In theory, Europe’s energy diversification away from Russia was widely agreed upon over a decade ago, however, the continent has only become more dependent on them over that time.
But the Russian/Ukrainian war has thrust European energy security back into the limelight ushering in a key political shift, as the lackadaisical approach that once dominated attitudes in the continent has now turned into a coordinated effort to finally address the issue with some resolve.
Before the Russia/Ukrainian war, any expectation of a shift away from Russia was expected to unfold at a snail-like pace. Following the start of war, the response by Europe has shown that this shift away from Russia is upon us, and it will be stronger and swifter than would have ever taken place during normalized relations.
While we are only concerned about how the market for LNG vessels may be impacted, we must first understand how the market at large will reconcile this situation.
Prior to the onset of the war, most LNG facilities we were already running near or at maximum capacity. Those facilities that were not are now doing so, offering a small, yet meaningful, increase in global supply.
Aside from that, we’ve seen increased European LNG imports relying primarily on the reallocation of existing supply. This supply rationalization has been dictated through pricing, evidenced by European gas prices being among the highest in the world for the past few months.
This outbidding for cargoes by Europe has been aided by ample natural gas stockpiles in Asia which has allowed for a relatively comfortable (though temporary) redirection of flows.
Normally, a redirection of cargoes to Europe from Asia would be met with some concern, as voyages to Europe represent, on average, a much shorter haul than those going to Asia. This impacts cargo mile demand, which is how we typically measure demand for shipping.
But, if ample volume is introduced as these cargoes are redirected, it can have an offsetting impact, which is exactly what is happening here.
Pouring over the data, we see that there has indeed been a very meaningful shift in trade flows and volumes introduced into the market.
Examining a three-month period between December 26, 2020, through March 26, 2021, we find the top eight routes (Exporter-Importer) in terms of cargo quantity aboard Large LNG carriers bound for Asia.
However, as we fast forward to that same period ending in 2022, we see a very different composition.
Here we see that half of the top routes in terms of cargo quantity delivered are in Europe, and all are supplied by the United States, which (as noted earlier) represents a shorter haul.
But a 12.5% increase in cargo volume transported has negated the negative impacts of this shift to a short haul and has even produced a 4.3% increase in cargo mile demand over last year’s totals.
Those cargo mile demand gains come in addition to an increase in days required in port for loading and unloading, as 183 additional voyages were recorded in that second period examined, representing an 11.8% increase.
As noted earlier, consider that the market was presented with a very favorable environment to accommodate such cargo shift from Asia to Europe, which also means this would be the environment most likely to see those long hauls to short haul shifts maximized – suggesting this is currently the extent of pain the market could suffer as a result.
But as we can see, there has been no pain, only higher rates which are well over 4x greater than this point last year.
The fact that rates have remained resilient indicates a favorable structural balance. This is an important point, as it is taking place under what we noted was likely most painful part of this trade flow shift (peak short haul voyages).
Which brings us to what may happen as we move through the year.
Asian importers have taken a back seat for the past several weeks, but this cannot last forever. This implies that Asia will eventually be forced to compete more actively for cargoes which will in turn further impact price. On a side note, with price competition and/or geographic price dislocation we see stronger arbitrage trading activity which aids in keeping vessels employed.
As Asia returns to the market, we will see some short haul European imports traded in favor of those longer haul Asian bound cargoes. Broad European demand will remain a constant, so with guaranteed volume uptake waiting in the wings (aided by more mature storage facilities), these temporary (usually seasonally influenced) upswings in longer hauls will provide a boost to the market by causing cargo mile demand totals increase significantly.
This scenario isn’t just confined to 2022 but will likely continue to play out annually until LNG supply, including vessels capable of transporting that supply, catch up to Europe’s desired goal of decoupling from Russia.
This all means LNG vessel employment, even during the seasonal low point and peak shift to short hauls which we are witnessing now, just experienced a massive structural gain, which also serve to establish a higher and firmer rate floor in the market.
Throughout the history of shipping, a well-established consequence of a tighter market and these structurally imposed higher floors is that charter/spot rate increases react more profoundly to bullish demand side moves.
Therefore, as we move to seasonal strength and/or a reemergence of long hauls for the LNG segment we can expect these bullish episodes to produce more frequent and acute spikes which will likely diverge more significantly from the baseline as this “new normal” market maintains or progresses.