Crisis in the pipeline: AGL's ominous adjustment

AGL’s result has provided another insight into the potential energy crunch facing New South Wales in the second half of this decade, as the domestic gas market links into the international market as the three big Queensland export LNG plants start operating.

AGL, one of the big three energy retailers, had made a big push into coal seam gas acreage in NSW to help secure its future gas requirement. Today it wrote down the value of three of its NSW projects by $343.7 million, or 44 per cent of their value.

The writedown was in direct response to the NSW government’s foreshadowed amendments to the state environmental planning policy. While the government has yet to release its final policy (which was expected to be issued in June), AGL appears to view the outcome as a foregone conclusion.

Between them, the three projects at Camden, Hunter and Gloucester had 2P reserves of 907 PJ of gas and 1230 PJ of 3P reserves. AGL says that, based on the expected changes to the NSW policy, the estimated reserves would be reduced to 504 PJ on a 2P basis and 615 PJ of 3P reserves.

Apart from the material financial impact, the likely changes to the policy – which sets up exclusion zones for coal seam gas exploration and development within two kilometres of residential communities and within some rural industry cluster areas – significantly impacts AGL’s access to supply. AGL said the reserves written off were the equivalent of enough gas to supply NSW residential gas demand for 17 years.

The three export LNG plants will start operation progressively from 2014 and then scale up rapidly over the next few years, essentially absorbing Queensland and South Australia’s surplus gas production. By accessing international gas prices, the exports of LNG will also import that pricing into the domestic market, pushing up domestic gas prices.

AGL has a good position in Queensland, with contracts out to 2027 that give it a long position in Queensland gas at most fixed prices with a CPI inflator. It was, however, relying on its coal seam reserves in NSW to help supply that market and supplement contracted gas, with a number of its bigger existing contracts ending from 2017. It now faces a short position in NSW.

‘’The effect of these changes (to the NSW policy) will be to increase AGL’s reliance on gas supply contracts, which is expected to lead to a material increase in gas supply costs and potential shortages for commercial and industrial customers,’’ AGL said today.

AGL’s warnings of price increases and gas shortages echo those of Santos earlier this year, which has been similarly impacted by the tide of opposition from environmental and community groups against CSG developments. Santos is still trying to press ahead with a development in the Pilliga Forest region at Narrabri in NSW, which it says could supply more than 25 per cent of the state’s gas demand, starting in 2017.

The Queensland LNG plants will treble the demand for gas from 2016 and divert that increased demand to export markets, although it should be noted that the massive increase in CSG resources in Queensland and South Australia wouldn’t have occurred without those projects. The surplus gas in Queensland and South Australia has been largely contracted, long term, to the plants.

NSW will be the eastern state most affected by the squeeze on supply because it imports about 95 per cent of its gas requirements, mainly from those states. There are question marks about the capacity of Victoria to fill in much of the looming shortfall in supply, with issues around processing and pipeline capacity that would take years to address, even if there were sufficient excess supply.

Even if there were surplus gas available, it will be considerably more expensive. AGL said today that the Queensland gas market was now showing prices of $9 to $10 per GJ from 2015 forward. Domestic prices have traditionally been closer to $4 per GJ. To contract gas and transport it into NSW there would be additional costs.

The NSW government appears paralysed by the environmental politics, but needs to do something soon if its industries aren’t to be disadvantaged and potentially face peak period ‘’brown outs’’ in the second half of this decade. It is facing a significant security of supply crisis.

The only obvious solution is to find some middle ground that protects the community’s concerns while allowing some meaningful CSG development in NSW under strict conditions and with stringent oversight. At present, that looks unlikely, a conclusion buttressed by AGL’s decision to slash its CSG reserves by 44 per cent.