The energy situation in Europe is shifting. Over the past year, changing supply and demand factors, along with energy security concerns, have pushed energy prices in Europe to new highs. In this new environment of energy volatility, the need for a stable source of energy to supply the European continent has driven a rise in the importance of U.S. gas exports to global markets.
After bottoming out in 2020, spot prices for natural gas across foreign benchmarks, Dutch Title Transfer Facility (TTF), and Platts Japan Korea Marker (JKM), have seen explosive price increases. A particularly cold winter coupled with outpaced energy demand in Europe saw the TTF spike in late 2021 with JKM following suit as world supplies of natural gas became strained. At the heart of this surge in energy prices is the rate at which world economies have recovered from pandemic lockdowns with energy demand outpacing the supply of
energy resources. In this environment of strained energy supplies, the war in Ukraine has put the European energy market into a precarious situation. As a major exporter of natural gas and oil to Europe, the Russian invasion and subsequent sanctioning against their major industries has put further pressure on European nations to find new avenues of supply to feed their massive economies. Declarations by European nations to reduce their reliance of Russian energy in response to the invasion coupled with uncertainly surrounding disruptions of western gas flows have kept European energy prices high.
The rapid surge in demand for U.S. LNG has pushed U.S. export capacity to its limit. Despite the sizable premium for U.S. LNG across international markets, U.S. LNG export volumes from January to May of 2022 didn’t diverge greatly from historical export trends during the same period. Except for the jump in February exports, which corresponds with the invasion of Ukraine, U.S. LNG export volumes appear to be hardly reacting to sky rocketing prices. The answer lies with U.S. LNG export facilities operating at or near capacity. U.S. LNG exports are limited by liquification plants and their ability to transform the natural gas into a liquid state. These liquification plants are capital and time intensive to build, with the average time to build a new LNG terminal being three to five years. The U.S. simply does not have enough liquefication plants to meet the demand of international markets in the short term and supply will remain sticky until new terminals are built with the newest terminal project not expected to be operational until 2023.
Although U.S. LNG exporters have been unable to drastically increase export volumes to meet international demand, U.S. LNG exporters have been able to divert shipments towards the lucrative European market. During the period of January to May 2021, 51% of U.S. LNG exports were shipped to markets in Asia, whereas Europe only made up 32% of exports. During the same period in 2022, 64% of LNG exports were shipped to European destinations. Asian deliveries have seen a considerable decline in deliveries as renewed
lockdowns in China, coupled with the inability for the Asian market to compete with European natural gas premiums, has resulted in U.S. exporters making a dramatic shift towards European deliveries. Japan, South Korea, and China all have seen LNG imports drop considerably with France, Spain, and the United Kingdom taking their spot as the largest importers of U.S. LNG.
This switch from Asian deliveries to European deliveries began in late 2021 right as natural gas prices in Europe also began to spike. From October to January, the distribution of U.S. LNG deliveries to Europe more than doubled. By the start of the Ukraine-Russian war, U.S. LNG deliveries had already topped 70% of U.S. destinations. However, while the war in Ukraine may not necessarily be responsible for this initial switch from Asian to European deliveries, it is responsible for maintaining Europe’s natural gas premium, which in turn has maintained U.S. LNG shipments to Europe. Yet how much LNG Europe can import is not just matter a price, it must take into account the import capacity of the continent. Falling natural gas flows from Russia cannot be 100% replaced by LNG imports since import terminals are already operating at or near capacity. European LNG imports are at an all-time high and ramping up import capacity will require the construction of additional import terminals, which are time and capital intense to construct. Therefore, no matter how high a premium Europe offers to the international market for LNG, they will still be limited by bottle necks at their own import terminals.
The U.S. is not the only LNG exporter looking to position themselves as the global leader in this space. Qatar and Australia are both major players in the LNG industry and have historically been the largest exporters of LNG. The shale revolution and subsequent exportation of U.S. LNG has allowed the U.S. to catch up, although there is still no clear break away winner. Yet, as the world’s largest producer of natural gas, the U.S. is well positioned to take advantage of its strategic location to absorb Europe’s premium for LNG. At the heart of the U.S. natural gas pipeline system is the Henry Hub distribution hub located in Earth, Louisiana. Given its critical role as a delivery location in the highly connected U.S. natural gas pipeline system, the Henry Hub futures contract serves as the premier U.S. natural gas benchmark and is used as a proxy to price LNG. Natural gas liquification facilities in the U.S. use the Henry Hub benchmark to price natural gas, which they can then ship as LNG to international markets. It is due to this close relationship between the benchmark and U.S. LNG exports that Henry Hub increasingly finds itself as a key pricing instrument for international LNG. As the energy relationship between the U.S. and Europe further develops, Henry Hub will continue grow as a core benchmark in international markets.
From January to before the start of the war on February 24, TTF and JKM spot prices already resettled at relative parity. However, the onset of the invasion saw European demand again swallow Asian deliveries. Even as European natural gas storages transitioned from the withdrawal to injection period, a period which historically results in lower prices, the scarcity of reliable energy continued to prop up European premiums for natural gas. In the short term, this will undoubtably continue to drive U.S. LNG into Europe.
Going forward, U.S. LNG appears to be well positioned to lead the world as a dominant LNG exporter. As additional export capacity in the Gulf Coast comes online in the coming years, and Europe continues to expand import capacity, U.S. LNG will continue to serve an increasing role in European energy security. By extension, this growing importance of U.S. LNG deliveries in global trade will further cement Henry Hub as the leading global benchmark for natural gas and LNG.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.