Press

Tight East Coast Gas Market Warning as Gas Reservation Emerges as More Palatable Option Now

Posted by OilVoice Press - OilVoice

11-Sep-2018


The following remarks and Highlights can be attributed to Dr Graeme Bethune, Chief Executive Officer EnergyQuest (an independent energy analysis and strategy consultancy) (+61 419 828 617) as they relate to the just-released formal September 2018 EnergyQuest EnergyQuarterly report.

Uncertainty now reigns over the Australian energy sector as politics have overtaken policy and sudden U-turns sow confusion.

In June I attended a side-event at the G20 energy ministers conference in Argentina. The G20 includes Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom, the United States and the European Union, an extremely diverse group of the world's largest economies. Most countries were represented at ministerial level (except Australia). Rick Perry, the US Energy Secretary was there.

This varied group managed to produce a consensuscommunique. Amongst other conclusions, the communique says, “At a worldwide level, while it is important to acknowledge that fossil fuels still play a major role, we stress the need to successfully transform energy systems, by increasing investments in cleaner technologies, cooperation in energy efficiency and deployment of renewables and innovation”.

Contrast that with the discussion over the National Energy Guarantee, which has collapsed following the failure to achieve consensus within the Liberal Party room. At the international level it is possible, with hard work, to achieve a consensus between the United States, Europe, China and Russia, but not among a small group of MPs in Canberra who all belong to the same political party.

So, what do business and investors do now? Probably nothing. The east coast needs substantial investment in electricity and gas supply, but without an emissions policy, what should anyone invest in? And what should energy buyers do, with uncertainty about future prices? The situation isn't helped by widely varying forecasts of energy supply and demand, when AEMO says Victoria won't be able to meet its own gas needs from 2022 and then three months later says everything will be fine until 2030. (The federal government hasn't produced any Australian energy projections since 2014, probably for political reasons.)

Highlights[1]

