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Natural gas: expect price to rise as market expands

With natural gas - like other commodities - it can be necessary for prices to rise in anticipation of increasing demand. Flickr/jasonwoodhead23

Many are concerned with the price of natural gas. Natural gas is an important part of Australia’s overall energy mix; it represents roughly a quarter of all primary energy sources consumed. And, as we move into a more carbon-constrained world with the introduction of a price on carbon in July, it is expected that this share will increase, primarily at the expense of coal if the incentives work as planned. But what will happen to price?

Generally, one would expect that there will be upward pressure on the price of natural gas. This will be due to both the increased domestic demand resulting from a carbon price, which makes coal relatively less desirable, and from increased international demand. For more natural gas to be produced, to satisfy either source of demand, price will have to rise or significant cost-reducing changes in technology will have to be introduced. In fact, both are currently occurring.

Prices are rising due to the elevated costs of accessing more challenging conventional natural gas resources (such as deeper reservoirs in more complex geology and those found deep offshore), the expected increase in demand for coal substitutes, and to the exposure to international demand. But on the other hand, some downward pressure exists from the introduction of enhanced technology that allows us to now commercially produce coal seam gas, and potentially shale gas, in an environmentally-sound manner but at much lower cost than previously for these resources.

The very nature of the carbon pricing system will place upward pressure on the price of natural gas, as well as other lower-emitting fuels and generation technologies. Putting a price on carbon is intended to raise the cost of using a relatively low-cost but high CO2 emitting fuel like coal, which then provides a market signal and incentive to shift away from coal to some lower-emitting fuel or technology that can replace its baseload generation function. With today’s technologies, the next best thing is natural-gas fired generation, which can meet the baseload needs of our modern economy, and it can be shaped to accommodate the intermittency of most renewables.

However, the fact that the price on carbon is intended to create an incentive to reduce consumption of coal also means that it is intended to increase the consumption of cleaner burning fuels like natural gas. The increased demand to meet this expansion in consumption will naturally put upward pressure on the price of natural gas. And, natural gas will also carry a carbon emission cost-obligation under the scheme. The price can remain the same or fall only if supply can be increased commensurately at the same or lower production costs. In the short run this is unlikely.

A natural gas pipeline vents in Spain. Flickr/Pedro Moura Pinheiro

It is also quite typical, and indeed necessary, for prices to rise in anticipation of enhanced demand. Prices in a modern economy tend to be based on a combination of the underlying costs to produce and deliver, and on expectations of what will be demanded relative to the expected supply capacity in the future. Basically, there will be very little incentive for an industry to expand productive capacity unless there is evidence that the additional capacity will be needed.

One piece of information in the market that lets producers know that more capacity is desired and valued is to see prices rise for the commodity being delivered. In the short run, without time for significant advances in technology, it tends to cost more per unit to bring more of a commodity to market, so a higher price is required or it will simply not be commercially justifiable to expand productive capacity.

In some cases this expanded production, over time, will lead to so-called economies of scale or new technologies will have time to enter the industry, and then prices will tend to fall. However, there is no guarantee that prices will fall back to earlier levels. The costs of both labour and capital may be pushed upward sufficiently from pressures within a given industry or augmented from pressures spilling over from other industries, domestic and international, to the extent that underlying costs per unit cannot retreat to earlier levels.

It should also be noted that even without international demand-pressures the domestic price for natural gas would be expected to rise to be able to meet the expected increased domestic demand, even without the price on carbon. In every state it is noted frequently that the prices being paid are not fully cost reflective. Much of this is due more to the network costs than to the cost of finding and producing natural gas, but finding and producing costs are not insignificant. If prices do not rise to reflect the full cost of bringing the natural gas to the consumer, there will be no incentive to increase the capacity to supply more. And, government subsidies are not the answer. A government subsidy is you and me paying in an indirect way; the government takes money from us to subsidise commodities. And it is indeed partly the fact that we don’t see this portion of the payment directly that leads us to demand even more. We only see what we have to pay directly, and we say, “Hey this is pretty cheap, so I’ll have some of that, please; but only if I can have it at the same price.” In the end, the full cost of bringing a commodity like natural gas to end-users must be covered, whether it is reflected in our payments or it is covered by the combination of our payments and the share of our taxes allocated to fill the shortfall.

Big business: James Price Point in Western Australia, where Woodside Petroleum has proposed building an A$30 billion liquified natural gas hub. AAP/Dan Peled

It is likely that we will have more natural gas available domestically as a result of the export projects being developed than we would if that external incentive was not there. Moreover, it is likely that these increased domestic supplies will be at relatively lower prices than would be the case if the industry had to provide the same domestic supply without the international component. This is because there are economies of scale to developing projects of the size that we are pursuing for the export sector. The cost per unit of natural gas is most likely lower with this combined effort than it would be if the development scope was limited to domestic natural gas needs alone.

So, more natural gas will be available, but prices are likely to be higher to reflect the cost of bringing more natural gas to market to satisfy increased domestic and international demand. However, the domestic market is likely to benefit by a lower price than would be the case without the international demand stimulating productive capacity expansion. While technology is helping, it will likely only soften the rise, not actually lower the price, even though that has been the experience in the United States. In the US there already exists a very extensive transportation pipeline infrastructure into which the new production may readily and quickly be delivered; this is not the case for most of Australia. The sub-surface resource ownership conditions are also strikingly different between the US and Australia, which may also affect the ease with which these vast resources may be developed and brought to market.

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