Easwaran Kanason

Co - founder of NrgEdge
Last Updated: September 29, 2021
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In mid-September, the TTF marker – otherwise known as the Title Transfer Facility virtual trading point in the Netherlands – that represents the price of LNG in Europe flipped into trading at a premium to its Asian equivalent, the Japan Korea Marker (JKM). In fact, the TTF spot price hit its highest level since 2008 in June, and then has proceeded to shatter historic highs since, more than tripling in price to US$24/mmBtu from its starting point this year of US$7.50/mmBtu in January. Onshore European gas isn’t in isolation on this trend as well. In August, the UK NBP (National Balancing Point) also hit its highest-level ever and has since recorded new highs every week, as have other European gas contracts.

And it is not as if Asian LNG spot prices haven’t been rising either. After a major spike to over US$33/mmBtu in mid-January due to winter demand in China, the JKM fell back to a more usual level of US$6-8/mmBtu after, trading at its typical premium to TTF. But in May, JKM breached the US$10/mmBtu mark, with TTF following a month later. By September, JKM is also shadowing TTF at around US$25/mmBtu, which is nearly 4 times higher than typical September levels. In the US, which is now a major LNG exporter, Henry Hub pipeline natural gas prices are also at their highest levels since 2014. With all these record rallies in natural gas markers, what is going on in the world of LNG? 

In short, resurgent demand and curtailed supply, which is beginning to look like a perfect storm that could see LNG prices explode if the coming winter proves to be particularly severe.

We start with Europe, where the potential problems seems most severe. Colder-than-usual weather in March and April, even spilling in May, meant that natural gas was in high use for heating. This delayed the start of the injection season, where piped natural gas or LNG is injected into storage infrastructure for stockpiling, to mid-May, instead of the usual time-frame of end-March. This meant that Europe’s natural gas inventories are now at their lowest levels in five years, due to intensive drawing earlier in the year and spillover reluctance over Covid-19 uncertainty from the previous year. And when the injection season did start, it was difficult to obtain cargoes. With JKM spot contracts trading above TTF, it was more profitable to send available LNG cargoes to China or Japan, where demand was rising for summer cooling requirements.

In fact, the price dynamics were so lopsided at one point that, LNG was extracted from tanks in Spain and sent to East Asia in six cargoes to meet demand there. Several planned and unplanned outages over summer also hampered the ability to amass sufficient inventories of natural gas. Maintenance on the Yamal-Europe and Nord Stream pipelines saw piped Russian gas volumes fall, with flows falling even more in August due to a fire at one of Gazprom’s condensate plants in West Siberia and outages at Norway’s giant Troll field.

All this means that Europe is now poised to enter winter with depleted levels of natural gas, which has caused prices to skyrocket to attract potential volumes. With TTF now at a premium to JKM, we could see more spot LNG cargoes make their way to Europe. But available spot cargoes are far and few in between this year. Most of the world’s LNG trade is locked up in long-term contracts linked to crude prices, and with crude currently cheaper than gas, that leaves less available for spot. There is also less supply in general, with liquefaction plants from Trinidad & Tobago to Nigeria to Egypt all underperforming this year. Planned efforts to bring in additional gas supplies into Europe through more immediate means, with all eyes on the upcoming start-up of the Nord Stream 2 pipeline in October and Norway clearing Equinor to increase gas production/exports from the Oseberg and Troll fields, could help cool down prices, but it still seems that European prices are set to remain very elevated over the winter. And that is already having dire consequences. Two of the world’s largest fertiliser manufacturers have cut production in Europe due to high gas prices, which in turn is causing a shortage of carbon dioxide that is impacting industries such as meat processors (CO2 is used to vacuum pack fresh produce) to makers of carbonated soft drinks. The high cost of gas is being passed on to consumers, and that is also affecting vital industrial processes like steelmaking and cement manufacturing.

How long the developing gas crisis in Europe will last will depend on what is happening elsewhere. In the US, where winter storms in Texas, the recent Hurricane Ida and the upcoming Tropical Depression Nicholas decimated production, natural gas prices are already double what they were in January, causing electricity prices to rise as well. There are already calls to limit LNG exports to keep domestic energy prices down, with the Industrial Energy Consumers of America trade group calling of the US Department of Energy to halt of LNG exports.

