This story is the second of a two-part series exploring the growing global interest in spot LNG deals and how a shift to more flexible contracts will become crucial as the market continues to change.
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Register NowWith LNG and gas fundamentals becoming a more pivotal driving force for LNG prices, traders have pointed to contracts across the globe increasingly adopting LNG and gas indexes over historically oil-indexed contracts, according to sources and an S&P Global Commodity Insights analysis.
Historically, long-term contracts in the LNG market were formed around oil indexes such as Platts Dated Brent benchmark. However, volatility in recent years has made it increasingly uneconomic for market participants to price their contracts solely based on an oil index.
In oversupplied LNG and gas markets, contracts priced against an oil index could rise above LNG and gas spot prices. Although the global market is not terribly oversupplied, the current high inventories across the world, have traders eyeing the potential divergence of oil, gas and LNG prices. With LNG and gas spot prices falling below oil-contracted prices, the incentive to purchase more on the spot market increases. Utilizing more gas and LNG linked contracts, such as the Platts JKM or Northwest European marker, could allow players to optimize their volumes seamlessly and offer more accurate hedging possibilities..
"The economic misalignment caused by oil indexation represents a major risk that can potentially erode the profitability of a commercial deal for either the buyer or the seller side depending on the direction of the price shock," Hilary Till and Adila McHich from the CME Group said in a 2020 report. "Arguably, oil-indexation contracts have lost their relevance as oil and gas prices continue to decouple."
While the CME report suggests that the level of transition from oil indexation to gas hub prices varies across regions, LNG traders said there has been an increasingly growing interest across the globe to transition towards more LNG and gas based long-term contracts.
The adoption of gas and LNG prices could help players to optimize their cargoes and allow them to more easily reroute cargoes to Asia or Europe. While sources are seeing this growing in Europe, with more players discussing switching to a more representative index, many sellers are still hesitant due to the high inventories and relatively poor demand causing LNG prices to cool over the past few months.
"Gas markets have been undergoing a significant transformation, with the most important trend being that of the growth of the share of competitively priced via gas-on-gas (GOG) competition, largely at the expense of oil-price-escalation (OPE) pricing, and forms of regulated pricing. Between 2005 and 2022, the GOG share of global gas consumption nearly doubled from 31.5% to 50%, while the oil-price-escalation (OPE) indexed price mechanism share fell from 24% to 17.5%," according to a 2023 report from the International Gas Union. "There was a significant rise in the GOG share in Europe as spot LNG imports increased sharply, and as some of Turkey's contracted pipeline imports from Russia switched to hub pricing away from oil indexation. Since 2016, the displacement of OPE by GOG, has largely been a result of the rise in GOG pricing share in LNG imports, especially via spot market LNG trade."
With the market looking at long-term deals to secure supply in the coming years, current negotiations over existing contracts as well as signing new ones has showcased the growing interest in gas and LNG indexes in long-term contracts of five years or more.
While there are some contracts based on gas those mechanisms need to be reworked to better reflect LNG fundamentals.
CME's NWM contract has traded both as a spread to Platts JKM and TFU, highlighting the two main current use cases for the European LNG derivative.
"We realized we have been misled in that pipeline gas no more reflects the price of an LNG cargo," said Patrick Dugas, Global Head of LNG Trading at TotalEnergies, at a December 2022 industry conference. "We will have to find a way to move ... to a Northwest Europe LNG index."
The market has also seen moves towards flexible shorter-term and medium-term deals. Medium-term contracts can be more than two years and below five years, while longer-term contracts can be traded under agreements of five years or more, according to analysts at S&P Global Commodity Insights,
Higher reliance on LNG
Before the Russian invasion on Ukraine, Dated Brent and gas prices such as TTF and Henry Hub saw relatively steady trends. Since the invasion, volatility has sparked and intensified price swings in the gas and LNG markets comparatively to oil.
On the gas side, Dutch TTF second month price was assessed by Platts on Jan. 29 at $9.007/MMBtu. Prices rose to $9.638/MMBtu after the Russia-Ukraine war on Feb. 24, before hitting a peak of $98.961/MMBtu on Aug. 26 and cooling down to current levels.
Although market dynamics are bearish in the near-term, the gas and LNG markets still remain susceptible to price swings due to weather and geopolitical risks.
"A higher reliance on LNG in Europe increases the risk of winter price spikes," Lucien Mulberg, analyst, and James Taverner, senior director, at S&P Global Commodity Insights said in a report. "Cold weather spells lasting more than two weeks or significant drops in LNG deliveries will increase the risk of significant upside price movements in winters in the absence of flexible backstop supply from Russia."
Asian LNG pricing
Despite a potential decrease in volume from new projects in 2024, supply is anticipated to surpass demand in 2024 and future years. Consequently, the significance of long-term contracts pricing against oil price diminishes, as buyers find less advantage in securing futures volumes given the prevailing market dynamics.
"In the current landscape, there's a notable inclination toward exploring spot trading, where spot traders are urged to provide greater optionality and flexibility during negotiations," said an executive from a Chinese provincial gas company who added that it was commonly seen in China that the slightly larger local gas companies and power plants are considering to shift to spot trading for adapting to the future trend of higher marketization and price changes of long-term contracts.
Komipo is looking for 15-year long-term contracts (starting from 2027) currently with pricing index linked to Henry Hub. This strategic move anticipates a growth in US supply from 2027 onward, with the expectation that Henry Hub pricing could play a pivotal role in reflecting the increase in supply through lower prices, sources said.
"Most current long-term contracts to Asia are oil-indexed. However, this is changing as more hub-linked North American LNG arrives online and buyers diversify their pricing terms," Mulberg and Taverner,said. "In the longer term, oil indexation will play a decreasing role in setting Asian term prices. More contracts are expected to have prices at least partially linked to gas market hubs, including outside North America."
Mulberg and Taverner added that prices for existing long term contracts would be progressively renegotiated over time, influenced by prevailing market trends. It was expected that long term contract volumes would drop to less than 50% of Asia's total imports by the early 2030s.
On new contracts, these could be signed linked to oil or natural gas hubs, with the ratio changing over time. In the longer term, oil is expected to play a weaker role in Asian LNG price setting, with global LNG market fundamentals and costs a bigger influence in setting contract terms and prices.