ECONOMICS AND INDUSTRY STANDING COMMITTEE INQUIRY INTO DOMESTIC GAS PRICES

 
 
ECONOMICS AND INDUSTRY STANDING COMMITTEE INQUIRY INTO DOMESTIC GAS PRICES
Submission 10 - APPEA




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    STANDING COMMITTEE                        PERTH OFFICE
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                          APPEA Submission
                                  JUNE 2010
ECONOMICS AND INDUSTRY STANDING COMMITTEE INQUIRY INTO DOMESTIC GAS PRICES
Submission 10 - APPEA
ECONOMICS AND INDUSTRY STANDING COMMITTEE INQUIRY INTO DOMESTIC GAS PRICES
APPEA Comments

TABLE OF CONTENTS


KEY POINTS........................................................................................................... 2
1.    INTRODUCTION ........................................................................................... 3
2.    THE PRICE OF GAS FOR CUSTOMERS THROUGHOUT WA................ 3
      2.1     Domestic gas price history in WA............................................................................3
      2.2     The determination of gas prices in the WA wholesale gas market...................... 4
      2.3     Claims about domestic gas prices in WA ................................................................6
      2.4     The gas supply chain and domestic gas prices........................................................7
      2.5     The WA Gas Market: overview ................................................................................7
      2.6     The WA Gas Market: demand..................................................................................7
      2.7     The WA Gas Market: supply.....................................................................................9
              2.7.1       Recent short-term tightness of supply....................................................................9
              2.7.2       Physical supply .................................................................................................11
              2.7.3       Suppliers ..........................................................................................................11
              2.7.4       New supply ......................................................................................................13
              2.7.5       Supply transportation and storage, linkages with other markets and the entry of
                          brokers / aggregators........................................................................................14
      2.8     The WA Gas Market: supply costs.........................................................................15
      2.9     The WA Gas Market: conclusions .........................................................................15
3.    THE COMPARISON OF THE PRICE OF GAS WITH OTHER STATES,
      ESPECIALLY VICTORIA, AND WHETHER THERE IS A SIGNIFICANT
      PRICE DIFFERENTIAL AND, IF SO, WHY? .............................................16
      3.1     Introduction...............................................................................................................16
      3.2     Comparison with other states, especially Victoria................................................17
              3.2.1       A brief overview of the Eastern Australian wholesale gas market ......................17
              3.2.2       The Victorian Gas Wholesale Market .............................................................18
              3.2.3       Gas market development and reform process in Eastern Australia.....................20
4.    THE CONTRAST BETWEEN DOMESTIC GAS PRICES IN WESTERN
      AUSTRALIA AND INTERNATIONAL LNG PRICES AND THE LNG
      CONTRACTS THAT GOVERN THESE INTERNATIONAL PRICES ....21




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KEY POINTS

•   As with most competitive markets, prices in the WA wholesale gas market are
    determined by the demand for and supply of gas (the market). In WA, supply is a
    function of the cost to develop the resource and the ability to deliver that resource to
    market through the transportation infrastructure. WA demand is made up of
    customers willing to commit to significant volumes over the long-term at prices which
    enable their project as well as new gas projects to proceed. Government policies and
    fiscal arrangements will also influence costs and thus gas supply commerciality.

•   Responding to calls from large industrial users for governments to intervene in the
    market in ways that will deliver them with long-term supplies of ‘cheap’gas will lead to
    market distortions and increase gas project risk; delayed new gas developments; and
    may create a wealth transfer from one group of stakeholders (gas producers and the
    Australian people via secondary taxes) to another (shareholders in mostly large
    industrial companies); a loss of economic efficiency and welfare; and, of course, less
    gas. Government intervention in the market aimed at shifting supply or demand,
    influencing prices or providing other forms of subsidy or protection, prevent markets
    from adjusting to equilibrium. This results in a reduction in economic welfare through,
    for example, increased costs, reduced investment and ultimately, less supply.

•   Governments have an important role to play by addressing impediments to investment,
    providing an internationally competitive investment environment, facilitating energy
    market reform and by regulating those parts of the energy supply chain that are natural
    monopolies (such as the energy transmission and distribution sector).

•   Key conclusions relevant to the Committee’
                                             s Terms of Reference include:

    -        wholesale gas prices in WA reflect the operation of the demand / supply balance
             in the market. The effective and efficient operation of the WA gas market should
             be encouraged. Interventions in ways that will distort the market (such as
             domestic gas reservation policies) should be avoided;

    -    policy initiatives that could encourage the efficient and effective operation of the
         gas market include the establishment of a Bulletin Board and Gas Statement of
         Opportunities in WA. These initiatives have been previously recommended by
         APPEA and supported by the September 2009 Report of the Gas Supply and
         Emergency Management Committee;

    -    although it is not valid to directly compare prices between unconnected individual
         gas markets as each has its own specific set of supply and demand fundamentals,
         WA average gas prices have historically compared favourably to other markets.
         For example:

         ..     average wholesale gas prices in WA remain comparable to average east coast
                gas prices;

        ..     average wholesale gas prices in WA remain below average domestic gas prices
               in the UK, US and Europe; and

        ..     average wholesale gas prices in WA remain well below average international
               LNG prices.

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1.         INTRODUCTION

The Australian Petroleum Production & Exploration Association (APPEA) is the peak
national body representing Australia’ s oil and gas exploration and production industry.
APPEA has 80 full member companies exploring for and producing Australia’       s oil and gas
resources. These companies currently account for around 98 per cent of Australia’     s total
oil and gas production (including all of Western Australia’ s gas production) and the vast
majority of exploration. APPEA also represents over 200 service companies providing a
range of goods and services to the industry. Further details about APPEA can be found at
our website, at www.appea.com.au.

