Boardroom Energy

This week:

  • Is there a global energy crunch?

  • Our very own local gas shortage

  • Lessons from the UK

  • Chart of the week: What gas shortage?

In Brief

There’s a difference between a short-term global gas supply crunch and a global energy crisis. Overall there’s plenty of gas in the world. Supply crunches occur when demand spikes and supply drops. Those economies who, by choice or mismanagement, find themselves swing players in the market get caught short. And that’s what has happened to Europe and China. They’ve been increasing gas demand while domestic supply hasn’t kept pace.

This summer there were heat waves and low winds across the northern hemisphere. It might be a portent of climate change. This reduced hydro and wind generation. Europe used up more of its gas reserves to cover the shortfall. Now it’s seriously short on gas. China has been wrestling with trying to sustain economic growth while curbing emissions. It hoovered up all the spare gas it could find to cover thermal shortages created by strong post-COVID economic growth and strongarming Australia’s coal supplies. Meanwhile there is no energy crisis in Japan, Korea, the US or other parts of the world. The Nationals’ latest effort to suggest that Australia is at the same energy risk as the UK is ridiculous.

The Prime Minister’s confidence about landing agreement with the Nationals on a net zero by 2050 commitment seems to be waning. So much so that ScoMo is no longer certain he will be able to catch up with BoJo and Biden. It would be an important pre-election photo opportunity.

But Australia does continue to face its own slow moving gas crisis in Victoria. Declining output from the Bass Strait gas fields needs to be replaced from somewhere. Import terminals seem the most likely solution, if only the Victoria Government would approve one. Or two. The alternative is painful deindustrialisation.

On a brighter note after 5 years of planning and preparation, the National Electricity Market today switched to 5 minute settlements. And no one noticed.

Investors from Australian pipeline operator APA and Canadian investment firm Brookfield remain in a tense stand-off over their rival bids for AusNet Services. The Australian Takeovers Panel is reviewing the Brookfield bid.

Portrait of thoughtful bearded businessman wants to explore unknown places, looks at worldwide globe, tries to choose destination, isolated over white concrete wall. Young male holds earth indoor

Is there a global energy crunch?

Major international news stories this week have centred around energy challenges in Europe and China. Europe and China are on opposite sides of the world and get their energy from (mostly) different sources. Europe’s problems are driven by gas while China’s are driven by coal. Global oil benchmarks reached a three year high this week too. So, it may look as if there is a general global energy supply issue. A closer look at other regions shows this is not the case as while there are global linkages in key fuels, they are limited by physical infrastructure and transport costs.

First, a brief reminder of the issues. China is facing widespread power shortages as high demand and fuel bottlenecks mean that it is running short of coal. The rigidities of central planning come in to play. High marginal coal prices and regulated wholesale electricity prices mean many coal plants are running at a loss, so some of them are turning off. Some regions have exceeded their emissions targets and are having to cut back to avoid punishment from the national government. And the spiteful decision to cut off Australian imports due to our temerity to question the source of COVID is backfiring. Sure, there are other sources of coal, but they are often 20 per cent less calorific than Australian coal but require the same infrastructure to transport. So, China is getting up to 20 per cent less energy out of its imports. Gas is filling some of the gap (and China continues to build astonishing amounts of renewables), but even China can’t build new gas import terminals pipelines and power plants at the drop of a hat.

China’s gas demand does have an impact on Europe (which for all practical purposes includes the UK, Brexit notwithstanding). Its gas price rises are caused by a combination of high demand and supply constraints on a global scale. But the impact is being felt more keenly in Europe than elsewhere because it is a major net importer and also has dynamic market structures that allow prices to fluctuate more than the rigidities of Asian markets. This means that Europe can typically get gas – it just has to pay the price.

Europe also has been enthusiastically shutting down coal as part of its climate goals. This has also led to its constraining new local gas supplies, so its internal production has been declining. Some countries have also started closing their nuclear fleet. These trends have combined to deepen Europe’s reliance on imported gas – both LNG and pipeline gas. The latter comes mostly from Russia, which has been unable to increase its supply – due either to its own production constraints or to geopolitical scheming. The fact that it could be either is a problem in itself.

Whatever the reason, the critical role gas plays in European electricity systems means that high gas prices mean high electricity prices too. Using fossil fuels to fill-in for renewables (low wind, low hydro) also drives up the EU carbon price, leading to an inflationary triple whammy. Small consumers are somewhat insulated in the short run by retail price regulations, but that has put the squeeze on suppliers instead and will have to flow through eventually. A tough winter beckons.

