The government wants the gas industry to subsidise manufacturing industry. The most likely result is that it gets bitten.
Following intense lobbying by gas-using manufacturing business leaders, east-Australian LNG exporters face the possibility of a government-regulated, artificially low price for their sales to domestic manufacturers. If the Morrison government were to succumb to that pressure, it would elevate sovereign risk to levels that would preclude new gas developments. Having grabbed a tiger by the tail, the government now has to work out how to let it go without getting mauled.
Executives of gas-using manufacturers are pressuring the Morrison government to insert a gas price trigger into two instruments. The first is a so-called voluntary code of conduct that the government has announced should be put in place between east-Australian gas producers and users by February next year.
If the producers don’t come up with a code the users are happy with, the government has threatened a mandatory code of conduct.
The second instrument is the heads of agreement between the government and the three Gladstone LNG projects that the government wants renewed by the end of this year.
This manufacturing industry pressure follows the urging of former CEO of the Dow Chemical Company, Andrew Liveris, through the now-disbanded National COVID-19 Coordination Commission chaired by Nev Power, who insisted that gas could be delivered to manufacturers at or below $6 per gigajoule.
Despite the delivery of east-Australian gas at these prices being ridiculed by independent market analysts, https://www.afr.com/policy/energy-and-climate/more-gas-is-hot-air-without-imports-capital-and-a-market-price-20200527-p54x2e gas-using manufacturers have been urging the Morrison government to impose on producers an obligation to supply them at a “competitive price.”
By a “competitive price” they don’t mean a domestic price that is competitive with east-Australian export prices. Rather, they mean the east-Australian long-term contract delivered price must be competitive with US prices – specifically the Henry Hub price, which is a gas price at a pipeline hub in Louisiana.
In other words, east-Australian manufacturers are demanding the government requires east-Australian gas producers to supply them at prices that make their energy inputs competitive with those of US manufacturers.
Like current US gas sources, gas from Bass Strait and the Cooper Basin was historically associated with highly valuable liquids when extracted, but new large-scale gas resources such as Queensland coal-seam gas do not have liquids. Nor does Australia have the extensive pipeline network of the US.
Imagine if all Australian manufacturing industries were able to require Australian producers of their inputs to supply those inputs at prices that make the manufacturers internationally competitive – regardless of the cost of producing the inputs.
If this fad caught on, most Australian manufacturers would complain about high input costs from their Australian suppliers and insist they pay their workers the same wages as in poor countries.
A recent report by Tony Wood and Guy Dundas for the Grattan Institute https://grattan.edu.au/report/flame-out-the-future-of-natural-gas/ points out that the east coast has already burned most of its low-cost gas, that rising gas prices primarily reflect rising costs and, contrary to some claims, Australians do not pay more for gas than the countries to which we export.
The only way for the government to meet the demands of east-Australian manufacturers to supply gas at US Henry Hub prices is to insert a price cap on domestic gas. This would constitute a major interference in the Australian gas market, elevating sovereign risk for all investors, including those from Japan, Korea, Malaysia and China who are partners in Gladstone LNG export projects.
We already have enough difficulties with the Australia-China relationship without adding another one. And we are trying to be besties with the likes of Japan, Korea and Malaysia.
Under a binding price cap, new gas provinces would not be developed; the sovereign risk would be too great.
Moreover, drilling for wells in existing fields would be cut back. Fewer wells being drilled would cost jobs in the gas fields in regional Queensland – the last place where the government would want to be seen to be destroying jobs.
Even if, through government intervention, domestic gas prices were reduced to the $6 per gigajoule that manufacturers are demanding, there would be no gas-led manufacturing recovery.
How do we know?
We have real-life experience in Western Australia, where there is cheap gas at around $4 per gigajoule. Yet, despite being closer to Asian markets than eastern Australia, Western Australia doesn’t have a large-scale, gas-using manufacturing export sector. Instead, Asian manufacturers have the advantages of massive scale of their manufacturing plants, lower labour costs and proximity to their own markets.
Energy minister Angus Taylor has made a commitment to the parties to the voluntary code of conduct – of which he has carriage – that it will not contain any hard price reference.
As for the heads of agreement – which is the responsibility of the resources minister Keith Pitt – tentative indications are that it will not contain a direct price trigger either.
However, the gas-intensive manufacturers will continue to pile pressure onto the federal government to require the supply of gas at around $6 per gigajoule if the government’s announced plan of a gas-led manufacturing recovery is to get off the ground.
If the tiger whose tail the government now holds doesn’t get what it wants it will turn around and maul it. But if the government tries to make the tiger happy by giving it the food it is demanding it will kill off any new food sources. The moral of the story is to steer clear of tigers.
Craig Emerson is managing director of Emerson Economics, whose clients include energy companies. The views expressed here are entirely his own. He is a Distinguished Fellow at the ANU, an Adjunct Professor at Victoria University’s College of Business, and Director of the APEC Study Centre at RMIT.