Policy the key to energy future

THE devil is in the details of federal policies to fix the country's energy crisis, Wood Mackenzie's Australasia oil and gas lead Saul Kavonic writes for Energy News.

    • Saul Kavonic
    • 10 May 2017
    • 08:06
    • News
Policy the key to energy future Saul Kavonic.

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If we look past the political theatrics of the last weeks, we can see structural shifts at play which present a new world for gas market participants, policy makers and Australia's energy security. 
There is plenty of blame to go around for the current state of affairs, including gas drilling moratoriums; too much export capacity built; rocks that haven't delivered as envisaged; low oil prices hampering investment in new supply; and the decline of legacy gas fields. 
But looking forward, the solution, for better or worse, lies in policy direction, across federal and state levels.  
It is inevitable that some gas-intensive industry will close, some gas will be substituted with coal or renewables, and more supply will come online, to bring the market to balance. Policy will determine exactly where the line will lie between these options.  
The effectiveness of the government's recently announced Australian Domestic Gas Security Mechanism depends on the devil in the details. At present, these details are lacking.  
The lack of transparency as to how the mechanism would operate creates confusion for gas suppliers and buyers; at the same time, the ACCC is tasked with bringing greater transparency to the market. 
We expect the greater regulatory oversight will put downward pressure on pricing of some contracts and facilitate negotiations for gas diversions to the domestic market to conclude. 
But we can also expect the announcement to increase the perception of heightened above-ground risk. This can only dampen investment in new supply - which is ultimately the best long-term potential solution, alongside structural demand-side changes.
Diversions of gas from the Queensland LNG projects to the southern states (rather than liquefying and exporting) have already occurred in a response to price signals. 
These will continue on a commercial basis, regardless of this announcement. Wood Mackenzie views this as the most efficient solution to gas shortages in the southern states. 
But the difficulty in reaching the alignment required between numerous players along the value chain from Queensland to the southern states - producers, end users, pipeline owners and capacity holders - could risk supply being made available when needed, and push up end-user prices, especially when gas is needed at short notice. 
Thus, more inefficient solutions, such as an LNG import terminal, are being considered by some.
The fundamental reason gas buyers in the southern states will pay much more for gas than LNG netback prices is due to the costs involved in moving gas from Queensland to where it is needed - either through domestic gas swaps or the pipeline network, and the numerous parties involved to make that happen. 
Restricting gas exports doesn't address this critical issue, which is beyond the control of any LNG export project. 
The reality is eastern Australia has an integrated gas market which has undergone a structure shift. 
Increasingly, domestic prices will be linked to international LNG prices. Gas buyers will have to adjust to this new reality.  
Buyers have benefited from low cost gas in the past, but price rises were inevitable as supply costs structurally increased. 
LNG exports may have accelerated this process, but price rises were on the cards anyway, so buyers need to adapt rapidly, including by adopting improved energy efficiency, substitution and productivity measures. 
Over the near-term, Wood Mackenzie expects the impact of the domestic gas security mechanism to be minimal in terms of volume changes to the LNG or domestic market, as supply for shortfalls was likely to be made available anyway on a commercial basis. 
But the calls for government intervention in the market are going to only increase for years to come, as the risk of some gas-intensive industry closing grows, and much needed longer-term policy reforms on the demand and supply side prove difficult to achieve politically. 
The gas industry will need to navigate this delicate environment carefully. 
Indeed, broader political issues, such as climate policy and federal GST distributions, are also inextricably linked with the operation of the gas market over the long term (climate policy drives gas powergen substitution investment, and the current GST redistribution mechanism combined with nimby-ism incentivises states to rely on their neighbours' gas rather than foster their own gas sector). 
While the mechanism has been announced as a short-term measure until longer-term structural solutions are found, it sets a precedent presenting the risk of regulatory creep. 
Wood Mackenzie expects the east coast gas shortage to become increasingly acute long-term. 
The risk for producers is that the policy could, over time, be extended in an attempt to try depress domestic wholesale gas prices to LNG netbacks - or lower - in the southern states. 
This would result in even lower than LNG netback prices at the wellhead in Queensland - which would in turn have a number of consequences including lowering overall Queensland gas production, which is price sensitive, reducing Queensland state royalties and Commonwealth taxes. 
So the net effect could be the Australian public partly subsidising some gas-buying companies, and, in particular, it could see Queenslanders paying in for the southern states. 
If Australia were to choose to adopt price regulation and subsidies - whether directly, or indirectly through export restriction policies - there would be trade-offs and costs involved, such as these, that would require consideration. 


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