Gas cooking means no reservations

The launch of the Australian Workers Union’s “Reserve Our Gas” campaign on Monday is timed, deliberately or not, just as the export LNG program that underlies the campaign is about to enter a new and transformative phase.

When BG Group’s $20 billion-plus QLNG project at Gladstone in Queensland begins exporting sometime in the final quarter of this year it will mark a decisive punctuation mark for the nature of the gas market in the eastern states.

In reality that point was reached some years ago when the three big coal seam gas-fed LNG plants at Gladstone received positive final investment decisions and the impact of the start-up of those plants has already been seen in soaring east coast gas prices.

Where once domestic gas was sold for less than $4 per gigajoule, today the domestic price is climbing towards double-digits and there is a scarcity issue which hadn’t previously existed. The three Curtis Island export LNG plants are the reason for the changed circumstances in the east coast gas market.

Where previously there was no export market for east coast gas there very shortly will be a major one -- all three plants will be operating sometime next year -- and that will effectively mean domestic gas will be priced (and is already being priced) in reference to the price available in export markets, where gas tends to be sold today on oil-linked prices.

While US dollar-stated spot prices have fallen recently into the low teens, the Gladstone plants have contract prices that should deliver outcomes in the mid-teens. After taking into account the capital and operating costs of liquefaction and transport, the “netback” price -- the Australian domestic price -- is likely to be in the high single digits.

For manufacturers that have historically been used to low gas prices because there was an abundance of east coast gas but only a domestic market to sell it into, the emergence of an export LNG sector in eastern Australia has come as a shock. Not only do they face much higher costs but the massive supply requirements for the Queensland plans has tied up much of the available new supply in Queensland and South Australia.

Faced with the prospect of having to compete with foreign buyers for the gas at prices far higher than they have been accustomed to, local manufacturers have been advocating the reservation of some domestic gas production for domestic use. The AWU campaign is for a proportion of the gas to be reserved at a “fair” price.

Given that the Queensland plants have locked up much of the available incremental production and acreage to support their export contracts, have invested more than $60 billion in building their plants and will invest considerably more if they decide to build additional LNG trains to improve the plants’ economics, the AWU campaign may have come too late.

It may also be misconceived. Across the entire LNG sector, including Western Australia, closer to $200 billion has been invested or committed to build LNG projects that will, according to the recent federal government energy white paper, generate export income of more than $60 billion in 2017-18.

That’s export income from selling gas and between three and four times (if not more) the price at which gas was previously sold in the domestic market.

Apart from the massive investment and the employment and prospective national income gains that flow from the LNG projects, a lot of the gas off WA and onshore in Queensland and elsewhere on the east coast would never have been developed on the basis of a gas price of $4 per unit or less. It costs significantly more than that to develop and produce unconventional gas from coal and shale deposits.

There may be a short-term shock to Australian manufacturers reliant on gas for their energy requirements but in the long term it is in both their interests and the national interest for the abundant but unexploited unconventional (or high cost conventional) gas resources to be developed.

The US shale gas revolution that has transformed its energy self-sufficiency and the competitiveness of its industry provides an interesting reference point.

It took a spike in US gas prices to get the shale gas industry off the ground. An explosion in drilling activity led to an explosion in supply and ultimately to a moderation in prices. Now there is a sufficient supply for the US to both meet its own needs and also contemplate selling LNG into export markets.

That US gas, and Russian gas that will be piped into China, will bring international LNG prices down -- with consequent downward pressure flowing through to domestic gas prices in Australia and the US until a new equilibrium is reached in the international market.

In the meantime, the rise in domestic gas prices here ought to stimulate more exploration and development and increase the supply of gas. Prices almost certainly won’t go back to $4 per gigajoule or below, given that the cost of producing shale gas, for instance, is closer to $6, but they will be lower than they would be in the absence of a big increase in supply.

The domestic manufacturers can also do something to help themselves.

Orica, Incitec and Dow Chemicals -- all heavy gas users -- have invested in or next to prospective gas supply either to get access to effectively low-cost gas or to gain a hedge against higher gas prices. That’s an intelligent piece of self-help rather than relying on rhetoric and reservation campaigns that have little prospect of success.

It would also make sense for government to do as Fortescue’s Nev Power advocated in last week’s KGB Interview and more forcefully police “use it or lose it” provisions for undeveloped gas resources.

The campaign initiated by the AWU will inevitably be supported by some of the bigger manufacturers and others reliant on gas for their energy because for them reservation is both a form of subsidy and protection.

What is usually unstated in debates over gas reservation, however, is that whatever the LNG price foreign manufacturers and other gas users are being forced to pay the domestic price will be lower because it won’t contain the costs -- capital and operating -- of liquefaction and transport. There’s already a level of protection against offshore competitors built in.

The national interest is best served by ensuring that the nation receives the highest value possible for its natural resources.

In the process, the entry of the east coast gas sector into the international market for gas will make a vast amount of known gas resources that were uneconomic now viable, generating a new wave of investment, jobs and flow-on benefits -- not the least of which would be lower domestic gas prices than will be the case without that development.