Morgan Stanley: Elevated gas, LNG volatility to persist into year-end

Surging demand and constrained supply have pushed key gas and LNG benchmarks to multi-year highs. Prices now sit well above what can be anchored by fundamentals, which poses a downside risk, according to analysis from Morgan Stanley. At the same time, winter heating season lies ahead, and inventories are low, which leaves room for further upside price volatility.

Just over a year ago, in May 2020, the global gas market was facing extreme oversupply. Prices had fallen to US$2/MMbtu or lower across key global benchmarks, near historic lows that fully eliminated regional price spreads for the first time in decades. Since then, surging demand, constrained supply and low storage have pushed key gas and LNG benchmarks to multi-year highs. Asia LNG and EU gas prices have rallied 10 times to near US$20/MMbtu, setting new seasonal and all-time price records, with US Henry Hub up three times to near US$5/MMbtu.

While US prices remain largely decoupled from the rest of the globe, compared with Europe and Asia LNG which are tightly correlated, the supply-demand setup for each regional market is similar: inventories are low, near-term supply remains constrained, and demand continues to grow, Morgan Stanley said.

Elevated volatility should persist into year-end, it continued. Global spot prices now sit well above what can be anchored by longer-term fundamentals (supply costs, parity with alternative fuels, and gas-coal switching). In isolation, this is a downside risk. However, with winter heating season near, low inventories and limited potential for fuel switching for alternative fuels creates the risk of significant upside volatility from colder than normal weather or further supply disruptions.

“Current lofty prices reflect a risk premium for this uncertainty, meaning 2021 second half-2022 futures in the EU, LNG, and US gas are well above our view of fair value under normal weather. As such, our base case continues to imply downside for near-term prices. That said, lingering upside risks may continue to support prices for now, with a wide range of potential outcomes into year-end,” Morgan Stanley wrote in a research note.

Global LNG

“Global LNG imports rose 7% y/y in both July and Aug, led by China, South Korea and Brazil, bringing the YTD average to +5%. While China’s increase is underpinned by structural growth in consumption, the recent trends in Korea and Brazil have been partially influenced by transitory factors (hot weather, nuclear outages in Korea and low hydro levels in Brazil).

High prices have started to curb some Chinese consumption in heavy duty trucking and energy-intensive industries like ceramics, and the latest government projections point to only mid-single-digit % consumption growth in second-half 2021 (vs >20% in first-half 2021). In Southeast Asia, some switching to alternative fuels has begun to occur, displacing some LNG demand with fuel oil and coal,” Morgan Stanley wrote.

“Global LNG export utilization has remained weak (around 82% average in Jul-Aug vs normal of 90%). Notably, Qatari supply averaged 6.5 million tons from June-August, 5% lower than the same period last year. Furthermore, Peru LNG has not exported a cargo since June and upstream issues persist in Nigeria and Trinidad & Tobago. Looking ahead, planned outages in the US and Australia (Wheatstone & Darwin) could continue to weigh on global export capacity utilization.

“Looking into 2022, we expect elevated downtime to begin to normalize while US expansions at Sabine Pass & Calcasieu Pass (15 mtpa total) bring much needed new supply to the market. That said, conditions remain tight, likely leaving prices at or near demand destruction thresholds.

“Elevated volatility should persist into the upcoming winter season due to the combination of low inventories and the potential for further supply outages or cold weather (which would boost winter heating demand). By mid-2022, we expect prices to re-anchor with fundamental drivers (supply costs and demand erosion thresholds). We continue to see a multi-year upcycle through 2025, as demand is set to grow at twice the rate of supply”.

Europe gas

“Storage is below normal as LNG imports continue to get diverted to other markets (Asia, Latin America). Furthermore, pipeline flows from Russia remain below pre-Covid level as Gazprom has had to contend with maintenance, domestic demand within Russia, and an increased supply to Turkey. We continue to argue that under the normal weather conditions, downside risks could start emerging in fourth quarter, including more pipeline gas from: the end of maintenance and reinjection season in Russia, supply via TurkStream’s second string ramping up and/or Nord Stream 2 commencing commercial flows.

“Key dates to watch: September 20th – auctions for additional discretionary transit capacity via Poland and Ukraine for October; throughout September – the return of Gazprom’s gas condensate processing capacity, which, if it is back in full, could unlock several billion cubic meters of supply; next few months- the start of commercial operations of Nord Stream 2 (this could include certification, insurance as well as the resolution of ongoing disputes related to the level of its utilisation); end September/early October – Gazprom may host an analyst day (which could include an update on its export guidance).”

US natural gas

“So far in 2021, producer discipline has left supply relatively stagnant while rising exports (LNG and pipeline to Mexico) have led demand higher. This has driven Henry Hub to $5, the highest seasonal price since 2008. Over the next six to nine months, low inventories, constrained production, and limited demand elasticity likely leaves room for significant upside volatility. Longer term, however, this price level cannot be supported, in our view.”

“Our end-Oct inventory estimate is 3.45 tcf (8% below normal). With limited supply growth into year-end, below normal inventories, and inadequate fuel switching to balance the market, prices could have substantial upside around any signs of a cold winter.”

“Rig counts have rallied to pre-COVID levels in the Haynesville, while associated supply is set to resume growth. In total, we forecast y/y supply up 3.4 bcfd. With next LNG export facilities on track to start operations in 2022 first half, demand is still set to rise more sharply than supply. By second-half 2022, we do expect accelerating supply growth to start bringing the market back into balance, moderating prices,” Morgan Stanley concluded.

Source: Oil & Gas Journal