TOKYO/BEIJING -- More of the liquefied natural gas market, typically dominated by long-term fixed contracts, is obeying the law of supply and demand. A number of factors are at play, including China's industrial policies.
A result is derivatives transactions for LNG are surging.
Specifically, Asia is seeing a rise in swap transactions that use the Japan Korea Market index, an S&P Global Platts LNG spot price benchmark, to fix future prices.
As the name suggests, the JKM tracks LNG delivered to Japan and South Korea; it has become a widely used indicator. JKM-based swaps settled on exchanges swelled to about 50,000 lots in 2017 -- four times the volume for the previous year. The quantity was roughly equivalent to 170 cargoes (1 cargo equals roughly 60,000 to 70,000 tons). In January of this year, swaps totaled close to 10,000 lots, a record for a single month.
The surge is coming as market players try to mitigate sudden price changes. Prices rose, for example, when China sharply increased imports last year in preparation for winter. Traders, utilities and other players hedged to avoid losses.
LNG consumption in Asia is growing and now accounts for two-thirds of worldwide demand. Mostly, the gas has been purchased under contracts that fix purchase volumes for over 10 years, and numerous contracts are coming up for review this year and next. The need for spot purchases, which allow for flexibility depending on supply and demand, is expected to significantly increase, which in turn will boost the need for hedging.
"The importance of the JKM as a price index is growing amid rising liquidity in spot deals," said Yuki Nishikawa, manager of Mitsui & Co.'s global gas trading department.
LNG exporters like Indonesia and Russia have invited bids for LNG with prices linked to the JKM, further raising the index's profile.
Most JKM derivatives transactions are conducted for hedging purposes, said Marc Howson, director of LNG market development at S&P Global Platts. Howson added that LNG buyers, sellers and traders are using the financial market to manage prices.
A big factor behind increasing spot purchases in the LNG market is China, where policy now favors gas over coal as a way to reduce air pollution.
The second half of 2017 showed just how the nation can cause prices to swing. Ahead of winter, China suddenly increased imports. This triggered a 100%-plus rise in prices over the half year through January 2018. In February, as the cold began to abate, prices turned sharply downward.
For this year, Beijing set a target of reducing coal mine capacity by 150 million metric tons. This follows cuts of 540 million tons over the past two years, as part of a drive to slash 800 million tons of capacity by 2020.
Japanese electric power and gas companies are turning to the spot market to cope with these fluctuations and better respond to shifts in demand.
On the supply side, the U.S. wants to ship more gas as shale production has rapidly increased. President Donald Trump's administration is working to develop export infrastructure, including pipelines.
Japanese and Chinese utilities alike are keen to buy American LNG to diversify their sources. And unlike LNG from traditional producers in the Middle East and Southeast Asia, gas from the U.S. can be resold. If the gas is resold twice or three times on the spot market, the number of hedges will also increase.
"The trend toward an increase in JKM-linked physical transactions, and more need for swaps, will remain steady," Mitsui's Nishikawa said.
Yoshihisa Yamada, general manager of the gas resources department at Tokyo Gas, sees a convergence of global markets.
"With the increase in U.S. LNG, the separate natural gas markets of North America, Europe and Asia are merging," he said.
As JKM-linked transactions grow in Asia, Yamada added, "arbitrage with the benchmark prices in the U.S. and Europe will be available and hedging will become easier."