Notably, other major energy importers are not suffering to the same extent. Japan’s gas demand has not budged in recent years and has locked in the supply it needs via long-term contracts, so is heavily insulated from spot price volatility. Korea is similar and additionally requires large gas users to have ample storage capacity as a physical buffer.

As for energy exporters, well it’s a good opportunity to cash in. The US has built up its LNG export capacity in recent years and is well placed to make a return on that investment. Unlike Australia, though, the export market does not dominate the domestic market. Gas prices have risen – to all of US$6/MMBtu. This is around a fifth of prices in Europe or Asia right now. The dynamic shale oil and gas industry in the US acts as a strong buffer against volatility and the US probably has the most diverse generation mix of a major economy. It’s true the US has had some high profile electricity blackouts in the last 12-18 months, notably due to extreme cold in Texas and extreme heat in California, but energy markets weren’t the underlying problem,  and better resilience planning is the solution to these challenges.

Similarly, no-one is talking about energy crises in the Middle East or Russia. Or Australia, come to that. Of course, we are a much smaller domestic market than the US so are more likely to be impacted by regional price volatility. So, the gas price rises may mean more pain for industrial gas users. But much of our coal-fired power has its own supply on site, so the coal price bonanza is largely confined to export markets.

This doesn’t mean there is room for complacency. The macro trends driving the price spikes: climate change, climate policies, the commodity price cycle are as relevant here as anywhere else. And the role energy prices are playing in pushing up inflation may have broader economic repercussions.

fuel level indicator in reserve, without fuel. Fuel empty.

Our very own local gas shortage

Australia is the world’s second biggest gas exporter, yet still we face an imminent regional supply crunch in Victoria as the result of transitioning gas field production and infrastructure constraints.

Gas is a logistics business. Globally there is plenty of gas. Getting the gas from the field to where it is consumed can often be the most challenging bit.

Australia’s new world class gas fields are in the north of the continent: the Carnarvon and Canning basins, the Browse and Bonaparte Basins off the northern WA coastline, Beetaloo 600km south of Darwin, and the Bowen basin north of Brisbane.

Australia’s gas fields (Geoscience Australia)

The declining gas fields are in the south: the Cooper Basin near the tri-state border of SA, NSW and Queensland, and the Gippsland Basin in Bass strait. And therein lies the problem.

Victoria has historically been a major consumer of gas. It has a number of major industrial customers as well as two-thirds of residential gas demand in Australia.

For the past three decades Victoria’s demand at just under 300PJ per annum was supplied by the gas from the Gippsland Basin, in Bass Strait. That meant the gas from the Cooper Basin could be piped into Adelaide, Sydney and Brisbane, but not Melbourne.

Gas demand by state, 2019 (PJ per annum)

The combined decline of production from the Cooper and Gippsland Basins means south-eastern Australia faces growing shortfalls in gas this decade, starting as early as next year if there is a cold winter. The ACCC has warned of a 6PJ shortfall in SE Australia in 2022.

Gas experts EnergyQuest think at least two gas import terminals will be needed in south-eastern Australia by 2030 to replace a 125PJ gas shortfall as the legacy fields decline.

This could be worse in cold winters, when low temperatures drive spikes in gas demand for heating.

Increasing gas pipelines south is possible, but expensive. There is already a $2/GJ price differential likely in the southern states by 2030, and piping the gas such long distances is both energy intensive and expensive.

Earlier this year the Victorian Government vetoed AGL’s attempt to build a gas import terminal at Crib Point in Western port. The Victorian government also lifted its moratorium of onshore gas development in 2020, but has banned unconventional gas development, like Europe. It has preferred to find alternatives to gas like electrification, hydrogen or bio methane. But these are long term solutions and the supply crunch is arriving now.

Viva Energy has a gas import terminal proposed for Geelong and Venice Energy has one proposed for Adelaide. Fortescue is claiming to have started work on its gas import terminal into Port Kembla, but there would still be the additional cost of piping the gas south to Melbourne. The former CEO of Squadron Energy, Mr Stuart Johnston, announced in August the terminal was four months into construction. Later that month he suddenly resigned. Media reports suggest the commercial contracting of gas customers has not progressed as hoped.


Lessons from the UK

Prominent Nationals politicians Barnaby Joyce and Matt Canavan have recently suggested the UK’s current woes are down to their net zero ambitions. Several commentators reacted with furious outrage at their claims. What’s really going on here?

Senator Matt Canavan’s is, as you might expect, playing hard ball retail politics, highlighting empty supermarket shelves in the UK and suggesting the recent energy crunch is driving short-term supply chain problems. That’s not true. These are Brexit-related, as the fallout from the UK’s departure from the EU has resulted in a sharp drop in the number of lorry drivers. This has caused a fuel shortage, which always makes for dramatic photos and glib comparisons with developing countries.

