Centre Alliance versus the gas “cartel”

Senate crossbench powerbroker Rex Patrick is demanding Queensland’s LNG export “cartel” provides enough gas into the east coast market to ensure a surplus of supply amid other measures under discussion as the price for the Centre Alliance’s support for the Coalition’s proposed tax cuts.

Under the proposal put forward to Resources Minister Matt Canavan, the Australian Domestic Gas Security Mechanism (ADGSM) would be strengthened beyond the current requirement just to avoid a shortfall in the domestic gas market.

That could require Queensland’s LNG shippers to divert export gas into the local market, with Senator Patrick saying prices should be lowered to $7 a gigajoule or less.

“I think there is a cartel operating and in these circumstances market intervention is required,” he told The Australian Financial Review.

That’s being generous. Under the existing agreement, the price is already supposed to be $5Gj!

Predictably, the “cartel” responded with lies:

Santos chief executive Kevin Gallagher said triggering the ADGSM would only stifle investment in much-needed new supply.

“No one is short of gas now,” one gas company insider said on Wednesday.

“Triggering the ADGSM won’t make any cheaper gas available.”

Yes it will, if it is forced to, including threatening expropriation and “use it or lose it” laws. There’s plenty of cheap gas in the cartel reserves that come out of the ground for $3-5Gj in QLD:

And that is not cash cost so it can be even cheaper, more like $1-3Gj, and there is cheaper still gas in all of the third party contracts that have been vacuumed up. Let’s not forget that it was Santos that was most at fault for lying about its reserves when it built the QLD LNG export facilities in the first place, previously from The Australian:

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.

“At the time of FID (final investment decision), there was a reasonable expectation during the early years that gas would be available in the market at the right price,” Mr Knox said. “However, large volume, long-term east coast gas supply and prices have tightened over the last 18 months, making third-party gas a relatively less attractive gas ­supply. This is what led to our ­announcement (that capital spending would increase).” For commercial reasons, Santos had not revealed the volumes of third-party gas needed to feed the ­second train.

Presentation slides reveal that by then, even with the $US2.5bn of extra spending, third-party purchases had grown from 140 terajoules a day, at FID, to 240 terajoules a day, or 20 per cent of east coast domestic demand.

Santos figured the gas it was taking out of east coast markets would be filled by accelerated production from the Cooper Basin (fuelled by the GLNG ­supply contract revenue), gas from the Narrabri coal-seam gas project in NSW and helped by the production of shale gas.

Unfortunately, shale drilling did not return hoped-for results, an oil price slump in late 2014 heavily restricted more Cooper Basin drilling and a community backlash, along with regulatory hurdles, stymied Narrabri.

Even before oil prices slumped, Santos revealed its call on domestic gas would be greater than flagged. In a June 2014 presentation slides to an analysts tour of the GLNG facility were told that third party gas would provide between 410 to 570 terajoules of gas per day, or the equivalent of up to half of total east coast domestic demand, even though it was planning to drill 200 to 300 domestic wells a year.

One very simple solution to the entire gas and electricity debacle is to force STO to use its own reserves for GLNG. Of the three Curtis Island carteliers, STO was most responsible for vacuuming up third party gas as its own reserves failed to meet export volume targets. As Credit Suisse argued in 2017:

■ Our preferred option is to reclaim the third-party gas currently being exported: Aside from the Horizon contract between GLNG and Santos, there was no evidence in the EIS or FID presentations that more non-indigenous gas was required. As such, one could argue reclaiming what has only been signed due to a scope failure, is equitable. Including the Horizon contract GLNG will be exporting >160PJa of third-party gas in the later part of this decade. Whilst we get less disclosure these days, BG previously said that after an initial 10–20% in the early days (now gone) QCLNG would use ~5%

■ Our preferred option is to reclaim the third-party gas currently being exported: Aside from the Horizon contract between GLNG and Santos, there was no evidence in the EIS or FID presentations that more non-indigenous gas was required. As such, one could argue reclaiming what has only been signed due to a scope failure, is equitable. Including the Horizon contract GLNG will be exporting >160PJa of third-party gas in the later part of this decade. Whilst we get less disclosure these days, BG previously said that after an initial 10–20% in the early days (now gone) QCLNG would use ~5% third party gas – 20–25PJa. APLNG is self-sufficient, but as can be seen the other third party gas would get extremely close to balancing the market. Clearly these things are far better done by mutual agreement from all parties, rather than a political mandate.

■ GLNG loses but can all be compensated? We estimate that, at a US$65/bbl oil price, GLNG as an entity would lose US$447m p.a. of FCF if they could no longer toll third party volumes. Interestingly, if Kogas and Petronas could recontract their offtake on a slope of 12x (doable in the current LNG market) then their losses as an equity partner are all offset (not equally between the two albeit). Santos would see ~50% of its US$134mn net GLNG loss offset if the Horizon contract could move up to a slope of 8x from 6x. The clear loser would be Total. We wonder whether cheap government debt, a la NAIF, could be provided at the (new, lower volume) project level or even to take/fund an equity stake in it? In reality all parties (domestic buyers included) have some culpability in the situation, so a sharing of pain does not seem unreasonable 02 March 2017 Australia and NZ Market daily 31.

Once the cartel knows the Government is serious it will simply buckle and deliver. It’ll have to take some write-downs and renegotiate some export contracts but so what? That happens all of the time. The cartel should have thought of that before it trashed the market and tore up its social licence to operate.

Given it is a $15-20bn energy gouge per annum impacting every business and household on the east coast it’s obviously in the Government’s interest to fix this and deliver a huge stimulus boost much bigger than the actual tax cut.