APPEA welcomes the opportunity to provide comment to the Legislative Assembly
Economics and Industry Standing Committee’   s Inquiry into Domestic Gas Prices. APPEA’  s
submission has been generally organised to address specific sections of the Inquiry’ s Terms
of Reference. The submission does not, however, directly address every aspect of these
Terms of Reference. Rather, it focuses on those areas of particular significance to the WA
upstream oil and gas industry.

In addition, many of the issues considered in this submission were also addressed in
APPEA’   s March 2010 submission to the Western Australian Government’     s Strategic
Energy Initiative Issues Paper1.

2.         THE PRICE OF GAS FOR CUSTOMERS THROUGHOUT WA

2.1        Domestic gas price history in WA

APPEA notes Terms of Reference 2(a) asks the Committee to investigate the price of gas
for customers throughout Western Australia. APPEA is not privy to pricing arrangements
contained in individual gas supply contracts or the specific terms and conditions2 under
which gas is supplied in the Western Australian gas market. APPEA relies on official data
sources for pricing information. A key source of data on domestic WA and international
gas prices is the Department of Mines and Petroleum (WA DMP). Figure 1, taken from
WA DMP data, shows average natural gas prices for the period June 2005-December 2009.

Figure 1: Average natural gas prices: June 2005-December 2009




Source: Western Australian Mineral and Petroleum Statistics Digest 2009, Department of Mines and Petroleum.

1A copy of APPEA’   s submission is available at www.energy.wa.gov.au/cproot/1789/2/APPEA.pdf.
2Such terms and conditions might include, amongst other things, the length of term, flexibility of volume taken, price review
periods/trigger points, payment method, nomination period and so on.


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As indicated in Figure 1, the average ex-plant price of gas in Western Australia has
generally been below that of gas in Eastern Australia and well below domestic wholesale
gas prices in the US, UK and Europe. The disruption to supply from Varanus Island in
mid-2008 led to an increase in prices, reflected in some contracts agreed during this period.
Average prices declined once the facilities resumed full production during 2009.

WA ex-plant gas prices averaged $A3.25 per gigajoule (GJ) during 2009 compared with
$A3.67/GJ during 2008 and $A2.86/GJ in 2007.

Gas prices for industrial customers (the bulk of the WA gas market) are reflected in these
prices. At the household level, the cost of gas is a very small part of the final cost. For
example, the lowest residential gas tariff in Perth of around 9 cents per unit equates to
$A25/GJ compared to the ex-plant $A3.25/GJ average price noted above.

In addition, Figure 1 illustrates:

•     trends in WA wholesale domestic gas prices in recent years reflect both an increase in
      tightness of supply and an increasing cost of providing supply –each of these issues is
      considered further below; and

•     the short-term price increase in 2008 led to an increase in supply from the North West
      Shelf (NWS) Venture. This meant that when supply from Varanus Island was restored,
      the market was oversupplied (as demand had been curtailed) and therefore prices fell.
      This shows how market signals in the WA gas market influence the behaviour of both
      suppliers and consumers, allowing the market to find ‘  equilibrium’. This outcome is
      the direct opposite of what would be expected to occur if the WA gas market was
      suffering from a ‘market failure’.

2.2        The determination of gas prices in the WA wholesale gas market

As with most competitive markets, prices in the WA wholesale gas market are determined
by the demand for and supply of gas (the market)3. In WA, supply is a function of the cost
of developing the resource and the ability to deliver that resource to market through the
transportation infrastructure. WA demand is made up of customers willing to commit to
significant volumes over the long-term at prices which enable their project as well as new
gas projects to proceed. Government policies and fiscal arrangements will also influence
costs and thus gas supply commerciality.

As noted above, recent upwards price movements are not an indication of ‘   market failure’
(Box 1 below considers the misuse of the term ‘  market failure’that has been a feature of
this debate). Competitive markets should not be protected from swings in supply, demand
and price volatility since these are the mechanisms by which changes are accommodated
and equilibrium is restored. As demand grows and spare production capacity is absorbed,
prices rise. This triggers investment in new supply which in turn exerts downwards
pressure on prices.

Any recent upward price movements are reflecting price fluctuations that characterise a
healthy, functioning market (consider, for example, movements in prices of commodities in

3 Noting that the price in any one contract may vary significantly from the ‘
                                                                            norm’due to the bespoke terms and conditions that can be
attached to a given contract.


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markets such as crude oil, coal, iron ore, copper, gold and so on). Rather than
characterising ‘
               market failure’these movements demonstrate a healthy and appropriately
functioning market.

In a WA context, price changes (up and down) can be exacerbated by:

•    the ‘lumpy’nature of Western Australia’ s contract-based market where, as is considered
     further below, increments to gas supply occur infrequently and in large amounts; and

•    increments to gas demand are subject to new energy-intensive mining or mineral
     processing and gas-fired power generation projects.

As has occurred recently, there is a lag between prices increasing and new supply being
developed. Project costs have risen substantially since previous developments, demand has
risen more quickly than anticipated and customers have not been willing to agree terms to
enable new projects to be economically developed. In addition, as has occurred recently,
there is often a lag between price increases and startup of new supplies that see prices
going up before coming down.

Box 1: Misuse of the term ‘market failure’

The basis for any intervention in the market (or an assessment that the market is not
‘
working’ ) must be a clearly and rigorously identified ‘market failure’4. In assessing whether
or not a market failure exists, three key aspects are worth emphasising:

•     when markets are out of equilibrium, say because the economy is experiencing rapid
      growth, imbalances between supply and demand are typically a feature. The fact that
      some experience the consequences of that disequilibrium does not connote market
      failure: it is a necessary precursor for resolving imbalances. Suppressing these market
      signals will aggravate rather than resolve any imbalance

•     even in an economy that is broadly in equilibrium, the fact that some believe that they
      are not getting as good a deal as they might does not mean that there is market failure.
      For example, where high initial (sunk) costs are required to secure output, then if
      buyers could escape covering these sunk costs, supply would never be forthcoming
      (absent public subsidies). That would constitute a market failure; and

•     even where there are market failures, it does not necessarily follow that society would
      be better off seeking to correct the situation. All forms of government intervention
      involve costs, and those costs may exceed the efficiency benefits achievable from
      correcting the market failure. The risks and costs of ‘ government failure’need to be
      given no less weight in the assessment of policy options than those of market failure.

