Factors influencing Australia s gas supply and demand Mark Cully, Nicole Thomas and David Whitelaw * March 2016 * This is the text of a keynote speech given by Mark Cully to the 2016 Australian Domestic Gas Outlook Conference, Sydney, on 8 March 2016.
1. Introduction In my presentation today I draw on our latest Gas Market Report, published just last Friday. As we have been saying for some years now, we expect Australia to become the world s largest exporter of LNG by the end of this decade. While we are confident about this headline forecast, we are entering uncharted and possibly choppy waters in energy markets, and in gas markets in particular. The outlook is highly contingent, both in the medium-term (5 years) and long-term (20 years). Let me begin with the long-term. [SLIDE 1:Title slide] 2. Long term outlook There are a range of organisations that publish long-term energy outlooks. Almost all of these will be wrong in their particulars, often wildly out. For example, a decade ago no one expected the US to become the world s largest unconventional oil and gas producer, something that has completely altered the dynamics of the energy sector. Long-term outlooks are not useful tools for canvassing the possible impacts of disruptive change. Some combination of cheaper renewable energy, developments in battery storage, and innovations we haven t yet thought of, mean the energy sector in 20 years time will be vastly different to now. So, why produce them? The purpose of long-term outlooks is not to predict the future but to guide us on what changes might need to be made now so as to avoid future problems. Are there sufficient reserves that are proven and probable to meet anticipated future demand? It is the same reason why the government produces every five years an Intergenerational Report to attempt to anticipate the long-run budgetary impact of population ageing. Just as that report has a fundamental driver in population ageing to underpin a base case scenario, so too do energy outlooks. The two main drivers are population growth and convergence in living standards. Over the next 20 years the world population is expected to increase by 1.5 billion people. Over the same period, we expect global GDP to almost double, around half of that driven by China and India. As living standards grow in emerging economies, the demand for energy and electricity will also grow. Factors influencing Australia s gas supply and demand 1
Perhaps the most useful aspect of long-term outlooks is their capacity to handle what if questions. For the energy outlook, the most confronting what if questions are the implied changes to energy mixes to meet the challenge of containing carbon emissions to levels agreed at COP21 in Paris. [SLIDE 2: The long term energy outlook is uncertain, but gas has best prospects amongst fossil fuels] This slide illustrates the breadth of possible future energy demand scenarios over the next 20 years. Compared to historical growth rates, both BP and the IEA see a fall in the growth of energy consumption in their base case assumptions. Both organisations also expect gas consumption to continue to grow at similar levels to the past, but coal and oil consumption to grow at a substantially slower rate. In the scenarios where greater efforts are made to reduce emissions, coal use declines and oil consumption either plateaus or falls. Both organisations expect gas consumption to increase under their low emission scenarios, but at a lower rate than in the baseline. This reflects the lower carbon emissions from gas consumption and its role as a transitional fuel. The position of gas in the fuel mix is not guaranteed. It will depend on its competitiveness against alternatives such as coal, renewable energy and nuclear. Gas is the higher cost alternative among the fossil fuels and so it must achieve the Goldilocks price, the price that is just right to both encourage demand while at the same time sustaining investment. 3. Medium term outlook [SLIDE 3: Global growth continues to disappoint] If the long-term outlook for gas is relatively benign, the same cannot be said for the medium-term. Factors influencing Australia s gas supply and demand 2
The global economy is currently characterised by record low interest rates and low inflation, with modest and at best a variable recovery from the global financial crisis. Estimates of the future of global GDP growth have consistently been revised downwards in recent years. A key issue for Australia is the trajectory of growth in China, and the effect this will have on our exports. The modest performance of the global economy has coincided with large additions to supply for a number of energy commodities. This has resulted in a collapse in commodity prices across the board, and prices are expected to remain subdued in the medium term. There are many factors behind this price decline, but one important contributor has been the huge expansion in shale oil and gas production in the US. This is transforming the US from a net gas importer to a net gas exporter, causing major shifts in energy flows across the globe. 3.1 Outlook for LNG exports Global demand trends What can we say specifically about LNG, looking globally in the first instance? LNG demand is expected to grow rapidly to 2020, after a period of relative decline from 2012 to 2014. [SLIDE 4: Strong LNG demand growth in new markets, but a growing excess of LNG capacity] We expect demand to decline in Japan, as its mothballed nuclear plants are restarted. However, more than offsetting this is substantial forecast growth in three regions of the world. First, demand will grow rapidly in Europe, as a result of the decline of its local gas reserves. Second, LNG imports will grow strongly to comprise about 40 per cent of total gas demand in China, although pipeline supply from Central Asia and Russia is expected to provide the majority of imports in the longer run. China is shifting its primary energy mix from coal dependency toward lower carbon energy sources, such as natural gas. It is now the third largest gas consumer in the world. Factors influencing Australia s gas supply and demand 3
Last, the rest of Asia has the greatest potential for growth, led by India. India s gas consumption is expected to increase by 60 per cent over the next five years, with the bulk of this to be met by LNG imports. That said, India s price sensitivity, the adequacy of its infrastructure, and ability to increase domestic production could have a large impact on this outlook. Australia is in a good position, owing to our proximity to the main growth regions in Asia. However, whilst demand for LNG is strong, supply capacity is also growing rapidly, leading to excess supply in the market. 3.2 LNG supply Australia is adding over 60 million tonnes of LNG export capacity from new projects on the east coast as well as the traditional gas regions in offshore north-western Australia, the result of around $200 billion of investment. Australia is expected to overtake Qatar and Malaysia to be the world s largest exporter of LNG by 2019, with almost 30 per cent of global installed liquefaction capacity by this date. The 63 million tonnes of LNG capacity under construction will bring Australia s total LNG capacity to 86 million tonnes, above Qatar at 77 million tonnes and Malaysia at 24 million tonnes. Construction on all of these projects is well underway. The US has five projects under construction, which will bring its capacity to between 63 and 72 million tonnes per annum. New projects are unlikely in the medium term, given current excess capacity and limited capital available as a result of low prices. Even if Australia has the largest capacity, there is always the potential that actual exports will be lower than anticipated. This is particularly the case in a market with excess supply. However, long term contracts should protect a large part of Australia s projected export volume. LNG demand growth, while strong, will be outweighed by these upcoming additions to supply. Excess supply capacity is expected to characterise the market until at least 2020. Factors influencing Australia s gas supply and demand 4