  • Australian petroleum production set a new record in the year to June 2018, increasing by 13.2% yoy or 101.3 MMboe (Million Barrels of Oil equivalent)to 870.4 MMboe (Table 1and Figure 1).The additional production of more than 100 MMboe is roughly equivalent to adding three Cooper Basins or two Pluto LNGs in the space of only 12 months. Australia is set to hit an annual run rate of 1 billion barrels of oil equivalentat some point in 2019.LNG production is now nearly three-times domestic gas production.
  • Queensland LNG projects continue tooperate well below capacity, due tohaving insufficient gas. Notwithstanding headlines like “Gas pressure rises as exports soar,” the increase in August LNG shipments from Gladstone represented just one LNG cargo, a modest 7% increase in August exports compared with July. More importantly, capacity utilisationacross Queensland's three projects is uncommercially low, falling to an average 77% in Q2 2018, compared with rates of over 100% in Western Australia. (1.76 Mt of August shipments, annualised, is only 82% of capacity.) Notwithstanding high LNG spot prices, there are few spot cargoes from Gladstone.
  • Domestic gas flowedconsistently from Queensland to the other states in Q2. Queensland domestic gas production in Q2was equivalent to 8% of gas used for LNG exports(including fuel gas), a similar percentage to that applied in Western Australia under the domestic gas reservation policy.
  • But increased Queenslandsupplies were unable to offset production declines in Victoria. Victorian offshore production in Q2 was 88.9 petajoules (PJ), down 23.9 PJ qoq. The biggest fall was in Gippsland production, which fell from 85.0 PJ to 68.0 PJ. Longford production in August 2018 averaged only 917 TJ/d, 18% below the same period in 2017.
  • The east coast gas market is likely to remain tight in 2019. Productionis running behind AEMO/ACCC forecastsso the outcome will depend on demand, particularly gas-fired generation.
  • Accordingly, east coast gas producers should prepare for heavy-handed political interventionover the next year, regardless of who wins the next federal election, whether the Coalition with its “big stick”approach to energy policy or Labor with its threat of restrictingeast coastLNG exports.
  • AEMO's 2018 Gas Statement of Opportunities contained the surprising conclusion that no east coast gas supply gapsare forecast before 2030. The conclusion of no supply gaps assumes that all of the current 2P undeveloped can be successfully developed,even though 2P is defined as 50% likely, not 90%. The conclusion also relies on successful and early development of Contingent Resources, despite an absence of much investment in converting 2C resources to 2P reserves.
  • Significant east coast reserves risks remain, even with Proved and Probable (2P) reserves. CSG 2P reserveshave decreased by 2,062PJsince June 2017 to 37,879 PJ, with large write-downs in Arrow Energy's Bowen Basin fields (-3,383 PJ).There is some good news though. Arrow's Surat Basin 2P reserves have increased by 558 PJ and over the last 12 months both QCLNG and APLG have successfully replaced their CSG production with commensurate increases in 2P reserves.
  • West Australian domestic gas prices continued to fall in Q2 2018. Woodside'saverage realised NWS domestic gas price in Q2 was $4.13 per Gigajoule (GJ)(19% lower qoq). Western Australia has plenty of domestic gasand is about to get more, with the start-up of Wheatstone domestic gas.
  • The Dorado-1 oil discovery is the biggest news in offshore oil exploration since the Vincent discovery in 1998 opened a new oil province just off WA's North West Cape. This ranks the discovery as the third largestin the history of the North West Shelf, behind Barrow Island and Wanaea. There is a real prospect of other oil discoveriesnear Dorado.
  • Gross Australian LNG productionin the year to June 2018 was a record 61.4 million tonnes (Mt), 19.4% higher yoy. LNG revenue for the year was $31 billion. This takes LNG past international education to become Australia's third most valuable export commodity.
  • LNG prices andrevenueshave surged thanks to rising oil prices and strong Chinese demand. Average LNG export prices increasedin Q2 2018 for the fourth quarter in a row to US$8.57 per Million British Thermal Units (MMBtu). The Q2 2018 price was up by 9% in only three months, up by 25% compared to Q2 2017 and an impressive 44% since Q2 2016.
  • Australian natural gas and ethane productioncontinued to set new records, climbing 16.0% yoy to 4,402.2 PJ in the year to June. This takes Australia close to Norway, the world's seventh largest gas producer, having already overtaken gas production by Saudi Arabia and Algeria.
  • Beach Energyis set to become Australia's biggest oil producerin Q3 2018, following further sharp falls in production from all of Australia's major offshore projects. The fact that an onshore operator could be Australia's largest oil producer was unthinkable until recently.
  • Chevronextended its lead over Shell as Australia's largest petroleum producer in Q2 2018, with production of 35.4 MMboe versus Shell's 32.1 MMboe. The US supermajor overtook Shell in Q1 2018 thanks to its massive investments in Gorgon and Wheatstone.

International politics

  • In June I attended the World Gas Conference in Washington DC.
  • The WGC was more politicalthan previously (unsurprisingly given the location). Russia and Iran were absent for political reasons and there was a focus by the US on gas as a political weapon. While there was lots of talk about free markets it was in the context of benefits for friends and allies. The main differences about reducing emissions were on how rather than whether, with the Europeans favouring regulation and the Americans favouring deregulation and innovation. According to the BP statistics, US CO2emissionsin 2017were the lowest since 1992 but EU emissions were the lowest since 1967.
  • The US has more cheap gas than it can use. US LNG supply is not limited by export sanctioning but by pipeline access. US gas production is oil dependant so it is argued that an increase in the oil price and US oil supply will lead to a drop in the Henry Hub price.
  • The WGC brings together many of the world's leading fossil fuel producers but there was little apparent pushback about the need to reduce emissions. The differences were more about how and how much. USemissions reductionsare focussed on replacing coal with gas. The EU on the other hand has moved on from just CO2reductions to decarbonisationof gas supply (green gas and power to gas via hydrogen). There was a strong focus on the need to reduce methane emissionsfrom the natural gas supply chain.

