ACCC Chair Rod Sims delivers an address to 2019 APPEA Oil and Gas Conference in Brisbane. Mr Sims discusses the state of the east coast gas market, gas prices and regulation in this sector.
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It is a pleasure to be here today at this conference.
This year the oil and gas industry achieved a significant milestone as Australia overtook Qatar to become the largest exporter of natural gas in the world. In doing so, you have boosted GDP, created local jobs and benefited the local economies in Queensland and Western Australia significantly.
In the east coast, you have transformed the gas industry by creating an integrated gas market, extended the life of some declining conventional gas reserves and unlocked the potential of unconventional gas resources, particularly CSG in Queensland.
However, what you have not yet achieved is the security of supply and sustainable prices for the domestic market in the east coast.
Domestic wholesale gas prices have risen two to three times higher than historical prices in a relatively short period, putting many trade-exposed Australian manufacturers under extreme pressure to remain internationally competitive.
There is also continuing uncertainty about the longer term supply outlook. In its latest Gas Statement of Opportunities (GSOO), AEMO has warned about potential supply shortages emerging on the east coast within five years, particularly in the southern states.
In this environment, it is very challenging for businesses to make long-term investment decisions and it is also challenging for governments to consider their response when businesses start to close or relocate their operations.
Governments certainly have a role to play in addressing these issues. I have been vocal in urging state government to provide access to gas resources and encourage development of infrastructure.
In this address leading up to the panel discussion, I want to touch on some of the things you can do to respond to these issues.
I will cover three topics.
- The state of the east coast gas market and what wholesale gas prices mean for the manufacturing sector. While I have said this before, it is worth repeating.
- What the industry can do to provide immediate price relief to the manufacturing sector and guarantee security of supply in the longer term.
- What the ACCC will be doing for the remainder of our current inquiry to help bring about a more transparent and functional gas market.
1. Gas prices have stabilised, but potential gas shortages are looming
One of the questions included in the program for this plenary session is whether there is a way to ensure that the export market operates without government intervention. To answer this question, you have to pinpoint what has brought on the intervention to date. This is not difficult.
The east coast of Australia is just about the only region in the world that allowed unrestricted exports in a liberalised gas market. However, signs quickly emerged that transition to an internationally exposed market was not going smoothly.
In the ACCC’s 2015 gas inquiry, we found that many large industrial gas users were having real difficulties sourcing gas. For too long, many simply could not get any offers for gas, and those that did received offers at very high prices and with less flexible terms and conditions.
The ACCC made a number of recommendations to improve the transparency of prices and the operation of the market. Many of those recommendations have now been implemented.
From your perspective, warning bells should have been ringing then that you need to pay greater attention to what is happening in the domestic market.
When the ACCC’s current gas inquiry began in April 2017, the gas market was even more dysfunctional than during the first inquiry. Those domestic gas buyers in the east coast that could get offers for gas supply were receiving offers at prices well in excess of export parity prices. The highest priced offers made by retailers peaked at $22/GJ.
It should not have been a surprise what then followed. The Australian Government enacted the Australian Domestic Gas Security Mechanism and, following the ACCC’s report on the state of the gas market, reached a Heads of Agreement with the LNG producers. Under the terms of this agreement, the LNG producers committed to offer sufficient gas on reasonable terms to the domestic market.
Following the government’s intervention, and, I believe, only as a result of it, domestic offers reduced substantially. By 2018, domestic prices stabilised in the $8–11/GJ range and converged with export parity prices.
The bulk of commercial and industrial gas users in the east coast market have now secured gas for 2019. We have found that most gas users are paying at least $9 per gigajoule and some more than $11 per gigajoule.
Smaller C&I gas users who do not have the option of sourcing gas from producers, and instead rely on supply from retailers, face higher prices. Most have had to settle for prices above $10 per gigajoule, and some above $11 per gigajoule.
As LNG prices rose over the course of 2018 because of an increase in the global demand for gas, so did domestic prices. By August 2018, some offers to large C&I gas users exceeded $12/GJ.
C&I gas users have been telling us for some time that at those gas prices, their operations are not sustainable in the medium to longer term. They are increasingly likely to relocate from the east coast or wind up their operations.
