Jim Snow Executive Director 31 August 2015 Trends in Australian Gas Prices.

Jim Snow

Executive Director

31 August 2015

Trends in Australian Gas Prices

Private and Confidential

INTRODUCTION

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Domestic Gas Market

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• Annual in 2013-2014 was 1,402 PJ

• Mining here includes LNG self use

• Actual gas demand is higher as the domestic market figures do not include LNG exports (another 1,285 PJ in 2014-15)

• LNG exports the growth area of the gas market – domestic market in serious decline

• The majority of gas in Australia has been used in the generation of electricity and manufacturing (approx. 71%) – electricity usage though is reducing rapidly – almost wiped out

• Residential direct usage of gas accounts for 11% of gas usage in Australia


INDUSTRIAL GAS PRICE REVIEW

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Private and ConfidentialCopyright Oakley Greenwood

Industrial customer segments

• Large Industrial Customers - >1 PJ/a– Can get GSA offers from Producers and Retailers

– Mainly supplied off high pressure gas systems – transmission & sub-transmission

– Tend to be sophisticated buyers – energy a high % of their costs – energy intense industries – metals, fertilisers, wall board, food prpaper, bricks, etc.

– Their prices are the wholesale gas prices – no Retail margins as such – more about portfolio head room, negotiations and vertical integration – also some strategic issues related to price reviews

– Error band for the large Industrial gas customer pricing presented has been estimated at +/- 10%

• Small Industrial Customers – 0.1 to 1.0 PJ/a– Retailer offers predominate and gas from lower pressures systems

– Small manufacturing and food production, etc.

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Key factors influencing Industrial gas prices

• Load Factor - ratio of MDQ to ACQ (set at 1.1) - been a “free” ride for the review period but this is changing - drives storage investment as well – underground, LNG

• Contract Terms - long term is typically longer than 3 years – used to be longer - major risks with longer term agreements when prices are volatile – buyers and sellers then prefer short terms to manage market price risks, and– The term of the agreement also specifies the total 2P reserves that must be

allocated to the contract - 2P reserves are finite until new gas can be “booked” by a Producer – important concept – especially when large volumes are contracted

• GSA Price Reviews - longer term GSA’s will generally have a market price review after 3 years - just another way of managing this market price risk – can also tend to dampen price increases in existing contracts

• Contract timing 2011-2015 - when market prices escalating the timing of individual customer renegotiations can have major impacts on their prices over 3 year period

• Transmission Prices - these vary a little across jurisdictions for Industrial customers and are normally charged on the basis of their booked MDQ which reflects the capital costs of the asset, with a smaller charge for operating costs

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Key factors influencing Industrial gas prices• LNG Netback - LNG demand for gas feedstock and then linking the

sale of this gas to oil prices has been the major factor that has driven up wholesale gas prices in Australia (east and west coast) – seeing a tripling of demand for gas– Also reflects the need to develop large scale new gas supplies –

conventional and unconventional to meet this demand – and these also come at relatively higher prices than past conventional gas supplies - even as LNG prices have been hit by oil price reductions negotiations have focused onto this cost of new gas supply issue - has had a major impact on large industrial prices for the southern gas markets (NSW, Vic, SA and Tasmania) – the linking of Moomba gas prices to LNG was the key

• Carbon Tax - this was applied 1 July 2012 to 1 July 2014 - for large Industrial customers only Scope 3 emission costs were applied to gas prices – carbon liberated from the production and transportation of the gas – typically low cost– For small Industrial customers Scope 3 and Scope 1 emissions were

applied – the difference was who paid for the emissions generated from the use of the gas (combustion or other forms of liberating the carbon as carbon dioxide) which is a much higher costs (circa $1.18/GJ)

– It should be noted though that different basins had different imposts – Moomba for example was 5 times higher than Longford

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INDUSTRIAL JURISDICTIONAL RESULTS

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East coast weighted average large Industrial gas price

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• The average large Industrial gas price for the east coast of Australia has been developed by volume weighting the prices for the averages of the state jurisdictions (Qld, NSW, Vic, SA and Tasmania). In 2015 the weightings were 20% NSW, 34% Vic, 29% Qld, 15% SA and 2% Tasmania.