Australian politics and policy: more east coast gas market intervention likely

  • East coast gas producers should prepare for heavy-handed political interventionover the next year, regardless of who wins the next federal election.
  • Resources Minister, Matt Canavan, stepped up the political pressure on east coast gas at the end of August. The AFR reported (30 August) that Canavan had summoned Santos,Originand Shellto Canberra for talks within the next fortnight about domestic supply, and warned that he had reserved his right to trigger the Australian Domestic Gas Security Mechanism (ADGSM) in 2019. Last October, a peace deal was struck that meant the newly legislated mechanism would not be triggered following a commitment by Santos, Origin and Shell to divert large volumes of gas from LNG exports into domestic markets. Until Canavan's latest summons, it was widely assumed the ADGSM would not be triggered in 2019, especially in view of AEMO's assessment that east coast supply is expected to continue to improve through 2019 and beyond. This will make it difficult for the Minister to find a technical basis for triggering a restriction on LNG cargoes from the east coast. In addition, the ADGSM was based on the theory the LNG projects were sucking gas out of the domestic market, but Queensland is now a net exporter of gas to the southern states. However, the politics is what matters, and the Minister has plenty of flexibility in deciding to restrict exports from Gladstone.
  • Visiting Incitec Pivot's Gibson Island plant on 3 September, Opposition Leader,Bill Shortenand Shadow Minister Jason Clare upped the ante by stating that Labor, if elected, would modify the ADGSM so it could be triggered whenever prices are above a benchmark set by the ACCC, not just when there is deemed to be insufficient volume. This is a more explicit threat than Labor's previous position on the ADGSM and raises the possibility of export controls being triggered sooner, and lasting longer, than the annual cycle currently set out by legislation. Mr Shorten said, “The ACCC's Gas Inquiry Interim Report of December 2017 set a benchmark price of between $6.55/GJand $9.93/GJ, but Manufacturing Australia says its members are being quoted prices of between $10/GJand $12/GJ[2]. There have subsequently been two ACCC reports, for April and July 2018. The ACCC does not appear to quote a “benchmark” price in the latest report but Chart 2.6 suggests that its estimate of contemporaneous expectations of 2019 LNG netback prices for the southern states are around $11/GJ.The report also acknowledges the volatilityof forecasts of LNG spot prices.
  • Asked if the Labor proposal would mean gas companies need to break contracts, Mr Clare said “No it doesn't. This is focussed on the gas sold on the spot market, as well as third party gas”. In fact, there are hardly any Gladstone spot cargoes. Santos is most exposed to claims that it is reliant on large volumes of “third-party gas”. However, much its so-called “third-party gas” either comes from contracts agreed prior to GLNG go-ahead or is from fields specifically developed for LNG. Santos of course has also significantly increased its supplies to the domestic market. In short, there is not enough flexible gas in the LNG projects to offset declining Victorian production. Moreover, Queensland CSG wouldnever have been developed without an LNG market able to pay international prices.
  • In what was admittedly a brief media grab, Messrs Shorten and Clare made no mention of production costs. Any regulatory action that means producers are required to sell gas on an uncommercial basis is likely to lead to them calling force majeure and leaving gas in the ground. The WA domestic gas reservation policy is careful to avoid attempting to regulate prices.
  • The federal government can control exports but not investment or productionand maintaining CSG supply requires substantial continuing investment, something that is unlikely to happen with heavy-handed price regulation.