Gas projects typically take 3 to 5 years to develop once a final investment decision has been
taken5 (as do most major new mining or mineral processing and gas-fired power generation
projects). Gas customers and suppliers need to anticipate their needs early and

4 It is vital that in considering any proposed intervention a rigorous definition of a ‘
                                                                                       market failure’is applied. In economics, the term
market failure has a clear technical meaning. It refers to a situation in which, in equilibrium, markets will not operate in a way that
maximises efficiency –that is, in a way such that the gains from reallocating resources would exceed the losses.
5 For example, time frames may involve 2 to 3 years before drilling explorations wells, then discoveries have to be appraised over 2 or

more years, then an economic development has to be worked up over 2 or more years, then the projects has to be built over 2½ years or
more.


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progressively firm-up contract terms as their respective projects obtain finance, markets,
government approvals and other pre-requisites to an investment decision.

Government intervention in the market aimed at shifting supply or demand, influencing
prices or providing other forms of subsidy or protection, prevent markets from adjusting.
This will result in a reduction in economic welfare through, for example, increased costs,
reduced investment and ultimately, less supply.

2.3         Claims about domestic gas prices in WA

Gas prices determined in a competitive market are just one of a number of inter-related
terms and conditions forming part of a negotiated contract between a buyer and a seller. It
is inappropriate, therefore, to compare prices alone without considering the other contract
terms and conditions and just as inappropriate to infer that a higher price for one
short-term, small volume contract, for example, is representative of all contracts. A true
comparison of market prices can only be made on the basis of “like terms and conditions”.

Dependent on short term-market fundamentals and other contract terms; prices for
short-term gas supplies may be different to those applying to the large volume, long-term
contracts needed to underpin major new gas developments.

Claims that gas prices have risen four- to five-fold or are around four- to five-times Eastern
Australian prices6 ignore the market conditions (that is, the supply/demand fundamentals)
in which past and present contracts were negotiated, and the other terms and conditions
contained in those contracts. Price comparisons between WA and other domestic and
international markets are considered in Sections 3 and 4.

APPEA understands that these claims reference a legacy gas price of around $A2-3/GJ.
These legacy prices are based on contracts written many years ago, when oil was trading at
$US20-30/ barrel, iron ore was being sold at $US20/tonne and real estate prices were such
that a beachside house in Cottesloe could be purchased for around $200,000. They do not
reflect subsequent and substantial increases in gas exploration and development costs, nor
do they reflect the fact that newer gas supplies are frequently ‘
                                                                leaner’and have less
revenues from liquids produced with the gas.

Very low legacy gas prices have not, and will not in future, support development of the
new gas supply projects necessary to meet future demand.

Market driven gas pricing does not mean that Western Australia is less competitive for new
gas-based resources processing. On the contrary market based gas pricing delivers what
new gas-based resource projects need –security of supply.

At the present time, access to capital, the course of future global growth and the
implications for commodities demand are major considerations. The importance of these
other factors has been clearly evident in the past when a number of major gas-based
processing projects failed to proceed even when Western Australian gas prices were
amongst the lowest in the world.

Responding to calls from large industrial users for governments to intervene in the market
in ways that will deliver them with long-term supplies of ‘
                                                          cheap’gas will lead to market

6   DomGas Alliance, May 2009.


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distortions and increase gas project risk; delay new gas developments; and may create a
wealth transfer from one group of stakeholders (gas producers and the Australian people
via secondary taxes) to another (shareholders in mostly large industrial companies); a loss
of economic efficiency and welfare; and, of course, less gas.

Governments have an important role to play by addressing impediments to investment,
providing an internationally competitive investment environment, facilitating energy market
reform and by regulating those parts of the energy supply chain that are natural monopolies
(such as the energy transmission and distribution sector).

Any appreciation of why Western Australian gas prices are at a particular level requires an
understanding of the structure of the WA domestic gas market and the local issues that
influence price.

2.4       The gas supply chain and domestic gas prices

In addition, when considering energy prices, attention should be focused on those parts of
the energy supply chain that contribute the most to prices. In both gas and electricity the
cost of getting energy to residential and small- to medium-sized businesses is made up of
many elements. Transmission and especially network distribution and retailing costs make
up a majority of the delivered cost.

For example, in the WA gas market, contract prices vary but upstream gas producers
receive less than one fifth of the price paid by residential customers in Perth (as was noted
above, the lowest residential tariff of around 9 cents per unit equates to $A25/GJ). Any
concern over domestic gas prices needs to consider the entire supply chain. In particular,
attention needs to be paid to the unique circumstances and critical position in the energy
supply chain held by gas transmission, and the need for appropriate regulatory oversight of
gas transmission until the market provides increased investment and competition in that
sector.

2.5       The WA Gas Market: overview

APPEA, on 19 May 2010, released the KPMG Gas Market Report7. The Report provides a
new independent source of information underscoring the vast size of Australia’  s natural gas
reserves and resources, key aspects of the operation of Australia’
                                                                 s natural gas markets and
the dangers associated with inefficient government intervention in competitive energy
markets.

It includes an overview of the structure and operation of the Western Australian gas
market, along with the Northern and Eastern gas markets. A copy of the KPMG Gas
Market Report can be found at Attachment 1.

APPEA notes, and the Report finds, prices in the Western Australia wholesale gas market
are determined by the standard market principles of demand and supply.

