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Consequences of Russia’s invasion of Ukraine on global LNG markets

Consequences of Russia’s invasion of Ukraine on global LNG markets
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ARTICLE TYPE
Insights
TOPIC
Credit,Ukraine
PUBLISHED
July 21,2022
READ TIME
5 mins
AUTHOR
Phil Wrenn
SHARE
Back
ARTICLE TYPE Insights
TOPIC Credit,Ukraine
PUBLISHED July 21,2022
READ TIME 5 mins read
AUTHOR Phil Wrenn
SHARE

Russia’s war with Ukraine has led to a substantial demand shock from European countries for liquid natural gas (LNG) imports as the EU seeks to reduce its imports of Russian gas by two-thirds. They hope to offset the shortfall primarily by increasing LNG imports by around 36.5 million metric tons (mmt), or 50%, in 2022. Historically, Asia has played the largest role in the 375 mmt trade of LNG imported in 2021, with China accounting for 21% of demand, followed by Japan at 19% and South Korea at 12%.  

 

However, demand momentum has shifted strongly toward European buyers who are trying to wean the EU off of Russian gas and secure supply. As a result, US LNG netbacks* for Europe’s benchmark Dutch Title Transfer Facility will likely hold a premium over the Japan-Korea Marker spot price and attract more LNG to Europe. With limited new meaningful LNG supply capacity not expected until 2025/2026, the market is likely to remain tight and, as a result, Europe will have to outcompete Asian buyers on price.  

 

The LNG spot market has also seen many Asian buyers exit due to higher prices. Asia’s drop in demand is particularly stark in China, where volumes were down around 30% during May 2022 compared to the prior year, due in part to its COVID-19 resurgence and corresponding lockdowns, but also as some Chinese LNG importers diverted cargos to Europe to capture the price arbitrage. However, Chinese pipeline natural gas imports were up 26% in May 2022 compared the same period the previous year, with plans to expand pipeline capacity with Russia. In addition, China’s plans for a green hydrogen strategy by 2025 illustrates that the country, which historically has been the largest buyer of LNG imports, is potentially pivoting away from the expensive LNG market. Japan, which in the past has received around 10% of its LNG imports from Russia, proposed a draft energy plan that indicates the percent of natural gas in the power mix will fall to 20% in 2030 from 37% as the country increases its renewable and nuclear mix over the next eight years.  

 

Emerging markets in south and southeast Asia are viewed as key destinations to drive incremental LNG demand through 2040. However, current LNG prices have become uneconomical for many of these countries and could lead to continued reliance on cheaper, more carbon intensive fuel sources or increasing government invention. For example, already this year Bangladesh has undergone some gas-to-oil switching in energy production, Pakistan has had difficulties in sourcing cargos as LNG is diverted to higher priced markets and India is ramping up domestic coal and gas production to deal with unaffordable imports. These buyers could potentially be further crowded out of the market and ultimately negatively impact long-term LNG growth given the greater competition from Europe and Northeast Asia and ensuing price dynamics.

 

Exhibit 1: Global LNG supply and demand 

7-21-22-LNG-Ex1-01.jpg

Source: BloombergNEF. Note: ‘Others’ includes Middle East, Americas, Africa, other markets, bunkering and operational/voyage LNG losses (such as boil-off). Demand is based on normal weather (10-year average) and current futures prices.

 

Europe’s thirst for LNG has resulted in average imports of 14.9 billion cubic feet per day (bcf/d), which is 5.9 bcf/d (66%) higher than the annual average during 2021 and 4.7 bcf/d higher than 2019’s pre-COVID levels. Europe has 14 countries with regasification facilities; however utilization rates vary across the region. Most LNG terminals in northwest Europe are operating at full or peak capacity, while LNG facilities in southern Europe are operating around at 58% as these facilities are less integrated with Europe’s greater pipeline grid and can only serve local and regional markets. 

 

To alleviate some of its import constraints, Europe is pursuing a multi-pronged strategy of onshore regasification projects, as well as floating storage and regasification units (FSRUs), which are essentially LNG import terminals built on a ship. Land-based regasification facilities generally take three to four years to design and build, whereas FSRUs generally require a timeline of 12–24 months for deployment.  

 

Assuming the delivery and ramp up of FSRUs in Germany, the Netherlands and Estonia by the end of 2022, new projects could add around 12.4 mmt of regasification capacity. Looking ahead, announced projects could add approximately 33 mmt of regasification capacity by the end of 2024 and increase to 72 mmt by 2028. Germany, which is most exposed to Russian gas and the potential for the Nord Stream pipeline to not come back online following its schedule maintenance, has several projects in the works. While the aggregate of this new capacity amounts to around 60% of its current supply from Russia, the timing for all these projects to be completed is by 2026 at the earliest.  

 

From a new supply perspective, around 15 mmt is expected to come online globally in 2022, mostly within North America and to a lesser extent from additions in Indonesia and Mozambique. Supply disruptions from a fire at an LNG facility in the U.S., coupled with any unplanned outages due to maintenance or hurricane activity, could further stress the market in the near term. By 2025, more than 120 mmt of new global liquefaction capacity is planned to progressively come online, which should partially relieve tensions in the LNG market. Given the cost and long lead time for most LNG projects, some exporters have been developing modular LNG facilities offshore, which can be developed in around a year at a third of the cost of traditional facilities.  

 

Near- and medium-term fundamentals suggest the LNG market will remain extremely tight and prices are likely to remain elevated. This is primarily driven by Europe further pivoting from its reliance on Russian gas and increases its share of LNG demand. Asian buyers will likely continue to be key consumers, particularly in the short-term as countries look to fill storage ahead of the upcoming winter. Long term demand from key markets like China and Japan face uncertainty given new policies to shift away from LNG. And emerging Asian countries, which are seen as a key demand engine through 2040, could exhibit sluggish growth should the LNG market remain highly competitive.

 

*Netbacks are calculated by taking the net revenues from downstream sales of LNG/natural gas in a destination market, less all costs associated with delivering natural gas from one point to another. 

Important disclosures

Aegon AM Consequences of Russias Invasion of Ukraine on Global LNG Markets.PDF

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More about the authors

Phil Wrenn Senior Credit Research Analyst

Philip Wrenn is a senior credit research analyst on the energy/utilities team responsible for credit analysis of high yield issuers within his coverage universe. 

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