Peter Milne is a guest contributor at IEEFA.
Economic regulators in Western Australia are grappling with what to do with a gas pipeline that faces the prospect of its economics failing before the steel and compressors.
A recent regulatory skirmish over the Dampier to Bunbury Natural Gas Pipeline (DBNGP) finished in a draw, but the fight revealed cracks in the business case for gas pipeline ownership that will only grow.
The DBNGP is not just any pipeline. It is Australia’s longest at more than 1500km and was the foundation of a massive LNG export industry.
There are cracks in the business case for gas pipeline ownership that will only grow
In the late 1970s, the WA State Government took a huge financial punt to back the DBNGP to connect undeveloped offshore fields in the north with industry in the south. The State Energy Commission built the pipeline and signed 20-year take or pay gas contracts it then had insufficient market for.
Revenue from the gas that first flowed from the North West Shelf (NWS) project in 1984 bankrolled the construction of Australia’s first LNG trains.
Today NWS operator Woodside is an Australian Securities Exchange (ASX) top 20 company; Australia vies with Qatar as the world’s largest LNG producer; and in WA gas fires a huge minerals processing industry and about 40 per cent of the electricity market.
Potential doom loop for regulated gas pipelines
Unlike the eastern states, WA has kept gas prices low by insisting the NWS and later LNG projects reserved some gas for the domestic market. If the Australian Government’s hopes for a gas-fired recovery were to succeed anywhere, WA would be the place.
However, a robust long-term role for gas was not the story the present owner of the DBNGP told the WA Economic Regulation Authority (ERA) when it pitched its case for access arrangements for 2021 to 2025.
Chinese-owned Australian Gas Infrastructure Group (AGIG) argued that the past practice of assigning 70-year lives to all new investments was not realistic now gas had competition.
“While the costs of renewable energy remain (only just) more expensive than natural gas for power generation, and hydrogen is more expensive than natural gas for other uses like heat and chemical processes, the costs of these substitutes are falling rapidly,” AGIG’s January 2020 submission stated.
If nothing changed, spend on the pipeline made at the end of the 2021 to 2025 period under review would not be fully depreciated until 2095. The rise of renewable energy would make the pipeline uneconomic well before then. The question was when.
AGIG argued for regulatory economic life to end in 2059. After a year of voluminous submissions from AGIG and numerous customers, the WA Economic Regulation Authority settled on 2063.
While 2063 is a long way off, the decision almost halved the depreciation period for capital spending in 2025 from 70 to 38 years.
When the next five-year access period is adjudicated in 2026, the end of economic life could well be brought forward to 2050 if Australia gets serious about the Paris Agreement. Investment at the end of the 2025 to 2030 access arrangement would then be depreciated over 20 years.
70 years, 38 years, 20 years. The squeeze is on.
Each cut in depreciation life increases the capital portion of the pipeline tariff, making transporting gas less affordable. That, in turn, could cut throughput, pushing up tariffs further.
It is a potential doom loop for regulated gas pipelines, albeit a slow one.
Pipeline operators enter uncharted territory
Competition from renewable energy may not even allow pipelines to charge the tariff determined by the regulator.
WA Economic Regulation Authority chair Nicky Cusworth said businesses that had expected to operate pipelines until the end of their economic lives in a regulated environment were entering uncharted territory.
“We’re starting to see the combination of technological and policy changes feeding through into the life of regulated assets in ways that maybe weren’t envisaged when the regulations were first drawn up,” Cusworth said.
Cusworth said the ERA would discuss with the Australian Energy Market Commission whether current rules catered for the risk of stranded assets in an energy transition.
Rule changes or not, gas pipeline owners and shippers face a more volatile future.
Rule changes or not, gas pipeline owners and shippers face a more volatile future
“There has to be (more uncertainty), simply because the future of the market is unclear,” Cusworth said, who added that regulators were in a similar position.
The ERA chair said to date, regulators aimed to prevent asset owners from making more than a normal rate of return on efficient investment.
Cusworth said in North America, where the regulation of monopoly infrastructure is less adversarial, there is discussion that regulators adopt a second role: to allow investors to make a reasonable rate of return even if markets change.
AGIG won the argument for a shorter depreciation life, but after a lower rate of return due to current interest rates was factored in, tariffs hardly moved.
If depreciation accelerates in future decisions when interest rates could be higher, tariffs will rise significantly, giving customers more impetus to move from gas to renewables.
In the Australian state where gas is most entrenched, low-risk long-term gas infrastructure investments are slowly looking higher risk and shorter term.
By IEEFA guest contributor Peter Milne who covers energy in Western Australia at Boiling Cold.