2.6       The WA Gas Market: demand

Natural gas is just one of several fuel sources in the WA energy market. It competes with
other primary energy sources to supply the WA energy market and gas suppliers compete
7See www.appea.com.au/index.php?option=com_content&view=article&id=679:major-new-gas-market-report-provides-a-
comprehensive-overview-of-the-natural-gas-market-in-australia&catid=183:media-releases&Itemid=600087 for further information.


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amongst themselves to meet the demand. In the south west, natural gas competes with
coal in the power generation sector and in energy-intensive industries such as alumina
production, cement and mineral sands processing. In the north, gas continues to compete
with diesel or coal import alternatives.

As noted above, gas demand is made up of customers willing to commit to significant
volumes over the long-term at prices which enable their project –as well as new gas
projects –to proceed.

Domestic gas demand in WA is dominated by industrial usage (58 per cent of supply) and
electricity generation (29 per cent of supply). Approximately 60 per cent of electricity
generation capacity in WA is fuelled by gas. Five large customers –Alcoa, Alinta, BHP
Billiton, Western Power, Burrup Fertilisers –take approximately 80 per cent of the
domestic gas supply, with Alcoa the largest at about 23 per cent8.

It is also important to note that all three of the largest industrial customers, Alcoa, Billiton
and Burrup Fertilisers, sell their products into the international market and all three enjoy
international market prices for their products.

APPEA notes this situation has changed little since 19989. Figure 2 shows major gas
buyers in 1998 and in 2009. Figure 2 shows that the majority of gas purchases in WA
continue to be predominantly from four or five major buyers. It also shows that with the
exception of BHP Billiton, market share of purchased gas in WA has decreased slightly for
the major buyers as the overall volumes of gas sales to the market increase.

Gas sales to domestic buyers outside of the top four have increased from 14 per cent of all
gas sales in 1998 to an estimated 28 per cent in 2009. Burrup Fertilisers comprised 8 per
cent of the 2009 “Other”buyers. Excluding Burrup Fertilisers sees other buyers increasing
from 14 per cent of the WA market in 1998 to 20 per cent on 2009.

In its assessment of the WA gas market earlier this year, Wood Mackenzie10 concluded:

            WA has experienced significant growth in total gas volumes contracted from 1998 to 2009,
            increasing from approximately 640 [terrajoules/day] TJ/d to an estimated 865 TJ/d for
            2009. From Wood Mackenzie’        s data bases, the number of gas sales contracts to the WA gas
            market have increased over this period from approximately 22 contracts in 1998 to a high of
            33 active contracts in 2005, falling to 26 currently active contracts in 2009. Despite this increase
            in volume and number of contracts, the concentration of major buyers and major sellers remains
            relatively similar to 1998, with the majority of the gas market comprised of only 5 buyers.




8 Wood Mackenzie (2010), Western Australia Gas Market Study, Final Report, 26th March 2010 (available at

www.accc.gov.au/content/trimFile.phtml?trimFileName=D10+3402413.pdf&trimFileTitle=D10+3402413.pdf&trimFileFromVersionId
=933846).
9 The Australian Competition and Consumer Commission (ACCC) noted similar in their Determination to grant, until 31 December

2015, conditional authorisation to Chevron Australia Pty Ltd, Chevron (TAPL) Pty Ltd, Mobil Australia Resources Company Pty Ltd
and Shell Development (Australia) Pty Ltd to jointly market and sell their natural gas entitlements from the Gorgon project for supply in
Western Australia, where they noted while “… the ACCC accepts that there has been an increase in the number of domgas purchasers since the ACCC
last considered the WA domgas market in 1998, it remains dominated by a handful of large customers. Approximately 90 per cent of domgas purchases are
from six large customers”. See
www.accc.gov.au/content/trimFile.phtml?trimFileName=D09+180600.pdf&trimFileTitle=D09+180600.pdf&trimFileFromVersionId=
901112 for further information.
10 Wood Mackenzie (2010), Western Australia Gas Market Study, Final Report, 26th March 2010.




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Figure 2: WA Gas Buyers, 1998 and 2009




Source: Wood Mackenzie (2010).

The second largest segment in WA is electricity generation, accounting for a further 29 per
cent of the market. As noted above, gas competes with coal as a primary fuel source in the
South West Interconnected System and diesel in other locations.

Finally, it is important to note that gas for household use represents less than 5 per cent of
the market (on an annualised basis). Prices for this segment of the market are regulated by
the WA Government and this is taken into account in negotiations between upstream
producers and those supplying gas to households.

2.7       The WA Gas Market: supply

As noted above, gas supply is influenced by costs and availability of transport
infrastructure. Government policies and fiscal terms will also influence costs and thus gas
supply commerciality.

In Western Australia, recent price movements are driving the biggest domestic gas
development effort in almost three decades (for example, Reindeer/Devil Creek and
Macedon, among others. For further details see Section 2.7.4).

The supply response is not immediate, however, due to the time required to develop new
gas projects but it is occurring. Gas projects typically take 3 to 5 years to develop once a
final investment decision has been taken.

2.7.1     Recent short-term tightness of supply

At the height of the recent resources boom, there was a short-term tightness of gas supply.
This was drive by a number of factors:

•     the disruption of supply from Varanus Island in mid-2008. On 3 June 2008 a series of
      explosions at the Varanus Island processing facilities cut all of its domestic gas
      production, reducing domestic gas supply in WA by approximately 30 to 35 per cent.
      Partial production resumed in August 2008 with full production recommencing in early
      2009;


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•    the significant upswing in demand for gas as a consequence of the commodities boom
     and a growing preference for a lower carbon-emitting energy sources, such as natural
     gas; and

•    the impact of the long-term ‘ take-or-pay’contract between the North West Shelf
     (NWS) Venture and the (then) State energy utility, the State Energy Commission of
     WA (SECWA). Prior to the development of the NWS domestic gas supply in 1984,
     natural gas consumption in WA was around 5 per cent of present levels. Gas supply
     was limited to relatively small volumes available from the Perth Basin, delivered to
     Perth through the Parmelia Pipeline.

