Are spot LNG prices headed up or down? Take a look at JKM Swaps

Trading volatility has been the defining hallmark of the Asian peak season winter market. But this past winter, Asia has seen the emergence of a nascent but increasingly liquid derivative market to not only trade and manage that volatility but also to shed some light into forward expectations.

Liquidity in the Platts Japan Korea Marker Swaps or JKM Swaps product has shown explosive growth in volume since late-2016. In 2017, JKM exchange-cleared derivatives surpassed 9.6 million mt, nearly quadruple of 2016 volumes.

The recent winter of 2017/18 has been particularly volatile, with the physical JKM spot LNG assessment not only charting the longest rally since its inception in 2009 but also briefly returning to double-digit levels not seen in three years.

The recent winter saw collective total imports for Japan, China, South Korea and Taiwan over December to February reached 53.2 million mt, up 10.7% compared to the previous winter season. Chinese imports rocketed 53.4% compared to last winter, buying nearly 4.8 million mt more, to reach 13.7 million mt in total -- and seizing the title of world's second largest importer from South Korea. In comparison, Japan saw winter imports rise 0.3 million mt or 1.5%, and Taiwan charted imports rise 0.1 million mt or 2.8%. South Korean winter imports fell 85,000 tons or down 0.7%.

So how did JKM Swaps perform through 2017, and more importantly, how did it perform through this past winter? The graph below suggests two insights.

The candlesticks are sorted by each JKM Swap contract month, showing the first done deal price, highest and lowest deal price, as well as the last done deal price. Increased liquidity in the derivatives market now better reflect and signal either a continuation or change in pricing trend. In instances of the gap between the first and last done deal levels widens, it suggests increasing momentum behind the uptrend or downtrend in the JKM settlement price. And when that gap narrows or flips direction, it also suggests a turning point can be expected for the JKM physical settlement price.

Secondly, the graph also shows that the derivative market is also mirroring the increased seasonal volatility seen in the physical market. Volatility - the length of the candlesticks - shown by the difference between the initial price expectations (first deal price) and final price expectation (last deal price). The JKM Swaps market also show stronger seasonality pattern and predominantly winter having an increasingly outsized influence compared to summer. It also shows that while summer JKM Swaps trading has seen highs and lows beyond the first and last done deal level, winter trading sees highs and lows converge on first and last done deal levels respectively.

Overall, improved visibility over price trends may seem modest progress. It has, however, facilitated the market's ability to mitigate risk, not only through price hedging, but also through inventory and portfolio management. Several Northeast Asian end-users concluded time swap deals over the winter period in part referencing forward JKM Swaps prices, easing the challenge to find an agreeable fair market cargo value for both buyers and sellers.

While JKM Swaps volumes have averaged over a cargo a day in January, liquidity is still ramping up as a proportion of total global LNG trade. In oil markets, derivatives trade several times the size of the physical market.

But baby steps, no matter how small, are steps in the right direction.