As the volatility of the global natural gas market continues to raise questions about the effectiveness of established futures benchmarks, Abaxx Technologies Inc. is pursuing a solution through physically settled LNG contracts.
Through a Singapore-based entity, Abaxx is preparing to launch physical settlement contracts for the three main LNG markets: North West Europe, North Asia Pacific and the Gulf Coast. The contracts could serve as an alternative to financially settled instruments such as the Japan-Korea Marker (JKM), which currently dominate international gas trading, including for LNG.
In an email, Abaxx senior management — including Chief Commercial Officer Joe Raia, President Dan McElduff and Chief Economist David Greely — told NGI how the contracts could help market participants. The team wrote that market volatility since the Russian invasion of Ukraine in February has highlighted inherent problems resulting not only from the lack of established benchmarks for LNG, but also from reliance on financially settled contracts backed by indices.
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“It is evident that the current structure of financially settled index-linked contracts does not meet the needs of market participants,” Abaxx management told NGI. “In case of [the Dutch Title Transfer Facility], because the markets for onshore gas in a pipeline in the Netherlands do not reflect the physical reality and supply-demand conditions of gas at sea on an LNG tanker. This has become evident more recently when Europe has been cut off from Russian imports and has become reliant on imported LNG for border supplies.”
Generally, a physical settlement futures contract requires a commodity to be delivered to a location or customer by a specified date. As part of financial compensation, due contracts are concluded with a final transfer of funds based on the terms of the contract.
The problem of the growing gap between Europe’s LNG price and the Title Transfer Facility (TTF), where most of the continent’s gas is traded, has prompted multiple reactions from regulators and exchanges over the past year. In order to stabilize the markets, the European Union introduced a price control mechanism for the natural gas markets in the member countries and tried to establish an LNG benchmark.
Intercontinental Exchange Inc. (ICE), the most liquid market for TTF futures and options, also introduced alternative futures contracts focused on European LNG transactions. On Friday, ICE said it was preparing to introduce new rules and set up an alternative exchange in London in response to the EU’s natural gas price cap. Exchanges like ICE and independent regulators like the European Securities and Markets Authority have warned that a price cap could increase market volatility by threatening liquidity and pushing traders to less regulated trading venues.
Abaxx’s exchange and clearinghouse would be regulated by authorities in Singapore, where most major LNG trading companies also have subsidiaries.
The Abaxx team said it was uncertain whether setting up a European LNG contract outside the reach of the EU regulator could make them more attractive to traders, as it could take time to “develop both a price curve and an open interest.” , which can support a financial settlement contract.
“We know that by controlling our own futures clearinghouse, we can continue to interact and co-develop contracts with global market participants,” the team wrote.
Abaxx spent three years advising stakeholders and building an experienced team to design the physically set benchmark. The company outlined its research on the transparency that new, alternative benchmarks could bring to the LNG markets in a whitepaper titled “Back to the Future: The Best Commodity Benchmarks Are Still Physically Fixed,” published earlier this month .
Researchers who have entered into financially settled contracts essentially rely on active and transparent markets to provide accurate pricing, which can become unreliable during periods of high price volatility and limited participation. Physically settled futures have a price reference built into the contract structure and tested “by a variety of market participants, not just index participants.”
While the European market’s woes have attracted attention over the past year, the team said the region has seen a heightened version of what Asian traders, who rely on the JKM, have increasingly had to navigate. Europe has also undergone an abrupt shift from a rare spot market player to the dominant cargo destination.
Just as global LNG trends have been reversed in a relatively short period of time, the team said Abaxx intends the contract launch to be a long-term process, following and evolving with the changing gas market. The company’s plan to launch three contracts covering key LNG trading markets is necessary to determine the best location for an established LNG futures benchmark, the Abaxx team said.
“As the gas market continues to globalize, we may see one region becoming the benchmark as futures markets seek to pool liquidity in one place, in one benchmark, and trade others as difference or basis markets,” the team wrote. “We don’t know which one that will be or when.”
The listing of the Abaxx contracts is still subject to final regulatory approval.
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