Slap domestic reservation on Santos to fix energy crisis now

Straya has dodged a bullet thanks to STO management:

The Santos move to reject Harbour Energy’s $US14.4 billion offer and to disengage from further negotiations arrived a stunning and unexpected blow to the ambitions of its US private equity pursuer.

Santos was scheduled to be the gas fired boat that would carry to Harbour on a rapid journey to serious relevance across regional export gas markets. So there was a lot to play for and an awful lot at stake. And perhaps there might yet be. So, it seems quite natural that Tuesday’s after-market rejection was greeted with bitter, expensively wrought disappointment.

But there is more to the Harbour response than just anticlimax. There was a whiff of cordite and enmity in Harbour’s reaction. Santos has been accused of a failure of engagement, of ignoring the inevitable cyclical realities of oil markets at a cost of long-term shareholder value, of being not quite the company it wants to be and even of leading Harbour to a point of bid restructuring that it subsequently highlighted as an issue of vulnerability in the rejection pitch.

Now, let’s get serious. STO lied about having enough gas for its LNG operations when they were being approved:

As Santos worked toward approving its company-transforming Gladstone LNG project at the start of this decade, managing ­director David Knox made the sensible statement that he would approve one LNG train, capable of exporting the equivalent of half the east coast’s gas demand, rather than two because the venture did not yet have enough gas for the second.

“You’ve got to be absolutely confident when you sanction trains that you’ve got the full gas supply to meet your contractual obligations that you’ve signed out with the buyers,” Mr Knox told ­investors in August 2010 when asked why the plan was to sanction just one train first up.

“In order to do it (approve the second train) we need to have ­absolute confidence ourselves that we’ve got all the molecules in order to fill that second train.”

But in the months ahead, things changed. In January, 2011, the Peter Coates-chaired Santos board approved a $US16 billion plan to go ahead with two LNG trains from the beginning….as a result of the decision and a series of other factors, GLNG last quarter had to buy more than half the gas it exported from other parties.

…In hindsight, assumptions that gave Santos confidence it could find the gas to support two LNG trains, and which were gradually revealed to investors as the project progressed, look more like leaps of faith.

…When GLNG was approved as a two-train project, Mr Knox assuredly answered questions about gas reserves.

“We have plenty of gas,” he told investors. “We have the ­reserves we require, which is why we’ve not been participating in acquisitions in Queensland of late — we have the reserves, we’re very confident of that.”

But even then, and unbeknown to investors, Santos was planning more domestic gas purchases, from a domestic market where it had wrongly expected prices to stay low. This was revealed in August 2012, after the GLNG budget rose by $US2.5bn to $US18.5bn because, Santos said, of extra drilling and compression requirements.

Since the plants opened, the east coast gas market has collapsed into an export cartel that is gouging every local household and business by creating an artificial shortage. This has created the perverse situation in which the higher the gas export price goes, the worse off Australia is. This was modeled by Victoria University:

Construction of the new LNG facilities stimulates national employment, but when building is complete, the direct stimulus ends. In the long-run, the new LNG production has a negligible impact on employment, but lowers the real wage rate.

The explanation of macro effects begins with the impacts on the national labour market. Figure 2 shows percentage deviations away from base case values in national employment (persons employed) and in the national real wage rate.

The LNG projects are expected to increase real GDP.

Figure 3 shows percentage deviations away from base case values in real GDP. The solid line shows the overall impacts. Initially, because of the LNG construction real GDP increases by around 0.3 per cent relative to its base case level (i.e., its level without the new LNG projects). This increase dissipates over time, with the long-run impact being an increase of a little less than 0.2 per cent.

The outcomes for real GDP reflect the balance of two offsetting forces. The expansion in LNG exports at the high global price results in a terms-of-trade increase for the economy. This tends to reduce the real cost of capital, leading to increased capital and increased real GDP. We call this the quantity effect. It is shown in Figure 3 by the upper dashed line. By 2020, the quantity effect adds around 0.8 per cent to real GDP. The annual increment persists thereafter.

Offsetting this, though, is the increase in gas prices for domestic use. The increase gas price allows for larger than normal profit for the local gas producers, but it also raises the cost of production for gas-using industries. Many of these industries cannot pass on these increases, and so cut production. Thus for these industries the increase in cost of gas means reduced production, employment and capital utilisation, resulting in a loss of real GDP for the economy generally. In Figure 3, this adverse price effects is shown by the lower dashed line. By 2020, the price effect subtracts around 0.6 per cent from real GDP.

Low-price (Baseline) compared to full-price (Baseline)
There is some uncertainty about the future international LNG price. The price assumption for the full-price (Baseline) is shown in Figure 1. To gauge the sensitivity of the modelling to changes in that assumption, we have simulated an alternative Baseline in which the price rises from the current average price of $4.50 per Gj to $7.75 per Gj, which is half the increase assumed in the full-price (baseline). Figure 7 shows percentage deviations in real GDP implied in both simulations. In the years to 2018, the absolute difference in results is relatively small, with the full-price (baseline) being less stimulatory than the low price (Baseline). The difference is magnified in the long-run. Roughly, with half the price increase, we get nearly twice the increase in real GDP.

This rule follows for most of the other results. For the long-run, in the low price (Baseline) scenario relative to the full-price (Baseline) scenario the sign of the deviations is the same but the magnitude of the deviations is roughly doubled.

Over the next decade, the local gas gap is around 200Pj or 10% of export volumes on the east coast. This amount must be reserved for the domestic market from all three Curtis Island players. If they won’t play ball then make it a fixed price quota at $5Gj. There is NO sovereign. Every other energy producer in the world does it.

As we know, this will not only fix the gas price crisis, it will fix the electricity price crisis because gas sets the marginal cost of power. In turn, that will put the national decarbonisation plan back on track and bury the energy loons demanding uneconomic coal-fired power stations.

Even STO agrees that reservation is required:

Gas users and trade unions have expressed concern that Territory gas might simply flow out of Gladstone as LNG, with no benefit for domestic gas users.

A blanket reservation policy would render development of the NT’s shale gas resource uneconomic, since it would prevent the achievement of scale that only an LNG industry can provide to justify the large capital investment required to extract the gas and bring it to market.

However, industry should be open to discussions with governments, gas users, unions and communities about sensible ways to reserve an agreed portion of NT gas for the domestic market.

Some will say that this is a retreat by the industry, but it is a necessary step on the journey we need to take to rebuild trust in our industry as part of a longer-term strategy to better engage with the Australian community.

They said it. The Coalition already created the lever in the Australian Gas Security Mechanism and refused to use it. Pull it now.