The Real Threat To Natural Gas Prices
By Matthew da SilvaJune 5, 2012
The carbon tax will add about 10 per cent to the price of gas in Australia from July, but a larger concern for consumers living in Australia’s eastern states should be how, for the first time, international market forces are set to push up domestic gas prices.
Gladstone is booming. Proof of the economic health of this central-Queensland coastal town emerged when new figures came out in March showing the value of land in Gladstone had risen by 19 per cent.
"The price of rental housing has gone up from between 50 and 71 per cent over the last three years," says Gail Sellers, mayor of Gladstone Region. "The occupancy rate for rental houses is less than one per cent. The motels in the area have been sold to companies for accommodation, because there's none available. So they buy a motel, plus it goes off the market. Caravan parks have been turned into accommodation for workers." There are also four temporary worker-accommodation facilities in the region, with two more being built.
Sellers compares the current boom to what occurred when Queensland Alumina opened its plant in Gladstone in March 1967. "I was at high school in the '60s and we had the same thing," she says. "We went from 6,000 to 12,000 people in roughly 12 months."
The current influx is being driven the construction of three liquefied-natural-gas (LNG) plants on Curtis Island, just off the coast of Gladstone township. The plants will process natural gas sourced from the eastern into a liquid form suitable for export.
One plant led by British company BG Group is expected to start operating in 2014, and the two Australian-led facilities - one by Santos and the other by Origin Energy — are expected to start operating in 2015. A fourth plant planned by Arrow Energy, a joint venture between Royal Dutch Shell and PetroChina, has the necessary approvals in place to proceed, and Sellers says that the company has been in town for 12 months. "They've rented quite a lot of office space," says Sellers. "They're employing."
A further six LNG processing plants, which could also be connected to the eastern states' gas market, are planned. Two are slated for Gladstone, another at Abbot Point near Bowen in Queensland, one at Newcastle in NSW, and one in South Australia. In addition, a planned floating LNG plant could also be positioned to take gas from NSW coal-seam-gas fields.
These include the coastal development projects that prompted a UNESCO warning on Sunday, June 3, that the current management of the Great Barrier Reef area could threaten its World Heritage status.
But quite apart from the environmental concerns, the prospect of these new LNG liquefaction plants — however many are ultimately built — may also be higher domestic gas prices for 3.5 million consumers in Victoria, New South Wales, Queensland, South Australia, even Tasmania, who are manufacturing, heating or cooking with gas.
For householders, the Gladstone-to-global business transaction means a whack to the wallet potentially far greater than the carbon tax. The wholesale price of gas could at least double — although some estimates suggest it could rise by a factor of five.
Gas producers will suddenly be able to sell to Asia, where the price of gas historically has been much higher than in eastern states of Australia. This prospect of a big increase in the price of LNG has driven speculators to take up fracking permits no one would have bothered with before - more expensive gas-extraction methods are becoming financially viable.
In the next two to five years, what we pay for gas will be influenced by all these factors — the ability to export more, overseas gas prices, the viability of more expensive exploration and extraction — plus others — key gas suppliers' contracts are coming up for renegotiation, and regulators already are scrambling for ways to respond.
Competition at Home
Australia's size and the distances between gas fields mean we've developed three separate gas markets: the eastern-states' market which includes South Australia and Tasmania; the Western Australian market operates separately because there's no gas pipeline crossing the Nullarbor to link them; and the Northern Territory gas market.
So if I'm an Australian gas producer in the eastern states and suddenly I can easily get the gas to an overseas customer who is prepared to pay a high price, then I can afford to pay more for the gas I source from the market — this then forces other customers in the market to pay more.
The Gladstone LNG plants will be capable of processing a tremendous amount of gas, says Dennis Cooke, of the Australian School of Petroleum at the University of Adelaide. Processing involves natural gas being piped from the gas fields and fed into compressors at the plants, which reduce its volume, turning it into liquid. The liquid is then loaded onto special ships that carry it to overseas markets, where it is regasified and distributed to homes and businesses.
"As soon as they turn [the LNG plants] on they want to fill them up immediately with input gas," says Cooke. "That's going to have a significant impact on the local gas market."
"Gladstone is going to be like a giant vacuum cleaner for the East Coast gas market, hoovering up all the gas it can get its hands on," AGL managing director and chief executive Michael Fraser told a gathering of the Australian British Chamber of Commerce in April.
The Australian Energy Market Operator (AEMO), an independent organisation, said publicly last year that by 2015 Australia could become the world's second-largest gas exporting country, after Qatar.
"The gas required for [the three approval Gladstone plants] will exceed all other gas demand in Eastern and South Eastern Australia, and is almost twice the energy currently generated for the National Electricity Market."
