- There's been a fire at a TX LNG plant, reducing eports
- How should we, could we, trade this?
- It's essential to pick the right index
When something happens to a commodity – like a fire at a Texas LNG plant – then we might think that we should be trading a commodity index, say the S&P GSCI Natural Gas (INDEXSP: SPGSNG) index. And there is indeed merit in trading such an index when something has happened in a commodity market. The thing is though it's essential to understand the construction both of the underlying market and also of the varied indices in order to be able to work out which to trade.
The direct effect of a TX LNG fire on SPGSNG should, in theory, be absolutely nothing. Which means that it's not the right index to be trying to trade on that piece of news.
We can explain this with a look at the underlying. So, there's natural gas, we're all familiar with what that is. Most of it is moved by pipeline therefore prices are closely allied to pipeline capacity and supply and demand around the route of said pipeline. It's even possible to have “orphan gas” which is gas that's worth nothing because there is no pipeline.
This means that the global gas market is really a series of regional ones. The European market is different from the UK, which is different from the Far East, which differs again from the domestic US.
Also Read: Natural Gas Trading Guide
Now we add one more factor, a method of arbitrating gas across those regional markets. That's liquefied natural gas, LNG. The effect of this should be – this is basic David Ricardo from 1817 – that the prices in the different regional markets converge onto one global gas price, minus transport costs. This is indeed happening.
However, we are not fully liquid across those boundaries of regional markets yet. There's not enough LNG capacity to equalise prices that is. We are still with differing regional prices, with some convergence from LMG, but not perfect convergence as yet.
So, what happens next? ” Gas prices have surged by more than a third after a fire at a large export terminal in the US threatened to wipe out deliveries and compound supply fears sparked by Russia’s war. UK gas prices jumped as much as 39pc in early trading, while the European benchmark was up 16pc.”
LNG export capacity from the US has fallen, delinking a little more the US gas price and those in Europe. So, the ICE (NFN22) price jumps. As does the European equivalent. Henry Hub ([email protected]:NYM) might drop a bit, there's more domestic to US gas as a result of lower exports. So, yes, trading natural gas indices can indeed be a useful way of attempting to profit from that Texas LNG plant fire.
The thing is though that the S&P GSCI Natural Gas index isn't the one to be using. For we're not changing the global amounf of gas there is, we're changing where in the world that same amount of natural gas is through this fire and reduction in exports. And SPGSNG is a global index, it's weighted world production. That is, S&P GCSI is a great way to play the global gas price and it doesn;t work at all as a way to play regional variations in gas prices.
Yes, indices are great ways to trade upon changes in the global economy. But it's necessary to understand first the industry being looked at and then index construction to work out which one of the best to use to trade any particular event.