movement of U.S. goods to Asia. Although U.S. natural gas prices in the winter of 2020 were well below the Asian LNG spot price level in the same period, due to the limited traffic of the Panama Canal, a large number of LNG ships were stranded, and the waiting time for traffic in December reached 17 days. This reflects that the global LNG market is still regional, and the Intergovernmental Region cannot sufficiently flow goods to effectively reduce inter-regional spreads.

1.4 Traders in the Platts window "market making" boosted the price increase

In recent years, the Asia-Pacific LNG trade market has continued to develop, and an Asian LNG price system with Platts JKM as the representative price level has been initially formed, and more and more LNG trade has begun to refer to the Platts JKM spot price index for pricing. For example, the short-term contract price of a monthly vessel of CPC in Taiwan is linked to the JKM price index from 2021; the 3-year contract between South Korea's POSCO and GLENCORE, and the 4-year short-term contract between Guangdong Yuedian and DGI are all priced by JKM.

Platts launched the MOC platform in 2018, where LNG buyers and sellers can bid and close transactions, and transaction information is the most important basis for Platts to evaluate JKM prices. Due to the small size of the international LNG spot market, there are not many market transaction parties, giving traders the opportunity to use the Platts MOC platform to influence the market price.

January 2021 is the period when the spot price of LNG fluctuates the most during the heating season, and the operating instructions on the MOC platform are also more active. In early January 2021, Asian LNG prices rose rapidly, with Platts JKM prices reaching $32/MMBTU from $15/MMBtu at the end of December 2020 to $32/MMBTU on January 13, 2021. During this period, traders continued to raise their bids at the Platts MOC window, pushing up JKM prices and boosting Asian LNG spot prices to record highs in the face of tight supply. From the middle of January 2021, the JKM price gradually declined, and traders in the MOC window during this period also mainly operated to lower the sales price. In general, during the period of sharp fluctuations in asian LNG spot prices, platts MOC window trading and JKM prices showed a strong linkage: MOC window traders mainly raised price orders when prices rose sharply in early January, and mainly lowered price orders when prices began to fall in mid-January.

In January 2021, the main traders who placed trading orders in the Platts MOC window, the top three companies in terms of activity were TRAFIGURA (11 times), VITOL (7 times) and BP (6 times), and the operating instructions of these companies had a significant impact on JKM prices: on January 5, TRAFIGURA raised the bid for the purchase of a des call for a des spot ship from February 10–14 to $19.7/MMT, and the JKM appraisal price rose by $2/ On January 11, TRAFIGURA raised its purchase bid twice, and JKM's assessed price rose by $7/100 million BTU on the same day. Overall, traders trading in the Platts MOC window has a significant boost to the unusual volatility of LNG spot prices in Asia in 2020–2021.

2 Recommendations for Chinese LNG Procurement

In the context of global "carbon neutrality", "carbon peaking" and green economic development, natural gas will play a more important role in the global energy structure due to its "clean" and "efficient" characteristics. LNG Due to its convenience of transportation, compared with the pipeline gas base investment is less, LNG will have a broader space for development in the future. According to WOODMAC data, global LNG demand was 227 million tons in 2010 and 369 million tons in 2020, and it is predicted that global LNG demand will reach 547 million tons by 2030.

At the same time, the global LNG market continues to develop, the liquidity of goods is enhanced, the trading mechanism of the market is gradually improving, and the participants in LNG trade are gradually increasing, which promotes the marketization of international LNG trade, but at the same time, the risk of market price fluctuations is also increasing.

Abnormal fluctuations in LNG prices in the 2020–2021 heating season have greatly increased the import cost of continental LNG, posing a challenge to the mainland's winter heating supply. Under the background of the mainland's economic transformation and the increasing volume of LNG imports, we should seriously sum up experience, actively respond to it, and improve trade capacity, which is of great practical significance for developing the mainland's natural gas trade and ensuring the mainland's energy security.

2.1 Seize the opportunity to obtain resources in advance

LNG trade prices have two significant characteristics: First, the volatility is relatively large. Compared with the mature international crude oil market, the international LNG short-term trade volume is small, most of the goods are still sold through the "point-to-point" long-term contract form, the degree of market competition is not enough, so the price is affected by external factors and fluctuates greatly. For example, the Asian LNG spot transaction level in May 2020 was only about US$2/MMBtu, and the price rose to more than US$30/MMBTU in early January 2021. Second, the seasonal characteristics are obvious. The demand for natural gas is significantly correlated with temperature changes, and in some parts of China, the demand for natural gas in winter can reach 2 to 3 times the demand in summer. Therefore, we should study the price change law of the international LNG market in depth, seize the opportunity to obtain resources in advance at the low point of the market, reduce costs and increase efficiency, and avoid being in a passive situation in international trade procurement during the period of sharp price fluctuations.

