East coast energy shock

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One of the slow time bombs in the Australian market is the probability of much higher gas prices on the east coast of Australia because of the effect of LNG exports. It has already happened on the west coast.

Manufacturers have to pay prices for gas that are four to five times the artificially low prices in the US. The US market, as Yves Smith observed, may be operating on an illusion, but there is little doubt that an energy shock is coming to Australia’s east coast. Macquarie has a report looking at the effect on energy producers, but the impact will be wider. It will have an effect on input costs for manufacturing, and, to some extent, inflation.
Macquarie says the effect is about two years away:

“Higher prices in the medium term…: It is difficult to overstate the market impact of impending LNG exports on the east coast as current timelines give the local market little time to adjust. As a result a key market window appears to be opening from 2015-2020 which is being actively targeted by producers as prices are likely to trade well above long run marginal cost.”

This will further exacerbate the two speed economy effect in Australia, and although it is probably wrong to anticipate severe shocks, it will be part of the energy equation in Australia: As Macquarie observes, it creates an interesting dynamic for the east coast oligopolies:

“longer term fears of LNG-netback pricing are overdone: With rising prices set to commercialise an apparently vast east coast resource base, any supply shortage looks likely to be short lived. As a result, we believe growing fears that LNG exports will import international parity pricing in the long term are overdone. What’s more, if Australia’s huge resource base doesn’t stop the rise to LNG netback, government intervention presumably will.

“LNG netback pricing in the domestic market would commercialise an estimated ~140,000PJs which could comfortably feed 6 LNG trains and meet growing domestic east coast gas demand for more than 50 years.

“As a result, we believe STO and ORG are incentivised to keep the market at least somewhat well supplied in order to keep a lid on prices to limit both future competition and political interference. Otherwise STO and ORG risk losing their long term stranglehold on the east coast.”

The politics of gas are becoming intense in the US. The same may soon be true in Australia.

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Macquarie a-NZ Equities 23 May 2012