Australian Competition and Consumer Commission Chairman Rod Sims today shared some early insights from the ACCC’s inquiry into the east coast gas market in a speech to the Eastern Australia’s Energy Markets Outlook conference in Sydney.
Gas seems to be an energy commodity in eastern Australia particularly amenable to government inquiries. Nearly all state governments or parliaments have reviews under way into some aspect of gas markets or production.
A consistent theme of previous inquiries, such as the Department of Industry and Science Market Study, is that they have not been able meaningfully to assess conflicting claims from gas suppliers and gas users about prevailing supply and demand conditions.
The confidential nature of gas supply negotiations and the terms available in the gas market also meant that it was difficult to determine policy recommendations for government out of these inquiries.
Indeed many aspects of the east coast gas market are opaque and complicated.
- The market is dominated by confidential, bi-lateral contractual arrangements which make price discovery almost impossible.
- Trading markets are immature and illiquid, with conflicting views as to their utility.
- At nearly all points along the value chain, the market is dominated by large players: be they gas producers and processors, pipeline operators or gas aggregators and retailers.
These types of characteristics have the potential to set a market up for the inappropriate exercise of market power.
Partly driven by this, on 13 April this year, the Hon Bruce Billson MP, the Minister for Small Business and the Minister for Industry and Science, the Hon. Ian Macfarlane MP, announced the ACCC would undertake an East Coast Gas Inquiry.
Holding the formal inquiry under Part VIIA of the Competition and Consumer Act 2010 allows the ACCC to use compulsory information gathering powers to cut through some of the opaqueness of the market. It allows us to clarify some of the uncertainties that colour much of the debate around the east coast gas market.
While we are not quite at the halfway mark in our 12-month Inquiry, and we are still some way off drawing conclusions, there are some preliminary observations I would like to make today.
- First, it is apparent that the arrival of the major LNG projects has upended the east coast gas market, likely permanently.
- Second, gas user complaints about a dearth of offers for the supply of gas in recent years are largely true. I will also discuss some other supply issues.
- Finally, I will outline briefly some of the issues and questions we need to address as part of our Inquiry.
1.The arrival of LNG has upended the east coast gas market
As we all know, QCLNG has commenced production from both its trains, and GLNG and APLNG are ramping up their initial trains towards production. Already LNG demand equals the total domestic demand of the east coast gas market.
By the time all six trains are operating, east coast gas production will need to have tripled to meet both LNG and domestic demand from industrial, commercial and household customers and the remaining gas-powered generation.
This burst in demand for gas over a very short timeframe for the LNG industry is effectively upending the east coast gas market.
To meet these changing market dynamics, transmission pipelines are being inter-connected and flows being made bi-directional. In other words, the transmission network is being prepared to enable some gas to flow north out of southern production areas and into Queensland.
There was originally a strong presumption that CSG with some incremental supply from the Cooper Basin would largely supply LNG demand.
Indeed, at one time it was thought that CSG in Queensland and unconventional gas out of the Cooper Basin was going to drive an LNG boom with 16 or more trains being mooted by different projects using gas sourced out of these areas.
However, despite this early expectation of a gas production boom, the east coast market seems to be perhaps one of the few gas markets in the world which is now living under the shadow of supply uncertainty.
These uncertainties are being exacerbated, but not necessarily caused by, the fall in oil prices with its links to international LNG prices.
One could argue that expectations of perpetual US $90 - $100 oil, which seemed to have pervaded markets since the commencement of the so-called resources super-cycle, has been proved wrong along with so many other commodity price expectations that went with super-cycle optimism.
We may well, instead, now be back at something approaching an historic average price for oil.
The industry is confronted by a much tougher outlook, where it needs to source lower cost gas to compete in a potentially over-supplied international market, and where aggressive cost cutting will be important to ensuring the success of the LNG Projects.
It is often said that linking the east coast market to international gas markets means domestic prices netted back from international prices. However, with lower oil and LNG prices, and a falling Australian dollar, it is becoming increasingly unclear as to what exactly a netback gas price for the domestic market should be.