East coast weighted average large Industrial gas price - components

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Queensland large Industrial customers

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• The large geographic extent of gas demand in Queensland has created three unique demand nodes and different gas pricing for each node.

• SEQ/Brisbane, Gladstone and North West Queensland

• Although there are consistent market fundamentals across Queensland, varying transportation and market structure issues have created different price outcomes across these nodes.

• The gas price paid by large Industrial customers has been shown for each of the nodes, and

• A high proportion of large Industrial customers have long term (10 to 15 year) GSA’s directly with gas Producers and arrange their own gas transportation


Queensland weighted average Industrial gas prices

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• This is the volume weighted price


Queensland weighted average Industrial gas price - components

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NSW & ACT large Industrial gas prices - components

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SA large Industrial gas prices – components

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Victorian large Industrial customers - price components

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Tasmanian large Industrial prices - components

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Victorian small Industrial gas prices - metro

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Victorian small Industrial gas prices - country

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Victorian small Industrial gas prices - comparisons

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NSW small Industrial gas price - comparison

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Some key points

• The NSW price rises were faster and higher than for Victoria due to the Moomba connection, and

• This is what has kicked off the Victorian price rises (and indicates what may happen to prices in Victoria)

• Sydney also has to pay additional haulage as there is no gas supply close by and this does add more to the costs

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WA large Industrial gas prices (Perth) – real and nominal

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WA large Industrial gas prices (Perth) - components

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INDUSTRIAL FUTURE GAS PRICE DRIVERS

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Key drivers of future Industrial gas prices?• The key issue in nearly all the jurisdictional markets that will impact future

wholesale gas prices is the supply and demand balance, including the ability to haul gas without undue transmission constraints.

• The simple economic models of supply and demand balances and clearing prices is always at play in this market.

• High prices develop, signalling scarcity, and this has seen the playing out of demand reductions and new supply entering the various jurisdictional markets to mitigate these prices or satisfy demand at the relevant clearing prices.

• For those with market power at the time price increases may seem to be a windfall but it can be seen from this report that this is also an essential component in the development of new supply (and in rationing demand)

• Once supply in those markets exceeds the demand the prices start to almost immediately retreat to cost of supply pricing, as long as there is reasonable competition.

• This produces WA type “pricing bubbles” where prices rise to signal the need for change in the market clearing volumes as supply becomes scarce, and then retreats once this occurs and supply can meet demand or is in excess of market need. In Australia’s case wholesale gas prices have escalated first to LNG netback and then retreated more to cost of supply.

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Key drivers of future Industrial gas prices?

• The east coast gas market prices are in the rising, and maybe even topping out, stage of this cycle/bubble.

• This is clearly dependent on the market satisfying the current demand for LNG plant feedstock and there being no new LNG plant development in this region. This cycle has yet to be played out but for the east coast gas markets it is critical in terms of pricing over the next 5 years, and there are a arrange of new explorers and developers that have entered the supply market.

• The impact of significant oil price reductions has been a distinct factor in wholesale gas price mitigation as it has negated LNG netback pricing cases. But this has simply exposed the true underlying problem of the need for new gas supply volumes to be developed, and that these look to be more expensive than the traditional gas supply.

• The interesting aspect of this cycle is how much it has affected the traditional market prices of Victoria, NSW and South Australia (and Tasmania). The transmission interconnectivity of the basins and markets has been enough to see the flow back of high Queensland prices that were more directly driven by LNG feedstock demand increases.

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Key drivers of future Industrial gas prices?

• The prices seen in the south eastern Australian gas markets have lagged those in Queensland and prices have been mitigated by distances and underlying contractual positions of Retailers and large Industrial customers (and greater competition for customers).

• The prices into the Sydney hub seem to be the clearing prices for this current market dynamic in the southern markets (largely because NSW does not have any major supplies of indigenous gas). Victoria is best served in this market as the available supply is so close to the market demand but it is also starting to suffer from price escalations as Sydney sets the clearing prices for Bass Strait gas sales.

• The issue over the next 5 years is the cost of new gas supplies to service the market demand as this will be the new wholesale gas market clearing price. The pricing bubble effect will continue until the demand is satisfied (be that in total or through reduced demand) and new supply starts to seek out market demand. The outlier is if demand again escalates should there be a believable increase in oil prices that sparks new LNG capacity in Australia.

