A shift in imports from Asia to Europe led to significant volatility in liquefied natural gas shipping last year, prompting industry experts to urge more stakeholders to consider use of hedging to even out freight rate peaks and troughs.
Speaking at the Baltic Exchange Tanker & Gas Market Insights Forum 2023, Benjamin Gibson, partner of financial products at Affinity Shipping LLP, noted that Europe imported substantially more LNG than China in 2022, which led to a decrease in tonne-mile demand for LNG shipping and more available capacity. As a result, freight rates were extremely volatile, reaching highs of $500,000 a day for an LNG carrier.
“When you have a cargo market that is incredibly volatile, and you have a freight market that has pivoted around a little bit and has a lot more supply than it used to then of course you get significant volatility for freight rates as well,” he said.
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The volatility was exacerbated by fundamental geopolitical shifts with the invasion of Ukraine by Russia “dramatically” disrupting supply into Europe, said panellist Adrian Callinan, senior director at CME Group. As a result, the LNG market has seen a recalibration of how risk is managed: “We’re seeing development in a whole new ecosystem of products. Desks are working collaboratively to manage their risk; the LNG desks are working side by side with their freight traders.”
He added he was looking forward to “a very, very challenging time, but also very exciting times”.
Matthew Cox, head of benchmark production at the Baltic Exchange, noted that in March 2022, round voyage numbers rose to over $500,000 a day on the BLNG2(g) route in November before dropping to around $145,000 a day in January. Today, rates are roughly around $55,000 a day.
Need for new routes?
In light of the volatility and changing market dynamics, Cox mooted the potential for new Baltic Exchange LNG Index routes, with possible demand for routes from Qatar to China. However, Callinan responded that the market needs to see greater liquidity in the existing Baltic LNG index routes before expanding into new derivatives.
“All three rates are highly correlated at the moment, but what you are seeing take hold is liquidity in the US Gulf Coast-Europe route,” he said. “There’s a desire to clear that risk, to monetise and risk manage the exposure that traders have in their books.
But the market needs to see confidence in the existing routes and liquidity to get to a certain threshold that gives confidence to product scope and expand, he added. “Right here, right now, what we’d like to see is greater liquidity in this product – that’s usually a great barometer for growth into the derivatives of derivatives.”
Callinan added that we are already seeing a “re-educated market” in terms of changed dynamics, changed landscape, emerging markers, and the evolution of new products. “I think there’ll be more confidence to use those tools going forward.”
To-date, participants in the LNG market have been slow to actively hedge their positions. Cox noted that there is a great deal more FFA activity on tankers and dry markets, which are less volatile, than on LNG markets. He asked the panellists why participants in the LNG market are not looking to hedge their positions, given the volatility.
Sara Stahl, LNG charterer at Cheniere Energy, noted the conservative nature of the LNG market, with only 20% of an already small market active in paper trades. While physical trades are picking up, there are obstacles to active participation in the paper market, such as imperfect liquidity. She said that adding a fourth route “doesn’t add value at this point of time because you have three routes and only one is trading”.
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Gibson noted that when making comparisons with the tanker markets, the audience had to remember that the LNG space is much younger and therefore “that leap in sophistication from a bilateral cargo deal between principles to more commoditised market where you can actually hedge has only happened relatively recently”. It should not, consequently, be judged too harshly for where it currently stands, given its relative youth, he said.
The orderbook of 200-plus LNG carriers coming into the market over the next 3-4 years will bring new participants, some of whom are described as “very experienced traders” in other markets by Gibson. “So there’s a pipeline of new blood coming in, which is great for LNG.”
Looking at the LNG fleet, Stahl noted that there is fleet rejuvenation underway to meet emissions regulations. Approximately one-third of the 600 LNG vessels on the water are “steam ships”, she said, which are becoming less attractive and more expensive to operate. “We’ve seen that owners are already putting a speed cap on them and that’s obviously restricted shipping. So, a third of the fleet has to eventually retire,” she said. New modern tonnage is coming in that is earmarked for new volumes from 2026 from Qatar and the spot market remains healthy, with over 500 fixtures on spot last year in the physical market.
The growth of the fleet also means new players are entering the market. Affinity’s Gibson said: “We’ve seen Chinese buyers coming into the market over the past couple of years for FOB from the US Gulf, but rather than just buying delivered in China, [they] want to actually own the shipping part.”
Those new players will “drive the real liquidity”, which will support a healthy spot market,” he added. “And of course, we’ve got these trade patterns that are constantly resetting. That actual outlook for hedging products, whether it be as FFAs or gas contracts, is quite rosy.”
Overall, the LNG market is experiencing significant changes driven by geopolitical events, emissions regulations, and the growth of the fleet. While there are challenges to be faced, such as retiring older ships, new players entering the market, and recalibrating risk management, there are also opportunities for growth and expansion in the industry.
Source: Baltic Exchange