The Inquiry is coming to grips with these issues. We are only about half way through our timeline and progressing through our hearings with industry participants and analysing a raft of documentary evidence.
While the Inquiry is still some way from drawing specific conclusions or recommendations there is one observation on the gas market that I can make.
2.Gas Users were largely right
It is clear from our work so far that the claims by gas users that there was a marked change in the gas market after the final investment decisions by the LNG projects in 2010-11, and that there was then a dearth of offers for the supply of gas, are largely true.
We have evidence that many domestic users went from a market where they received, say, 3 – 5 offers of supply on terms that were able to be negotiated, to one where they received zero or one true offer, on largely take-it-or-leave-it, inflexible terms.
Particularly during 2012-2014 it was hard to find signs of an effective domestic gas market.
When you look at some of the gas deals that were struck in this period, it is clear that a number were related party transactions with the LNG projects shoring up supply positions, or other deals between suppliers.
It does appear, however, that during 2014 and into this year, there may be some more offers in the market.
This has coincided with some slippage in the LNG project timeframes which has freed up some gas for the domestic market coupled with early CSG ramp gas also being available.
Some have also asserted that once the Government started to publically canvas the idea of an ACCC Inquiry into the gas market, behaviors also changed. The prospect of regulatory scrutiny can affect behaviour.
There remain, however, large changes in the terms and conditions of gas supply. Some of these are bringing increased risk for gas users.
Gas supply contracts now tend to be for considerably shorter duration and at higher prices. The current contracts also have much less flexibility around some of the delivery conditions.
As an example, a contract struck today for the supply of gas may be only for one, two or three years. It may now have some form of oil price linkage.
It may also have a lower limit of liability for a producer’s non-performance in the delivery of gas, coupled with a higher obligation on the buyer to take or pay the contracted quantities. It is unlikely to include provisions for banking gas and it will have limited flexibility on usage.
The shortening in contract length, however, may have advantages for some gas users who are uncertain about future gas use, and current low oil prices may now be providing a lower gas price.
Gas User Strategies
In response to this uncertain environment, there is evidence that gas users are also changing their behaviour.
Gas users started responding to the lack of offers in the market by taking on deals which entailed moving to unfamiliar territory of exploration risk in return for assured supply. The big proviso in these deals is that the exploration and development of new gas resources is successful and new supply becomes available.
Some larger gas users are going short on supply contracts and relying on the short-term trading markets (STTMs) to fill any supply gaps. Other users are relying entirely on trading markets for gas supply with smaller users relying on agents to utilise trading markets for them.
There has been a range of views expressed on the usefulness of STTMs, and the Wallumbilla Gas Supply Hub, but there is evidence that there is a gradual increase in volumes traded and a resultant increase in liquidity in these markets.
However, for trading markets to flourish, suppliers and gas users need to be confident they can access pipeline capacity to shift gas into the markets or for buyers to move gas from a trading hub.
The Inquiry is looking at whether capacity constraints or unwillingness to trade capacity is limiting the ability of gas users to access appropriate supply deals available in the market.
With a shortening of gas supply agreement terms, the misalignment with longer term gas transport agreements also has the potential to increase risk and transaction costs for shippers. This may be challenging some of the assumptions that have underpinned pipeline business models of long-term foundation customers and sure rates of return.
It will be important that in the current round of market reform consultations being undertaken by the Australian Energy Market Commission (AEMC), that any reforms proposed to these trading markets fosters their growth, making trading simpler and more efficient and not stifling growth through increased uncertainty on market direction.
The ACCC is working with the AEMC to ensure that the findings of our Inquiry informs the work of the Commission..
In this market characterised by uncertainty, the scope, timing and changes in LNG demand will be critical. It will be important to establish with some certainty if production meets project expectations and if the reserve base of these projects is sufficient to cover production over the life of the project.
