Not without reservations….

When the non government members of the prime minister’s manufacturing taskforce delivered their report last August, all bar two recommendations were given in-principle support.

A sovereign wealth fund and a gas reservation policy were two possible ways that the beleaguered manufacturing sector, suffering under high energy and labour costs and the strong Australian dollar, could be offered relief; both were immediately dismissed.

Neither side of politics currently supports a reservation scheme.

Kicked along by high-profile manufacturing executives (especially those with high energy needs), union leaders and others, arguments regarding a reservation policy came up regularly in the second half of the year. The low gas costs in the US, pushed down by the boom in shale gas exploration, and the corresponding resurgence in the country’s manufacturing industry, were often cited by those in favour of cheaper gas for industry.

Gas developers – who had roughly $200 billion worth of LNG projects in development at the end of 2012 – understandably were less enthusiastic about the idea.

Below are a few quotes from one side of the argument.

– “Cheap energy has fuelled the Australian economy for the 20th century and, with a smart gas reservation policy, could do so again.” – Paul Howes, AWU, Sunday Telegraph, October 21
– "[Australia] has naively allowed the unfettered export of this resource without regard to the immense opportunity lost in not retaining gas onshore for value adding.” – James Fazzino, Incitec Pivot, speech to American Chamber of Commerce, July 26
– “Aside from anything else, the fact that the price of natural gas supplied to industrial users in Australia is about to double should of itself instigate urgent review.” Craig Arnold, September 4, The Australian

As soon as manufacturers and others suggested something be done about the price of gas in Australia, gas and oil companies would dismiss this as a retrograde step, not just for them, but for every gas user, who would ultimately be forced to pay more as the price of exploration became uneconomic.

Both sides of the argument acknowledge the benefits of Australia’s rich supply of gas. This country has, on some estimates, reserves that on projected demand could last another 50 years. And that’s not including its shale gas reserves, the world’s sixth-largest.

Manufacturers’ Monthly has attempted to look at some of the issues around the argument about gas, which is sure to continue over the year.

Exporting away our wealth or encouraging investment?

According to a report released by the Plastics and Chemical Industries Association and the Australian Industry Group last October, Large scale export of East Coast Australia natural gas: unintended consequences, the coming export boom in LNG might forfeit more wealth than it could earn if the gas was used by industry.

The PACIA and AiG-commissioned research suggested constraints to domestic supply were in our future, and “East coast gas prices will rise, potentially to as much as triple the current $3-$4 per gigajoule.”

One of the most unsettling suggestions by the report – which was not an explicit plea for a reservation policy – was that each petajoule of gas exported surrendered over a quarter of a billion dollars’ worth of industrial output.

“That is, for every dollar gained $21 is lost – a worrying figure,” wrote the Ai Group’s CEO Innes Willox in Manufacturers’ Monthly in November.

Other comments about the value-add potential around different policy settings for gas use have been made by executives at companies, notably Dow, Incitec and Alcoa.

According to those who mine gas, without unfettered exports, energy users would suffer. Without the incentive of exporting to energy-poor nations such as Japan, there’d be less reason to develop supplies.

“Without the economies of scale that come from large export volumes, Australia’s gas resources would remain uneconomic and unavailable to Australian industry and consumers,” a Santos spokesperson told Manufacturers’ Monthly.

“Further, these economies of scale would do more to keep down domestic gas prices than any form of reservation policy, which would create market distortions and inefficiencies and render gas more costly than it would otherwise be.”

Cheaper gas: the result of business or government?

Free market advocates support the argument that regulating the supply of gas would ultimately cause the resource to become more expensive. Less incentive to sell to markets that would pay a higher price equals less gas about equals a higher price for what a customer has to pay.

“What you’re actually saying to the developer is ‘we want you to set aside gas for sale domestically,’” Alan Moran explained to Manufacturers’ Monthly.

Moran is an economist and the director of the deregulation unit at the Institute of Public Affairs, a free market think tank.

“Now the implication is that the reason you’d say that is that you want to sell it cheaper, otherwise you wouldn’t bother saying it at all. And one of the real problems is that if you sell gas, say at 20 per cent gas at 10 per cent below the level, the export level price…

“The problem is that the way industry operates is that it doesn’t operate by saying a two per cent reduction. It operates with profit as a driver. And so if you’re earning 15 per cent of your revenue goes to profit, that 10 per cent reduction in profit goes straight off the bottom line, which then becomes quite a significant motivator in terms of whether the project will be viable…So it can cruel a budget.”

On the other hand, those seeking to limit exports argue that there are restrictions across the world, and the United States – enjoying a gas boom and prices as low as $2.50 per gigajoule, spurring what some have called a “manufacturing renaissance” – LNG exports are approved on the basis of ensuring affordable local supply.

The DomGas Alliance – WA’s peak user group – highlights the lack of attention given to local energy users compared to the rest of the world in its 2012 Report in a section headed “Australia is the only country that allows gas exports without prioritising local supply.” Its essential thrust is easy to guess.

