Gas prices and global competition

Image: Sergio Dionisio/Bloomberg

Australian manufacturers are facing ever-escalating prices for gas.  In 2016, local spot gas prices have gone from being substantially less than those in Japan to being substantially more. Spot prices will put pressure on contract prices.

On average spot gas prices in Australia were 33% higher than Japanese prices in the  month of July 2016.  The previous month the situation was even more absurd, with  Australian consumers paying  on average 62% more than their Japanese counterparts for gas produced in Australia.  Australia is the world’s biggest exporter of LNG and Japan is our largest customer.

Australians should pay substantially less than their Japanese counterparts.  To get the gas to Japan it must go through the expensive liquefaction process and be shipped in purpose-built vessels,  a process that costs at least A$3/GJ.

In Australia there are three Short Term Trading Markets, run by the Australian Energy Market Operator (AEMO) operating in Sydney, Brisbane and Adelaide.

The volatility within the three spot markets as shown in the graphs below makes spot gas markets in Australia virtually useless for Australian manufacturing businesses.  What the graphs do not show is that the daily volatility is even greater.


Chart1.jpgIn Adelaide in July local consumers paid 65% more for gas produced in South Australia than the Japanese for the same gas.chart3.jpg


In Brisbane in July local consumers paid 20% more for gas produced in Queensland than the Japanese for the same gas.


chart2.jpgIn Sydney in July local consumers paid 14% more for gas produced in Australia than the Japanese for the same gas.  In June the situation was more extreme with Sydney consumers paying 82% more for gas produced in Australia than the Japanese for the same gas.

Historically, the East Coast Australian gas market was domestic only, with stable prices around A$3-4/GJ.  With the building of the three LNG export facilities at Gladstone, the East Coast Australian gas market was opened up to exports the market went from being a wholly domestic market to a “global market” with prices linked to “global prices”.

What has transpired however, is that local prices are now above those of the most expensive market for gas in the world, the north Asian market.

The gas industry often quotes the term “global market” and the need for Australian consumers to pay “global prices”.  It then proceeds to cherry pick the most expensive gas market in the world, the north Asian market, to compare us to.

A far more appropriate comparison for global prices would be the third largest LNG exporter in the world, and one of the largest domestic markets in the world, the USA, where domestic consumers pay $A3-4/GJ.   Perversely, the same price as East Coast Australians used to pay prior to the LNG export industry opening up the market.

Spot prices are, of course, only part of the problem.  Contract prices are even more important for the manufacturing industry.  Unfortunately, information is sparse in the gas industry.  What is known, however, is that as of December 2015, according to the Australian Competition and Consumer Commission (ACCC) prices had risen pretty consistently and stood at A$8/GJ nationally.  This is around the current contract price in Japan.

It must be remembered that prices in Australia should not include the costs of liquefaction and shipping and so should logically be at least, very conservatively, A$3/GJ less than those in Japan.

So why are you paying way over the logical price for gas in a nation that is awash with cheap gas supplies?

Lack of Transparency the key

The first reason is the extreme lack of transparency and lack of information that Australian consumers and policy makers can obtain from the gas industry.

In the production part of the industry, reserves and resources are calculated using totally different assumptions as to oil prices, gas prices, forward curves for prices and exchange rates.  This makes inter-company comparisons extremely difficult and industry aggregation almost impossible.  Essentially no one really knows the reserves and resources of gas that exist in Australia today.

The same goes for current production capability of the wells that are in existence.  No policy makers can tell you what the current production capability of the industry is.  It makes a mockery of claims of a “gas shortage” in a nation like Australia that is awash with cheap gas.

You do not have to believe me however, you can believe the head of BHP petroleum Mike Yeager, who said in 2012:

“We want to make sure that the market knows that the Bass Strait field still has a large amount of gas that’s undeveloped,” Mr Yeager said. “We have a lot of gas in eastern Australia that’s available. It’s more important to let the citizens of Victoria and New South Wales, and to some degree, you know, even Queensland … there’s plenty of gas to supply those provinces for – you know, indefinitely.”

The same goes for the transmission pipeline sector of the industry where super monopoly profits are being made at the expense of Australian manufacturing industry.  This is a whole topic on its own that has been covered in this article.

Suffice it to say that in the UK, Europe and the USA gas transmission pipelines are heavily regulated as to price and availability.  Pipeline companies are also forced to produce individual pipeline accounts.  No such regulation or transparency exists in Australia and hence pipeline costs domestically are not globally competitive.

Market Structure

 The market on the East Coast of Australia is dominated by five companies: Shell, Origin, Santos and BHP/Exxon.    With so few major producers, one would have thought that our regulators would be particularly wary of anything to lessen competition, however, the ACCC has allowed BHP and Exxon to form a “Joint marketing arrangement”, further lessening competition.

The power of this “Joint marketing arrangement” in the domestic market has been enhanced, as the other companies in the industry are heavily committed to the export industry through their shareholdings in the three LNG plants at Gladstone.

It is little wonder that manufacturers fail to get many offers for gas or at a reasonable price.  The cartel of gas producers has no incentive to sell gas at a reasonable price.

Global Glut

 While prices in Australia continue to rise,  globally gas is in a state of glut and prices have crashed.  The oil-linked basis of contracts is under threat and contract defaults have already begun to occur.

While gas prices are depressed globally our major customers Japan and Korea are faced with declining demand and a surplus of contracted gas.  They have had to re-export some gas.  Essentially, our customers are now competing with Australian producers on the global spot market for gas.  Gas prices will stay depressed as the spot market gets flooded with gas.

The glut will deepen into 2017 and 2018 as more plants that are nearing completion open and demand is crimped by declining demand and competition from renewable energy sources.

 The Solutions

The manufacturing sector has been poorly served by its peak bodies that have failed to grasp the scale or the causes of the problem.  Many are now calling for the opening up of more onshore gas into a global gas glut.  This will not solve the problem.  Onshore gas in Australia is more expensive to produce than offshore gas and producing expensive gas is no method of bringing down the price.   In addition most of the onshore permits are owned by the existing members of the Cartel.

The existence of a Cartel is the problem.  The market structure allows the gas companies to extract extraordinary prices for gas domestically in the face of a global glut and globally depressed prices.

Until policy makers and peak bodies recognise that the market structure is the problem all solutions proposed will fail.

Australian manufacturers do not have the luxury of time to watch the proposed reforms fail.

Bruce Robertson, Analyst
Institute for Energy Economics and Financial Analysis
Ph 0434 197 932

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