Should we reserve some gas for ourselves?

From the AFR this morning:

Australia faces spiraling gas prices and a domestic gas shortage by 2016 unless new reserves are opened up for production, according to the official energy forecaster.

…AEMO’s Gas Statement of Opportunities report, to be released today, says the LNG export market based around Queensland’s Gladstone was having a significant impact on the domestic market.

…The AEMO report also found projected gas demand exceeds the capacity of pipelines to supply gas in several business hubs. Shortfalls are expected to hit Gladstone next year, Brisbane in 2020 and Townsville in 2021.

…Mr Zema said he would prefer the market to sort out the potential shortage. “There are enough reserves, it just depends on whether people want to develop them and bring them to the market,” he said.

I’m not a expert on the local gas market but my research suggests the following. Current east coast gas prices have already shifted upwards from a historical range of $3-4 per gigajoule (/GL). Santos estimates that you need a price of $6/GL to stimulate more non-conventional east coast production so that’s the base increase. Large contract users are already being asked to pay such rates.

On the west coast, WA has used gas reservation (setting aside 15% of supply) to ensure that it is not overly exposed to the much higher prices available in North Asia ($8-$12/GL). This seems to have worked for the big contract users, who pay in the $4 to $5/GL  range (though much more on spot) which is up from $2.50/GL historically. Should the east coast do the same?

For a start QLD did do something in 2011. Under the Gas Security Amendment Act, the government has the right to reserve entire gas fields for domestic use only. Since then, however, the production from every new development has been sold into international markets and, given the development lead time for new production, the policy does not seem workable as solution if supply crunches develop.

Basically, the answer comes down to a certain amount of economic planning. If you don’t do it, you will add significantly to the burden carried by manufacturing. As Andrew Liveras has argued, if you do not reserve you will expose domestic users to the highest gas prices in the world in Japan. You will effectively price your own gas as if you don’t have any.

With the advent of a US LNG boom, the North Asian gas price is likely capped in the $7-8/GL range so leaving it to the market will increase prices a lot but probably not beyond double.

But do you want that? It will continue the process of Dutch disease, making the nation more and more dependent upon a narrow band of export commodities. It’s basically a question of where you want to be competitive. It’s also worth noting that Australia is the only gas producing country on earth that does not require security of supply for domestic gas users. Prima facie gas reservation does seem like a workable solution assuming you want to preserve some measure of economic diversity. It means the local price is suppressed but still keeps the overall economics of gas projects robust via much higher offshore margins. There is zero sovereign risk given its global practice (indeed the sovereign risk may well be to not do it).

Just one other point. To some extent this subject is moot. Despite the recent Energy White Paper washing its hands of security of supply provisions, the Feds will remain under pressure to reserve simply because high household electricity is a political issue. This is especially so given gas is supposed to be the primary low-carbon transitional fuel as move from coal to renewable energy in the decades  ahead.

Reader input welcome.

David Llewellyn-Smith
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  1. Must admit I’m ignorant of comparative energy costs, but of all countries in the world – particularly those that are developed, have excellent engineers and access to technology as we do – shouldn’t we have the bloody cheapest energy costs of anywhere?

    Lucky/2nd rate quote rings a bell here again.

    But no, quick, dig it out of the ground, sell it once and buy it back at 20 times the price in form of finished goods…quick! hurry! can only do this once!!

    • You don’t understand/subscribe to free trade, globalisation and comparative advantage.

      Our price will be the price that renders it more profitable not to export (after taking into account some risks of depending on export vs domestic markets).

      • I agree with the Prince because I subscribe to the suspicion that our captains of industry and commerce are mugs who could not negotiate a good deal with Mother Theresa.

    • You reply with a link to a 55 minute video? Without even a short summary?

      I enjoy debate and getting other points of view, but 55 minutes of video to know the gist of your point is too high a price to pay.

      • I take your point Explorer. I was on the road and didn’t have time to write a synopsis. The main point that Mr Liveris makes is that Australia should be using its energy resources to build up its manufacturing sector rather than simply exporting the raw materials. The money is in the value add. Australia is fueling the manufacturing needs of other countries and creating millions of jobs overseas to the detriment of our own manufacturing sector. Australia should be exporting the finished product, rather than the base product.

        “I believe that Australia should have a balanced economy with manufacturing, not on the sidelines, but part of its centre.” he said

  2. In my opinion the cost of a nationwide Australian gas reservation policy may outweigh the benefits. For example, a domestic gas reservation policy, in the short-term, will provide cheap domestic gas however the cost may be that the policy will:

    1) Discourage investment in Australian gas projects
    2) Reduce investment in domestic gas infrastructure
    3) Reduce the economic viability of marginal producers – supply reduction
    4) Increase the cost of regulation above the benefits – potential dead weight loss

    A reduction in the cost of domestic gas, as both a feedstock and as a primary energy source, will not in my opinion be significant enough to overcome the issues facing the competitiveness of the Australian manufacturing industry.

    • Define investment. It seems to me that the word investment has become euphemism for wholesale sell off with the lions share of the profits going off-shore. You admit as much when you say having to set aside even a fraction for domestic use is a burden to heavy for the “investors” to bear.
      Would you like to expand on your opinion that cheaper energy will not assist the competitivity of manufacturing in this country? I do not see how it could not. Maybe we should be using our natural endowments for competitive advantage instead of competing on wages alone.

  3. If as a broad economic principle Australia has reduced economic protectionism in its various forms over the last few decades, why do we treat gas supply as any different?

    The argument that cheap domestic gas will lead to much more jobs than otherwise is a qualitative and subjective argument, and comes directly from those that have an interest in cheap gas. Asking for it is no different from rent seeking, with those companies simply looking to indirectly take the profits from gas extraction for themselves.

    Securing supply for domestic consumption will serve only to deter investment, as has been seen in the US. The $2.50 price there has seen the rapidly expanding gas industry actually contract, with well publicised consequences for investors such as BHP.

    These companies should stop pretending that they’re campaigning in the national interest and instead admit that they are asking for protection, no different from the widely chastised car industry today, or the textiles industry of the 60’s and 70’s.

    • Australia has reduced economic protectionism in its various forms over the last few decades, why do we treat gas supply as any different?
      Because economic rationalism and free trade ideology has failed to improve the quality of life of the average Australian citizen. Only few benefit from the adherence to globalist ideals.

      Could you please expand on your argument that cheap domestic gas will NOT lead to much more jobs? I do not see how cheaper energy will not assist the competitivity of manufacturing in this country?

      And anyway, what is the big urgency to dig it and ship it straight into an international glut?

  4. Royale With Cheese

    Pardon my ignorance, but isn’t this analogous to reserving 10% of all iron ore/coking coal production for domestic steel mills, to allow for cheaper steel production for use in Australian construction, car making and whatever else we have left?

    Domestic gas users could always take an Arrium-esque approach of owning and developing a gas field to mitigate the risk. That way, the cheap gas is put to use in Australia without discouraging investment elsewhere.