Dynamics of a catastrophic event – LNG terminal explosion

Today, natural gas futures were headed to their 15-year highs when the following happened:

What happened?

Apparently there was an explosion at the Freeport LNG temrinal.

Freeport LNG handles about 2 BCf/d of volume, which is about 1/6ths of the USA’s current export capacity. Let’s assume this is out of commission for a while, which is what the market is pricing until it figures out what is happening (we do not know the severity of this explosion).

The 1-year out natural gas futures curve was relatively unaffected (it dipped about 20 cents and is roughly unchanged for the day).

We work through the logical consequences of a temporary shutdown of 1/6ths of the US LNG capacity. Obviously spot drops due to 2 BCf/d less demand on domestic North American natural gas (the LNG terminals otherwise are pumping it out as quickly as they can export it). Pure gas players (TOU, ARX, PEY, SDE, BIR) get a profit hit depending on their Henry Hub exposure, but this will diffuse out to AECO/Dawn.

One unexpected winner will be crude futures. Reason? With less LNG export capacity, Europe will now face increased LNG prices and they will face substitution decisions (i.e. they will burn crude instead of oil). Crude is up for the day across the curve.

SAGD producers that are net heavy on steam (SU, CVE, MEG) will do better with a lower natural gas price.

Coal is more vulnerable, due to natural gas to coal substitution.

The reverberations are fascinating to watch in the markets, and they are incredibly quick to occur. They are impossible to trade unless if you have eyes and ears everywhere.

This is also an indication of the liquidity capacity of the market if you remove demand – 2 BCf/d is good enough for a 10% drop in the market. Heaven forbid if 2 BCf/d of supply capacity was added, or if demand dropped by 2 BCf/d in the future (say, perhaps due to an economic depression). Events like these give you good information for future expectations.