4. LNG market trends [SLIDE 5: Global LNG markets are becoming more fragmented and flexible] There are two other factors at work today in the LNG market which will have consequences for Australia. First, the market is becoming more fragmented, with a growing number of importing as well as exporting nations. This trend is worldwide, and is being facilitated by the use of small and relatively cheap Floating Storage and Regasification Units in importing nations, and by the growing liquidity of the market. Second, the market is becoming more flexible, with an increase in shorter term trades. Spot and short term markets now constitute 30 per cent of the total market up from 5 per cent in 2000. This is a result of the high levels of uncertainty in the market, and the growing liquidity which enables these trades. The consequence for Australia is a more diverse, and more volatile market. Lower spot prices are expected to prevail for some time. The combination of excess supply and low prices means that it will be more difficult to underwrite new investments in LNG capacity. 4.1 Supply and investment drivers in the domestic market [SLIDE 6: The East Coast market is undergoing a major transformation] Factors influencing Australia s gas supply and demand 5
As these transitions unforld in global LNG markets, the east coast gas industry in Australia is undergoing a major transformation. LNG exports have now commenced from Gladstone and will ramp up sharply over the next year or so. The LNG industry has been built on the discovery, development and production of the extensive coal seam gas fields in Queensland, the first in the world to produce LNG from CSG. [SLIDE 7:The eastern Australian market is undergoing a major transformation] It is really quite remarkable that proven gas reserves globally have grown at 2.7 per cent a year since 1980 and the ratio of proven gas reserves to consumption has never dropped below 50 years over that entire period. The transformation of the LNG industry in Australia has sparked two major concerns. First, domestic gas prices are rising and this is having a major impact on households and businesses, particularly in the gas-powered generation sector. Second, there are concerns about potential supply shortfalls in the domestic market. Are these concerns warranted? We have addressed this question as you might expect economists to do: by building an economic model, of the east coast gas market. The results presented here are from the first analyses using that model. There are a number of key issues that will determine outcomes in the market, but to understand them it is useful to consider the market as two distinct geographical regions subject to different drivers. Factors influencing Australia s gas supply and demand 6
[SLIDE 8:Investment into new supply will be needed, despite falls in demand] In the northern market (Queensland and the Cooper Basin), the main driver is the incentive to invest in new production capacity. The investment in production capacity in Queensland to supply LNG production has been huge, but there is a limit to how much capacity will be installed to supply both the domestic and LNG markets. Small changes in LNG production can absorb the available gas production, or free-up spare capacity for use in the domestic market a particular issue given the limited ability to turn down CSG wells. The problem is particularly acute with CSG production, as new investment is required on a continual basis in order to maintain production levels. The current low price environment is pulling the market in two directions at the same time. Given current low LNG prices and excess global capacity for LNG we expect Queensland LNG production to be at the lower end of the feasible range, although this is ameliorated to some extent by the lower Australia dollar. This will enable greater supply to the domestic market. On the other hand, given the financial exposure of the producers in Queensland and the Cooper to the LNG market, the ability of these producers to invest in production will be constrained. How this plays out in practice is difficult to say, but it is clear that the more independent producers in the market, the better the outcome. This analysis assumes there will be no new brownfields developments at Gladstone to expand LNG export capacity. New trains at Gladstone would require substantial gas reserves to be dedicated to LNG production under longterm contracts. This creates an option value over the excess gas reserves in Queensland, which would exclude this gas from the domestic market. However, under the current outlook, this option value is becoming less likely. In the southern markets, almost all gas supply comes from the offshore Victorian gas reserves in the Otway and Gippsland basins. Gas production appears to be sufficient in the short term, given the large falls expected in gas powered generation demand. However, gas reserves and deliverability are expected to decline over the next decade, initially in the Otway basin, and later in Gippsland. This creates two issues. First, there will be a concentration of ownership in the Gippsland Basin Joint Venture. Second, new gas supply is needed, either from expanded exploration and development in Victoria, or alternatively for substantial imports from Queensland or the Northern Territory. Factors influencing Australia s gas supply and demand 7
The Government is responding to these concerns, and is working to identify potential market failures, and to facilitate market development. Its objective is to create a more liquid and transparent east coast market, with transparency and equal access to information, price discovery and the facilitation of trading. 5. Conclusions It is common for Treasurers to boast that Australia has had continuous economic growth for 25 years. We too often attribute this to an independent Reserve Bank, flexible exchange rates and a series of economic reforms in the 1980s and 1990s, and in the 2000s the China boom. But it must be more than this. It requires real investment and activity to occur. We do not often enough celebrate the remarkable innovation and ingenuity in Australia s primary industries, such as the creation of these huge new export markets for Australian gas which will contribute to ongoing economic growth and higher living standards in Australia. [SLIDE 9:Further information and contact details] Factors influencing Australia s gas supply and demand 8