ANALYSIS: LNG, European gas futures liquidity languish on margin raises, uncertainty

Activity in LNG and European gas futures contracts cleared on exchanges has cooled significantly over the past week as heightened margin requirements force participants to curtail trading.

That has reduced the ability of companies to hedge effectively and manage risks associated with the recent volatility in global gas markets, according to industry sources.

"The margin requirements and volatility has sucked the liquidity out of the market, which in turn creates [more] volatility because of the lack of buyers and sellers," a Singapore-based trader said.

The volume of JKM LNG contracts cleared on ICE over March 18-25 averaged 2,174 lots per day, compared to 3,408 lots per day across February, according to exchange data.

ICE-cleared Dutch TTF gas contracts averaged 175,652 lots per day over March 18-25, a drop from about 225,000 lots per day over February.

The heightened challenges in futures trading come amid fluctuating global gas and LNG prices due to the ongoing war in Ukraine.

That has prompted exchanges to raise initial margin rates to protect against the higher risk of default by counterparties. Some clearing banks have been said to have raised margins above those set by exchanges.

The margin rate for a front-month JKM LNG contract was $160,960 per lot on March 23, up from $30,600 per lot on Sept. 22, 2021, according to ICE data.

Meanwhile, the applied margin rate for a front-month TTF LNG contract was Eur70.708/MWh on March 23, up from 11.417 Eur/MWh on Sept. 22.

On March 23, the ratio between the value of the front-month contract and margin requirement was 48% and 60% for JKM and TTF, respectively.

"Margining requirements will depend on the size of the market participant, their clearer and the exchange, and differ based on the tenor of the contract. But at around 50% currently it is no wonder that liquidity has started to dry up," according to a source at a brokerage.

Furthermore, a change in margin rate could prompt a significant shift in trading liquidity.

After the applied margin was lowered to $160,960 per lot on March 23 from $176,440 per lot, the ICE-cleared JKM derivatives volumes traded nearly five times higher day on day at 6,117 lots on March 25, which was the highest since Feb. 14.

ICE did not respond to requests for comment.

Market participants said soaring cash requirements meant many counterparties were unable to support current positions, which could force them to close them.

That was especially crucial for participants getting stopped out of positions due to daily price fluctuations and needing to extend or expand credit lines for costlier new positions, according to a second trader.

Recent market conditions have stoked a clamor by commodity firms, trade associations and governments for changes in European gas markets.

"If you want to put a hedge on TTF today at the price of Eur96 [per MWh], the initial margin is Eur80, and that tells you just cannot do that ... if you are buying it, it is probably OK. But if you are selling it, the actual upside is higher than the value of the contract and there is no simple answer to how to get out of that," Gunvor CEO Torbjorn Tornqvist told an audience at FT Commodities Summit on March 22.

The EC said March 8 that as part of its latest energy security proposals it would look into "all possible options for emergency measures to limit the contagion effect of gas prices in electricity prices, such as temporary price limits."

The higher margin costs could spark a shift of trading away from exchanges to over-the-counter trade where credit lines are mutually agreed between bilateral trading partners, sources said.

However, OTC trading carries heavy risks of defaults in volatile market conditions, the Singapore trader said. But this must be weighed against the "security premium" of higher margins in exchange-trading, he added.

Still, the pick-up in LNG physical trading liquidity at the end of March could help bolster flagging futures volumes by increasing the need for financial hedging.

Towards the end of the week ending March 21, at least seven buy and sell tenders were issued by Asian suppliers and buyers for spot LNG cargoes delivering across April and May.

Chicago Mercantile Exchange recorded 755 lots of JKM derivatives cleared over March 22 and March 23 -- the highest daily volumes recorded since early December on the exchange. The CME margin rate for a front-month JKM LNG contract was $155,000 per lot on March 23.