     Following the discovery of large gas reserves on the NWS, the Western Australia
     Government played a major role in the development of the reserves by signing –
     through the SECWA –a long-term take or pay contract to purchase gas from the
     project for domestic consumption for 20 years.

     Also key to the development of the reserves was the construction of the Dampier to
     Bunbury Natural Gas Pipeline (DBP), which would deliver the NWS gas to customers
     in Perth and further south. The pipeline was commissioned in 1984 and deliveries of
     gas followed soon afterwards.

     The take-or-pay contract between the NWS Venture and SECWA created a supply
     overhang –there was more gas supply than gas demand –and that kept prices low,
     which, in turn, discouraged new domestically-focused gas exploration and development
     for many years because it was not commercially viable.

     This is highlighted in Figure 311, which shows the significant gap between total WA gas
     consumption and total capacity that existed between 1983 and 2007.

Figure 3: Western Australian gas market supply and demand (1983-2007)




Source: Woodside Energy Ltd, “Gas supply to Western Australia”, Australian Institute of Energy, 15 August 2007.




11See www.woodside.com.au/NR/rdonlyres/2F1AE476-5776-4A58-9EB7-
4BEE6C95D331/0/KeithSpenceaddresstoAIEPresentationPack.pdf for further information.


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2.7.2      Physical supply

WA has access to substantial gas resources found mostly in remote Commonwealth waters
off its north-west coast.

According to WA DMP’    s Western Australian Mineral & Petroleum Statistics Digest 200912, these
known gas resources are estimated to total 160.4 trillion cubic feet (Tcf). As a general rule
of thumb, 1 Tcf is enough gas to power a city the size of Perth for around 15 years.

New discoveries are regularly being made, and in his Rice University speech on 13 April
201013, Western Australian Premier, the Hon Colin Barnett MLA, predicted that

           … ultimate reserve levels will prove to be well in excess of 200 Tcf as further discoveries are made.

Figure 4 shows the growth in WA gas sales since 1998 and the role of new fields in
meeting supply.

Figure 4: Western Australia Gas Sales by Fields (1998-2009 (TJ/day))




Source: Wood Mackenzie (2010).

2.7.3      Suppliers

The NWS Karratha facility is operated by Woodside Energy on behalf of the NWS
Venture. The NWS produces approximately 600 TJ/day of domestic gas or approximately
67 per cent of total WA supply. The Karratha domestic gas facility is running close to
capacity14.

The Apache Energy operated Varanus Island facility sources gas from two joint ventures,
Harriet and John Brookes. The Harriet joint venture produces approximately 95 TJ/day
and John Brookes produces approximately 245 TJ/day. In total, the Varanus Island facility
represents approximately 30 to 35 per cent of WA domestic gas production.

Several fields in the onshore Perth Basin supply around 2 per cent of the market; Beharra
Springs operated by Origin Energy, and Dongara and Woodada operated by AWE.


12 Department of Mines and Petroleum (2009), Western Australian Mineral & Petroleum Statistics Digest 2009 (available at
www.dmp.wa.gov.au/documents/Western_Australian_Mineral_and_Petroleum_Statistic_Digest_2009.pdf).
13 Available at www.mediastatements.wa.gov.au/Pages/Results.aspx?ItemID=133337.
14 Noting that in the middle of 2008 production was able to be temporarily increased to above 700 TJ/day to compensate for loss of

supply due to the Varanus Island explosion.


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Figure 5 shows WA gas sellers in 2009 and their respective market shares.

Figure 5: WA Gas Sellers 2009




Source: Wood Mackenzie (2010).

Figures 6, 7 and 8 show WA gas fields commercial and technical reserves for large, medium
and small fields. These figures highlight the size and diversity of gas reserves enjoyed by
WA from onshore sources and from Commonwealth waters offshore from WA.

Figure 6: WA Gas Fields Commercial and Technical Reserves15 (> 2,000 petajoules
(PJ))




                                                                                                                16

Source: Wood Mackenzie (2010).

Figure 7: WA Gas Fields Commercial and Technical Reserves (< 2,000 PJ; > 200 PJ)




* indicates speculative Wood Mackenzie estimate only.
Source: Wood Mackenzie (2010).



15 Commercial reserves refer to volumes that have commercial contracts as well as volumes deemed “technical”, that is, known but not
yet developed and currently without off-take contracts.
16 While Figure 6 separates West Tyral Rocks from the Greater Gorgon Area, gas from the field is to be processed through the Barrow

Island LNG and domestic gas plants and is thus considered to be part of the Greater Gorgon Area.


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Figure 8: WA Gas Fields Remaining Commercial and Technical Reserves
(< 200 PJ)




Source: Wood Mackenzie (2010).

2.7.4     New supply

A range of new projects are under consideration. Together, they represent the largest
exploration and development effort in Western Australian gas supply in nearly three
decades.

Devil Creek/Reindeer17

The Reindeer project is a joint venture between Apache Energy and Santos with the
domestic gas to be processed through the Devil Creek processing facility near Karratha.
The Devil Creek gas plant will have two gas processing trains with a combined capacity of
around 200 TJ/day and both are expected to be in production by the end of 2011.

Gorgon18

Chevron, ExxonMobil, and Shell are actively jointly marketing 150 TJ/day sourced from
the domestic gas plant under construction as part of the Gorgon Project and to commence
production in 2015, with plans to expand capacity to 300 TJ/day by 2021.

Macedon19

BHP Billiton and Apache Energy are planning to develop the Macedon gas field with
production of 200 TJ/day from sometime in 2013.