And then there is China. Having emerged early from the Covid-19 pandemic, Chinese power generation demand exceeded pre-Covid levels this summer. And with China making a concrete show to tackle its emissions, that means that it has been more reliant on gas than coal for power generation. Experience from harsh winters in the past decades will also mean China will want to be fully prepared this year. And just like in Europe, the high price environment for gas is already biting into some key industries, with reports suggesting that several dozen major steel, ceramic, glass, aluminium, fertiliser and chemicals manufacturers are reducing production to avoid the worst effects of a high gas prices. A similar situation is also playing out in Japan and South Korea, to a lesser extent. But the one advantage that East Asian markets do have over their European counterparts, which are firmly wedded to natural gas, is that they have greater flexibility in power generation sources. Coal is an immediate and obvious, if more polluting, option. But there have also been reports that other Asian countries like Pakistan and Bangladesh that are not as entrenched in natural gas have started switching to fuel oil, since the run-up in crude prices in 2021 is nowhere near what has happened in natural gas.

It is crunch time for gas, particularly in Europe. Record high prices are still not enough to fill the natural gas void. Desperate moves are already being made to stave off the worst potential effects of this, with a lot of hope being pinned on Nord Stream 2. But it might not be enough. Winter is coming. And if it is harsh and cold one, then the situation could turn apocalyptic. This year, the European energy industry will not be wishing for a white Christmas, but a mild and balmy winter.

  *"Winter Is Coming" is the motto of House Stark, one of the Great Houses of Westeros. The meaning behind these words is one of warning and constant vigilance, from the HBO television series Game of Thrones

End of Article

Market Outlook:

-       Crude price trading range: Brent – US$75-78/b, WTI – US$72-75/b

-       Even with the easing of OPEC+’s supply quotas, global crude markets continue to appear tight, especially with recovering demand, leading crude benchmarks to inch closer to the US$80/b level

-       A slide in US crude inventories following extreme weather and ahead of winter demand also bolstered concerns over supply/demand fundamentals, with most analysts agreeing that crude tightness will continue into 2022

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High Oil Prices and Indonesia’s Ban on Oil Palm Exports

Supply chains are currently in crisis. They have been for a long time now, ever since the start of the Covid-19 pandemic reshaped the way the world works. Stressed shipping networks and operational blockages – coupled with China’s insistence on a Covid-zero policy – means that cargo tanker rates are at an all-time high and that there just aren’t enough of them. McDonalds and KFCs in Asia are running out of French fries to sell, not because there aren’t enough potatoes in Idaho, but because there aren’t enough ships to deliver them to Japan or to Singapore from Los Angeles. The war in Ukraine has placed a particular emphasis on food supply chains by disrupting global wheat and sunflower oil supply chains and kicking off distressingly high levels of food price inflation across North Africa, the Middle East and Asia. It was against this backdrop that Indonesia announced a complete ban on palm oil exports. That nuclear option shocked the markets, set off a potential new supply chain crisis and has particular implications on future of crude oil pricing and biofuels in Asia.  

A brief recap. Like most of Asia, Indonesia has been grappling with food price inflation as consequence of Covid-19. Like most of Asia, Indonesia has been attempting to control this through a combination of shielding its most vulnerable citizens through continued subsidies while attempting to optimise supply chains. Like most of Asia, Indonesia hasn’t been to control the market at all, because uncoordinated attempts across a wide spectrum of countries to achieve a similar level of individual protectionism is self-defeating.

Cooking oil is a major product of sensitive importance in Indonesia, and one that it is self-sufficient in as a result of its status as the world’s largest palm oil producer. So large is Indonesia in that regard that its excess palm oil production has been directed to increasingly higher biodiesel mandates, with a B40 mandate – diesel containing 40% of palm material – originally schedule for full implementation this year. But as palm oil prices started rising to all-time highs at the beginning of January, cooking oil started becoming scarcer in Indonesia. The government blamed hoarding and – wary of the Ramadan period and domestic unrest – implemented a Domestic Market Obligation on palm oil refineries, directing them to devote 20% of projected exports for domestic use. Increasingly stricter terms for the DMO continued over February and March, only for an abrupt U-turn in mid-March that removed the DMO completely. But as the war in Ukraine drove prices even further, Indonesia shocked the market by announcing an total ban on palm oil exports in late April. Chaotically, the ban was first clarified to be palm olein only (straight refining cooking oil), but then flip-flopped into a total ban of crude palm oil as well. Markets went haywire, prices jumped to historical highs and Indonesia’s trading partners reacted with alarm.