In the first quarter of this year, RemaPak, a Sydney-based producer of polystyrene coffee cups, and Claypave, a Queensland-based brick and paving manufacturer, went into administration. Both cited rising gas costs as an important contributing factor.
Many other manufacturers are close to making critical decisions on their future operations. If wholesale gas prices do not soften, it is just a matter of time before they follow RemaPak and Claypave.
If more businesses start to fail, pressure will inevitably ramp up again on governments to do more.
Exacerbating this situation is the uncertain longer term supply outlook.
In late March, AEMO released its 2019 GSOO for eastern and south-eastern Australia, warning about potential looming shortages in the east coast. The GSOO forecasts that gas shortages in the southern states could arise as soon as around 2024 in the absence of major pipeline infrastructure upgrades to allow more gas to flow from Queensland, or new sources of supply emerging.
AEMO is not alone in its forecasts. EnergyQuest’s March 2019 quarterly report forecasts gas shortages in the southern states even earlier than 2024 and forecasts broader east coast-wide shortages beyond 2026.
2. Sustainable domestic prices and more investment in gas development and infrastructure are required
This brings me to my next topic; what the industry can do to provide immediate price relief to domestic manufacturers and avoid potential looming gas shortages in the longer term.
In the short term, if gas suppliers do not want to drive domestic gas buyers out of the market, then they should not offer prices that see businesses close.
A number of C&I gas users have told us that some gas suppliers were quick to put the domestic prices up when expectations about export parity prices were increasing last year. These expectations have fallen significantly over the past six months. The 2020 average of expected LNG netback prices at Wallumbilla fell from around $11 per gigajoule in October 2018 to around $9 per gigajoule as at the end of April 2019, where, based on our latest information, it is still sitting.
We expect that those same suppliers have revised their prices down this year to reflect these latest expectations as quickly as they escalated them last year.
Suppliers should also be mindful how they engage with prospective customers. Refusing to respond to requests for offers, and instead insisting that users participate in the supplier’s own expression of interest processes, does not create an impression that a gas supplier is actively participating in the domestic market. Worse, it can indicate a level of contempt for the local market.
Everyone in this room knows that the best way to avoid potential looming shortages flagged by AEMO is to bring on additional supply by accelerating investment in gas exploration and development. Current domestic gas prices should be providing strong signals for this investment to occur.
For our December report, we asked suppliers to provide us with their estimates of production for the period from 2020 to 2030 from proved and probable reserves as well as contingent and undiscovered resources.
Consistent with AEMO’s forecasts in its recent GSOO, current estimates of production from proved and probable reserves are not likely to be sufficient to meet the expected demand over the next decade. This is particularly critical for gas users in the southern states, who are likely to become increasingly reliant on gas from interstate or overseas in the absence of new developments.
A number of producers flagged that they expect to produce gas from contingent and undiscovered resources. This includes additional quantities of gas from basins in the southern states that are currently in decline.
Investment to convert contingent and undiscovered resources into proved and probable reserves is critical for the domestic market, particularly in the southern states and, indeed, was needed a number of years ago.
We will be watching with interest whether producers carry out those investments as planned.
If additional supply does not come on in the southern states in a timely manner, then, as AEMO has flagged in its March GSOO, further investment in infrastructure will be required. If more gas will need to flow from Queensland, then there will likely be a need to expand pipeline capacity on the key pipelines and increase storage capacity in the southern states. Alternatively, gas could be imported into the southern states through an import terminal and, as you are well aware, there are currently five proposals to do so.
However, I wish to emphasise a critical point. The level of future domestic prices in the southern states will depend on the marginal source of supply in the southern states. Producing additional gas in the south is likely to result in much better pricing outcomes for domestic gas users than transporting gas from Queensland or importing it through an LNG import terminal.
Therefore, I urge the producers to carry out the investment in gas production they planned. Also, as I have done for some time now, I urge state governments to play their role in providing access to gas resources by adopting policies that consider and manage the risks of individual gas development projects, rather than implementing blanket moratoria and regulatory restrictions.
3. The ACCC to continue to promote transparency, monitor progress of reforms and monitor the operation of the market
I now turn to the role the ACCC has been playing, and continues to play, in the market.
