Unblocking the pipes

The AER’s annual state of the energy market, released yesterday, is one of the most comprehensive overviews of Eastern Australia’s gas and electricity systems going.

Covering two energy vectors and all aspects of the supply chain, it is hard to boil down to a few key messages. The most obvious one is change, as the AER notes the transition in the electricity system towards variable renewables, much of it on customers’ rooftops, and the challenges and opportunities this creates. By contrast, the gas market is still reeling from a key economic change – the introduction of international pricing as a result of the emergence of an export market that exceeds the existing domestic market.

However, the snapshot of pricing trends is modestly positive from consumer perspectives, with most indicators trending down, albeit off the back of some eyewatering price rises over the last decade. The AER suggests this is due to a mix of both market factors and regulatory interventions.

In the gas market, the key driver is market-based. Long-term export contracts are benchmarked against the oil price, while spot prices are based on the balance of supply and demand at any given time. COVID-19 has collapsed oil demand and thus the long-term price, while falling gas demand has softened spot prices. Accordingly the “netback” price (where an exporter is indifferent between selling overseas versus domestically) has fallen from  $13/GJ in October 2018 to under $4/GJ in March 2020. However the prices customers paid are influenced by other factors including how easy and cheap it is to move gas around.

One frustration that gas market participants have found is that there may be spare physical capacity on a pipeline but if it is contracted to someone who is not using it at the time, it may not get made available to other parties. A recent reform has been to introduce secondary markets in pipeline capacity – both a voluntary trading platform and a compulsory auction of spare capacity. This has freed up flows and allowed more gas to flow north to south – i.e. into domestic markets in NSW and Victoria. The chart below shows total net flows with the additional flows generated by the capacity reforms in green

The AER estimates this has pushed down post prices in NSW by an average of $0.76/GJ over 6 months. The effect in Victoria is less but still downward. This outcome is a reminder that energy markets are rarely “natural” markets that simply emerge spontaneously to cerate mutual gains from exchange. They are rather facilitated market, where the rules of the market are largely created and enforced by governments ore regulators (albeit ideally with some industry input). Gas markets in Australia have historically had less direct intervention of this sort than electricity, but that is changing in response to the frustrations of customers -even if the reforms aren’t going as far or fast as many of them would like.