IEEFA Australia: In need of a domestic gas reservation policy to bring electricity bills down

SYDNEY— This week the Australian government announced a new policy to fix retail electricity prices, as a way to reduce increasingly high electricity bills for people living on the east coast,  but failed to enact additional reforms including a much-needed national energy policy.

Prime Minister Scott Morrison and Energy Minister Angus Taylor’s announcement demonstrates that the government now recognises that consumers would never get lower bills without a regulated price for electricity in the absence of a competitive marketplace.

A big shortcoming of their initiative however, is that it fails to tackle two major issues: the network costs of poles and wires, where the biggest savings in retail prices could be made, and the absence of a ‘domestic reservation policy’ on the east coast earmarking Australian gas for Australian consumers. Thus, the fixed price initiative is likely to fail in putting downward pressure on bills.

Australia’s national electricity market includes:

Generation – power stations make electricity

Transmission – power lines carry electricity from power stations via transmission towers to substations in towns and cities

Distribution – electricity is carried into homes via poles and wires

Retail – Metering and sale of electricity to consumers

Until the 1990s, state governments in Australia owned and ran all aspects of the electricity market, but ownership of the electricity market is now broken up and shared by a mix of government and private companies.

These private energy companies can make profits through the size of their asset bases: the more money they spend, the more money they make. The companies ‘gold plated’ their poles and wires in the distribution system, charging their customers for the privilege of receiving electricity. Demand however did not rise substantially so it was a poor investment which must now be written off.

The Australian Competition and Consumer Commission (ACCC), a consumer watchdog agency, recently recommended that the Australian government subsidise the write-offs to reduce electricity prices.   Alternatively, the energy companies could accept they made a poor investment and own the cost failure. If energy companies would write down the value of their assets, energy charges would fall.

The other significant mechanism the government failed to tackle this week is electricity generation, and specifically the influence of gas prices in the system.

Australia’s high electricity prices are caused by high gas prices. Gas sets the price because it is the highest cost producer in the electricity market. As the ACCC recently noted, when gas prices increase by $A1/per gigajoule (Gj), wholesale electricity prices increase by$A11/Megawatt hour (MWh).

Australia’s high gas prices are the result of high oil prices and price fixing by a group of producers on the east coast of Australia – Shell, Origin, Santos, BHP and Exxon – which we have no hesitation in calling a cartel. These producers sold out Australia’s domestic supply in 2012 when they locked in 15-year export contracts tying the price of Australian gas to the price of oil. At the time, the price of oil was over US$100 a barrel. But oil prices subsequently fell below US$50 a barrel, and suddenly these gas companies were in a lot of financial trouble.

The usual way to develop gas markets is by drilling out fields and supplying domestic markets first, with exports coming next. But because the east coast cartel of gas producers had locked in 15-year export contracts before ensuring supply, they ended up diverting cheaper traditional sources of gas for export In order to meet these obligations.  They used the failing LNG export plants to collectively reprice domestic gas to above international parity prices.

Australia’s east coast market became one third domestic and two thirds exports. While production of gas tripled to meet export demand, the price of domestic gas also tripled.

Most countries have a domestic gas reservation policy at a price that sits well below international parity, or they have a national interest test: something like, before you open a facility you must guarantee it will not affect domestic prices. Australia does not have a national interest test, but on application, companies had to spell out their intent. For example, the Gladstone LNG environmental impact statement (EIS) clearly stated they would not affect the domestic market.

Australia’s major exporter competitors – to whom they should compare their prices—are the U.S. and Qatar. Gas prices in the United States are under half what they are in Australia, and in Qatar they are around one third of those in Australia.

Even Western Australia has a domestic gas reservation policy. They pay $5/Gj for gas.

But the east coast of Australia remains an energy policy-free zone and consumers keep picking up the tab for higher prices. Locals pay $10/Gj for contract gas, and the price is set to increase to a whopping $15/Gj, a fifty per cent increase in the short term.

Gas policy and gas royalty arrangements have had a paralyzing political effect in Australia, but it is time now for policy makers to move on. The east coast gas oligopoly needs an urgent shake-up. There is no ‘free’ market, and gas prices are through the roof.

The government needs to rectify the cost and availability of domestic supplies by expanding upon the ACCC’s recommendation to apply a gas reservation policy on any new fields on the east coast, by applying it to existing fields where the gas reserves are located.

A full gas reservation policy on all gas fields will reduce gas prices while enforcing the original terms of the company’s LNG plant contracts where they said they would not affect the Australian domestic market.

While we applaud the government’s price control initiative responding to the total market failure in electricity in Australia, an additional distribution network write-down and a full domestic gas reservation policy on existing gas fields would ensure lower electricity prices for all Australian consumers.

Bruce Robertson is an IEEFA Australia-based investment analyst. He can be reached at [email protected]. A version of this column first appeared this week on the public-interest website michaelwest.com.au.

Related items:

IEEFA op-ed: Gas oligopoly is gouging Australia

IEEFA Australia: A gas cartel run amuck

IEEFA Update: Australia’s National Natural-Gas Scandal