This problem has been exacerbated by the UK’s high COVID case rates, which has caused staff absences at supermarkets and distribution centres. There’s really no link to energy and climate policy here. The only warning for Australia is that as we open up, we might see some supply chain disruption arising from worker absences as cases track higher.

Meanwhile, Barnaby Joyce referenced UK gas price shocks and supplier failure in an interview ostensibly about Australia’s net zero targets. This was interpreted as a claim that the UK problems were a direct result of their net zero targets and policies, although Joyce never advanced a clear argument as to how this was the case.

The cause of the UK’s energy price squeeze is the rapid ramp up of European gas prices. This flows through to both direct gas consumption and to electricity because gas-powered generation is the largest source of electricity as well as the main price-setter.

Brexit has left the UK with the worst of both worlds. It is physically interconnected to Europe by both gas and electricity infrastructure, so its markets rise and call with its continental neighbours. But they are only semi-coupled now, and the UK’s emissions trading scheme has yet to be linked back to the wider EU scheme, so it has the friction effect to deal with too.

Its dependence on gas is nothing new, though and has been increased rather than decreased by its energy transition. Like most countries the sequencing and pace of its transition is affected by a range of factors. Its coal reserves, which it started tapping at scale before any other country, have been running low for decades and the Conservative government of the 1980s saw a double benefit in reducing the power of the militant coal union. Public opinion (and economics) stalled the nuclear sector and there is now a supply gap as older plants are retiring but the new plants are only just being built. The economics remain unfavourable. Its renewable resources are heavily oriented to wind – there is limited new hydro opportunity and the UK is not famous for its sunshine. So the claim that it should simply have diversified its renewables is short on reality.

The UK is also a densely populated country that limits the level of onshore renewables. So, its big push is into offshore wind, in which it is a world leader in deployment. There is plenty more on the way, too. But the recent run of low winds has affected onshore and offshore wind output, so it seems unlikely that this will give it sufficient diversity to avoid a heavy reliance on dispatchable plant for some time to come. While in the long run, big batteries and green hydrogen may deliver low carbon storage options, gas will be the key fuel for many years to come.

In this light the big issue is that the UK hasn’t paid more attention to its own ability to produce and store gas as a buffer against price volatility. North Sea gas (and oil) have been in decline for years and activists have ensured fracking for new onshore gas has stalled. Meanwhile, the largest storage facility, a depleted gas well in the North Sea, closed in 2017 and has not been replaced, leaving the UK with storage capacity of only around 2 per cent of its annual usage, far lower than other big gas importers.

The UK’s low carbon options are likely to improve over the next few years: more offshore wind, the eventual completion of the new nuclear plant at Hinkley point and new interconnectors (the link to Norway opens for business today). But while this will mean UK needs less gas, it will still be a critical balancing fuel. It’s also worth noting that these new supply sources are years or even decades in the planning.

High prices play an important, if sometimes painful role in the transition. High gas prices improve the economics of low carbon replacements for industrial and domestic heat. Volatile fuel and in turn electricity prices are necessary economic signals for storage, which needs arbitrage opportunities to pencil out. In a high renewables world where fuel price impacts are muted, there will still be volatility – it will just come from the weather. And if it doesn’t result in volatile prices to attract balancing solutions, there will be supply crunches.

The real lessons for Australia are not about whether net zero is a good idea or not – it’s already policy in every state and territory anyway – but a recognition that it’s a bumpy ride, and that we need to start planning now to minimise the bumps that may arise in ten years’ time or more.

Chart of the week: What gas shortage?

There is plenty of gas globally. There have been short term supply issues (extreme weather in Texas) and short term demand issues (low wind in Europe, low hydro in northern hemisphere, high demand from heat waves in China). Global supply and demand of gas has been increasing every year since the global recession in 2009.

Chart 1: Natural gas production and consumption by region

Source BP

Global reserves of gas have been increasing too. Proven reserves reached 197 trillion cubic metres (TCU) in 2019, up from 170 TCU in 2009 and up from 133 TCU in 1999.

Chart 2: Global gas reserves 1999, 2009, 2019 (TCU)

Source BP

What has changed significantly is the net gas position of China and Europe over the past five years. They have both continued to produce less gas and consume more, increasing their reliability on imports. The US and Australia have increased net exports. Japan imports all its gas. Its gas demand has remained stable over the past decade, supplied by long term gas contracts, much of it from Australia.

Chart 3: Net gas import balance 2009-19 by country/region exojoules

Source BP