Where to next for Australian gas?

Even before the government’s price cap legislation passed through parliament last week, the gas industry was vigorously opposing it. Yet the $12 a gigajoule (GJ) price cap now enacted in law ensures a bright future for gas companies but continual decline for Australia’s manufacturing industries.

The $12/GJ price cap now enacted in law ensures a bright future for gas companies but continual decline for Australia’s manufacturing industries.

The gas industry, however, has continued to characterise the price cap as a calamity, with Santos CEO Kevin Gallagher going as far as to label it a “Soviet Style” response. Mr Gallagher has now warned of gas rationing in the domestic market or the breaking of international contracts.

His counterpart at Woodside and now Chair of oil and gas industry group APPEA, Meg O’Neill, told the AFR: “We need to unlock gas supply now … no-one wants to see energy shortages and gas rationing.”

The fact is there is no shortage of gas in Australia, just a shortage of desire to supply it at a reasonable price to domestic consumers.

Further, the $12/GJ gas price cap actually ensures super profits in the east coast market for these companies as the average costs of production for gas fields in Eastern Australia is around $5/GJ.

Share price reactions from both Santos and Woodside have been muted. Clearly the market does not see the price cap as a “Soviet style” nationalisation or even affecting the companies’ profitability on any time horizon.

The market realises that the domestic market is not the principal driver of profitability of either Santos or Woodside, export markets are. On the east coast of Australia, 72% of gas is exported. 

The gas industry has painted itself into a corner

The gas industry threats of shortages in the domestic market will spur further government action. Neither the prime minister’s nor Chris Bowen’s political careers could withstand gas rationing with consequent electricity price spikes in Eastern Australia.

The government is being forced into a full gas reservation policy on all fields on the east coast. It simply cannot risk real shortages that the producers are threatening.

Will international contracts be broken?

The industry has threatened that a reservation may precipitate the breaking of international contracts. This simply won’t occur. Eastern Australia is swimming in gas. According to the Australian Energy Market Operator, the developed proven and probable reserves — that is, those the gas industry could utilise in the short term — are equivalent to 8.4 years of production at the current record production rates of 2021.

Gas as a transition fuel?

A greater threat to the gas industry than the price cap is the lack of future demand in Australia and globally. In Australia domestic demand is down 17% since 2014 and gas usage for gas-powered generation is down 43% over the same period. Eight big grid battery projects to store renewable energy were announced just this week with a combined capacity of 2GW/4.2GWh, directly usurping gas-powered generation. Each will have grid-forming inverter technology, which provides stability to the grid usually offered through coal and gas.

A greater threat to the gas industry than the price cap is the lack of future demand in Australia and globally.

To get the gas cap package through the parliament the government did a deal with the Greens. While we have yet to see the details of the package it will include subsidies to switch domestic gas consumers to electrical appliances for cooking, hot water and heating. Along with the Victorian government’s Gas substitution roadmap these policies will induce substantial reductions in Australian gas consumption. Demand reduction is one of the most cost-effective ways of increasing supply for exports.

Manufacturing

Gas is winding its way out of the electricity system and homes in Australia. It is, however, vital in local manufacturing of products that are commonly used in Australia such as urea-based fertilisers for our farmers, plastics and alumina. Globally uncompetitive domestic gas prices will see the continued decline of energy-intensive manufacturing in Australia.

Australian manufacturers already face a number of challenges: a relatively small domestic market, high labour costs and distance to export markets. Among the few competitive advantages they do have is abundant energy in most forms – coal, gas, wind, solar and rare earths for batteries. An abundance of gas has not led to low domestic prices in Eastern Australia unlike our Western Australian compatriots. In WA the domestic gas price has commonly traded in the $5-7/GJ range ensuring gas-intensive manufacturing stays onshore.

The $12/GJ gas cap ensures that the decline of gas-intensive manufacturing continues in Eastern Australia.

The $12/GJ gas cap ensures that the decline of gas-intensive manufacturing continues in Eastern Australia. Indeed, the flow-on effects from high domestic gas prices to electricity prices ensures all Australian industry is less competitive. Gas sets the price for electricity when the prices are high in the market. It has an effect on prices far greater than its contribution to generation.

“Reasonable price” clause in the legislation

Perhaps the saviour for our energy-intensive manufacturing businesses is the proposed code of conduct, which is “intended to include ongoing wholesale price regulation through a ‘reasonable pricing provision’ based on production costs and a regulated margin of profit”.

It is this longer-term measure that may provide relief for manufacturers. IEEFA research has shown that $7/GJ would provide a return on equity and a handsome profit for all Eastern Australian gas fields.

The issue for Australian manufacturers is can they survive in the interim or will they close before a reasonable price for gas is achieved.

This analysis first appeared in Michael West Media.