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RESIDENTIAL GAS PRICES

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National Residential Gas Market Overview

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107 PJ

0.1 PJ

26 PJ

3 PJ

12 PJ

10 PJ


Residential Gas Consumption by State

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2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-150

20

40

60

80

100

120

140

160

180

Residential Gas Consumption by State

VIC TAS NSW ACT SA QLD WA

PJs

• Percentage portion of gas consumption by each state is relatively constant.


Average Household Gas Consumption

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Declining household consumption across all jurisdictions:

• Improved building standards

• Fuel substitution and switching

• Govt energy policies

• Number of household members reducing

Jurisdiction Average Household

Consumption (GJ)

Victoria 51

Tasmania 30

NSW (Sydney) 20

NSW (Rural) 37-45

ACT 45

South Australia 18

Queensland 11

Western Australia 15

• Appliance efficiency

• Long weather changes – Effective degree day declining trend.

• Jurisdictions that do not use gas primarily for heating have a much lower average consumption


RESIDENTIAL JURISDICTIONAL RESULTS

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Australian weighted average residential gas price

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• Weightings determined from each residential jurisdiction consumption. Vic dominates national average (64.9%)


• Households have declining average consumption (even while new connections have grown). There are a number of causes:– Switching fuel type

– Improved building construction

– Energy efficiency

– Long term trend in weather changes and decreasing EDD

• Retail costs fall into a number of components:– Retailer component (costs within retailer control) which are wholesale cost,

retail cost and margin ~47-53%

– Distribution and transmission component (costs outside retailer control) which covers mostly regulated costs such as pipeline distribution and transmission. ~46-52%

– Environmental Policy component (Carbon Tax) ~5%

• Tariffs and costs increasing with large distribution network cost increases in some jurisdictions and retail in others over the last 5 or so years.

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National Review – key points


Some key points – distribution cost analysis • Graph highlights the

economies of scale issues that face a number of the jurisdictions with regard to gas networks.

• As distribution density increases (e.g. Victoria) the overall distribution charge on an energy per unit charge decreases.

• Distribution business seem to be restructuring tariffs – fixed and declining block – defensive – and some Ramsey pricing to reduce switching

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Allgas

AGN - Qld

JGN

ActewAGL

AusNetMultinet

AGN - Vic

AGN - SA

Tas Gas

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

45.00

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5

$/G

J N

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ork

Ch

arg

es

Gas Distribution Energy Density (GJ/m network)

Distribution Network Benchmark 2013/2014


Queensland Pricing Analysis

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• The price per GJ is quite high in Queensland in comparison to other jurisdictions

• The high price is largely driven by the distribution costs which make up between 53-61% of the overall price throughout the period

• This high proportion of distribution costs is driven by the low penetration of gas and the low average household consumption – thereby resulting in a smaller economies of scale than other jurisdictions

• It can be seen also that the retailer component has gradually decreased as a portion of the average price over the period (from 35% in 2009 down to 20% by 2015)

0

10

20

30

40

50

60

70

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

$/G

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Averaged Qld Gas Retail Pricing ($2015)

Wholesale Market Price Retail Transmission Distribution

Retailer Component Environmental Policy Qld. Avg. Offer

Qld. Avg. Standing Offer

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Averaged Qld Gas Retail Pricing - Bill Component Percentages

Wholesale Market Price Retail Transmission DistributionRetailer Component Environmental Policy


NSW/ACT Pricing Analysis

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• Significant difference in the average price per GJ between Sydney and rural NSW.

• There is not as such though a big differential in the average annual bill due to different average consumption between Sydney (20.4 GJ) and rural NSW (37-45 GJ)

• Until 2011 the wholesale market and network costs where relatively similar and the average price differential was driven by the retailer component

• Following 2011 there has been a much greater increase in distribution costs in Sydney compared to rural – it is quite a marked trend

0

5

10

15

20

25

30

35

40

45

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

$/G

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NSW Metro Gas Retail Pricing ($2015)

Wholesale Market Price Retail Transport DistributionRetailer Component Environmental Policy Standing Offer

0

5

10

15

20

25

30

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

$/G

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NSW Rural Gas Retail Pricing ($2015)

Wholesale Market Price Retail Transport DistributionRetailer Component Environmental Policy Standing Offer


ACT Pricing Analysis

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• Penetration of gas is higher in ACT at 68% compared to NSW (43%)

• Gas heating is almost double NSW installations.