  • There are also likely to be other challengesto any attempt by Labor to restrict east coast contracted LNG exports. The Queensland Governmentis likely to be against heavy-handed attempts to divert more of its gas to southern states that have failed to develop their own gas. Rather than being forced to prop up industry in NSW and Victoria, the Queensland Government would probably prefer industry to move to Queensland. While the Commonwealth Governmenthas the power to control exports, it has no control over onshore gas exploration, production or development. The Queensland Governmentis the one that has ultimate jurisdiction over Queensland gas.
  • Proposals to restrict exports are already having international ramifications, harming Australia's reputation as a destination for foreign investment. These will not only affect Queensland but also potential west coast LNG projects. Platts (6 September) quotes Osaka GasChairman Yasuo Ryoki's concerns: “We were surprised and embarrassedby last year's announcement to limit LNG exports under the Australian Domestic Gas Security Mechanism”. He said the salesmen at Osaka Gas, which is one of Japan's largest gas buyers and power utilities, were busy taking phone calls from panicked end-users who had read about the possibility of Australia's export restrictions. "While we understand the notion of the federal government that exports should be based on stable supply within the country, we ask for more discretion in the future since a more careful explanation beforehand would have avoided misunderstanding and confusion. We never thought that there could be any sovereign risk in Australia. It was really, really surprising and made us very uneasy.” Platts commented that Osaka Gas has been ramping up energy investments in Australia to counter shrinking markets in Japan. These investments include upstream, midstream and downstream energy sectors. But companies like Osaka Gas find regions like the US offering better opportunities, which is why a decline in sovereign risk could be a gamechanger for Australia.
  • Any unilateral attempt by the Commonwealth to negate export contracts is also likely to invite international litigationby LNG buyers who have invested in and contracted for LNG from the Gladstone projects. This is not just a theoretical possibility. As we noted in our March report, Argentinaand Egyptare two examples of countries being subject to international litigation over cancelled exports.
  • Mr Shorten also joined a long-list of federal politicians who have told Victorian Premier Daniel Andrewsto reconsider the state's opposition to conventional gas exploration. However, there is no sign that the Victorian Premier is interested in advice from Canberra. He claims to have more gas than he needs (even though technically it is Commonwealth gas produced offshore rather than Victorian gas), notwithstanding falling Longford production and gloomy forecasts from AEMO.
  • Mr Shorten also said Labor would take a tough position on retention licencesover undeveloped gas fields and give the ACCC new powers to act on anti-competitive behaviour by gas producers. He also reaffirmed the policy Labor took to the 2016 election to introduce a national interest testfor new LNG projects and significant expansions of supply at existing projects, although neither of these events is likely on the east coast.
  • Labor's aggressive position ran well in the media and attracted plenty of headlines, which in turn puts pressure on the Coalition to toughen its position. Either way, east coast gas producers should prepare for heavy handed intervention. Politics has overtaken rational policy that is in the national interest. To date, the industry has muddled through and foreign investors in Queensland's LNG projects have maintained a diplomatic silence over being brow-beaten into diverting exports to the domestic market. However, if Labor wins and its policies are implemented, the pain will be much higher and there will be further real damage to Australia's reputation as a place to invest in and buy LNG, regardless of whether it is on the east or west coast. The even bigger issue is the damage that price intervention will cause to development of gas supply for domestic markets. As the ACCC has correctly said, the east coast needs more gas supply. Regulated, lower prices will inevitably kill production, exploration and development that would otherwise have occurred.

