ADGSM review recommends gas reservation price trigger

Sort of. From the Australian Goverment:

The Australian Government introduced the Australian Domestic Gas Security Mechanism (ADGSM) in July 2017 in response to a forecast gas supply shortfall in the eastern domestic gas market. The ADGSM provides the Government with the ability to restrict LNG exports to secure domestic supply.

On 6 August 2019, the Government announced the 2020 statutory review of the ADGSM would be brought forward. Following over two years of operation, it is timely to review the ADGSM. The review assesses the ADGSM’s effectiveness against terms of reference stipulated in the ADGSM’s regulations. Stakeholder consultation has been undertaken largely through a submission process.

The eastern gas market has undergone significant changes in recent years. Most notably, from 2015 the ramp up in exports from Queensland’s LNG industry transformed the market, with domestic gas prices rising to closer align with international prices. Production costs have also risen, reflecting more expensive unconventional coal seam gas production and some declines in offshore production, requiring new and more expensive gas developments.

It is important to note the ADGSM is a temporary supply security measure and not a direct price control mechanism. It aims to ensure there is sufficient gas supply in the domestic market.

Increasing domestic gas production remains the most effective method of increasing competition, alleviating market tightness and placing downward pressure on prices.

Since the ADGSM’s introduction in 2017, pressures in the eastern gas market have moderated. The Australian Competition and Consumer Commission’s (ACCC) most recent reporting found that average gas price offers from producers between January and April 2019 were mostly below $10 per gigajoule (GJ). For the same period, average gas price offers from retailers ranged between $10–12/GJ. These prices are significantly lower than the peak-prices reportedly offered in early 2017 which ranged to over $20/GJ. The recent successful negotiation of gas supply contracts between major gas users and producers reinforces this improvement.

However, the gas market and underlying supply chains are complex. A range of factors, both domestically and internationally, influence the supply-demand balance and ultimately prices paid by consumers. These complexities are reflected in Australian governments’ extensive gas market reform agenda. Reforms are being progressed across the gas supply chain, including encouraging more supply and competition, improving regulation, and increasing market transparency.

It is difficult to quantify the impact of specific factors and reforms on market outcomes, including that of the ADGSM. However, the improvement in the domestic supply outlook and subsequent market conditions can in part be attributed to the ADGSM. LNG exporters have increased their supply to the domestic market since the ADGSM was introduced and are currently, in aggregate, net contributors to the domestic market. Australia’s energy market bodies and regulators (Australian Energy Market Operator – AEMO, Australian Energy Regulator – AER, and ACCC) have acknowledged the ADGSM’s contribution in this regard.

Price is an ongoing concern of many gas users, particularly manufacturers and feedstock users. The review found that price formation is complex with numerous influences that vary across domestic markets, including bespoke requirements of individual gas users and the production characteristics and geographic locations of different gas production centres. The review does not therefore recommend adopting a direct price trigger as part of the ADGSM.

Nevertheless, price does serve as a signal of how well a market is functioning and is an important input (along with other signals including production levels and the number of producers, exploration activity, number and range of offers, export levels) in establishing whether there are real supply constraints for Australian gas users. The review recognises that the LNG netback price series released regularly by the ACCC is the most relevant series for Australian gas users, noting the limitations identified by the ACCC on the use of this series.

Submissions to this review have ranged from the general view of gas producers that the ADGSM is no longer required, to calls from gas users for stronger interventions in the gas market. There has been a level of acknowledgement from gas users and producers that the ADGSM has been effective, at least to some extent, in compelling more domestic supply.

Stakeholders have also acknowledged that the ADGSM is only one of a suite of reforms and is not in itself a standalone solution to gas market pressures.

Sitting alongside the ADGSM, the review acknowledges the important role the Heads of Agreement between the Government and LNG exporters has played in encouraging more gas into the domestic market and safeguarding against a shortfall. The Heads of Agreement has provided both an incentive and a mechanism for an industry-led initiative to ensure gas is available in the domestic market, with new gas supply agreements being made between exporters and some industrial users.

Recommendations:

1. The ADGSM was introduced as a temporary measure alongside a broad suite of gas market reforms aimed at addressing market pressures. While there have been clear improvements in the eastern gas market, the market remains uncertain and persisting pressures still need to be addressed. As such, the review recommends retaining the ADGSM until its scheduled cessation in 2023.

2. Whilst the ADGSM has worked well to date, it is important to ensure its effectiveness should it be required. This review has examined the Total Market Security Obligation (TMSO) and found that it may not be able to recover sufficient domestic gas to address a market shortfall. As such, the review recommends consideration be given to changing the TMSO from the current ‘net-deficit’ test to a ‘50/50’ hybrid model which allocates:

 half of the identified shortfall volume to applicable LNG projects on a pro-rata basis against LNG production capacity, and
 the remaining half of the shortfall split in a way that is inversely proportional to the domestic gas contributed by each project.

Any change to the TMSO would be developed in consultation with industry and other affected stakeholders to avoid any unintended consequences. The Government’s intent remains to ensure domestic market security while continuing to attract investment in gas exploration and development and remain a reliable LNG supplier.

3. The review recognises that price is an important indicator in establishing whether the domestic market is functioning effectively and considers that the ACCC’s forward LNG netback price series is the most applicable prices when estimating the likelihood and extent of a potential shortfall. As such, the review recommends amending the ADGSM’s guidelines to include referencing the ACCC’s LNG netback price series in estimating a potential shortfall.

This amendment clarifies the relevance of the ACCC’s LNG netback price series to considerations under the ADGSM and strengthens the ADGSM’s ability to deliver on its objective of securing domestic gas supply.

OK, so the net back series is based upon the Japan/Korea Marker (JKM) minus roughly $1.50Gj. JKM is currently trading at around $5.80 so the relevent benchmark for east coast gas is $4.30.

That’s under half the current price in the contract market ($10-12Gj) which allocates 95% of volumes.

Thus the Government has set itself up to pull the trigger on the mechansim immediately and force prices much lower (if it follows through).

However, even if this succeeds, longer term we’ll still be exposed to any global gas price spike via the export net back price or a falling AUD. Moreover, by benchmarking to export net back we have implicitly given up any advantage we ever had in cheaper gas than elsewhere and have instead priced ourselves against the marginal cost buyer, which remains staggeringly stupid.

Still, at least we’re not now putting oursleves at a massive disadvantage, so long as the Government enforces this new ADGSM (which is one big “if”).

Bravo Center Alliance (and me). Get on with it Canavan.

David Llewellyn-Smith

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Comments

  1. In order to be seen as the saviour, you need a crisis first.
    And there isnt a crisis in their minds YET.