Shale Gas To Feed Demand
Coal-seam gas has been grabbing headlines lately, especially in NSW, where farmers and environmentalists are protesting against fracking, which they say can contaminate groundwater. Like coal-seam gas, shale gas is called an "unconventional" resource because of the way it is extracted from below ground. "Conventional" gas resources are reservoirs of gas that a prospecting company can simply tap in to. An "unconventional" gas play requires water, sand and chemicals to be injected into rock matrices under high pressure, forcing the rock apart — a process known as fracking — thereby releasing the gas to be captured above ground and piped away.
The difference between shale and coal-seam gases are the depth at which they can be found: coal-seam gas occurs at round one kilometre underground, while shale gas is found at three to four kilometres deep, so it's harder to extract. Shale gas is therefore expensive to commercialise: both prospecting and actual extraction require substantial drilling.
But Australian shale-gas companies have seen their share prices soar this year. Icon Energy shares rose from 16 cents each at the beginning of January, to 27 cents each at the end of April. Over the same period the shares of Strike Energy nearly doubled, from 10 cents to 19 cents. Shares in Drillsearch Energy rose from 80 cents to $1.40 in that period. And although the Eurozone crisis has dampened share prices since the April high point, these stocks remain above January levels.
Meanwhile permits for prospecting for shale gas around Australia are all but taken.
"The obvious ones — where people know that there's a thick, organic-rich shale available at the proper depth — certainly have been taken up," says Cooke.
"The Cooper Basin is almost entirely leased," he says. A large geological structure that straddles the border between South Australia and Queensland, the Cooper Basin has been the source of gas from conventional wells for decades. Now unconventional exploration, such as shale-gas wells, is underway.
"The leases that are available are those that we know very little about. For example on this Hess [Corporation] play in the Beetaloo Basin of the Northern Territory; or the McArthur River Basin. These areas were previously unknown, or very poorly understood to Australian explorers.
"All of a sudden even these fringe permits have been tied up," says Cooke.
The reason for the sudden intense interest is those LNG-conversion plants being built in Gladstone, making for ready export.
"LNG prices throughout Asia have [been] linked to petroleum prices," says Cooke, "but the domestic Australian gas price is not. It's about to become linked, or it's likely to become linked, with [the release of] a large amount of export LNG gas.
"That's what's driving this investment in alternative gas supplies in Australia."
The spot Asian LNG price — the price bid for cargoes of LNG — was around $17 per gigajoule in mid-May. This price was near the high reached in 2008 during the commodities boom, and is attributed to higher demand in Japan which turned off its nuclear-energy plants in the wake of the Fukushima earthquake and has been scrambling for alternative sources of power.
Compare that to $3 a gigajoule, which has been the wholesale price of gas in the eastern Australian states for a long time, according to Tony Wood, the energy program director for the Grattan Institute.
Without the expectation of higher prices, it wouldn't be economical to develop those remote outback shale-gas prospecting plays. Graeme Bethune, chief executive of research firm EnergyQuest, says the only way you can effectively commercialise shale gas is by selling it into high-price markets such as the current Asian market.
The expectation of high export prices already is affecting how the market operates. Santos chief executive David Knox told security analysts in February that his company has not been writing long- term contracts with domestic customers for "quite a few" years, because Santos believes gas prices will go higher.
This dynamic is playing out in the company's balance sheets. In the March quarter, Santos reported a 50 per cent annual increase in revenues, to $754 million, driven partly by a 24 per cent increase in the average gas price, to $5.21 per gigajoule.
The Grattan Institute's Wood says there's a diverse range of views on how high east-coast gas prices could go.
"Most likely, in the short to medium term, domestic east-coast gas prices will move up," he says, "but there's lots of things that would mean that they're unlikely to go to $15-a-[gigajoule] type levels."
Also using cautious language, the Australian Energy Market Operator's chief, Matt Zema, says the construction of an export LNG industry would see domestic gas prices — which have historically been low compared with prices in other developed countries — rise "toward parity with international prices".
In November the AEMO said that the "boom" in LNG exports is likely to put pressure on Australian eastern-states' gas prices. Its Gas Statement of Opportunities for Eastern and South Eastern Australia noted the large commitments to LNG export, leading to domestic uncertainty about both supply and price: "There are indications that LNG development is putting upward pressure on gas price."
The federal government's 2011 draft Energy White Paper, released in December, noted: "The growth in energy export opportunities may change the dynamics in domestic gas and coal markets over the medium term. Domestic gas prices in eastern and western markets are expected to rise above historical levels."
A departmental spokesman said that among the public comments were "a number of major energy users raising security of gas supply as a major issue", which would be considered in the final White Paper, due later in 2012.
According to the Queensland Gas Commissioner's 2011 Gas Market Review, new contract prices are expected to rise "substantially" from 2013, to more than $8 per gigajoule in most markets.
One gas executive in late March said he had heard of an industrial gas contract negotiated at $6 per gigajoule.
Manufacturers who use large amounts of gas are already wary: "Australian manufacturers are currently facing export-level prices for future gas contracts, which are approximately double the production cost, with a further risk that gas is not even available for domestic use at any price," said Manufacturing Australia. The business coalition says that pressure on domestic pricing threatens Australian competitiveness, adding that the Gladstone LNG projects are likely to cause domestic gas prices to increase to LNG export levels of around $7 to $8 per gigajoule.