In addition to the projects noted above, a number of developments are tentatively forecast
to either commence production of domestic gas prior to Gorgon or shortly after:

•    Pluto (Woodside) –LNG production forecast to commence in 2010 with possible
     domestic gas supply from 2015;

•    Wheatstone (Chevron) –possible domestic gas supply of 200 TJ/day from 2016;



17 See www.apachedcdp.com.au for further information.
18 See www.chevronaustralia.com/ourbusinesses/gorgon.aspx for further information.
19 See www.bhpbilliton.com/bb/ourBusinesses/petroleum.jsp for further information.




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•       Scarborough (BHP Billiton and ExxonMobil) –currently in a feasibility study, possible
        production post-2015; and

•       market forces are also encouraging a range of innovative supply solutions (for example,
        the Warro Gas Field development has seen Latent Petroleum Limited and Alcoa form
        a joint venture to appraise and develop the Warro Gas Field north of Perth20). A range
        of other onshore ‘  tight gas’fields are being actively appraised and onshore exploration
        is taking place in the Canning Basin. Rapid growth in the production of coal seam gas
        (CSG) in Eastern Australia and shale gas in the US is also triggering interest in WA’  s
        unconventional gas potential with several drilling programs now underway or being
        planned.

2.7.5        Supply transportation and storage, linkages with other markets and the entry of brokers /
             aggregators

The DBP is the largest of the Western Australian gas pipelines with a current capacity of
840 TJ/day. It runs almost 1,600 kilometres. The firm full haul capacity of DBP is fully
contracted under pre-existing contracts until 2019 with options potentially extending this to
2029.

The Goldfields Gas Pipeline (GGP) transports gas from the Carnarvon region to
customers in the Pilbara and Eastern Goldfields Regions. It has a current capacity of
130 TJ/day.

The Parmelia Gas Pipeline (PGP) transports gas from the Perth Basin to industrial
customers in the wider Perth region. It has a capacity of 65 TJ/day.

It is important to note that pipeline owners are frequently only willing to expand capacity
based on firm shipper commitments.

The PGP includes the Mondarra storage facility, which is the largest storage available in
WA. The Mondarra storage field has current functionality of approximately 12 TJ/day
injection and 12TJ/day outlet.

The Western Australian domestic gas industry sits apart from the rest of Australia as there
are currently no pipelines enabling domestic gas supply either to or from the Eastern
States. In addition, there exist no facilities in WA that would enable the importation of
LNG that could then be subsequently re-gasified for supply in WA.

Also, the Western Australian electricity industry does not have physical interconnection or
governance linkages with the National Electricity Market. The Western Australian
electricity industry is linked to the domestic gas industry as currently 60 per cent of
installed generation capacity is fuelled by domestic gas.

Recent years has seen some modest evolution WA gas market brokering and aggregation
services. Gas brokering, trading and aggregation may be around 10 per cent (at most) of
the DBP daily throughput.

Brokering and aggregations services are understood to be provided by four established
parties (Alinta, Synergy, Verve Energy and Perth Energy), as well as two new gas trading

20   See www.latentpet.com/about.asp for more information.


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start up businesses, and perhaps most materially via the DBP’
                                                            s “Inlet Trade”system which
runs as a part of the DBP’ s Customer Reporting System.

2.8       The WA Gas Market: supply costs

As well as facing declining liquid yields from leaner gas, one of the most significant
impediments to gas development is the escalating costs associated with exploration and
production. These are illustrated in Figure 9 below.

Figure 9: Global Upstream Petroleum Capital Costs Index: 2000-09
                          240
                          230      Index 2000=100
                          220
                          210
                          200
                          190
                          180
                          170
                          160
                          150
                          140
                          130
                          120
                          110
                          100
                           90
                           80
                            2000     2001    2002    2003    2004   2005   2006   2007   2008   2009   2010


Source: IHS Cambridge Energy Research Associates. See www.ihsindexes.com.

Western Australia’
                 s upstream gas industry has been facing significant cost pressures from
several sources:

•     the next generation of new field developments are generally further offshore, deeper
      water, contain less (valuable) liquids and have higher levels of impurities (resulting in
      higher processing costs) than the ‘ inboard’(around 100 kilometres or less from the
      coast) Carnarvon Basin fields that have met most of the market’    s needs over the past
      20 years;

•     since 2004, upstream petroleum development costs have more than doubled. Costs
      have declined marginally since late 2008 (as result of the global financial crisis (GFC)
      and downturn in the world economy) but may resume an upwards trend as the global
      economy and its demand for energy recovers. This is particularly relevant in the
      context of the Western Australian market with significant competition for labour
      resources; and

•     inefficient approvals and regulatory processes, increased wages and industrial unrest,
      increasing conditions and objections in relation to environmental protection and the
      growth of ‘ user pays’and cost recovery in regulating the industry are contributing to a
      substantial increase in the cost burden facing large gas projects.

2.9       The WA Gas Market: conclusions

In conclusion, an analysis of the WA gas market and its implications for gas prices to
customers throughout WA reveals:



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•     most of the gas sold in Western Australia is sold through long-term contracts (the
      details of which are generally confidential). Some gas is sold on a short-term basis,
      from time to time, but for the most part, no liquid market for gas exists in Western
      Australia;

•     it has relatively few developed gas supplies together with concentrated demand –there
      is also a very large geographical distance between the location of the gas reserves and
      the end users (requiring long haul pipelines with few genuine hubs);

•     the Western Australian domestic gas market is dominated by a small number of very
      large customers with the five largest customers accounting for over 80 per cent of
      domestic gas consumption. The high degree of customer concentration has been a
      consistent characteristic of the Western Australian domestic gas market;

