How long will canyoning oil and gas prices last?

Federal energy minister Angus Taylor wants to use lower gas prices to encourage more investment in gas peaking capacity and drive down electricity prices. What could possibly go wrong with such a strategy? Actually, more accurately, what could possibly go right?

First, it’s hard to drive down wholesale electricity prices when they can’t really get much lower.  Spot prices in the National Electricity Market are currently tracking below $40/MWh, more than halving since January this year. This has been driven by a combination of increased renewable supply, softer COVID-19 demand and canyoning gas prices. The biggest driver – the gas price drop – is the direct result of oil price wars which escalated in March.

Soft wholesale prices discourage investment and encourage existing plant to exit. Potential builders of new gas reciprocating engines, the type Minister Taylor is keen to back in,  will be building assets to operate for more than 30 years, and will need some long and lucrative fuel contracts and off take agreements to get any new deal across the line. That extra cost will, one way or another, be borne ether by consumers or taxpayers.

Oil prices went negative a week ago as Russia refused to cut supply as demand was dropping in March and then Saudi Arabia increased production. A subsequent OPEC deal earlier this month to cut production by 10 per cent has not stopped the oversupply, as oil demand will fall by 30 per cent in 2020 according to the International Energy Agency, although some analysis’s think this demand cut will be even bigger. Oil prices took gas prices with them, as a direct substitute.

Oil prices are now at or below the cost of production for many oil producers, which has already started to stop production from higher cost shale oil producers in the US and increase the likelihood of many of them going to the wall. Which is the strategic rationale of the supply glut in the first place.

Australian gas producers are cutting production in the face of a $20 billion revenue cut next financial year.

Oil prices are now at unsustainably low prices. These prices will recover when global storages are full and enough higher cost suppliers are forced to stop production. These higher cost producers are already cutting output and some, like privately owned and highly leveraged US shale oil companies, may never recover. Some production may never come back on line given the increased risks created by their competitors in the market.

Cost of oil production by country: Rystad Energy

Current oil and gas prices are the result of a strategic market intervention, which means these prices will increase when this intervention ends. Low oil prices only increase risk and uncertainty for investors of all electricity generation assets in Australia. The only real long term solution is to decouple gas and therefore electricity prices from the destabilising actions of major oil producers.