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Analysis: Exchanges clear 1.83 mil mt of LNG JKM derivatives in January

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Analysis: Exchanges clear 1.83 mil mt of LNG JKM derivatives in January

Exchanges cleared a record high volume of 9,523 lots of the Platts JKM Swap contract in January, the equivalent of 1.83 million mt of LNG, compared with the last record high of 6,720 lots in August 2017, according to exchange and broker data.

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Two key factors are driving exponential growth in LNG derivatives: demand for risk management solutions as the industry transitions from the inflexible supply agreements of the past into a more versatile industry, and support for the only liquid LNG financial instrument, the JKM Swap.

Swap liquidity for January

"Over the past 12 months, we have seen a surge in the volume of JKM LNG futures traded, as the contract is increasingly seen as the benchmark contract for LNG in Asia," said Gordon Bennett, managing director for utility markets at the Intercontinental Exchange.

"The growth in volume and the resulting increase in liquidity can be attributed to a number of factors around the changing dynamics of the LNG market, including the potential for the globalization of natural gas markets and the need for a more specific price benchmark for LNG and for the region's energy supply and production," he added.

JKM Swaps cleared through ICE and CME

A total of 9,258 JKM lots - the equivalent of 1.78 million mt -- were cleared through ICE in January, with another 265 lots through the Chicago Mercantile Exchange.

The total size of the LNG derivatives market could be much bigger as market participants estimate that as much as 50% of the total JKM Swap transacted volume has been conducted without exchange clearing.

The JKM swap is a monthly cash-settled futures contract based on the Platts JKM daily physical spot price assessment for LNG cargoes delivered to Japan, South Korea, China and Taiwan, which import nearly 60% of the world's LNG. It was launched in 2012 and reflects a standard size of 10,000 MMBtu.


FURTHER GROWTH LIKELY


Further LNG derivatives growth is likely to be driven by the necessity to mitigate new risks in a commoditizing industry, and greater adoption of the JKM in the physical markets, as global supply expands and more participants abandon the traditional oil-linked supply model.

The most recent example of JKM adoption was the tender issued by Russian exporter Sakhalin Energy in January, offering four Sakhalin-2 LNG cargoes indexed to the Platts JKM.

Other Asia Pacific exporters such as Australia's North West Shelf and Indonesia's Tangguh have also offered LNG volumes against the JKM, while Indonesia's gas utility PGN issued a tender offering two Bontang FOB cargoes for February and May loading solely linked to the Platts JKM assessment.

Portfolio sellers, trading houses, North Asian end-users and European utilities have also used the JKM in strip deals or short-term/mid-term contracts, as buyers and sellers alike become more and more comfortable with pricing LNG not against an associated commodity but LNG itself.

At the same time, the market's hedging requirements are growing as trading competition sharpens, arbitrage windows shorten, and physical portfolios expand into new geographies.

Post-Fukushima efforts by Japan and other legacy importers to deregulate downstream markets and liberalize global LNG trade are also forcing utilities out of their comfort zones and into new trading and hedging activity.

A more liquid JKM derivatives market is de-risking the LNG supply chain, encouraging more physical spot trade activity and greater exposure to the pricing benchmark.

As JKM indexation increases, stakeholders become more incentivized to share physical transactional data and participate in price formation activity, leading to greater transparency and a robust benchmark. This ultimately boosts liquidity and efficiency in both the physical and financial markets.


LIQUIDITY IN THE FRONT MONTH


The most active contract in January was the March JKM Swap, which saw 2,594 lots, largely driven by uncertainly over pricing as the market exits the winter peak demand period.

Close behind was the Q3 2018 Swap, which saw 2,169 lots changing hands. However, other periods were less active, with volume for Q2 hitting 1,530 lots, while the next highest contract volume was seen on the Summer 18 Swap at 930 lots.

The biggest volumes were recorded early in the month, with January 3 and January 9 seeing 1,495 and 1,085 lots cleared, respectively.

Market participants said this was likely due to the market taking positions against developments that occurred during the winter holiday period. "People were trading a lot of March [lots] because they saw physical prices suddenly go up again," a market participant said. "So when they saw the trades going through, they had to trade March."

Market sources also said that participation in the JKM swaps market had grown. While the number of active daily counterparties remained stable at around 10-15, sources said there were more companies, boosting overall liquidity.

-- Abache Abreu and Desmond Wong, abache.abreu@spglobal.com

-- Edited by E Shailaja Nair, newsdesk@spglobal.com