•     gas supply to these customers is under long-term contracts resulting in ‘lumpiness’in
      demand for new sources of domestic gas. In particular, demand is very project-based
      with major demand increments coming on at discrete intervals linked to specific gas
      using project developments. The ‘  lumpiness’of demand in Western Australia presents
      very significant challenges for new domestic gas projects in modelling likely demand
      and the consequential level of cashflow over time periods many years into the future;

•     this lumpiness of demand with long-term contracts coupled with a limited domestic
      gas transmission network results in the Western Australian market being illiquid.
      Unlike mature overseas markets, there is no integrated network of pipelines, with only
      three major pipelines transporting domestic gas in Western Australia;

•     the effect of long-term contracts with minor variation allowances results in little
      demand for short-term supply which might give rise to the emergence of a spot or
      secondary market. Unlike overseas markets such as the US and UK, in WA there are
      very few intermediary services such as energy traders and brokers;

•     a lack of storage options exist in WA to enable domestic gas producers to store, lend
      or park domestic gas to address imbalances in supply and demand. Storage facilities
      allow market participants to manage imbalances that result from demand and supply
      fluctuations;

•     in response to recent price movements, the largest domestic gas project development
      activity in over three decades is currently underway; and

•     average gas prices in WA remain comparable to average east coast gas prices and (as
      will be considered below) below average international LNG prices.

3.       THE COMPARISON OF THE PRICE OF GAS WITH OTHER STATES,
         ESPECIALLY VICTORIA, AND WHETHER THERE IS A
         SIGNIFICANT PRICE DIFFERENTIAL AND, IF SO, WHY?

3.1      Introduction

As noted above, most of the gas sold in Western Australia is sold through long-term
contracts (the details of which are generally confidential). Some gas is sold on a


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shorter-term basis, from time to time, but for the most part, no liquid market for gas exists
in Western Australia.

This, and the unique characteristics of the Western Australian gas market considered in
Section 2.8, means according to the Chamber of Commerce and Industry of WA’      s Meeting
the Future Gas Needs of Western Australia report21

             … the comparison of WA domestic gas prices to other jurisdictions [is] a difficult task.

Within that context, the following sections consider the nature of the Eastern Australian
gas market and publicly information about gas pricing in the eastern market, including in
Victoria.

3.2          Comparison with other states, especially Victoria

The Inquiry’ s Terms of Reference, at (2)(b), asks the Committee to include a comparison
of the price of gas with other states, especially Victoria, and whether there is a significant
price differential and, if so, why.

As noted in Figure 1 above, east coast domestic gas prices have historically been slightly
above WA gas prices, while similarly well below prices in most overseas markets.

This shows that while individual contract prices, prices facing certain segments of
individual markets and terms and conditions may vary, the price differential between
average domestic wholesale gas prices in Eastern Australia and WA is not very significant.

In addition, a fundamental point to note is that Eastern and Western Australian gas
markets are not connected and the market prices are determined by a different set of
supply and demand fundamentals. As such it is not valid to directly compare prices in the
two markets without understanding the differences in supply and demand conditions.

3.2.1        A brief overview of the Eastern Australian wholesale gas market

An analysis of the east coast domestic gas market is contained in Section 3.2 of the KPMG
Gas Market Report at Attachment 1. It shows:

•       in terms of suppliers, the main suppliers of gas in the Eastern Australian market are
        Origin Energy, the BG Group, Santos, Arrow Energy, BHP Billiton and ExxonMobil.
        The Cooper and Gippsland Basins have dominated gas supply under long-term
        contracts. The market has now expanded and offers numerous sources of supply. The
        acceptance of coal seam gas as a viable form of gas for commercial and retail customers
        and as a feedstock for gas-fired electricity generation and LNG trains has facilitated this
        step change in market structure

        -    the Gippsland Basin, which lies mostly offshore from the south-east corner of
             Victoria, has great potential for bringing on-line new gas supplies for the east coast
             market. Exploration at the Otway Basin (located off the south western corner of
             Victoria and the south east corner of South Australia) is mature onshore and
             immature offshore;


21   See www.cciwa.com/Resource_Energy__Environment.aspx#13791 for further information.


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     -     not all states have equal access to gas supplies. Unlike other mainland states, NSW
           does not have substantial indigenous gas production. It sources nearly all of its
           natural gas from interstate. NSW remains highly unexplored for natural gas
           compared to its neighbouring states, despite it being one of Australia’
                                                                                 s largest
           sources of potential gas demand. NSW has, however, significant gas production
           potential. While the NSW CSG fields are yet to be proven commercial, this local
           supply has the potential to rapidly expand and reduce the need for interstate gas
           import in the future;

•    gas transport in the east coast market is relatively more mature and interlinked than that
     of the west coast and services a greater demand base. That said, it still experiences
     some of the ‘lumpiness’of the west coast market and is not liquid. There exists an
     interconnected network of transmission and distribution infrastructure, which is still
     progressively evolving to support the development of a competitive gas market. While
     cross border gas volume swaps between counterparties still remains a significant means
     of meeting gas demand on the east coast, some capacity expansions have been
     announced that could potentially enable greater deliveries of gas from Queensland to
     the southern states; and

•    gas storage facilities, while limited, are larger than on the west coast22. Also, a volume
     of storage is provided in the form of linepack (capacity within the gas pipelines). It is
     anticipated that more storage facilities will be built as demand for gas is forecast to
     increase

     -     there are two gas storage facilities in Victoria: the Iona Gas storage facility23 and the
           Dandenong LNG24 storage facility

           ..         the Iona Gas storage facility is owned by TRUenergy and located near Port
                      Campbell in southwest Victoria. This facility is connected to the Declared
                      Transmission System (DTS) via the South West Pipeline to Melbourne. It
                      is also connected to the South East Australia Gas Pipeline to provide flow
                      to Adelaide.

