Australia needs a market gas valve

Amidst calls for a reserving for domestic purposes some of the natural gas earmarked for export, Santos' David Knox has made an intelligent argument as to why there is no need for governments to intervene.

The Western Australian Government has a policy of reserving 15 per cent of gas for domestic use and there have been calls from others, including Dow Chemicals' Australia chief executive, Andrew Liveris, to extend that policy more broadly to encourage development of industries based on cheap energy.

In a Business Spectator KGB interview, Knox cited the current US experience in advocating allowing the market to work.

The shale gas boom was ignited in the US by soaring gas prices, which sparked a frenzy of drilling and massive increases in production that drew the energy industry majors, including BHP Billiton, into the sector. As production swelled during a mild winter, prices collapsed and drilling and production has been scaled back, although very recently prices have started edging back up.

The debate about reserving gas in Australia relates to the extraordinary investment in export LNG production now underway offshore Western Australia and, using coal seam methane resources, onshore at Gladstone in Queensland.

The Queensland projects in particular will, as they come on stream in the middle of this decade, effectively import export pricing of gas into the domestic market given that the gas producers will be able to choose between selling their gas into either market.

The point Knox was making is that the far higher prices for LNG relative to domestic gas prices will spark more exploration and production and, over time, the increased supply – and Australia has extraordinary resources of both conventional and unconventional gas – will impact prices.

The sheer scale of export LNG capacity now being built within Australia has raised some questions about market capacity, even though most of the anticipated production is supported by long-term supply contracts with predominantly Asian buyers.

As the shale gas phenomenon in the US has developed, the price differential between the gas in that market, where it sells for around $US2.50 per thousand cubic feet, and LNG prices of around $US14.50 per thousand cubic feet, has raised the prospect of that US gas competing with the Australian projects within Asia.

Until recently that prospect was remote as there were no LNG export terminals in the US and it appeared the US government was more focused on ensuring that shale gas was deployed to transform its energy security and provide a competitive advantage for its manufacturing sector.

Last year however, Cheniere Energy gained approval to build an export terminal in Louisiana, which means some of the US gas will have a conduit into the international market. Its pricing is going to be based on the Henry Hub domestic gas prices and therefore, even with the liquefaction and transport costs, would be able to significantly undercut Australian LNG within the Asia Pacific region.

The minute the US gas gets access to international pricing, however, it will inevitably have an impact on US domestic gas prices, so there is a counter-balancing element that will almost certainly narrow the differential between the US gas and the Australian supplies.

If the market is allowed to work, much the same thing will happen here. Domestic gas prices are almost inevitably going to rise as the Queensland plants start operating, but that will drive increased production, make higher-cost, unconventional resources economic, and act as a dampener on the extent of the price rises unless governments intervene and prevent the market mechanism from working and stimulating that extra production.