From the ACCC’s Rod Sims on his inquiry into the east coast gas market:
1.The arrival of LNG has upended the east coast gas market
By the time all six trains are operating, east coast gas production will need to have tripled to meet both LNG and domestic demand from industrial, commercial and household customers and the remaining gas-powered generation.
This burst in demand for gas over a very short timeframe for the LNG industry is effectively upending the east coast gas market.
To meet these changing market dynamics, transmission pipelines are being inter-connected and flows being made bi-directional. In other words, the transmission network is being prepared to enable some gas to flow north out of southern production areas and into Queensland.
There was originally a strong presumption that CSG with some incremental supply from the Cooper Basin would largely supply LNG demand.
Indeed, at one time it was thought that CSG in Queensland and unconventional gas out of the Cooper Basin was going to drive an LNG boom with 16 or more trains being mooted by different projects using gas sourced out of these areas.
However, despite this early expectation of a gas production boom, the east coast market seems to be perhaps one of the few gas markets in the world which is now living under the shadow of supply uncertainty.
These uncertainties are being exacerbated, but not necessarily caused by, the fall in oil prices with its links to international LNG prices.
One could argue that expectations of perpetual US $90 – $100 oil, which seemed to have pervaded markets since the commencement of the so-called resources super-cycle, has been proved wrong along with so many other commodity price expectations that went with super-cycle optimism.
We may well, instead, now be back at something approaching an historic average price for oil.
The industry is confronted by a much tougher outlook, where it needs to source lower cost gas to compete in a potentially over-supplied international market, and where aggressive cost cutting will be important to ensuring the success of the LNG Projects.
It is often said that linking the east coast market to international gas markets means domestic prices netted back from international prices. However, with lower oil and LNG prices, and a falling Australian dollar, it is becoming increasingly unclear as to what exactly a netback gas price for the domestic market should be.
2.Gas Users were largely right
It is clear from our work so far that the claims by gas users that there was a marked change in the gas market after the final investment decisions by the LNG projects in 2010-11, and that there was then a dearth of offers for the supply of gas, are largely true.
We have evidence that many domestic users went from a market where they received, say, 3 – 5 offers of supply on terms that were able to be negotiated, to one where they received zero or one true offer, on largely take-it-or-leave-it, inflexible terms.
Particularly during 2012-2014 it was hard to find signs of an effective domestic gas market.
When you look at some of the gas deals that were struck in this period, it is clear that a number were related party transactions with the LNG projects shoring up supply positions, or other deals between suppliers.
It does appear, however, that during 2014 and into this year, there may be some more offers in the market.
This has coincided with some slippage in the LNG project timeframes which has freed up some gas for the domestic market coupled with early CSG ramp gas also being available.
Some have also asserted that once the Government started to publically canvas the idea of an ACCC Inquiry into the gas market, behaviors also changed. The prospect of regulatory scrutiny can affect behaviour.
There remain, however, large changes in the terms and conditions of gas supply. Some of these are bringing increased risk for gas users.
Gas supply contracts now tend to be for considerably shorter duration and at higher prices. The current contracts also have much less flexibility around some of the delivery conditions.
As an example, a contract struck today for the supply of gas may be only for one, two or three years. It may now have some form of oil price linkage.
It may also have a lower limit of liability for a producer’s non-performance in the delivery of gas, coupled with a higher obligation on the buyer to take or pay the contracted quantities. It is unlikely to include provisions for banking gas and it will have limited flexibility on usage.
The shortening in contract length, however, may have advantages for some gas users who are uncertain about future gas use, and current low oil prices may now be providing a lower gas price.
3.Some questions we need to address
While it may be tempting to view the pre-LNG world on the east coast as a halcyon time of sure supply, low prices and easy contract terms, there were also supply uncertainties which drove projects like the PNG Gas Pipeline, where markets were disconnected and somewhat inefficient and where negotiations may have been just as tough as those occurring today.
The dynamics of a market shaped around a dominating demand feature like LNG, however, is new and the market cannot return to models that may have worked, albeit not optimally, before LNG.
The Inquiry is still to hear some of the counter views to the above story of market failure, where supply is uncertain, and where prices are unrelated to costs.
Notwithstanding this, I think it is clear that we are in an environment which is not merely in a transitory phase of adjustment but which is moving to a new dynamic.
The Inquiry will be considering if the mechanisms available to market participants to manage risks around supply, demand and price are adequate in this new environment.
The Inquiry is looking across the gas value chain and will be making recommendations to Government on where reform is required, how markets can become more efficient and if significant market power and competition concerns exist in the east coast market.
All good and right and absolutely essential. I remain less concerned than some about the dangers of of the LNG price shock – though the LNG ramp up is clearly poorly structured – given my very bearish outlook for LNG prices. For instance, at current oil-linked contract prices of $7mmBtu, the local net back price for gas is around $5mmBtu. While that is higher than the $3-4mmBtu historical average, it is far from the apocalyptic scenarios predicted around the place.
What’s more, I expect oil-linked LNG contracts to erode materially (to the point of breaking in some cases) as the Asian basin glut grows. This ensures that the QLD white elephants, which are the global marginal cost producers, will be running at cash cost for a very long time (and at times below, cutting volumes).
The cash breakeven price is around $6.50mmBtu but will keep falling with the Aussie dollar. If it falls to $5.50 with an Aussie dollar at 50 cents then that pushes the export net back price back into historical average ranges. Though that may not last as the dollar rebounds in time. But even then that may result in lost market share not rising east coast gas prices.
The glut is going to last a good decade!
