Australia | Jul 11 2017
Electricity prices are expected to remain elevated with gas prices having a more important role in influencing east coast electricity prices.
– Elevated gas prices are pushing up electricity prices
– Higher gas prices are expected to remain
– Australian gas prices linked to oil prices
By Nicki Bourlioufas
Electricity prices are expected to remain elevated for the next two to three years, with a higher gas price pushing up energy costs.
A July research note from the Commonwealth Bank’s Global Markets Research team said gas has become a vital part of electricity generation in the National Electricity Market (NEM).
Australian gas prices have lifted with supply limited by restrictions on unconventional gas exploration and development in several states. Unregulated pipelines have also added meaningfully to costs. That means that high gas prices may be the norm even if liquefied natural gas (LNG) exporters are compelled to fulfill Australia’s gas shortfall in the short term.
“With the withdrawal of coal power and the consequent reliance on gas power to meeting domestic power needs, electricity prices are being set by the gas price,” the note said.
In particular, the cost of gas power generation (GPG) has surged on the back of higher domestic gas prices. With GPG now a vital part of the NEM, it is increasingly setting the price of electricity.
“Most market participants that we spoke to believe that GPG will set the marginal cost of electricity for another two to three years. While we see high electricity prices edge lower, we don’t envisage electricity prices falling back to around AU$60/MWh.
“An industrial price around AU$100/MWh could be a sustainable long-term level,” CBA suggests.
Higher domestic gas prices to remain
The LNG market has ballooned in a relatively short period of time, with LNG now accounting for around 70 per cent of gas consumption in the eastern gas market.
While increased demand is leading to higher gas prices, conventional gas production is on the decline – due largely to falling output in offshore Victoria – and future projects require gas prices closer to AU$11/mmbtu to come online.
“Another factor holding back more supply in Australia is that some state governments have restrictive regulations and moratoria on the exploration and development of gas reserves,” CBA said.
“Pipeline tariffs are also adding as much as around AU$2.7/mmbtu to deliver gas from Queensland to the southern states. These charges are well above marginal costs and have led to calls for more pipeline regulation.
“These supply-side factors will need to be addressed if Australia’s eastern gas market is to re-balance via a supply response. The evidence points to higher gas prices remaining for longer as Australian gas supply needs those prices for further investment.”
Domestic gas price linked to international LNG
Higher costs have forced Queensland LNG producers to tighten their budgets and slash capital expenditure. Some operators are now buying gas from third parties rather than investing in new fields.
“The end-result is a greater association between domestic Australian gas prices and international prices,” CBA notes.
With Australia’s eastern market gas prices now closely associated with international LNG prices, gas producers and wholesalers are taking advantage of newfound market power by supplying the highest bidder between LNG producers and domestic gas users.
“In some cases, that market power has resulted in prices tracking higher than international prices. LNG exporters like Gladstone LNG (GLNG) have exacerbated this linkage by purchasing domestic gas to fill their LNG contracts.”
Given Queensland’s three LNG projects can choose to supply domestic or international energy markets, it is unlikely domestic gas and international LNG prices will de-link in the foreseeable future.
Australia’s production of LNG will continue to grow over the next year before plateauing in late 2018. It’s around then Australia is expected to take the mantle as the world’s largest LNG exporter, before being overtaken by the United States by the middle of next decade.
Decoupling gas from electricity
Gas power generation provides a level of flexibility and fast frequency response that cannot currently be replicated by renewables, making the decoupling of gas from electricity difficult.
Without taking appropriate steps, however, risks such as shortfalls in gas supply, coal supply contracts, and delayed renewable generation mean exposing the market to higher electricity prices linked to GPG for longer than two to three years.
“With all the shortfall risks facing the domestic gas market, it would sound counter intuitive to add incremental gas power. However, that is exactly what is happening now,” the analysts note.
“The remaining black coal-fired generation fleet in the NEM are broadly expected to increase output from historical levels. That will help minimise the role of GPG in setting the marginal price of electricity in the next couple of years.
“If black-coal fired generation fails to lift above historical levels, AEMO sees a GPG shortfall of 55-65PJ (26 per cent of GPG demand) and electricity supply shortfalls of 5.6-6.8TWh (3 per cent of NEM demand).”
Oil prices a key factor
The link between electricity and oil prices works through Australian LNG exports, which are priced via oil-indexed contracts. LNG contracts are being used to set the price of Australian gas.
Despite oil prices hovering near nine-month lows on mounting oversupply concerns, oil prices are expected to trend higher in coming months as OPEC cuts back supply, which will flow-on to the price of electricity.
“We believe that oil prices have room to move higher if OPEC-led production cuts are successful in bringing down global oil stockpiles,” the note said.
But the links are not instant. With fixed-price contracts common, the link with oil prices will become more obvious as contracts are renegotiated.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