Joko Widodo has said that the ban will be indefinite until domestic cooking oil prices ‘moderate’. With the global situation as it is, ‘moderate’ is unlikely to be achieved until the end of 2022 at least, if ‘moderate’ is taken to be the previous level of palm oil prices – roughly half of current pricing. Logistically, Indonesia cannot hold out on the ban for more than two months. Only a third of Indonesia’s monthly palm oil production is consumed domestically; the rest is exported. An indefinite ban means that not only fill storage tanks up beyond capacity and estates forced to let fruit rot, but Indonesia will be missing out on crucial revenue from its crude palm oil export tax. Which is used to fund its biodiesel subsidies.

And that’s where the implications on oil come in. Indonesia’s ham-fisted attempt at protectionism has dire implications on biofuels policies in Asia. Palm oil prices within Indonesia might sink as long as surplus volumes can’t make it beyond the borders, but international palm oil prices will remain high as consuming countries pivot to producers like Malaysia, Thailand, Papua New Guinea, West Africa and Latin America. That in turn, threatens the biodiesel mandates in Thailand and Malaysia. The Thai government has already expressed concern over palm-led food price inflation and associated pressure on its (subsidised) biodiesel programme, launching efforts to mitigate the worst effects. Malaysia – which has a more direct approach to subsidised fuels – is also feeling the pinch. Thailand’s move to B10 and Malaysia’s move to B20 is now in jeopardy; in fact, Thailand has regressed its national mandate from B7 to B5. And the reason is that the differential between the bio- and the diesel portion of the biodiesel is now so disparate that subsidy regimes break down. It would be far cheaper – for the government, the tax-payers and consumers – to use straight diesel instead of biodiesel, as evidenced by Thailand’s reversal in mandates.

That, in turn, has implications on crude pricing. While OPEC+ is stubbornly sticking to its gentle approach to managing global crude supply, the stunning rebound in Asian demand has already kept the consumption side tight to match that supply. Crude prices above US$100/b are a recipe for demand destruction, and Asian economies have been preparing for this by looking at alternatives; biofuels for example. In the past four years, Indonesia has converted some of its oil refineries into biodiesel plants; in China, stricter crude import quotas are paving the way for China to clamp down on its status of a fuels exporter in favour of self-sustainability. But what happens when crude prices are high, but the prices of alternatives are higher? That is the case for palm oil now, where the gasoil-palm spread is now triple the previous average.

Part of this situation is due to market dynamics. Part of it is due to geopolitical effects. But part of it is also due to Indonesia’s knee-jerk reaction. Supply disruption at the level of a blanket ban is always seismic and kicks off a chain of unintended consequences; see the OPEC oil shocks of the 70s. Indonesia’s palm oil export ban is almost at that level. ‘Indefinite’ is a vague term and offers no consolation to markets looking for direction. Damage will be done, even if the ban lasts a month. But the longer it lasts – Indonesian general elections are due in February 2024 – the more serious the consequences could be. And the more the oil and refining industry in Asia will have to think about their preconceived notions of the future of oil in the region.

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Market Outlook:

  • Crude price trading range: Brent – US$110-1113/b, WTI – US$105-110/b
  • As the war in Ukraine becomes increasingly entrenched, the pressure on global crude prices as Russian energy exports remain curtailed; OPEC+ is offering little hope to consumers of displaced Russian crude, with no indication that it is ready to drastically increase supply beyond its current gentle approach
  • In the US, the so-called NOPEC bill is moving ahead, paving the way for the US to sue the OPEC+ group under antitrust rules for market manipulation, setting up a tense next few months as international geopolitics and trade relations are re-evaluated

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