Spreads Tighten as Gas Markets De-Link from Oil
June 2017
The oil price crash has reduced the gas spread between Europe, Asia and the US over the past few years. Going forward, the rise of hub-priced US LNG will keep gas spreads closely aligned to Henry Hub prices going forward. We expect smaller spreads will benefit companies with geographically diverse and flexible portfolios as arbitrage profits shrink.

Narrowing Price Spreads Likely to Persist in the Future

Japanese and European gas prices have converged towards Henry Hub prices in recent years. Japan’s gas price spread compared to Henry Hub widened after 2011 because of the Fukushima disaster and the subsequent shut down of Japan’s nuclear reactors. Japan’s increased demand for LNG saw the gas price spread reach as high as US$13.50/MBtu in November 2011. The restart of nuclear reactors as well as the drop-in oil prices has resulted in gas prices dropping back down to an average US$7.20/MBtu in 2017. The gas price spread between the US and Japan has also narrowed and averaged US$4.60/MBtu in 2017.

Similarly, European gas prices have seen a drop alongside worldwide oil prices because Europe’s gas supply contracts with Russia are oil-linked. Historically, Russia’s oil-indexed pipeline contracts have been the predominant driver of European hub prices since Europe’s gas markets were liberalised.



Increasing Supplies of Uncontracted LNG

Asian and European gas prices maintain their tight spread to Henry Hub going forward as US LNG facilities come online. Uncontracted LNG supplies have dried up in the past few years. Operators have reacted to the low oil prices by reducing utilisation rates at liquefaction facilities to only just meet contractual obligations. However, past 2018, we expect that the rise of hub-based pricing will increase the liquidity and supply of LNG in the market.

From 2013 to 2016, the average contract length fell by 45% whilst average contracted volume fell from 1.9Mtpa to 0.9Mtpa. Japan, Korea, and other major LNG importing nations are delaying their decisions to renegotiate long-term contracts. These countries are waiting to see what impact hub-index cargoes will have on the global market.

Japan is currently pressing Qatar to renegotiate its long-term contracts. Japan has 7.2Mtpa of LNG contracts expiring in 2021.  India’s GAIL is seeking to renegotiate its 20-year LNG contract with Gazprom. The contract is for 2.5Mtpa and will begin in 2018. GAIL have already announced plans to charter four to five LNG vessels on short-term contracts to receive upcoming US LNG supplies. We see these situations continuing throughout 2017 as LNG buyers use their increased negating power to achieve greater volume and pricing flexibility.


Will the US Put a Cap on European and Asian Gas Markets?

We have calculated the marginal cost for Japan by assuming the selling price of US LNG to be 115% of Henry Hub prices, plus a tolling fee (US$2.5–3/MBtu) and a shipping fee (US$1.6/MBtu). Europe’s prices are slightly lowers because of the shorter distance and lack of a Panama Canal fee. This reduces shipping costs to US$0.6–0.7/Mbtu.

We can see that if the US continues to increase its LNG capacity at current rates it will help to cap the price of Japan’s LNG imports. US cargoes to Japan will directly compete with Qatari, Australian and Malaysian cargoes. These three nations favour oil-index contracts and will be pressured to sell cargoes at approximately US$9/MBtu or risk contract renegotiations and cancellations.

We expect US cargoes to also have an impact on European markets. Europe’s direct connection to Russia will make it difficult for US cargoes to compete effectively. However, as we saw this winter, there is ample space in Europe’s gas market for the US to act as a swing supplier during times of peak demand.