The greenies are getting a bit desperate. They are clearly worried about the political implications of the substantial increases in the domestic price of gas that are coming down the pike.
These increases are hefty, in the order of 25 per cent or more, and are unlikely to end there. Nothing to do with us or our opposition to fracking (hydraulic fracturing of rock to release natural gas), they will claim.
Their approach is to wheel out some tame economists and see if they can divert attention from the obvious conclusion that if the supply of new gas reserves is constrained, then the price will rise.
Now economists are useful, and even this is debatable, only when they get their facts straight. But when these tame economists claim there is a world price for gas, that demand for gas is effectively limitless and the supply curve is perfectly elastic, they are talking through their hats.
They would have been better served had they looked into the history of gas prices in Australia and to observe the resistance of local users to lock in long-term contracts at lower prices than are now available — because they thought they could get a better deal, which they now can’t.
And how do these apologists for the green movement explain the fact the price of gas in the US has fallen from $10 per 1000 cubic feet to less than $3?
That would be because of fracking and the dramatic increase in the exploitation of unconventional gas. More supply has driven lower prices — the basic laws of economics have not been suspended. So here is the real story about gas prices in Australia.
Until recently, gas in eastern Australia was not a traded commodity; it could not be exported, it could be used only locally. Historically, the price of gas was heavily regulated by state governments and, even now, there is price oversight at the retail level in some states. Initially, the price of gas was set far too low to justify the risk and investment undertaken by the producers. But with Bass Strait being mainly an oil play, the producers reluctantly accep ted a low gas price as gas was the by-product of producing oil.
Through time, the domestic price of gas moved up to about $3-$4 a gigajoule, as the easily accessed and cheap-to-exploit reserves needed to be replaced by more expensive ones. But those buying the gas were very reluctant to move above these prices and expensive arbitration between the supplying and contracting parties led to very marginal changes to prices.
The refinement of techniques to locate and exploit unconventional gas, mainly in the form of coal-seam methane, has meant that what had long been known as a theoretical potential for profitable endeavour and growth has become a reality. We now have three producers — Santos, BG and Australia Pacif ic (a partnership of Origin Energy and ConocoPhillips) — constructing six liquefied natural gas trains at Gladstone.
When they are fully operational, Queens land will be the world’s fourth largest exporter of LNG. So how have these developments affected the domestic price of gas and how have the local users of gas responded?
The first thing to note is that there is a very big difference between the price to an international customer, which includes the cost of liquefaction and shipping, and the price to supply the local market. The average difference is about $5-$6 a gigajoule. But here’s the kicker: there is no single world price for gas. Non-domestic prices around the world vary from less than $10 a gigajoule to more than $15, on a comparable basis.
The producers in Gladstone have concluded a variety of contracts with customers on different terms and different prices. There was originally talk of 15 LNG trains in Gladstone, but six looks to be the limit for some time to come.
The prospect of the US and Canada entering the market, plus Australia’s high costs, have ensured this outcome. Had local customers been happy, some time ago, to pay a negotiated gas price that included the transportation costs that apply to them (which can be as high as $1.50 a gigajoule), there was scope for them to lock in long-term contracts with local producers.
But many of the local customers thought that they could play this game better than the producers. They assumed that gas prices would fall in the ramp-up phase of these large-scale projects and so were happy to take their chances. By the same token, the producers understood these risks and played their cards carefully.
In the meantime, the scope for the exploitation of unconventional gas has been dramatically curtailed in NSW and Victoria, as weak-kneed and short-sighted politicians caved in to the irrational and unfounded fears of green groups, farmers and some ill-informed radio presenters.
But, as the saying goes, you reap what you sow. NSW, in particular, is facing a monumental shortage of gas, with close to 95 per cent of supplies coming from interstate. The domestic price of gas will go up and up and there is very little that can be done in the short term.
By blocking the development of unconventional gas, even when Santos has agreed to reserve the gas extracted in NSW for domestic consumption, the state will become hostage to Exxon Mobil and its conventional gas supplies in Victoria. Interestingly, these conventional gas supplies now have higher CO2 content than the unconventional gas located in NSW.
So here’s the real story. Increasing the supply of gas would mean lower domestic prices. Australia is sitting on a pile of unconventional gas, including in NSW and Victoria. It is complete madness that these governments have sought to inhibit its development. In the meantime, we can only observe with a sense of envy the developments in the US, where the price of gas has fallen by two-thirds (in the context of the poten tial to export) and the manufacturing sector in that country shows clear signs of resurgence.
When Australian businesses and households moan about the higher price of gas and potential shortages, no one should be fooled by the misleading and erroneous proposition that the green movement’s opposition to fracking has not contributed to these outcomes.
Judith Sloan was a director of Santos Ltd from 1994 to 2009.
MEL Price at posting:
10.0¢ Sentiment: Hold Disclosure: Held
(20min delay)