Lessons from The West
In Western Australia exploration has led to the discovery of lots of gas but abundance hasn't resulted in low-cost energy. The price of domestic gas in WA, where LNG has been exported for 20 years, is higher than it is in the east.
Western Australia's wholesale gas prices have risen from about $2.50 per gigajoule in 2005 to around $7 to $8 per gigajoule now.
A WA government committee last year conducted an inquiry into domestic gas prices and reported that, despite the fact that WA is one of the world's largest gas regions, domestic prices have risen sharply in recent years.
The huge North West Shelf gas project was underpinned by 20-year contracts taken out by the State Energy Commission of Western Australia and other domestic customers, the report said. These legacy contracts are now reaching maturity and must be renegotiated with producers: "There have been reports that … some domestic prices are being set at levels reflecting or exceeding that of high prices in Asian LNG markets."
Wood says that if the government capped domestic prices and constrained some gas for domestic use (a prospect raised by federal Coalition resources spokesman Ian Macfarlane in The Australian on June 4), this would reduce the financial incentive of every large, new facility currently under consideration. In other words, it would diminish the desire to drill for gas in the first place. Such a measure would threaten jobs in the gas industry. It would also anger gas companies.
The WA committee has recommended measures to address the high household gas price, including establishing an independent Gas Market Monitor modelled on the Queensland Gas Commissioner.
A mines spokesman for the Queensland government says it is committed to ensuring adequate gas supplies are available to meet demand from domestic gas users, industry and the LNG export industry. That's adequate supplies, not low prices.
There's Only So Much Government Can Do
Residential gas prices are regulated in South Australia and New South Wales.
In South Australia, the retail price regulator is the Essential Services Commission of South Australia. The retail price of gas for households in the state is about $13 per gigajoule. The Commission is currently assessing an application from Origin Energy to pass on costs associated with the carbon tax to consumers — this increase would amount to about $1.70 per gigajoule.
The commission last year reviewed whether the Gladstone LNG plants also would push up the price of wholesale gas in the eastern states market.
"Specifically for 2013/14, the issue of these LNG projects and the impacts they might have on domestic wholesale gas prices was an issue of contention," says Nathan Petrus, director, pricing and analysis at the commission.
"The commission here determined there was significant uncertainty around the timing and impacts of those LNG projects and the extent to which [they] would increase domestic wholesale gas prices. And it determined that it would not include a specific amount in our retail gas price in 2013/14 to include the potential impacts of those LNG projects…[rather, it] would wait until the time of the next three-year price review to make a call on the impacts of those plants on retail gas prices."
The next three-year price period starts on July 1, 2014 and Petrus says the commission will undertake another review in 2013/14.
In NSW, prices are regulated by the Independent Pricing and Regulatory Tribunal (IPART), which is also currently assessing applications from gas suppliers to pass through costs associated with the carbon tax. The O'Farrell government in NSW has not announced whether price regulation will continue past 2012/13.
In the past, the tribunal has reviewed AGL's wholesale costs and their underlying contracts when making determinations as to retail prices. AGL's Fraser said that its major contracts with suppliers expire at the end of 2016 and 2017.
Wood says that when such contracts expire any increase in the wholesale price will pass through to the consumer.
"If a company like AGL is in the middle, a regulator cannot logically screw them. You can't say, 'No, I agree your costs have gone up but you're not allowed to pass them through to the consumer', because AGL literally goes broke. That's what happened in the great Californian crisis of 2000 when the cost of wholesale electricity went up and the companies in the middle weren't allowed to pass it through."
In states where there is no regulator, Wood says, it will come down to competition: "If all the competitors are all paying an increase in the price, then it will go through as quickly as they can pass it through."
The wholesale price of gas accounts for about 26 per cent of the household gas bill nationally, according to the Australian Energy Regulator. Network costs account for 53 percent and retail services costs account for the remaining 15 percent.
"If the wholesale price doubles, then for that average customer the price goes up by about 40 per cent, if it represents 26 per cent [of the total gas bill]," says Wood.
"But you've got to be very careful with that number because that 26 per cent, if that's the number across the eastern states, would be probably 10 per cent in Queensland and 80 per cent in Victoria, for example. So the impact on Victorians of an increase of the wholesale price is much higher."
Wood says the carbon price has a much lower impact than this change.
If gas development continues there will be gas available for manufacturers in the eastern states and for households there that use gas for heating and cooking — as well as for export. Right now it's impossible to predict a price point, but it's certain that as the current wholesale contracts between gas producers and gas retailers expire, the new market price will be noticeably higher for retailers — and consumers.
So as gas prices rise over the coming years it won't just be due to the effects of the carbon tax, and, from 2015, the emissions trading scheme. Economic forces put in play by global businesses will also be responsible for raising the gas bills of Australian households.