Over the course of the current inquiry, we have undertaken substantial work to promote transparency, monitor the progress of reforms, and report on the operation of the gas market.
More transparency is needed to assist market participants
As many of you know, the gas market in eastern Australia has traditionally operated in a very opaque manner. This opaqueness has hindered the market’s ability to respond efficiently to the changing market conditions.
We have therefore sought, in this inquiry, to improve transparency by publishing a range of information on upstream activities, transportation and storage services, and the prices paid for gas and infrastructure services.
But there is much more work to do.
Late last year we provided to the Australian Government and the COAG Energy Council a joint report prepared with the Gas Market Reform Group on measures to improve the transparency in the gas market.
The joint report emphasised that the level of transparency in the east coast gas market is poor compared with other developed countries. While steps have been taken to improve transparency, there is still nowhere near enough information available about:
- reserves and resources and other upstream activities
- infrastructure availability and developments
- gas and infrastructure prices, and
- LNG shipments and operations.
To address this, the joint report recommended the implementation of a range of transparency measures, spanning all aspects of the supply chain.
One such transparency measure is the reporting framework for reserves and resources. The current reporting of reserves and resources across the east coast is fragmented and inconsistent. In response, the joint report recommended that suppliers should be required to report information on their reserves and resources to AEMO on a consistent basis, based on the reporting framework developed by the ACCC.
We have developed a framework that we believe will best address the information gaps. Over the past few months, we consulted on this framework with market participants and provided our final recommendation to the COAG Energy Council Senior Committee of Officials.
We have also made further recommendations on continuing reporting of long-term prices and export parity prices post the ACCC inquiry.
All these recommendations will form part of the broader consideration of the transparency measures by the COAG Energy Council.
A more efficient transportation network is required to enable gas to more easily move to highest value users
In a tight market, access to competitively priced capacity on key pipelines has become critical to ensure that gas can freely move to where it is needed the most. Another key area of focus for the ACCC is therefore the progress of the pipeline reforms, many of which have been implemented in response to the findings from our previous inquiry.
These reforms are twofold. First, a new information disclosure and arbitration framework was implemented on 1 August 2017. It is intended to place a constraint on the exercise of market power by pipeline operators that were previously unregulated.
Second, a range of capacity trading reforms came into effect on 1 March 2019. These reforms should improve the efficiency with which capacity is allocated and used by increasing incentives for shippers to trade capacity and by posing constraint on the prices charged by pipeline operators.
The ACCC has concerns with some of the information published in October last year by pipeline operators that are subject to the new information disclosure requirements.
For example, some of the financial information published by pipeline operators seems to suggest that they have not recovered any of their original capital investment. This is very surprising given pipeline operators have previously provided information indicating investments are normally fully underwritten by shippers through contracts and they do not tend to build pipeline capacity on a speculative basis.
Further refinement of the information disclosure requirements, and greater scrutiny of the information published by pipeline operators pursuant to those requirements, will therefore be necessary.
The ACCC is currently analysing relevant information provided by pipeline operators. I note that the level of cooperation and timeliness of the provision of information by some pipeline operators has been disappointing. We will report on our examination of the information provided in July 2019.
The ACCC to review the costs and margins of the three largest retailers
As we reported in December, the ACCC is currently reviewing the costs and margins of the three largest gas retailers — AGL, EnergyAustralia and Origin.
Preliminary analysis shows that the average earnings before interest, tax, depreciation and amortisation of the three retailers over the period from 2014 to 2017 ranged from $1.60/GJ to $2.29/GJ and accounted for 15 to 21 per cent of the delivered price of gas.
We will be reporting in more detail on this in July.
Future work of the inquiry
The ACCC gas inquiry is due to finish in April 2020.
For the remainder of the inquiry, the ACCC will continue to focus on the issues I raised today and to monitor the actions of market participants across the entire supply chain.
The ACCC will also continue to improve transparency in the east coast gas market by publishing key market information, monitoring the effectiveness of reforms and monitoring the operation of the market.
Thanks for your time. I look forward to continuing the conversation about these critical issues during the panel discussion.