Geology dictates that crude oil and natural gas go hand-in-hand. Drill a well for one, and there's a good chance you'll also find the other.
For years, oil's coupling with gas (for better or worse) underpinned pricing and trading for a variety of petroleum products worldwide. That includes liquefied natural gas (LNG), which was traditionally bought and sold through long-term contracts linked to Brent crude.
The American shale revolution, and the emergence of U.S.-produced LNG as an energy source for markets around the world, changed that, says Derek Sammann, Senior Managing Director, Global Head of Commodities and Options Products for CME Group.
"With the global natural gas markets increasingly referencing U.S.-sourced Henry Hub natural gas as a central reference point for global natural-gas markets, what could the future of U.S. energy markets look like?" Sammann asked in introducing the Future of Energy forum at a Chicago Council on Global Affairs event in June with former U.S. Energy Secretary Ernest Moniz.
Overnight Trading Surges
Market activity when traders in the U.S. are off work illustrates Henry Hub's growth. Average daily volume during overnight trading (4 p.m. to 8 a.m. Eastern time) for NYMEX Henry Hub natural gas futures increased 120 percent from January 2017 to January 2018, according to CME data.
Natural gas futures posted record trading in the first quarter, including a single-day all-time high of over 1.02 million contracts that changed hands Jan. 12.
"We're seeing a de-linking of LNG from crude oil prices," Sammann says. "And the rapid evolution of a global gas market with Henry Hub as the global benchmark."
The global market for LNG is worth about $90 billion annually, as demand from China and other countries escalates amid efforts to reduce dependence on coal and generate more power from lower-carbon sources.
Global LNG trade reached 38.2 billion cubic feet (Bcf) a day in 2017, up 10 percent from 2016 and the largest annual volume increase since 2010, according to the Energy Information Administration.
LNG Futures Next?
The rise of the global natural gas market recently led CME Group and Cheniere Energy (LNG) - Get Reportto agree to develop an LNG futures contract with physical delivery to Cheniere's Sabine Pass terminal.
The terminal operates four trains capable of producing 18 million metric tons of LNG per year. Two additional trains under construction would take capacity up to 27 million metric tons.
"This agreement with Cheniere is significant because it will be the foundation for developing a new LNG risk management tool for producers, consumers and traders around the globe, while further cementing the role of Henry Hub Natural Gas futures as the global gas pricing benchmark," Peter Keavey, CME Group's Global Head of Energy said in a press release.
U.S. LNG exports hit a record in March of about 2.95 billion cubic feet per day, more than double the levels from the same month in 2017. By 2019, U.S. exports are expected to quintuple from 2017 levels, putting the country on track to become the world's third-largest natural gas exporter by 2020, behind only Australia and Qatar.
De-Linking From Crude
As LNG grows in the global markets, the shortcomings of crude-gas pricing mechanisms are becoming increasingly apparent to the industry.
Historically, natural gas markets were fragmented and region-centric. U.S. gas has been priced off Henry Hub, a delivery point connecting several intrastate and interstate pipelines near Louisiana's Gulf Coast.
Meanwhile, in continental Europe, gas has been priced off the Dutch Title Transfer Facility (TTF) or the National Balancing Point (NBP) in the U.K. In Asia, there are a variety of benchmarks linked to crude, but no established price marker.
At the World Gas Conference in Washington, D.C. in June, several energy executives said LNG needs a better pricing benchmark to facilitate major investment decisions and stabilize demand. A rise in crude prices unrelated to natural gas fundamentals, for example, could scare off price-sensitive LNG buyers.
Jack Fusco, CEO of Cheniere, said benchmarking to oil also risks hurting demand. "My fear is that if the price - whether it's the spot price or the oil index price - gets too high, (buyers will) look at other forms of energy to meet their needs and we will have real demand destruction," Fusco said, according to Reuters.
Henry Hub Extends Global Reach
Fundamentals of the current LNG expansion appear to be shifting the global market toward Henry Hub-based pricing, analysts say.
LNG has had previous growth phases over the past 50 years, said Andrew Buckland, principal analyst, global LNG trade and shipping, at Wood Mackenzie.
L-R: Chicago Council on Global Affairs President Ivo Daalder, Former U.S. Energy Secretary Ernest Moniz and CME Group Global Head of Commodities and Options Derek Sammann at the Future of Energy event in June.
Things are different this time, in large part because of a "huge ramp-up in production" from Australia and the U.S., he said. "There's a lot of supply coming to market."
"As U.S. LNG exports increase, U.S. gas prices are going to have an increasing impact on gas prices elsewhere in the world," he added. "You'll see Henry Hub prices affecting other markets."
U.S. LNG growth "is a big story," says Lucas Schmitt, Senior Gas and LNG analyst at Wood Mackenzie. "But you also have a big wave of new players in the last few years on the production side shaping market dynamics. "We're seeing demand growth in China and other parts of Asia, including some new importers, like Pakistan and Bangladesh, and Europe. That's going to soak up a lot of the supply."
Natural gas fits the classic definition of a "bridge" to a low-carbon future, former U.S. Energy Secretary Moniz says.
In the U.S., gas "will have a principle role in the energy sector in displacement of coal and going to lower carbon," Moniz said during the Chicago Council event.
As LNG produced and shipped out of the U.S. increasingly helps meet the world's energy needs, a dynamic similar to that of the West Texas Intermediate crude oil's role as a global benchmark is taking shape, CME Group's Sammann said.
Thanks to advances in shale drilling, the U.S. is now the world's No. 2 oil producer, trailing only Russia. The U.S. is already the world's top natural gas producer, and, according to the International Energy Association, is expected to account for 40 percent of the world's extra gas production by 2022 (five additional U.S. export facilities are expected to open over the next few years).
Similar to WTI crude's global benchmark status, "we're seeing exactly the same thing happening with natural gas," Sammann says.
"As Henry Hub continues to make landfall internationally, this creates a viable and tradeable basis between the U.S. and European gas hubs. Henry Hub is increasingly connecting the global LNG market."
Watch the full Future of Energy forum from the Chicago Council on Global Affairs.
Written by Bruce Blythe. Read more from the author here.
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