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A gas reservation scheme is protectionism in disguise

Queensland is poised to become a major export hub for liquefied natural gas (LNG). Given the West Australian experience, where LNG is already exported to Asia, this will cause domestic gas prices to rise…

As LNG prices rise towards export parity, there have been calls from energy groups to implement a gas reservation scheme. One Ten

Queensland is poised to become a major export hub for liquefied natural gas (LNG). Given the West Australian experience, where LNG is already exported to Asia, this will cause domestic gas prices to rise. According to the DomGas Alliance, a group of Western Australian energy users, “gas prices have risen sharply from $2.50 per gigajoule in Western Australia to $8/GJ”.

The overseas price of LNG is currently well above the price of natural gas in eastern Australia. Gas producers will only sell locally if the domestic price rises to the export parity level - the overseas price that exporters receive less the cost of exporting. So prices in eastern Australia are rising towards export parity.

Fearing this price rise, major energy users, such as DomGas, have called for domestic gas reservation. Their report stated: “Australia should implement a national reservation policy that would require major LNG projects to set aside 15% of gas production for local industry and households”.

The report by non-government members of the Prime Minister’s Manufacturing Taskforce echoed this sentiment: “The non-government members of the Taskforce recommend that the government take action to ensure Australian industry has access to natural gas for the domestic market at fair and competitive prices.”

Similarly, in the AFR (paywalled), Brian Green, chairman of the Energy Users of Australia, argued for “[a] national inquiry chaired by a hard-headed economist” into gas exports.

Well, as a hard-headed (but hopefully soft-hearted) economist, what do I make of the calls for a gas reservation scheme?

First, it is important to note that a gas reservation scheme is not needed to obtain domestic gas supplies. Australia is a major exporter in many areas, but we have no difficulty obtaining domestic supplies so long as we pay the export parity price. Coal, dairy products, wine, beef, and grain are simple examples. So a gas reservation price will only make a difference for domestic manufacturers if it keeps the domestic price of gas below the export parity price.

To do this, the amount of gas “reserved” for the domestic market must be more than the amount of gas that domestic users would otherwise buy at the export parity price. In other words, the scheme must create “excess supply” in the domestic market to drive the local price down below the export parity price.

Second, to analyse the effects of a gas reservation scheme, I will use an old economist’s trick. I will break down the complex policy into two simpler policies. The two simpler policies “add up” to the complex policy. This enables us to isolate the good and bad effects of the scheme.

A gas reservation scheme is really a combination of an implicit “tax” on gas producers and a “subsidy” to domestic gas users.

Because of the scheme, gas producers who only sell into the domestic market — and exporters who would otherwise sell overseas — get a lower price. From the producers’ perspective, this is like a tax on the sale of domestic gas.

For example, if they would have sold the gas at an export parity price of $10 per GJ, but because of the scheme, only sell it at $8 per GJ, then from the producers’ perspective they get “taxed” $2 per GJ on all the gas they sell domestically.

Of course, it is not really a tax because the money doesn’t go to the government. Rather, the money goes to domestic gas users. But they only get the money if they buy and use natural gas. So from the gas users’ perspective, it is like the government subsidising the price of gas. They would have paid $10 per GJ but because of the reservation scheme, they only pay $8 per GJ for gas.

So from the gas producers’ perspective, the scheme is like a “tax” on domestic sales. They cannot avoid the ‘tax’ because they have to sell the reserved quantity domestically. And from the gas users’ perspective, it is like a ‘subsidy’ for using gas.

A tax on gas producers may or may not be a good idea. Like the mining resource rent tax, it could be argued that the government should ‘get more’ of the revenue from LNG exports.

However, a gas subsidy for manufacturers is wrongheaded. It will encourage Australian manufacturers to choose gas rather than alternative fuels. It will reduce their incentive to adopt energy reducing technology. It will mean that they use gas to produce even when the (unsubsidised) cost of production exceeds the value of the output.

I can think of many things the government could do with the money that it would raise from a tax on gas producers. Improving our schools, hospitals, roads and other infrastructure would be close to the top of my list. Subsidising domestic manufacturers to use more gas would not be on the list.

If the government really believes that gas producers should face higher taxes, then that is up to the government. But a gas reservation scheme effectively raises taxes and wastes the money on a gas subsidy. It is blatant, inefficient and inequitable protectionism for part of our manufacturing sector. It is bad policy and the government should reject it.