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Energy & Utilities

Solving Australia’s gas crisis – policy initiatives versus supply side response

25 Jul 2019, by Amy Sarcevic

Amid an escalating gas crisis, Australia is not short of ideas on how to elevate domestic supply. From gas reservation policies, to tougher export controls, prospective energy import terminals, and pipeline proposals and reforms, the gamut of policy initiatives and supply side responses is impressive. But to what extent do each have merit?

“In short, none of the mooted solutions present a silver bullet”, says Saul Kavonic of Credit-Suisse ahead of the Australian Financial Review National Energy Summit. “Particularly against a challenging political backdrop where the imperative remains to save manufacturing jobs, regardless of long-term economic impacts, and we see policy making ‘on the fly’ in response to populist pressures.

“It’s a bit of a catch 22. Any short-term measures which lower gas prices south of the marginal cost of extraction may ultimately disturb the market, deter exploration and lead to more gas being left in the ground. Conversely, longer-term market-based initiatives may not provide the short-term relief we so desperately need to alleviate pressure on manufacturing jobs”.

Recently there has been increased momentum behind the proposed gas reservation policy, in which a portion of domestic supply is mandatorily retained to serve national demand at an affordable rate, and the remainder exported at a significantly higher profit margin.

Australia remains one of the few civilised countries globally, not to have a nationwide gas reservation policy in place. Though one has been implemented in some blocks in Queensland, industry has been somewhat adversarial about a nationwide rollout, given its potential to deter future investment.

“I don’t believe a gas reservation policy is the answer. Any prospective reservation policy is going to take many years to have impact on prices”, says Saul.

“A retrospective approach to gas reservation may counter that, but would be an administrative nightmare, given how interconnected and sophisticated the East Coast Gas Market is. There are fundamental reasons a reservation policy we see in Western Australia cannot work on the East Coast. Moreover, it will likely disrupt the long-term sustainability of the market and prove destructive for both domestic use and exports. We need price signals to encourage more marginal developments”.

The related price-control-based export restrictions policy, backed by Labor, has also received its fair share of industry backlash. Within this model, Government will have powers to pull the rug out from exportation when prices become too high, not just in the event of a shortfall.

Saul disagrees with this approach, acknowledging the harm an annual export restriction policy trigger has already caused the industry. “It has encouraged shorter term contracting – a negative for both gas buyers and sellers who need longer term certainty to make investments”, he says.

“Within these kind of policies, the devil is always in the detail. And the details here are lacking. Based on our analysis, export controls will most likely be ineffective and, to the extent they are effective, could lead to scarcity in the longer term.

“You are fighting an economic wall of increasingly higher ongoing production costs in Queensland. Any policy which suppresses prices below the marginal cost of extraction will deter further exploration and drilling, leaving gas in the ground, as opposed to freeing up more supply at low prices in the domestic market”.

In the wake of the Federal election there has also been mounting pressure to bring down prices by opening up onshore drilling in the southern states. “Onshore drilling restrictions, coupled with the recent royalty hike in Queensland, hurt gas supply and raise prices. We have government policy that is demanding strong action from gas producers, and at the same time, tying their hands behind their backs”, says Saul. But, he admits there is a way to go on the social license front, in terms of lifting the restrictions.

Of all the policy initiatives being proposed, Saul believes that pipeline reform has the most likely chance of getting traction and providing some relief.

“You have existing pipeline systems which are largely depreciated, coupled with weighty pipeline transportation costs. It’s a material part of end user pricing – and a relatively soft political target”, he says. “The challenge for pipeline reform lies in how to bring down legacy costs while still encouraging new pipeline investment, which will likely be needed to avoid shortages within a few years”.

It is ultimately supply side responses, though, that have his backing.

“Supply side solutions are likely to be the most effective. They are market based and structurally sustainable. Having said that, they are longer term solutions. Given the political imperative to save jobs, further government intervention in the market seems inevitable.

If intervention is required, Saul says it should be targeted at manufacturing sectors, which are genuinely at risk, rather than “distorting the whole market”.

Any policy should also incorporate mechanisms to address rent seeking behaviour by buyers, he suggests. “There are gas buyers in the market who see the current policy climate as ripe to seek extra profits via subsidised gas, despite not really facing any existential threat”.

Saul Kavonic heads up oil and gas equities at leading financial advisory firm, Credit-Suisse. Saul will join representatives from BP, Santos and Senex on a panel at the Australian Financial Review’s National Energy Summit – taking place 9-10 October in Sydney.

Learn more and register here.

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