Back to the Future(s): the best commodities benchmarks are still physically settled

Benchmarked commodity futures markets afford the benefits of price discovery and liquidity while enabling market participants to efficiently transfer price risk. This allows those participants the ability to make business decisions based on their economics and exposure to the underlying good.

Physically-settled benchmarks exist in several key commodity markets including — and certainly not limited to — crude oil, petroleum products and natural gas. Market stakeholders with preliminary or contractual investment exposures in geology, property rights, capital markets and technology conveniently secured necessary financing by revealing hedged positions to demonstrate not only that they could get supply to market, but could do so with the economic certainty delivered with an effective hedge marked against an accurate benchmark.

Reflecting inherent values

Benchmarks are vital in commodity markets in reflecting the values in the dynamics of production, storage and transport logistics. These dynamics are inherently volatile, with varying qualities and grades being sold at different locations for delivery at different points in time. Reliable benchmarks must bridge these tensions. A market supported by a reliable benchmark creates a centralized market with competitive price discovery and a deep pool of liquidity for risk transfer. Over time, meaningful common references have flourished to determine comparable differential or basis spreads to the benchmark.

In today’s developing global LNG markets, there as of yet does not exist a physically-settled waterborne LNG benchmark that promotes price discovery, risk transfer and transparency. Financially-settled contracts alone are not adequate. Virtually no commodity market has enough active, transparent spot market activity to support financial settlement, certainly not the LNG market.

Waterborne LNG benchmark

As evidenced during the maturation of today’s oil and onshore natural gas markets, reliable physically-settled benchmark prices are the result of a liquid physical futures markets which in turn make possible the financing and development of critical energy projects including exploration and production, pipelines, refineries, storage hubs and export/import capacity that grew the physical market.

As the European natural gas market has become more dependent on LNG, the lack of a waterborne LNG benchmark is having a greater impact on these markets, as onshore gas price references cannot, by definition, reflect the dynamics of the international LNG market. As that pipeline gas flow became prone to disruption, Europe was forced to look to global LNG markets for incremental supply.

Abaxx is addressing these issues by listing a physically-settled LNG futures contract for the region that will complement the existing bilateral contracting taking place. More effective price discovery and hedging gives market participants the confidence needed to rely on a benchmark forward curve that can inform and de-risk project finance decisions.

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