           ..         the Dandenong LNG storage facility is owned and operated by APA
                      Group. It has a fully contracted capacity of around 0.7 PJ and provides
                      peak shaving and security of supply services for the DTS.

3.2.2      The Victorian Gas Wholesale Market

Victoria is Australia’ s longest established wholesale gas market. Natural gas has been a
major source of energy for Victorian business and households since it was first rolled out
in the state in the late 1960s.

A daily imbalance market25 was introduced into Victoria in March 1999 providing for the
trading of daily imbalances in Victoria since that date. Following a detailed review, a new
wholesale market commenced operation in February 2007. The market is now operated by

22 The only storage facility to be developed in WA is the Mondarra facility, which has a capacity of 12 TJ/day or approximately one per
cent of the domestic gas market. By contrast, the Iona storage facility in Victoria operated by TRUenergy has the capacity to inject
approximately 320 TJ/day up to a total of 12 PJ.
23 See www.truenergy.com.au/Production/Iona/index.xhtml for additional information.
24 See www.apa.com.au/our-business/gas-transmission-and-distribution/victoria.aspx for additional information.
25 An overview of the Victorian Gas Wholesale Market is available at www.aemo.com.au/corporate/0000-0156.pdf while a more detailed

technical guide can be found at www.aemo.com.au/corporate/0000-0157.pdf.


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the Australian Energy Market Operator (AEMO)26, the national gas market operator, with
previous market operations run by the Victorian Energy Networks Corporation (Vencorp)
superseded by AEMO on 1 July 2009. The market operates as an imbalance market
allowing parties to manage the underlying contract positions (rather than as a ‘
                                                                               true’spot
market) and in conjunction with the underlying gas supply, transportation and network
contracts.

There are now more than two million Victorian natural gas customers and annual demand
for natural gas exceeds 230 PJ. Annual residential use of natural gas, driven by winter
heating and hot water needs, exceeds 90 PJ, by far the highest in Australia. In addition,
annual demand from gas-fired generation is expected to grow considerably, in line with
efforts to reduce the carbon emissions from electricity production. The coverage of the
Victorian market is shown in Figure 9.

Figure 9: Victorian gas transmission pipelines




Source: AEMO (2010).

The market applies to the DTS shown in Figure 9 above. The DTS comprises of pipelines
extending from Longford in the east of Victoria, across to Portland in the south west,
central Victoria and north to Albury/Wodonga and Culcairn in New South Wales. The
DTS is directly interconnected to the rest of the east coast gas market through the Eastern
Gas Pipeline (EGP) via VicHub (from Longford to Sydney –Horsley Park and
Wollongong) the Minerva to Iona pipeline (SEA Gas adjunct), BassGas Pipeline (Lang
Lang Gas Plant to Pakenham), Carisbrook to Horsham Pipeline and the Culcairn to Wagga
to Young pipeline (NSW system) and is indirectly connected to the SEA Gas pipeline
(Iona to Adelaide pipeline) via the Iona Gas storage facility. The Tasmanian Gas Pipeline
(from Longford to Bell Bay) is connected to the EGP near Longford.

AEMO also provides monthly Gas Market Reports that include information on price and
withdrawal information reflecting the five intra-day price updates which occur within the
wholesale market, Unaccounted for Gas, Retail Transfers and Allocated Injections at each


26AEMO, which commenced operation on 1 July 2009, is responsible for management of the National Electricity Market (NEM) and
the retail and wholesale gas markets of eastern and southern Australia and oversees system security of the NEM electricity grid and the
Victorian gas transmission network. In addition, AEMO is responsible for national transmission planning and the establishment of a
Short Term Trading Market for gas. AEMO was established by the Council of Australian Governments (COAG) and developed under
the guidance of the Ministerial Council on Energy (MCE). It took over these operations from previous state-based organisations
operating in NSW, ACT, Victoria, Queensland, Tasmania and South Australia. Only the Northern Territory and Western Australia sit
outside AEMO. Further information is available at www.aemo.com.au.


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major supply point27. Figure 10, taken from the April 2010 Gas Market Report shows daily
gas price information for different parts of the day and gas withdrawals from the market
during April 2010.

Figure 10: Victorian Gas Wholesale Market: prices and withdrawals (April 2010)




Source: AEMO (2010).

3.2.3     Gas market development and reform process in Eastern Australia

Unlike WA, the Eastern Australia gas market has been in recent years undergone a
program of gas market reform, driven by an industry-led Gas Market Leaders Group –of
which APPEA is a member –under the auspices of the Ministerial Council on Energy
(MCE)28.

The major developments to come out this ongoing reform process has to date been:

•    the commencement on 1 July 2008 of a national Gas Market Bulletin Board (BB)29.
     The BB is a single electronic communications system covering all major gas production
     fields, major demand centres and natural gas transmission pipeline systems, including
     the interconnected systems of South Australia, Victoria, Tasmania, NSW, the ACT and
     Queensland. The objective of the BB is to facilitate trade in gas and capacity over the
     relevant pipeline systems through the provision of system and market information
     which is readily available to all BB users. Provision exists within the BB and its
     supporting legislation for WA and the NT to join the BB;

•    the annual Gas Statement of Opportunities (GSOO)30, launched in December 2009, is
     prepared by AEMO in association with industry stakeholders, and aims to assist
     existing participants and new investors in making commercial decisions about
     investment in infrastructure or entering into contracts in the Eastern and South Eastern
     Australian gas industry. The GSOO includes information for the 10 years after the
     year of publication, incorporating natural gas reserves, capacities and constraints of
     production, storage and transmission facilities, projected annual and peak day demand


27 The April 2010 Gas Market Report can be found at www.aemo.com.au/reports/0813-0077.pdf.
28 See www.mce.gov.au for further information.
29 The BB can be viewed at www.gasbb.com.au.
30 See www.aemogas.com.au/index.php?action=filemanager&folder_id=1588 for further information.




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