Wounded government resets energy policy

  • As the dust begins to settle from the outbreak of open warfare within the Coalition, the direction of energy policy in the Morrisongovernment is becoming clear.
  • In the days prior to the dumping of Malcolm Turnbull, we already knew he had fatally wounded the National Energy Guaranteeby dropping its emissions target in a bid to stop conservatives crossing the floor. It failed to head off a revolt, and at the same time made the NEG unacceptable to state Labor governments that hold a veto over the scheme.
  • The new prime minister has appointed anti-wind farm campaigner Angus Tayloras energy minister and dubbed him the “minister for getting electricity prices down.” Morrison has also separated the ministerial responsibilities for energy and environment previously held by Josh Frydenberg. The new environment minister, Melissa Price, has been given the unenviable responsibility of implementing the government's climate change policies. Morrison has said the Coalition is sticking to its target of a 26-28% reduction in 2005 emissions by 2030, but now the NEG is dead no-one knows how the government intends to achieve this.
  • The return of uncertaintywith the demise of the NEG means potential investorscontinue to sit on the sidelines, and still have no idea when there will be a policy and regulatory framework that allows them to commit to projects in Australia. A potential foreign investor told EnergyQuarterly “(the NEG was) a hope for us, a potential investor for power generation, to get a clear and stable view on the energy policy, but the current political situation is somewhat disappointing.”
  • com.au reported (3 September) that business had given up on engaging with the Coalition on climate and energy policy and was instead engaging with Labor and the states. “There is even some hope that Australian states could take a leaf out of the US playbook, where individual states have created regional markets and agreements in the absence of any serious initiatives. That means, despite everything, the NEG is not quite dead. Buried in its present form, yes, but there are discussions about including some of its more attractive aspects – such as locking in a mechanism into the National Electricity Rules, to allow for any federal moves to be more enduring. And more Abbott-proof. Even NSW and South Australia, both Liberal governments, appear amenable to this thinking.” Tasmania should be added to this group. Generation in South Australia and Tasmania is already dominated by renewables.
  • At a state level, Labor governments have renewed their commitment to state renewable energy targets.Queensland is targeting 50% by 2030, while Victoria is targeting 40% by 2025. Policies in these states are helping to support investment in renewable energy, which remains at high levels even though investment under the federal RET scheme recently reached its target – two years early.
  • Taylor's first speechas energy minister on 30 August elaborated on the new government's energy policy, but still left some questions hanging. Power companies, which Taylor likened to the major banks as price gougers, are in for a very difficult time.
  • Taylor said the government would adopt the core pricing recommendation in the ACCC'srecently released inquiry into retail electricity pricing. The current retail “standing offer” – originally designed by government as a safety net to stop price gouging by newly privatised energy retailers – will be replaced with a lower-priced “default offer” at a level determined by the Australian Energy Regulator.
  • Taylor also threatened the government could use “last resort” divestiture powersagainst generators if they did not charge the kind of wholesale prices it wanted to see. (The ACCC report concluded that forced divestments were not necessary or appropriate in the NEM, except possibly in Queensland where state government dominates the market).
  • Of most interest to gas producers is the new energy minister's statement the government would proceed with a program to guarantee finance for generation projects. He said the program would increase electricity supply by supporting the expansion of existing generators, upgrading and extending the life of “legacy” generators, as well as supporting new-build projects. In the absence of certainty about emissions policy, the degree of necessary government support may be significant.
  • “We need to encourage all of these. It's ironic that in a country with an abundance of natural resources – coal, gas, water and solar – we should be in this position. We need to leverage those resources, not leave them in the ground,” the minister said.
  • Of course, Australia does not actually have an abundance of uncontracted gas on the east coast, but the government finance guarantee for new generators could dovetail neatly with plans by Australian Industrial Energyto build a generator fuelled by gas imported at Port Kembla. Stage 1 of the project is to build a regasification terminal bringing in up to 100 PJ/a. Stage 2 is building up to 750 MW of new gas-fired power generation. Venice Energyhas similar plans to tie gas generation with LNG imports in South Australia.
  • Taylor's speech did not make any mention of the NEG,address reliability of the NEM or hint as to whether he planned to abolish the Renewable Energy Target, of which he has been a strong critic. To be fair though, he had only been in the job a few days.
  • More information about the Coalition's energy policies will no doubt emerge over the next few weeks, but the future of energy policy in Australia most likely rests with the Labor Party, if the polls are anything to go by.

Gas reservation a more palatable option?

  • With heavy handed market interventions now a normal part of discussion about gas policy, the idea of prospective reservation of gas reserveson the east coast is starting to look like a moderate way to respond to concerns about domestic supply. At least it does not trash Australia's reputation with investors, provided it is not retrospective. Governments in South Australia and Queensland have already shifted towards reservation with acreage releases and cash grants that are conditional on domestic supply only. These have been well received by industry. Santos CEO, Kevin Gallagher, has also proposed reserving some of the gas from the NT's unconventional gas projects as a pragmatic way of addressing domestic supply concerns. However, in a July 2018 report entitled Bad to Worse, the Australian Industry Group, which is certainly no friend of gas producers, presents a well-argued discussion of the hazards of a reservation policy. The AIG report says it is quite possible to end up with gas reservation that achieved nothing or simply inhibited new investment, which is an argument that APPEA has made forcefully. The issue is complex, but it is clear the industry is no longer in a political environment where it can keep asking the community to put its faith in the market to deliver the best outcomes.

 

[1]Comparisons in this report between the June quarters of 2018 and 2017 are described as qoq (quarter-on-quarter). Comparisons between the 12 months to June 2018 and the 12 months to June 2017 are described as yoy (year-on-year).

[2]The ACCC benchmark quoted was for the southern states based on forecast average LNG netback prices at Wallumbilla plus transport costs.



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