LNG market turmoil: the U.S. and China trade bubbles

The emergence of two new superpowers, the U.S. and China, is causing more uncertainty and price fluctuations in the once-staid commodity market, as analysts and traders are grappling with the biggest shakeup in the 60 year history of liquefied natural gas.

In December, China became the biggest importer of liquefied natural gas, surpassing Japan for the first time since it pioneered the industry in the 1970 s. The US is poised to become the world's top exporter of fossil fuel on an annual basis, beating cornerstone suppliers Qatar and Australia.

The data from China is hard to come by, and neither of the two superpowers are as predictable as their predecessors. As a result of the wild swings in LNG prices, the commodity has become a traded commodity, similar to crude oil. Trading desks have proliferated around the world, with Japanese LNG giants like Jera Corp. and Tokyo Gas Co. setting up their own, while banks like Macquarie Group and Citigroup Inc. are hiring traders to cash in on the volatility.

Gas markets have never been this volatile. They are trading up and down on single days in ranges they barely covered over decades. European natural gas prices, often used as a benchmark for LNG, hit a record high of €180 $205.3 per megawatt-hour in mid-December, before collapsing more than 60% in the next 10 days.

Ronald Smith, senior analyst at broker BCS Global Markets, says his clients can sometimes spend hours looking for minutiae out of China, like the number of trucks moving from diesel to natural gas. He said that such data, which can help predict Chinese demand, can be hard to come by.

Smith said that gas prices could be big surprises when China demand grows stronger or weaker than the market thought. He said that U.S. supply is easier to predict, though there are sometimes unexpected developments there, like cargoes meant for Asia suddenly heading to Europe.

For much of its history, LNG — natural gas in liquid form that is used for everything from transportation to heating — was only bought and sold via rigid multi-decade contracts. The method of ferrying fuel between two nations involved using legacy pricing mechanisms linked to crude oil.

The country was transformed from being a net importer of fuel to an exporter after hydraulic fracturing unlocked vast U.S. shale gas reserves started just over a decade ago. Once a new terminal comes online in Louisiana, the U.S. is expected to have the world's largest export capacity by the end of 2022.

U.S. LNG contracts are some of the most flexible in the industry, allowing buyers to take their gas wherever they need to, or whatever will pay the most. Buyers can even pay a fee to cancel the shipment when it isn't economical, as was the case in 2020 when spot prices crashed to record low levels. This is perfect for traders who want to make profits off price arbitrage between regions.

American LNG producers have broke the industry-wide norm of pricing shipments to crude oil and instead chose to sell cargo linked to the domestic Henry Hub gas marker, the main pricing point for U.S. futures contracts for the fuel and the name of the delivery location in Louisiana where several pipelines intersect.

U.S. gas prices are lower than overseas rivals because of Robust shale output.

The U.S. has gained greater heft within the market. In the last month, a surge in American LNG deliveries to Europe helped cool off a record spot price rally as Russian supplies remained weak.

The greater flexibility brought in by the U.S. comes with a raft of new challenges. Political action, like stricter emissions guidelines, could boost the price of LNG shipments, as traders must closely monitor hurricane disruptions in the U.S. Gulf of Mexico.

There are also other risks since the U.S. and China are ascending at the same time. A few years ago, LNG was swept up in a trade war between Beijing and Washington. After Beijing slapped tariffs on shipments in retaliation for American levies in 2018, Chinese firms stopped importing U.S. LNG cargoes or signing longer-term supply contracts.

The emergence of the U.S. and China is a big shake-up, especially given the geopolitical rivalry between Nikos Tsafos and James R. Schlesinger Chair in Energy and Geopolitics at the Center for Strategic and International Studies. There is the possibility that their tensions could disrupt markets. In 2006, China opened its first LNG terminal, and its import volume was a mere 20 million tons in 2015 - just a fourth of Japan's total deliveries. China accelerated the effort to replace coal with gas to heat houses and fuel industries in a bid to curb emissions.

China is an unknown to the industry, especially as many smaller, so-called second-tier LNG importers start to flood the market looking to sign deals and buy spot shipments.

Shipments may have to change directions on a dime if China s government suddenly decides it needs spot shipments to feed its economy or if a geopolitical flareup results in sanctions.

Tsafos said that China is a country whose decisions can move the spot LNG market.