The Inquiry team does understand that reserve certification is a somewhat fluid science, with changing prices, technological innovation, new infrastructure or changing regulatory frameworks all having the potential to facilitate increases in reserves into the future.
As we have seen recently, this can also go the other way, with a number of reserve write-downs occurring over the past 12 months.
However, the size of the LNG demand and the supply base required to meet that demand, will continue to place uncertainty and risk into the market.
Only relatively small swings around LNG production are required for supply to be either coming into or being withdrawn from the domestic market. In a tight market, even a relatively small swing in volumes has the potential to have comparatively major impacts on domestic users either through price or supply.
In this environment, you would expect that the upstream sector would respond to price signals in the market and look at new opportunities for gas production.
There are a number of projects and companies that are responding and see this tight supply situation with rising prices as an opportunity to bring on new projects.
Importantly, there is the potential here not only to increase overall supply but also to increase the diversity of supply both in terms of the basin source and in the number of actual producers.
As is often the case in a cyclical sector, the fall in oil prices is, however, bringing pressures on a number of these companies who have either relied on oil revenues to fund gas exploration and development projects, or who are caught up in the general capital malaise facing the sector and are unable to access development funding.
Some projects also face difficulties gaining necessary approvals, and moratoriums on new supply are also in place.
Moratoriums seek to address community concerns about the environmental effects of gas projects. However, they are a blunt instrument and do come at a potential cost of delaying further gas resources being developed and more gas being made available in a tight market.
In addition to investment in new supply, new gas storage would also be welcome in the market.
New storage would assist in smoothing some of the demand fluctuations especially in the southern states and could be a contributor to increasing the efficiency and liquidity in trading markets.
While new supply is to be welcomed and encouraged, existing supply is also an important focus for the Inquiry. With Queensland and to some extent the Cooper Basin becoming effectively an LNG production zone, albeit with a number of legacy domestic contracts, the southern states will be increasingly reliant on the Gippsland Basin for gas supply.
The Inquiry has not reached any conclusions as to the materiality of joint marketing out of the Basin, but its importance to the market means that it is an issue which we must and will consider.
Shell / BG Proposed Merger
The other ACCC involvement currently is to assess the large acquisition of BG Group by Royal Dutch Shell.
The ACCC will today release a Statement of Issues regarding the proposed acquisition.
Currently, Arrow has the largest quantity of uncommitted gas reserves in eastern Australia and there are a limited number of other potential suppliers to the domestic market.
The ACCC’s preliminary view is that the proposed acquisition will align Shell’s Arrow interests with BG’s interest in QCLNG, which may see Shell prioritise supply to LNG and decrease the incentive for Arrow to supply gas to the domestic market. By removing some (or all) of Arrow’s gas from the domestic market, the proposed acquisition could substantially lessen competition in either the Queensland or eastern Australian gas market.
We have not formed a firm view on this. To use the parlance, this is an amber light concern. We are seeking information from interested parties to help us further assess this acquisition.
3.Some questions we need to address
While it may be tempting to view the pre-LNG world on the east coast as a halcyon time of sure supply, low prices and easy contract terms, there were also supply uncertainties which drove projects like the PNG Gas Pipeline, where markets were disconnected and somewhat inefficient and where negotiations may have been just as tough as those occurring today.
The dynamics of a market shaped around a dominating demand feature like LNG, however, is new and the market cannot return to models that may have worked, albeit not optimally, before LNG.
The Inquiry is still to hear some of the counter views to the above story of market failure, where supply is uncertain, and where prices are unrelated to costs.
Notwithstanding this, I think it is clear that we are in an environment which is not merely in a transitory phase of adjustment but which is moving to a new dynamic.
The Inquiry will be considering if the mechanisms available to market participants to manage risks around supply, demand and price are adequate in this new environment.
The Inquiry is looking across the gas value chain and will be making recommendations to Government on where reform is required, how markets can become more efficient and if significant market power and competition concerns exist in the east coast market.
Thank you for your time this morning.