LNG Shipping Quietly Poised for Record Breaking Year

Containers and dry bulk have commanded the lion’s share of attention in 2021, but what may be lost in all this is that the LNG shipping trade is on track to shatter records. Spot rates have already surpassed last year’s highs and a nearly 90% chance of another La Nina looms on the horizon (all while inventories remain exceptionally low) which will lead to spur massive cargo mile demand gains.

Before we get to all that, let’s take a quick look at the problem that never was. 2021 presented a hurdle in terms of vessel supply, but it looks like the market will clear it with ease, kind of like a horse jumping over a chihuahua.

Source: Data Courtesy VesselsValue – Chart by VIE

The 8.6% gross vessel growth in the Large LNG class was the greatest challenge ever seen by the market. But, as we’ll soon see, thanks to the impressive cargo mile demand growth it was absorbed quite handily.

This year’s record vessel growth will give way to just 5% gross fleet growth in 2022 and 5.8% in 2023. While 2022 will likely not be able to accommodate additional newbuild orders due to their very long build times, 2023 is not yet etched in stone, though it is noteworthy that the vast majority of all large LNG vessel orders placed since the start of July have found their delivery slots in 2024 and beyond.

The trend of slowing supply additions is manifesting right now. The first 8 months of the year saw approximately 5 vessel deliveries per month. That will now slow to a bit over 4 through the end of 2021. 2022 will see that pace shrink to less than 3 per month.

The lack of supply additions coupled with growing expectations for a very active 2022 has put that year squarely in the spotlight for further market tightening, especially if expectations for another La Nina come to fruition.

Over the past several years we have seen how the LNG segment is impacted by global weather conditions. While weather forecasting remains a less than perfect science, the NOAA is now forecasting a nearly 90% chance of a La Nina event. This represents a significantly high degree of confidence, and unlike weather forecasting the economic outcomes for various forecasts leave far less mystery.

Already in 2021, the LNG segment has been quietly posting record breaking cargo mile demand gains. We will get to that in a bit, but first let’s focus on another catalyst (on top of the La Nina or perhaps more like a compliment of the La Nina) which is likely to enhance these already astounding cargo mile demand gains: the arbitrage trade.

In my last LNG report I stated: “Typically with high demand comes the opening of an arbitrage window. While that has materialized, I wouldn’t characterize it as a window, more like a fire truck sized garage door that looks to be jammed open for quite some time.”

That simile was meant to convey both the degree and duration of the expected gap between US and Asia price and landed delivery, respectively, which would support an arbitrage trade similar in magnitude.

Source: Chart by VIE

This arbitrage trade supports increasing long haul activity between the US and Asia, as traders profit off the price difference between US prices (plus transport) and landed prices. Currently the gap is so great that transport costs are a non-issue and traders are trying desperately to capitalize on every available cargo and have been for a while. However, this has done little to slow that growing gap – signaling a worsening supply/demand imbalance.

Meanwhile, the high prices for delivered LNG in Asia have impeded Europe’s ability to replenish their own stockpiles.


Source: John Kemp, Reuters

Shortages in Europe appear to be the most pronounced, though the US and Asia are also facing shortages. In fact, those shortages all set records when looked at relative to demand.

Source: ForexLive

The best way to measure natural gas inventories is days of storage available compared to demand. By that measure, the western hemisphere is facing a massive problem as illustrated by the US stockpiles above, and Europe being at an absolute multi-decade low for this time of year.

Asia, specifically China, has what would be considered extremely low storage capacity relative to demand making them even more highly dependent on short term flows relative to places like Europe and the US. This would be another reason why Asia is currently willing to pay so much for LNG and will likely be forced to continue paying what the market commands – up to the point of demand destruction/substitution.

If demand destruction/substitution surfaces it will probably come from more elastic users such as industries with heavy gas consumption, including steelworks, cement, ceramics, glassware, fertilizers, and petrochemicals. They will have to consider whether to reduce output or close temporarily to reduce costs. Substitution becomes more likely for electricity generators as they seek to minimize gas-firing and opt for coal where possible. Of course, that substitution phase would benefit dry bulk shipping at the expense of LNG.

All that we’ve discussed; the upcoming La Nina, massive arbitrage window, and depleted stockpiles will add further fuel to a market that is already poised to break records.

The record of which we speak is that of cargo mile demand. As of September 12, year to date, the large LNG vessel class has seen cargo mile demand growth soar 22.07%.

Quarter to date we find an even more impressive figure, up 27.12%. This is especially noteworthy as it comes amid higher prices which have failed to stymie volumes yet has contributed to a longer haul because of the aforementioned arbitrage trade.

To put this in some perspective, current growth is shattering 2017 and 2018’s bullish run by over 5% at this point in the year.

Source: Data Courtesy VesselsValue – Chart by VIE

Remember, this 22.07% growth should be weighed against a mere 8.6% gross vessel supply increase. This gap between supply and demand represents a degree of market tightening unlike any I’ve witnessed thus far while covering shipping – So, another record there for me personally.

Conclusion

It’s becoming clear that the most likely path this winter is one of above average natural gas demand set against a backdrop of depleted storage and high prices. This is a recipe for spot price volatility as short-term demand will be less planned and more responsive to needs. Traders across the natural gas spectrum as well as complementary industries are going to have an abundance of opportunity this season.

Newbuild additions should begin tapering off as we near the year’s end, and deliveries should fall to 3/5 of H1 2021’s pace for the full year of 2022. An orderbook of 20.5%, which spans several years, should be considered very acceptable especially when compared against a backdrop of cargo mile demand growth which is exceeding that figure this year alone. Though the market is optimistically poised we have seen relatively subdued newbuild orders with many of those now beginning to fall in 2024 for delivery, indicating tightening yard space for these specialized builds.

A “season of shivers” could await the US and much of the world if the growing consensus and conviction for a La Nina year proves true. This comes on the heels of an especially strong La Nina last year which took nearly full natural gas stockpiles the world over and reduced them to some of the lowest points in recent history. However, this year we are set to start from a far different point, as those ample stockpiles are a distant memory, and several key economies are well below average. Price will be the first way the market will attempt to rationalize supply and demand, meaning we could be in for some extreme price swings. Demand destruction could follow if things get crazy.

But let’s not forget how this colder than average winter may forge the markets in 2022. If you thought stockpiles were low by the end of the 2020/2021 winter (and they were) think of the desperate situation many will find themselves in after 2021/2022. Demand for replenishment over the course of 2022 could be even stronger and met with the slowest newbuild vessel growth we’ve seen in a while. All of this points to a strong finish in 2021 and what will likely be a game of catch-up in 2022, which should further add to that strength.