Time for a new conversation on gas reservation

This old chestnut again, is it?

Once again the idea of gas reservation on the east coast of Australia has been raised – this time by Labor as part of the election pitch.

The idea that proponents of large LNG projects put aside some of their massive gas reserves for the Australian market is not a new one.

It’s been bandied about again, and again, and again during the near five-year imbroglio surrounding coal seam gas and LNG export.

It goes a little bit something like this:

The massive LNG plants at Gladstone in Queensland have been selling off CSG to Asian buyers at a premium.

Prices in Asia have reached as high as $16 GJ in the past, while the east coast domestic gas price has been about 2-3GJ.

So, quite a disconnect – but there’s a pretty important caveat here:

The CSG reserves being tapped by the LNG proponents would not have been destined for the domestic market – and needed the price support of Asian buying to extract as on a per GJ basis CSG is quite costly to extract.

The domestic market could have happily been supplied by existing sources including the Cooper Basin and Bass Strait going forward – only something funny happened.

The proponents found that extracting gas at volume from CSG – especially in the early stages, was kind of difficult. They had targets to meet, so dipped into the regular domestic market to source gas.

Long story short, they were able to offer higher prices because of the Asian linkage so the price of regular gas went up as a result.

So – now we have another round of the gas reservation debate, wherein LNG proponents promise to put aside a certain percentage of their reserves for the domestic market – hopefully creating an oversupply in the local market and yada yada yada you can see where this is going.

But would an east coast domestic gas requirement actually work?

Would it provide a disincentive for investment?

As national peak body for oil and gas, APPEA, likes to say quite often, the LNG scene around Australia coast represents $200 billion worth of investment.

The LNG plants on the east coast represent a fair chunk of that investment – certainly not chump change.

The whole rationale for pulling the trigger on these projects is that they can (or could given the oil price at the moment) get higher prices in Asia.

So does putting, say, 15% of its total reserves into the lower-margin Australian domestic market alter the case for the investors to put up billions of dollars for the plants in the first place?

Well, it never has in WA.

Western Australia has had a 15% domestic gas reservation policy in place since about 2006 – and this has not slowed the rate of investment in new plants and additions to the North West Shelf project even slightly.

Those arguing the case for a reservation on the east coast quite often point to the WA experience, but in reality it’s like comparing chalk and cheese.

The overriding thing driving the WA reservation is that the source of the gas in the state’s north is very, very far away from the domestic consumer gas market driver.

Namely, Perth and the south west corner.

There’s a huge amount of distance between the source of the gas and the market, and really only one pipeline to get it to market.

So, perhaps naturally, the domestic gas price in WA is a lot higher than it is on the east coast – which has multiple supplies of gas despite concerns raised by the ACCC recently around joint marketing.

So for an LNG player – the ones spending millions on finding massive amounts of gas and billions on LNG plants, the price differential between the Asian price and the domestic price is smaller.

They may not like it, but the LNG players out west can live with a gas reservation policy – it also helps that major industrial customers in WA are buying a lot of gas too.

But, when all is said and done, has the lassaiz-faire attitude of the Australian government on the east coast actually worked?

Well, of course that really depends on what you mean by ‘worked’.

Has it worked?

The theory behind the government’s attitude to this point in time is that by giving explorers the carrot of Asian prices, it would encourage a swathe of exploration to take place.

That exploration would invariably lead to a whole mess of gas, more than what can possible be exported.

So, there would be a heap of gas without a natural outlet – LNG plants do have production capacities, after all.

That gas would make it onto the domestic market, providing longer-term certainty for buyers and pushing down the domestic price.

The other school of thought is that by keeping domestic gas prices on the higher side to cover the increasing cost of exploration and production, domestic gas explorers have a pricing incentive to get drilling.

Thanks to the price of oil and all the knock-on effects that has, this supposed uplift in activity from domestic gas explorers hasn’t really occurred either.

In any case, it’s clear that something is broken here and it hasn’t quite worked out the way it had been hoped.

Supply remains tight to the point where the ACCC is concerned about it, and yet while we are seeing some downward pressure thanks to the lower price of oil the price of gas is expected to keep on rising for the east coast.

So, time for a new approach then instead of the tired old debate around a national interest test and gas reservation?

We’ve seen this dance play out before – it’s time for some innovative ideas.