On the Spot: How a Surfeit of Supply is Transforming LNG Trading

In September of last year, I gave the dinner speech at an LNG conference in Singapore. The dinner was held at the Singapore Aquarium, and I spoke in front of the Aquarium’s giant shark tank. I couldn’t help but think of the scene with Kim Jung Il and Hans “Brix” Blix from Team America. Especially after the way my remarks were received, which ranged between cool and rather hostile.

I predicted the demise of oil-based pricing, and increased reliance on the spot market or long-term contracts indexed to spot prices. There were three basic parts to my argument. The first was that the large increase in supplies coming online in 2015-2017 combined with the even-then apparent slowdown in demand in China, and the likely decline from Japan due to the restarting of its nuclear plants, would lead to a large overhang of cargoes that would need to find a home. The trading of these cargoes would lead to increased spot market activity.

The second part of my argument was that the dynamics of liquidity would then take over. Liquidity creates liquidity. More spot market activity reduces the transactions costs of trading spot, which leads to more spot trading. There is a virtuous cycle in liquidity, and the increase in spot trading to dispose of contracted of but now unneeded cargoes would start the cycle.

The third part of my argument was that a robust spot market would support gas indexing, as opposed to oil indexing, in term contracts. Oil indexing is akin to the drunk looking for his wallet under the lamppost, because the light is best there, not because he lost it there. LNG buyers and sellers looking for a price benchmark looked to oil in the early days because in the 70s oil was a substitute for gas in power generation, so there was some connection between the markets, but mainly because oil was the only lamppost around. But especially now, with gas and oil having little fundamental connection in either consumption or production, oil prices are not closely correlated with the marginal value of a ton of LNG. The development of a liquid LNG spot market would-will, in my view-allow contracts to be indexed to a price that reflects gas values. This would also permit the development of a paper hedging market.

My unpopular prediction is now looking much better, though not all are persuaded. There is a huge LNG overhang, with Australian and US supplies about to come on stream. This supply increase is occurring simultaneously with a protracted decline in demand. Much of this overhang will find its way to the spot market. That, in turn, will start the virtuous cycle.

The supply overhang will have other consequences. It will force down prices world-wide, and lead to a redirection of supplies from Asia to Europe. One of the biggest losers from this will be Russia, which will face more intense price competition in its biggest export market in Europe, and a reduced Chinese appetite for the gas it had hoped to send east. Another will be Qatar, at present the world’s largest supplier.

Making things even more interesting is that Russia and Qatar are adversaries in Syria. (And by the way, those conspiracy theorists who think that the Syrian civil war was started by Qatar because Assad would not allow the construction of a pipeline to bring Qatari gas to Europe-spare me. Qatar’s big LNG investment dramatically reduced its need for a pipeline, and it anticipated being able to sell all it could to a growing Asian market.)

The next few years will be interesting in LNG. I am even more convinced that in 3 to 5 years the market will look nothing like it does today. It will look more like the oil, iron ore, and coal markets. Furthermore, in the near-to-medium term it will be more of a buyer’s market, and indeed, these things are connected. The surfeit of supply that makes it a buyer’s market will catalyze the development of a spot market.