There are three tests that need to be passed before the global LNG market can accurately be described as "oversupplied," and the market has not yet met any of these criteria.
One of the zombie ideas that refuses to die in the energy world is that the global LNG market is “oversupplied”.
This idea of excess LNG repeatedly reappeared in 2017 despite all the evidence pointing to the contrary.
Northeast Asian LNG prices climbed to their highest in over three years this winter, testing levels that would be uncompetitive with oil in energy terms.
Strong demand from China and India has absorbed most of the new supply coming on stream, which has helped lift prices.
And Spain had to actively compete with the usual premium global markets for LNG throughout much of last year as low hydroelectric generation lifted power sector gas demand.
Hardly the signs of a market weighed down by oversupply.
Another reason for a widely anticipated oversupply failing to materialise is that the projects driving the increase in global liquefaction capacity had been planned several years previously.
New importers — such as Pakistan — have been able to respond quickly to the expected increase in supply. It is quicker to build a floating storage and regasification unit (FSRU) than an LNG export terminal, allowing demand to adjust to higher supply with a short lag.
So here are three tests that need to be passed before the LNG market can accurately be described as “oversupplied”.
1) LNG is dumped in northwest Europe
Excess cargoes will be sent to the liquid hubs in northwest Europe if demand growth in premium markets is insufficient to keep pace with the scheduled rise in global liquefaction capacity.
Northwest Europe has previously become a destination of last resort for cargoes — particularly from Qatar and the Atlantic basin — when demand in premium markets was saturated.
Northwest European LNG receipts and sendout climbed around 2010-11 as Qatari supply initially earmarked for the US had to find other destinations because of the increase in US gas production.
But imports and regasification tumbled in 2012 following Japan’s Fukushima nuclear disaster and have stagnated in recent years, despite the increase in global liquefaction capacity.
Northwest Europe’s LNG sendout would climb rapidly if the global market approaches an oversupplied situation. And prices in typical premium markets such as northeast Asia and the Middle East would fall towards the TTF, rather than being at a wide premium as they have been this winter.
2)European gas prices test fuel-switching support
An increase in northwest European LNG receipts would still not constitute an “oversupply”. Instead, prices would drop enough so that there was an incentive for Europe to buy more cargoes.
LNG output would still be at full available capacity, once taking into account upstream constraints and maintenance periods.
An influx of LNG would push TTF prompt prices down for gas to compete more with coal, particularly in the summers. Gas-fired plants pushing out the oldest coal-fired units provided a support level for the TTF day-ahead market for periods in the summers of 2016 and 2017.
Northwest Europe has capacity for gas demand to increase, particularly in the Netherlands and Germany where there are more coal-fired plants to displace. The pressure would be on the Netherlands’ Gate terminal to take more supply in this event.
France, Belgium and the UK have little coal-fired generation, limiting the flexibility for gas demand to step up. And pipeline capacity to move gas further east, such as into Germany, has already been tested at times, such as for parts of the 2017 summer.
3)US LNG gets shut in
TTF prompt prices would tumble if coal is entirely displaced from the generation mix. Henry Hub prices could provide a support level in this event, which would be the point at which the global LNG market could begin to be described as oversupplied.
European gas prices would need to be at a premium to the Henry Hub wide enough to cover variable costs. These could be as little as shipping transport costs if firms own other assets, such as tankers and regasification capacity, which would count as sunk costs.
TTF prompt prices would need to slide enough to encourage almost entirely displacing coal from the generation mix to be at a tight premium to the Henry Hub, assuming US gas remains competitive with coal.
There would be less incentive for US LNG loadings and supply would be sold at the Henry Hub rather than liquefied. The halt to liquefaction trains, which is mostly likely in the US, because of global LNG and European hub prices would be a situation where demand is unable to meet potential supply.
This is still a plausible scenario in the future, but so far the global LNG market has not even reached step one, never mind ticking off all three of these criteria.