After record lows in mid-2020, Asian spot prices for LNG rose tenfold to reach record highs in January 2021. This volatility is an obstacle to the development of the gas infrastructure that’s essential to the region where demand for gas is growing, explain Jean-Baptiste Dubreuil and Gergely Molnar at the IEA. There were multiple causes for the price spike, including the cold winter, limits to nuclear and coal generation, and outages at regional liquefaction plants. The backdrop is a growing number of customer nations with strategies that vary greatly – from those that are highly dependent on LNG to those that only buy it when it’s cheap. What Asia needs is faster gas market reform to ensure transparent pricing, short-term liquidity, and competition through fair access to gas infrastructure, say the authors. They go into the details and summarise the obstacles and their recommendations. Many nations – Japan, Singapore, China, India, Korea – understand the need and are making progress. But the recent volatility shows how urgent reform is for the sake of gas. And it’s also vital for the transition as gas’s flexible generation supports the growth of variable renewables and the decline of coal.
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A cold spell and tight supply send Asian LNG prices to record highs
A plunge in temperatures in Asia in early December 2020 took gas markets by surprise and caused prices to soar. Having sunk to record lows in mid-2020, spot prices for liquefied natural gas (LNG) increased tenfold to reach unprecedented highs in January 2021. While milder weather will alleviate the immediate pressure on Asian gas markets, policy reforms are needed to improve market resilience and flexibility, especially given the role of gas in balancing the growing share of variable renewable energy sources.
The Covid-19 pandemic was behind the unprecedented drop in natural gas demand in the first half of 2020, which pushed Asian and European spot prices to historical lows. By the end of May, negative gas prices were deemed possible and widely discussed. The gradual recovery in natural gas demand and adjustments on the supply side helped spot prices recover in the second half of 2020, rising above 2019 levels in Europe and Asia by the beginning of the fourth quarter.
Asian spot LNG prices more than quadrupled between the start of December 2020 and mid-January 2021, climbing above USD 30/MBtu. Some cargos were reportedly purchased close to USD 40/MBtu, breaking the record prices experienced after the Fukushima nuclear accident in Japan in 2011. This spike was caused not by a single exceptional event but by typical supply and demand factors combining to produce a “perfect storm”.
Northeast Asian LNG demand grew 10% between mid-December and early January, compared with a year earlier, because winter temperatures were lower than average, nuclear availability was low in Japan and coal generation faced limits in Korea.
China, the world’s top natural gas importer, faced stronger demand because of lower-than-average temperatures and lower pipeline import flows from Central Asia. By the end of 2020, Chinese buyers had increased purchases of LNG on the spot market and pipeline imports from Russia.
This increase in Asian LNG demand coincided with outages at regional liquefaction plants, including in Australia and Indonesia, leading buyers to call on more remote suppliers, in particular from the United States. As voyages lengthened and the Panama Canal became congested, spot charter rates climbed to historic highs of more than USD 230,000 per day from less than USD 30,000 six months earlier. One vessel was reportedly hired at USD 350,000 per day. The sharp increase in spot LNG prices was accompanied by extreme volatility. Despite the growing flexibility of the global LNG market, which has surely helped relevant industries find solutions in the very tight market, these fluctuations show that the market’s short-term liquidity remains limited and timeliness is an issue.
LNG markets still need to become more flexible
The global LNG market, once a limited club of buyers, has gone through profound changes recently. The number of countries and territories with LNG import terminals has grown from nine in 2000 to 42 in 2020. New buyers range from fast-growing economies to mature markets seeking new sources of supply. Supply strategies and exposure to price risk vary more widely, from LNG-dependent buyers to those who have more diversified supply portfolios, occasional buyers who use gas as a back-up fuel, and buyers who are mainly driven by prices.
As LNG demand expands and buyers’ profiles diversify, the global market thrives on increasing trade flexibility and improving transparency in price discovery mechanisms. Recent supply contracts show a clear transition towards more flexibility, both in terms of destination (with more destination-free contracts) and time (with an increasing share of short-term volumes). A similar trend is observed in LNG spot trade, where traded volumes have doubled since 2014 to reach more than 30% of global LNG trade in 2020.
Asia drives demand growth for gas
In Asia, the primary source of gas demand growth, LNG is particularly important because regional pipeline networks are absent and price-setting mechanisms for gas are still in transition. There are no regional organised exchanges. Local spot price indices have emerged, and their trading volumes are expanding, but their liquidity remains limited – especially when supply-demand fundamentals tighten up as they did recently. The India Gas Exchange was successfully launched in June 2020 but acts as a domestic price reference. The Singapore Exchange discontinued its LNG index in 2019 because market participation was low.
Globally, an increasing share of LNG is priced on market-based indices. In Asia, however, gas pricing is not linked to supply and demand fundamentals because gas trade is still predominantly oil-indexed and domestic price-setting mechanisms are either regulated or depend on oil indexation. The result is a combination of midstream price volatility risk from lack of liquidity and downstream price disconnection from fundamentals. This can cause wide supply pricing spreads and short-term concerns over deliverability and security of supply. Price-sensitive Asian buyers can bear the brunt of such problems. In some cases, short-term tenders have been cancelled because bids were too high.
Asia needs more gas market reform
While warmer weather will ease the pressures on the Asian gas market in the short term, policy reforms will be needed to avoid a repeat of this winter’s price spike. The development of short-term natural gas trading in Asian markets will help establish market-driven competitive pricing mechanisms. However, the transition to efficient and competitive markets with transparent pricing and diversified supply requires a larger set of policy reforms. Several Asian markets are undertaking such structural reforms, which are necessary to ensure the development of liquid marketplaces that can in turn reinforce flexibility and security of supply.
To enhance the flexibility and responsiveness of the gas system, regulatory policies need to guarantee open and transparent access to gas infrastructures. Frameworks for third-party access rules exist or are being developed in several Asian countries, but they sometimes lack implementation due to the market position of incumbents.
Transparent market mechanisms, such as the online capacity trading platform established in India in 2018, need to be developed in more markets. Ensuring the independence of infrastructure operators from supply incumbents, such as the incorporation of PipeChina in 2020, is another prerequisite. Competitive and transparent market rules provide a framework for stability and reliability, and foster investment to meet additional demand needs.
Some reform is happening
Diversity of supply and open access to infrastructure support the establishment of competitive end-user markets and the emergence of market-based price signals. Some Asian countries such as Japan and Singapore have partially or fully liberalised their gas markets. Some, such as China and India, have reformed their pricing policies to increase market indexation or have enabled big consumers to develop their own supply, as in Korea. Market-based pricing and price-responsive demand support the development of domestic market hubs and promote their liquidity, which in turn reinforces access to flexible and diversified supply and improves market resilience.
Such a transition in Asian gas markets is even more important in the wider context of global clean energy transitions, where natural gas will be required to make a more flexible contribution as the share of variable renewable energy sources grows and coal use progressively declines. Asian gas market and pricing structures need to keep evolving alongside new demand requirements in order to reinforce market resilience to price volatility and supply disruption risks – including the next cold winter.
Jean-Baptiste Dubreuil is a Senior Natural Gas Analyst at the IEA
Gergely Molnar is an Energy Analyst (Natural Gas) at the IEA