2.2 Enrich the pricing methods of LNG procurement

The international LNG market did not develop for a long time, and initially because there was no complete trade market, LNG goods were generally linked to the price of crude oil for pricing. With the continuous development of LNG trade, the way LNG goods are valued is also changing, in addition to the way of oil price linkage, some goods are now also priced by linking European and American natural gas prices, Platts JKM prices and other indicators. These price indicators have a certain correlation, but they also have different laws of change. If LNG spot is purchased in the 2020-2021 heating season by using oil price linkage, it will have greater economic benefits than the accompanying market procurement method. Research on various price indicators of LNG should be strengthened, and the pricing method of LNG procurement should be enriched to effectively diversify risks.

2.3 Carry out pontoon operations for LNG ships

The seasonal characteristics of LNG trade are obvious, with large spreads between low and high seasons. Changes in the market price structure in the off-peak season should be taken advantage of, and the way to charter ships in advance should be considered, and the goods purchased and stored in the pontoon cabin in the off-season should be transported to the domestic market in the peak season to meet the demand. Traders often use this method to arbitrage the price spread in the off-peak season, and in recent years, TRAFIGURA, VITOL and other companies have repeatedly purchased goods in advance before the peak season to make "floating cabins" in the waters near Singapore, waiting for the motivation to rise when the price rises and then shipping them to Northeast Asia to obtain economic benefits.

2.4 Hedging operations to reduce the risk of price fluctuations

After a period of development, the JKM OTC futures market has a certain liquidity, mainly some brokers such as TULLETTPREBON, ICAP Company, etc. in the OTC market matching transactions. In general, the JKM forward price has a strong correlation with the spot LNG market situation, and if the spot market is weaker, then the forward JKM futures price is also lower. So on the one hand, it is possible to lock in the forward transaction price when the market is weak. For example, the corresponding forward February 2021 JKM price on September 2, 2020 is $6.075/million BTU. If a buy hedge had been made at that time, the buy price would have been half as cheap compared to the actual JKM closing price of $12.258/MMBTU (see Figure 3). On the other hand, cross-hedging can be used to reduce the risk of price fluctuations. For example, the Asian JKM price has a strong correlation with the European TTF price, because the forward JKM price may be insufficient liquidity, then buy JKM-linked physical goods and buy forward European TTF futures for cross-hedging. When the JKM price unexpectedly rises sharply and produces a loss, it can be compensated by the change in the TTF price of the futures market.

2.5 Strengthen the participation of the Platts MOC platform

After years of development, platts JKM pricing system has become a price index that is more accepted by the market to reflect the level of LNG spot trading in Asia. Since its launch in 2018, the trading situation between buyers and sellers on the MOC platform has been the most important basis for Platts' JKM price assessment. At present, the participants of the Platts MOC platform are increasing, and the activity of LNG spot trading on the platform is increasing. The participation of the Platts MOC window should be increased, the influence on market prices should be enhanced, and the dominance in LNG international trade should be expanded.

2.6 Strengthen the construction of domestic natural gas peak regulation facilities

After years of development, the natural gas infrastructure in developed countries in Europe and the United States has been relatively perfect, forming a relatively complete off-peak season gas storage and peak regulation mechanism. In contrast, the construction of natural gas infrastructure in the mainland is relatively lagging behind, the gas storage and peaking facilities in various regions are uneven, there is a situation of "strong south and weak north, east and west less", gas storage capacity can not fully meet the demand growth in the peak season, and gas storage capacity is far behind the global average. We should speed up the construction of natural gas storage facilities, promote the balanced development of regional natural gas infrastructure, and form a good coordination mechanism for production, supply, storage and marketing, so that the mainland can have a stronger initiative in LNG international trade.

3 Conclusions

Unusual winter weather, unstable supply upstream of LNG, bottlenecks in LNG canal transport and trader speculation in the market have all contributed to large fluctuations in LNG spot prices in the 2020–2021 heating season. In order to ensure the supply of LNG in the mainland and reduce the fluctuation of procurement prices, in terms of trade, we should seize the opportunity to obtain resources in advance, enrich the LNG trade pricing method to establish a risk-resistant resource portfolio, and carry out pontoon operations to stabilize seasonal price changes in a timely manner; in terms of finance, we should strengthen the participation of the Platts MOC platform and choose the opportunity to use hedging means to lock in costs; in terms of infrastructure, we should accelerate the construction of natural gas storage facilities and promote the balanced development of regional natural gas infrastructure.

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