• Since 2004 ACT government has offered rebate scheme for upgrade from wood to gas heating with only minor impact (1000 rebates)

• Significant difference in the average price per GJ between Sydney and the ACT, however the average price is relatively consistent with rural NSW

• The retailer component has increased from 25% in 2006 to 34% in 2015 (with a reduction in the retailer component during the carbon price years of 2013 and 2014)

• It appears as though the impact of the carbon price was effectively absorbed by the uplift in the retailer component in 2013 and 2014.

0

5

10

15

20

25

30

35

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

$/G

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ACT Gas Retail Pricing ($2015)

Wholesale Market Price Retail Transmission DistributionRetailer Component Environmental Policy Average OfferStanding Offer

• For the ActewAGL distribution network (~134k connections) which straddles two jurisdictions, it was assumed that the residential connections (~25k) in NSW were part of the ACT analysis.


South Australia Pricing Analysis

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• Distribution charges almost doubled in the last 5 years. Year on year increases of 15% from 2010 to 2014

• Distribution makes up over 70% of the overall bill

• Retail margins on standing offers steady and trimmed after full contestability as would be expected

• Typical residential gas bill based on 18GJ/a is circa $800 per year. Third lowest behind QLD and WA.

• Average charges $44/GJ second highest behind QLD.

• Carbon contributed an increase of approximately 3.3% in 2013 (or $29 out of $880)

• Transmission and wholesale gas prices currently trending steady - slight increase in wholesale gas price over time


Victoria Pricing Analysis

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• Distribution and Retailer components accounted for between 60-70% throughout the period

• The distribution component is the lowest of the jurisdictions and declines over the period– This most likely reflects the economies

of scale that can be generated through higher network usage within a smaller geographic area

• The carbon price and VEET initiatives contribute a maximum of 7% in 2013

• The analysis shows that the retailer component has been increasing as a proportion of the retail price, this is consistent with the ESC’s findings for electricity retailers in 2012.


Tasmania Pricing Analysis

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• Doubling of network fixed price charges from 2014 20c/day to 2015 42c/day translates to a 10% increase in $/MJ for distribution charges

• Distribution makes up 50% of the overall bill

• Retail margins steady increase over time to about 20% in 2015

• Typical residential gas bill based on 30GJ/a is circa $1,000 to $1,200 per year. Second highest behind ACT.

• Average charges $33/GJ third lowest behind Vic and ACT.


• Transmission and wholesale gas prices currently trending steady


Western Australia data and analysis summary

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• Alinta was exposed in the 2007-2008 period by renewing gas contract arrangements with NWSJV where wholesale gas price doubled and the tariff was capped. Pincer movement.

• ERAWA increased the tariff cap year on year for the next three years to allow headroom for Alinta and also to encourage new entrants without a competitive gas supply. Retail margins escalate.

• ATCO bought WAGN in 2011. Distribution component goes up.

• Typical residential gas bill based on 15GJ/a is circa $640 per year. The lowest in Australia.

• Average charges $38/GJ in the middle.


Private and Confidential44

National Review – Comparative Household Bills


RESIDENTIAL FUTURE GAS PRICE DRIVERS

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Key drivers of future Residential gas prices?

• It is a confusing jurisdictional story in all likelihood – at a turning point probably

• Caused by fuel switching issues in response to escalating prices – reductions in volumes will be critical to network charges and retail income, and

• This will largely in the major markets be driven by switching for heating – to reverse cycle air conditioning mainly – complex story here with PV, batteries, peaked pricing, etc. – and retailers may well be indifferent – unlike networks, so

• The responses by networks to this decline will also be critical – far more so in regions with very high prices – and lower WACC’s will assist here as will aggressive treatment of capital and operating cost budgets by the AER

• Victoria seems to have seen a price peak – might see this elsewhere

• Retail margins maintenance can be expected with targets likely of $10 - $15/GJ

• Underlying gas price increase – marginal though given final prices46

Jim Snow Executive Director 31 August 2015 Trends in Australian Gas Prices.

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Transcript of Jim Snow Executive Director 31 August 2015 Trends in Australian Gas Prices.