Canadian gas to JKM - Buckle up!
The usual disclaimer - this article is for general information only, and it is neither financial, investment, or legal advice. It’s a complex topic, and the calculations and conclusions presented here are by necessity highly aggregated and simplified. Content remains subject to change.
Just a decade ago, few outside the LNG marketing world had heard of JKM. Now, talk of “selling gas into JKM” is all over Canadian gas industry investor calls and news, and it even finds its way into the general press and politicians’ speeches. A quick look at JKM’s price history shows the remarkable spikes that made some big fortunes in the energy industry:
In energy terms, six MMBtu are roughly equivalent to one bbl of crude oil - thus the spikes approach the equivalent of USD 300/bbl for oil.
That’s the revenue side. But how about the cost to get Canadian gas “to JKM”? What would netbacks have been over a longer period of time?
For our back-of-envelope, benefit-of-hindsight analysis, we will aim to estimate the profitability of selling Canadian gas into the JKM spot market beginning the same month when US exports started to take off, February 2016.
What is JKM?
JKM stands for Japan Korea Marker. It is a North East Asian spot market index published by S&P Global Platts. The JKM price establishes the spot market value of cargoes delivered ex-ship (DES) into Japan, South Korea, China and Taiwan. In contrast to Henry Hub (US), TTF (NL) and NBP (UK), JKM is not a physically settled trading hub. It is a survey-based index, i.e. it is established through S&P’s survey of spot market activity. Cash-settled JKM futures contracts exist.
Between 25% and 30% of LNG is traded on the spot market, with over 70% through long-term contracts indexed to crude oil prices or through a tolling formula to Henry Hub prices. Before the US started exporting LNG on a large scale in 2016, almost all long-term volumes were crude-indexed, and the spot market was even less liquid than today. Most spot deals are agreed bilaterally with cargo-specific terms. Prior days’ JKM price reports inform trades, but JKM-indexed long-term sales agreements are still the exception
How can you sell Canadian gas “into JKM”?
The two most straightforward ways are to:
Ship gas to the US gulf coast, enter into a liquefaction agreement with a US LNG plant, ship the LNG to Asia and sell it in the spot market
Do the same but via an LNG plant on the Canadian West Coast
The second path will only emerge with the start-up of LNGC’s Phase 1, with access limited to LNGC’s joint venture participants.
Thus we will use the US-route for our calculations; it also comes with more public information to underpin the key premises. (The delta for “Canadian LNG” can be estimated as a differential - feed gas and shipping will generally be cheaper, and pipeline & LNG plant more expensive; the size of the differential being highly project-dependent). Canadian gas producers Tourmaline and ARC Resources both have disclosed sales agreements with US gulf coast plants indexed to JKM.
The specific marketing arrangements can be quite complex and exact terms of the above-mentioned arrangements are not public.
Cost estimate formulas
To calculate the cost of Canadian-sourced LNG “at JKM”, we start with the AECO price, and add the cost of shipping the gas to the US gulf coast. For companies with capacity rights on existing pipelines, transportation cost should be about USD 0.8/MMBtu. Those who don’t hold such capacity rights would first need to swap Canadian gas for US gas, which at current market prices would add USD 0.2-0.4/MMBtu to the equation (basis differential of USD 1-1.2/MMBtu).
Next, liquefaction. The fixed liquefaction fee, the “alpha”, has ranged typically between USD 2-3/MMBtu. The lower end of the range is normally only available for large anchor clients with strong balance sheets - Shell, BP et al. For our scenario, we will assume USD 3/MMBtu.
The liquefaction fee also contains a “beta”, a multiplier with the Henry Hub gas price of typically 115% that covers commodity plus fuel gas and other operational costs. How this is implemented in Tourmaline’s and ARC’s agreements is not public, thus we need to make an assumption. Since the commodity would be provided in-kind and since we already included pipeline transport cost, we’ll assume 10% of the “AECO plus” costs for fuel gas and other incidental costs.
And then we need to ship the LNG to Asia. Vessel day rates are highly volatile, but can be locked through long-term charters etc. We will again make a simplifying assumption, using long-term mid-market rates. Using the Panama Canal, this would lead to about USD 2.5/MMBtu shipping costs. Due to congestion and drought conditions at the Canal this route may not be available however. A diversion via the Cape of Good Hope would add another ~USD 1.5/MMBtu in shipping costs. We will use this for our high cost case.
ARC Resources’ April 2024 investor pack (page 45) states that its “all-in landed cost to reach JKM is US$5-6/MMBtu”, which would be about USD 1/MMBtu lower than our base case. We’ll include the mid-point of this range (i.e. AECO + USD 5.5/MMBtu) as a low case.
Thus our three cost scenarios for Canadian gas to reach Destination JKM are:
Base Case: (AECO + USD 0.8/MMBtu)1.1 + USD 3/MMBtu + USD 2.5/MMBtu = 1.1*AECO + USD 6.38/MMBtu
High Case: (AECO + USD 1.1/MMBtu)*1.1 + USD 3/MMBtu + USD 4/MMBtu = 1.1*AECO + USD 8.21/MMBtu
Low Case: AECO + USD 5.5/MMBtu
Netback Scenarios
As a final step, let’s deduct these costs from the reported monthly average JKM prices since 2014, yielding the following Netback time series:
Whilst we used a very large cost range of over USD 2.7/MMBtu between Low and High cost cases, both bookends would have been out of the money for substantial amounts of the examined time horizon. Here a look at cumulative netbacks for each of the scenarios:
Note that our hypothetical netbacks were all cumulatively negative until around the start of 2022 - but then very positive for the following two years. The last time JKM rallied in a similar fashion (albeit with lower absolute price levels) was after the Fukushima incident in 2011, when Japan’s temporary shutdown of nuclear power plants created a demand surge for LNG.
[Units removed from the illustration, as they are not intuitive and easily misleading.]
Key conclusions
Cost to market is crucial for cumulative success - even “small” differences in liquefaction & shipping costs make a big difference.
As there is no reason to believe that JKM will be less volatile going forward, sustained periods of negative netbacks need to be budgeted for.
Given the high volatility of spot prices, most long term sales agreements’ pricing formulas will likely remain on tolling or crude-indexed basis.
JKM-indexed LNG sales agreements resemble “profitable lottery tickets” - costing money when spreads are tight, but with significant upsides.
Thus for those with long-term JKM-indexed sales agreements: Buckle Up and enjoy the ride!
As outlined in the beginning, these are simplified back-of-envelope formulas - don’t use them to analyze any company’s specific financials. We ignored inflation and cost of capital. Specifics may differ in many ways, including shipping costs, liquefaction fees, upstream costs & alternatives, etc. If you would like to discuss the assumptions, modeling and conclusions in more detail, please don’t hesitate to get in touch.
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Sources
JKMc1 price series: https://ca.investing.com/commodities/lng-japan-korea-marker-platts-futures-historical-data
AECO gas prices: https://www.alberta.ca/alberta-natural-gas-reference-price#jumplinks-1
Exchange rates: https://www.bankofcanada.ca/rates/exchange/monthly-exchange-rates/