Market intervention proves tricky

A GLOSSY copy of the state government’s ‘Strategic Energy Initiative: Energy 2031’ directions paper hit my desk last week.

On almost the same day, the Legislative Assembly’s economics and industry standing committee tabled its report on domestic gas prices.

The latter report provided a more stimulating read, helped by the fact that the committee reached some firm conclusions and expressed strong opinions.

The report also showed just how difficult it will be for the state government to craft an energy policy that satisfies all stakeholders, but the government must not allow that to stop it trying.

The report starts by pointing out that 97 per cent of the state’s domestic gas supply comes from three joint venture projects – Woodside’s North West Shelf venture and Apache’s John Brookes and Harriet projects, which process gas at Varanus Island.

The demand side of the equation is also highly concentrated; 90 per cent of demand comes from five customers, namely Alcoa, Alinta, BHP Billiton, Burrup Fertilisers and Verve Energy.

The DomGas Alliance, which represents buyers of gas, has been highly critical of gas suppliers, arguing prices have risen unfairly.

A Department of Mines and Petroleum forecast, suggesting there may be a substantial gas supply shortfall by 2020 because of lower North West Shelf volumes, encouraged the critics.

The committee concluded that this low supply scenario was unlikely to eventuate and noted that three new domestic gas-processing plants (Devil Creek, Macedon and Gorgon) are under development.

Having dismissed one line of criticism, the committee then rounded on the gas producers.

“Despite this, the committee remains concerned that the lack of new capacity since around 2007 is inconsistent with a well-functioning market,” it said.

The committee noted that gas prices in Western Australia have risen substantially, with prices on new contracts ranging from $5.55 to $9.25 per gigajoule, and are at least double recent prices in the eastern states.

This isn’t necessarily an issue, since the WA and east coast markets are fundamentally different.

However, it is an issue if gas producers get a higher price selling in the domestic market than they would exporting liquefied natural gas (LNG). The committee said it is “highly likely” that this is happening.

“Prices that persistently reach or exceed an LNG netback equivalent reflect an absence of competition and are inconsistent with a well functioning market,” the committee said.

“Under such circumstances, some form of policy intervention in the market is warranted.”

This conclusion is particularly interesting, given the committee was chaired by Liberal MP and free market advocate Mike Nahan.

The committee advocates some policies that already have bipartisan political support – continuation of the domestic gas reservation policy, and introduction of a gas market bulletin board and a statement of opportunities.

The curly issue sits around the domestic gas reservation policy, which requires LNG projects to set aside 15 per cent of production for the domestic market, subject to commercial viability parameters.

To date, this policy has had a benign impact, contrary to the alarmist predictions made at the time of its introduction.

As the committee noted, it must continue to be delicately handled to ensure gas producers have sufficient incentive to explore and develop new supplies.

The committee suggests the establishment of an independent gas market monitor “to ensure the appropriate amount of gas is supplied to the market under domestic reservation obligations”.

However, what is “appropriate”? This goes to another, far more challenging question – what are the parameters for commercial viability?

There is no easy answer. Just look at the tortuous process the Economic Regulation Authority goes through when it tries to define capital values and rates of return for the owners of regulated energy assets.

Commencing a robust debate around this issue will probably cause some pain but may head off a bigger confrontation later.

It would also be a prudent step before adopting some of the committee’s more interventionist ideas, such as holding regulated auctions, limiting specific fields to domestic use, or toughening the process for renewal of retention leases.