The gas industry dismisses this argument, and attributes the low prices in the US to the massive in investment in shale gas extraction technologies and an effective network of pipelines.

“Santos today has the largest number of onshore drilling rigs in

Australia and we have 11 operating,” the company’s CEO, David Knox, told an Australian Institute of Energy Conference last November.

“At its peak in the US, around 1,500 drilling rigs were exploring for shale gas, with both local and International Oil Companies, together with an experienced and mobile drilling service sector – bringing new technology to play, along with a ruthless focus on low cost operations and an appetite for risk.”

Protectionism? Rent-seeking?

Another aspect to the debate is that a gas reservation policy is the contention that it would be a step towards protectionism.

Those in favour of government action to make gas more affordable suggest that Australia’s market is uncharacteristically free (see above) and needs a little intervention.

Misha Zelinsky, the Australian Workers Union’s national policy and economics adviser, told Manufacturers’ Monthly  “every other nation uses its natural resources to promote its economic interest, yet Australia decides that we’re going to let the market decide for us, and that as a result we’re paying higher gas prices in Australia than we should be.”

“Why Australia doesn’t favour its national interests [but] the interests of multinational energy conglomerates is an argument that should be had in the public arena.”

In the eyes of those wanting a free market, regulated cheap energy for some is merely an example of one company’s shareholders subsiding the shareholders of another. If you force a company to sell gas cheaply to Dow Chemical, for example, why not force them to sell their products to industry cheaply?

Moran believes that putting gas aside for local use would be getting government involved in a place where it doesn’t belong.

“It’s a regression to protectionism which some people would like to be cured of, although this present government and indeed the opposition is sort of flirting with that with things like anti-dumping legislation, which is a regression to protectionism,” he said.

“But I think, in terms of set asides, that’s a more blatant attempt.”

Some industrial users have also pointed to the difficulty securing a long-term supply, which seems strange in a country with abundant gas supplies.

“It’s becoming a tightening market – previously there would have been perhaps a bit more diversity,” Miles Prosser, the executive director of the Australian Aluminium Council, told this magazine.

“If you were a large customer you’d be treated in the way you’d expect a large customer to be treated – as someone of interest and worth talking to – but now it becomes harder to get potential suppliers to even be willing to talk about terms and conditions and prices in contracts.”

Prosser agreed – as have many others wanting solutions for gas supply issues – those against gas reservation have a case, but as it stands, the market is failing industrial users.

“Our view is that what we want is a competitive domestic gas market. We’re not after a subsidised domestic gas market or a regulated one,” he clarified.

“Some people with expertise in the marketplace suggest that a domestic gas reservation is one way to do that, others suggest there are other ways. We’re not bound to a particular solution at the moment, but we do want others to acknowledge that the existing domestic gas market is not functioning.”

Other issues

As in the case of the Aluminium Council above, a gas reservation isn’t always put forward as a solution by those with concerns over the energy market.

“A national gas reserve… is a hard option, but all options should be on the table,” Willox wrote in these pages last November.

Others, such as Andrew Liveris, CEO of Dow Chemical, have suggested that the current supply infrastructure isn’t developed enough to serve industrial energy users effectively.

“We have to create an infrastructure such that we can have gas-on-gas on competition domestically,” he suggested last year, comparing a possible solution to having the private sector build a broadband network. “The term reservation doesn't tend to quite cut it.”

Prosser knows his group’s members are especially concerned about the situation – alumina refineries are some of the biggest gas users there are – but concedes they are not experts on how the market works. All the same, issues like pipeline capacity and anything else affecting the price of what they use are worth putting on the table.

“These are the things that we should be considering and someone with greater expertise than me needs to be working through these things and identifying what the key bottlenecks are,” he said.

“If we can increase the diversity and quantity of supply to domestic markets by investment in pipeline infrastructure or by changing the regulations of infrastructure, then that would be a positive thing.”

Likewise, the Australian Workers Union is not wedded to a specific solution (nor a specific target for how much gas should be set aside for industry) but thinks a discussion is long overdue. “I think what we need is a national conversation on the best way to use our energy reserves,” said Zelinsky.

The gas industry thinks the worst approach for those wanting affordable energy would be to interfere in the market.

“Interventionist policies that artificially create a separate domestic market will have a significant impact on Australia’s ability to attract the billions of dollars of international capital required to develop the next wave of unconventional natural gas resources,” said Santos’s spokesman.

“Foreign investment to develop the east coast gas market today is the result of large-scale export contracts.”

Users feel cheated: their access to an essential input is being tightened while a boom in exports looms. To them it doesn’t make sense.

To those who stand to profit (after investing billions and billions, of course) from increased Asian urbanisation and the resulting increased demand for energy supplies, any discussion on how to secure a better deal for users is a plea for subsidies. 

“I can understand why some people on the gas suppliers’ side of the agenda object to the suggestion of domestic gas reservation,” pointed out Prosser. He agrees that more needs to be done to understand the issue by users and others.

“The nature of the debate tends to come straight to the possible solutions and domestic gas reservation is one of them. We’ve sort of missed a step where we need to get some sort of agreement on the problem.”