Over the past two winters (18/19 and 19/20) El Niño has brought warmer than average winter temperatures to key natural gas demand epicenters. This was unfortunate timing as the LNG fleet experienced its highest gross fleet growth in several years, with 2018 seeing 48 LNGC newbuilds completed, double the number of vessels delivered in 2017.
2019 and 2020 also had to deal with 38 vessel deliveries, respectively, over the course of the year. Again, this came as natural gas stockpiles were building leading into the pandemic of 2020 where demand destruction also came into play.
This stymied growth expectations and time charter rates languished, even as the market over that time still posted high seasonal rates which dwarfed previous years.
However, heading into this winter there was an extremely high probability of reversing that warming trend in a big way as La Niña was set to dominate weather patterns. Additionally, a global recovery will likely bring with it increased industrial, commercial, and electrical demand for natural gas, the other four legs of the demand table for LNG. Furthermore, the US to China long haul is showing some real promise. Finally, a renewed emphasis on bridging to an environmentally sustainable economy should see the trend of gas replacing coal continue in a more aggressive manner in some economies.
All of this, as noted in my last LNG report and my last VIE live interview, was setting up for a potentially interesting trade in the segment. Rates have indeed responded to much of this expected dynamic.
Of course, these short-term rate movements are good for those in the spot market, but most companies are engaged in longer term charters which have yet to experience a major market shift.
For those companies, and investors, much of their fortune hinges on a 2021 rebalancing act. Here I’d like to share a small excerpt from my latest LNG report on how the winter of 2020/2021 may impact the structural LNG market at large.
Let’s discuss these factors a bit more in depth, starting with how the winter is unfolding and the likely results.
Mid-December saw the onset of an early and particularly cold winter chill in S. Korea, Japan, and parts of China, which are all major demand epicenters for LNG.
Ongoing cold weather is expected in Asia and Western Europe during the first two weeks of this year. Let’s also not forget that a key natural gas supplier, the US, is facing its own cold winter along with restricted supply due to pandemic related crude demand destruction. This is reflected in natural gas prices at major global hubs which continued to climb over the holidays and in some cases reached multi-year highs.
As some might recall, in a recent LNG report I noted that a precursor to trade normalization would require a particularly cold winter to chip away at stockpiles which had the opportunity to grow over the past two years.
Already this cold winter has created market shifts. Gas inventories are beginning to shrink in Europe, the US, and in some parts of Asia. Asia has now started to absorb spot cargoes which were once grudgingly being absorbed by European stockpiles.
The increased Asian demand and consequent shorter to longer haul trade shift had a massive impact in Q4 2020 cargo miles, which were up 16.33% over Q4 of 2019 for the large LNGC fleet.
Remember, Q4 of 2019 was our previous all-time high in terms of cargo miles traveled, so crushing it by double digits is no small chore.
Unlike some rate spikes, this one has actual roots in demand, instead of rates benefiting from something like vessel positioning (as we’ve seen lately in dry bulk and tanker instances). This confirmation can be found in vessel utilization which is leaving the number of idle vessels plumbing the depths of previous bull markets.
We are also seeing confirmation of this with regard to feedstock demand in the US.
Let’s circle back to Asian demand taking shipments previously destined for Europe. EWB Analytics Group offered up a solid take, noting that with “record European Union carbon prices discouraging coal use, poor performance by France’s nuclear fleet, Russian supply trailing 2019 levels and strong Asian demand diverting LNG cargoes away from Europe, European gas storage has begun to decline rapidly.” Gas storage in Europe “could drop below five-year average levels by mid-January and end the winter several hundred Bcf below 2020 levels, buttressing injection-season demand for U.S. LNG.”
In fact, European imports were down 38% between November and December as price premiums paid by Asian buyers are proving difficult to overcome. It was reported that Trafigura Group recently bid $18.15 for an early February LNG cargo to South Korea. That is a massive jump from cargoes to be delivered to Asia in January which broke the $12 mark, already representing six-year highs.
A possible side effect of this could be buyers seeking security in the form of long-term contracts. North American LNG export developers are optimistic that sustained high prices will provide incentive to buyers, especially those in Asia, to sign more long-term commercial deals.
Some Asian demand epicenters still lack adequate long term storage capacity to guard against high spot market reliance. This means Asian stockpiles will see a significant pull this winter relative to their market size. Given that the vast majority of demand is concentrated in this region, the trading and consequent restocking effort could be substantial.
This also means that undersupplied pockets could emerge, bringing with it the potential for lucrative arbitrage trades.
Remember, it’s not just the winter that impacts current demand, but the aftereffects linger as we witnessed in 2018 where replenishment efforts were met with memories of high prices and gas shortages from a bitterly cold (2017/2018) winter, keeping spot rates from experiencing a massive seasonal swing that year.
It’s noteworthy that the last two years have seen greater variations in swing seasonality and spot market movement, likely as a result of these warmer winters. Ideally, this reduced seasonality will play out again in 2021. At the very least, the cold winter and lack of vessel availability may play into an extension of seasonal strength as the market is forced to wait for vessels to fulfill a given demand.