By Kumar Padisetti
IN JULY last year, Deloitte Access Economics delivered a report to the Australian Industry Group (AiG) and others titled Gas market transformations – Economic consequences for the manufacturing sector which highlighted that Australia’s gas markets – on both east and west coasts – were undergoing unprecedented change.
East coast transformations were driven by the development of new LNG export facilities in Queensland that had the effect of linking domestic wholesale gas prices to higher international LNG prices for the first time.
LNG prices in Asia are linked to oil prices, and with the price of oil (Brent) averaging US$109 per barrel for the period January 2013 to June 2014, east coast domestic gas prices were between A$7 and A$9 per gigajoule, , an increase of between 50 per cent and 100% on historical prices.
In addition, the significant ramp up required in CSG production to meet committed export LNG volumes created supply uncertainty for the domestic gas market.
This was due largely to the perceived risk of CSG production not being able to meet LNG export commitments in time, and LNG project proponents scrambling for conventional gas.
Based on our modelling at the time, we concluded that changes on both coasts would generate both positive and negative impacts.
The gas and construction sectors would deliver net gains to the economy from the expansion of a new east coast LNG industry.
Almost all other sectors within Australia’s economy, and particularly manufacturing, would likely experience losses in income based on greater input costs associated with higher gas prices and greater risk arising from a more difficult gas contracting environment.
Six months on, the industry doesn’t need to be told that the market dynamics for gas couldn’t be more different.
Firstly, the domestic demand for gas has fallen sharply as a result of a much lower use of gas in power generation and also a reduction in industrial usage.
Secondly, and more importantly, oil prices have collapsed – down from over US$100 per barrel to less than US$50.
This is almost completely driven by the substantial increase in US oil production, where new technology deployed to extract tight and shale oil has increased production to more than nine million barrels a day, up 25 per cent, and Canadian oil sands production.
The US is now the largest producer of oil and liquids combined, and this significant growth in production has resulted in imports as a percentage of US domestic consumption declining from 60 per cent in 2005 to a projected 21 per cent in 2015.
In addition, the decision of OPEC not to cut their oil production from their target of 30 mmbbls/day has resulted in oversupply depressing prices – Standard and Poor’s has forecast oil prices to be below US$80 per barrel until 2016 at the earliest.
As a result, stock prices of domestic gas players have fallen sharply on this weaker outlook for oil.
Exact impact on the value of businesses will depend on the type of contact including the ‘s-curve’ slopes, pivot points, level of contracted volume etc.
The fundamentals referred to above suggest that weak domestic demand and lower oil prices should now translate into lower gas prices – a significant change from just six months ago at least for the short to medium term.
More fundamentally, as the disruption and transformation of the domestic gas market continues:
• Domestic producers and investors have made announcements of significant cuts in spending. They are required to prioritise austerity and productivity improvements over growth
• Local policy makers are now forced to consider international market dynamics, including the geopolitical nature of the global oil, LNG and gas markets. Not considering international market dynamics could lead to suboptimal outcomes.
• Large domestic industrial gas users, particularly those which are trade exposed, will have to become more attuned to global oil and gas market dynamics
• On the pricing front, gas consumers were supporters of delinking oil and gas prices. Now, one would expect that even the producers of LNG may be considering the benefits of delinking – and oil linkage to LNG pricing could come under a lot more scrutiny
Based in Melbourne, Kumar Padisetti is a partner at Deloitte Access Economics.