If it wants stable gas supply and lower gas prices, the federal government needs to be adaptive and flexible in reserving domestic gas production for domestic users. Otherwise, domestic manufacturing will wither.
Three things in life are certain: death, taxes, and a jump in oil and gas prices whenever there’s geopolitical conflict.
Thanks to the US–Iran conflict, the Strait of Hormuz is effectively closed, and 25 percent of the world’s liquefied natural gas (LNG) trade is cut off. The LNG benchmark price for Japan and South Korea jumped in response to the initial closure, from about US$10.70 (about A$15) to more than US$15 (about A$21). And it jumped again following missile strikes on Qatar’s biggest LNG facility, to more than US$22 (about A$31).
Because Australia is a big exporter of gas, this price (and the jump) flows through to the Australian economy. It affects electricity prices, domestic gas prices, and, through both of these, the cost of everything from groceries to domestic manufacturing, including manufacturing that’s essential to national resilience in the face of security threats.
Stand by for a repeat of the effects of the Russia–Ukraine war: higher gas prices, higher electricity prices, higher inflation, a higher cost of living, and more domestic manufacturers unable to stay in business.
Successive federal governments have tried for years to break the link between world and domestic gas prices. Complicating matters on the east coast, gas fields in Victoria are starting to run dry, raising the real prospect of gas shortages in coming years.
Late last year, the federal government admitted it was time for wholesale reform, and it is now designing a domestic gas reservation.
The government’s stated intention is to make gas exporters supply the domestic market first, before they can export. This should give the domestic market more gas than it needs so that prices fall on average and there’s a buffer if international prices spike.
The government says exporters won’t be prevented from exporting gas under contracts they’ve already signed. This creates a tricky design problem, and the simplest answers are not the ones that deliver the results the government wants.
The simplest design that comes to mind is to take a portion of the spot cargoes—the gas that isn’t exported under a contract and is currently being sold at wartime-high prices.
This is what the gas producers want. But it will lead to disappointing results for domestic gas users and leave the link to international prices unchanged. The volume of spot cargoes is small compared to domestic demand. Just targeting these will mean significant volumes of gas won’t be delivered to the domestic market until the mid-2030s, by which time distressed manufacturers would have closed down, and the remaining ones would be switching over to using electricity where they can.
At the Grattan Institute, we’ve identified two key decisions the government needs to get right:
—How much extra gas does the government want supplied to the domestic market?
—How will the government allocate that obligation to exporters?
The amount of extra gas that closes supply gaps and keeps downward pressure on prices is going to vary from year to year. Demand for gas is inherently unpredictable, though it is generally trending downwards.
In our proposed model, the government would use its forecasts of domestic supply and domestic demand to work out how much extra gas is required for the coming year. In 2029 (the year supply gaps first appear), only 3 petajoules will be needed to avoid shortages. In 2032, it’s more like 50 petajoules.
The government could then allocate the obligation to supply this extra gas across the exporters by applying a percentage proportional to how much LNG they are planning to produce and export. It’s critical that this is based on all planned exports, not just spot cargoes, because, as noted above, the spot cargoes don’t provide enough gas.
Once the amount of gas had been divvied up between exporters, it would then be up to each exporter to figure out how they get the gas to meet this obligation: export fewer spot cargoes, increase production or pay another domestic producer to increase production on its behalf. Exporters could also choose to divert gas from an existing contract, with the other party’s consent.
To give certainty to exporters so they can sign long-term contracts, the percentage used to divide the obligation should have a ceiling on it—we suggest 15 percent of all exports. But underneath that ceiling, it should fluctuate to reflect how much gas the domestic market requires.
Under our model, everyone gets what they need. The exporters have certainty that there’s a ceiling on their obligations. The domestic market has a steady supply of gas that matches demand and puts downward pressure on prices, helping households and manufacturers. Domestic producers know there’s a limit on how much competition they face from government-mandated supply. And the government can relax a little when the next geopolitical conflict comes along.