Natural gas, LNG markets clutch onto risk premium despite ample supply

Global natural gas and LNG prices are holding onto risk premiums accumulated in recent weeks, highlighting how jittery markets continue to be despite comfortable inventory levels and weak seasonal demand, according to traders and analysts.

The higher prices in the gas complex also contrast with other commodities like oil and gold that have seen downward price corrections this week, while LNG prices and European natural gas prices have only shed a fraction of the risk premium.

Asian spot LNG prices had risen nearly 48% to around $19.055/MMBtu on Oct. 18, from $12.878/MMBtu on Oct. 6 just before Hamas attacked Israel, but the gains tapered down to just 21% by Nov. 2. European TTF gas prices also lost gains to around 37% from as high as around 71.4%.

Meanwhile, ICE Brent futures were back to around $87/b in Asian trading hours on Nov. 3, the same level as early October.

"The global natural gas market might have priced in too high a risk premium on geopolitics and supply, when prices of other commodities that have similar risk exposure have not had such a premium," analysts at Citi Research said in a note to clients on Nov. 1.

"The Israel-Hamas conflict has certainly lifted geopolitical risks. However, a comparison between different commodity prices shows that TTF natural gas prices have remained a significant outperformer," Citi wrote, adding that it had compared oil, gold and Asian/European natural gas, which are all exposed to similar geopolitical risks.

Citi said that despite loose fundamentals, bullish sentiment supported TTF and JKM prices because markets generally don't expect prices to rise in a straight line in the event of a disruption, and the narrative had been supported by events like the Norwegian production outage, Australian strikes and the Israel-Hamas war.

Weather-related premium

JP Morgan said Oct. 31 that the geopolitical risk premium could linger because of weather.

Support for TTF prices started as far back as June, when players took the opportunity to unwind overwhelmingly short positioning at the front of the forward curve, JP Morgan wrote. When large positions are unwound they can send prices higher very quickly.

The bank said derivatives positions after the start of the Israel-Hamas war were also bullish, but the Brent flat price has retraced much of its rally as time has shown no disruption to oil supply, while gas has remained high.

"We believe that the difference between the crude and natural gas markets comes down to weather," JP Morgan said.

"While weather has underperformed so far this winter season in Europe and Asia, uncertainty regarding peak weather-related demand in the heart of winter -- December through February -- allows for the current risk premium in flat price to have staying power," it said.

"For Europe alone, we estimate one standard deviation weather event during the heart of winter could reduce Northwest European natural gas storage by around 9 percentage points," JP Morgan said.

"We believe that the support of weather for the current price premium will remain in place until the market has a better view of weather during December and January. Until then, the European natural gas market is not in a position to repel LNG cargoes despite its current brimming state of storage," the bank said.

This is likely to mean continued LNG price competition between Asia and Europe.

Price-sensitive LNG buyers in Asia have shifted to the sidelines as high prices persist despite Europe crossing 99% gas storage levels, strong inventories in North Asia, early procurement by China's national oil companies and muted demand for December cargoes.

Low demand sensitivity

Citi Research also said that gas price volatility was partly due to low demand sensitivity and almost non-existent supply sensitivity to prices.

"The market has also been volatile partly because there do not seem to be immediate supply or demand responses to price changes, so that prices move quickly until they reach some major fuel switching levels," it said.

The bank was mainly referring to a situation where rising gas prices would create a feedback loop, by driving demand for cheaper fuels like oil or coal, and curbing gas demand. But with so many coal and oil fired plants shutting, this control mechanism has failed.

At the Gastech conference in September, Trafigura's Global Head of Gas and Power Richard Holtum said that in terms of pricing, the natural gas market was very nervous and all the risks were to the upside.

"There is no news headline tomorrow that could cause the price to drop by $10/MMBtu but there are plenty of headlines that could cause the price to spike by $10/MMBtu," he said, adding that a huge amount of flexibility has been taken out of the system with Russia cutting supplies to Europe.

"As a result, we are much more sensitive to price spikes than you were only a few years ago," he said.