When markets operate normally, a sharp rise in the price of any commodity triggers a boom in exploration, development and new supply. The resource boom at the start of this century, underpinned by rapid expansion of Australia’s iron ore and LNG industries, is a textbook example.

So where is the boom in domestic gas development and supply in response to a doubling of prices over the past year? On the east coast, spot prices on the Brisbane Short Term Trading Market (STTM) more than doubled from an average of $3.13 per gigajoule (GJ) in Q4 2015 to an average of $7.36/GJ in Q4 2016, and have since climbed sharply higher to $10/GJ or more. Spot prices in Sydney, Adelaide and Melbourne have also risen spectacularly over the past year. Average east coast contract prices are twice historical levels and rising sharply as contracts roll over in a new environment of very tight supply.

Despite booming prices you can count the number of new projects on the fingers of one hand: Kipper (Gippsland Basin Joint Venture), Cooper Energy’s Sole project, the Northern Gas Pipeline operated by Jemena and the Senex Western Surat Project. Between them these projects will at best be able to offset decline from mature fields rather than providing significant new supply.

Not only is there little new development, existing producers are selling gas-producing assets. Santos has sold its offshore Victorian acreage to Cooper Energy. After unsuccessfully trying to sell its Cooper Basin interest separately, Origin Energy has wrapped it into its New Co IPO package.

So what is the problem?

1. Lack of attractive exploration acreage

Eastern Australia has an absence of attractive new exploration plays, particularly at current oil prices.

2. Slump in oil prices

There are a number of causes but the slump in oil prices in November 2014 is a major one. Most oil and gas companies produce oil as well as gas. A halving of oil prices cuts heavily into their cash flow available for exploration and development. Oil companies around the world have been slashing capital spending on both oil and gas. Australia’s new LNG producers were hit hard because the price of LNG from their new projects is linked to oil prices. Locally, Santos and Origin Energy had just completed development of their billion-dollar LNG projects and were carrying particularly heavy debt burdens at the time of the slump.

The fall in the oil price has also taken the shine off potential new gas plays such as unconventional Cooper Basin gas. Companies are having to be more risk-averse and cannot afford to invest too much in longer term opportunities.

3. High development costs

Costs are another factor. While gas prices are high, costs have also increased. Some costs are coming down, such as drilling costs. However in the absence of new discoveries companies are developing more marginal fields that require more wells but produce less gas per well. Drilling for gas is a risky business and as fields mature the geology gets more difficult and costs rise. This is evident offshore Victoria, in the Cooper Basin and in Queensland.

Offshore, gas explorers still have opportunities to make big discoveries that could transform the supply-demand balance on the east coast, but the 2014 collapse in oil prices has all but wiped out the appetite for high-risk offshore exploration drilling. And even if there was a major greenfield discovery tomorrow, it would take at least five years to bring the gas to market, and possibly closer to a decade.

4. Moratoria or bans

Another factor is the restrictions on development in NSW and onshore Victoria. The Santos’ Narrabri gas project, based on coal seam gas resources in northwest NSW has the potential to supply up to 50% of NSW’s gas needs, but has been bogged down for several years due to a state moratorium on coal seam gas development and environmental protests.

And therein lies another major reasons for the failure of investment in new gas projects. Onshore, conventional reserves in the Cooper Basin, which has been the mainstay of gas supply to SA and NSW for decades, are quickly depleting.  Unconventional gas is the great hope for new gas discoveries, but exploration and development is now permanently banned in Victoria. In NSW, the state government is watering down its opposition, but the damage has already been done. NSW in particular has over 2,000 petajoules of gas that was intended for development but is now effectively locked up. In Victoria the restrictions on drilling mean that it is impossible to tell how much gas is locked away but studies by Geoscience Australia suggest that it could be trillions of cubic feet. If we cannot drill, we will never know.

5. Confusion or misinformation

Government restrictions on exploration access are only part of the problem. Equal responsibility can be sheeted home to environmental groups that have no interest in facts if they get in the way of their objective of closing down the fossil fuel industry. For example, Beach Energy ran into protests from anti-fracking groups in the southeast of South Australia even though it was drilling conventional wells in the Otway Basin. Drilling in the region is now a political football after the state opposition promised a moratorium on fracking. Gas explorers are now steering clear of any kind of exploration in southeast, given what happened over the border in Victoria.

6. Political/sovereign risk

Any company considering investment in the east coast faces these kinds of political risks. Will an investment become a political football or be targeted by activists. What will happen to renewable energy targets?  Also will state governments intensify or roll-back their drilling restrictions? Will the federal government make major changes to PRRT, as is currently being considered? Will a domestic gas reservation policy be implemented?

7. Market concentration-supply side and demand side

There are also commercial risks. The two biggest gas producers on the east coast now are Shell and the ExxonMobil/BHP Billiton Gippsland Joint Venture. Any investor has to consider the likely future moves of these two players. The buying side is also dominated by a small number of big players: AGL, Origin Energy and Energy Australia. Any investor in new gas development will need offtake contracts from one or more of these buyers. Selling gas into the short-term trading markets is too risky. These markets are small and illiquid. Another risk an investor has to consider is the possibility of LNG imports, which has the potential to transform the balance of supply and demand.

8. Lack of market transparency

Another impediment to investment is the general lack of transparency of the Australian upstream gas market. Any overseas investor is likely to have great difficulty getting the most basic information about reserves, production and drilling results. An executive in a US oil and gas company without interests in Australia recently made the comment: Australia is not a very data transparent country.Australia is treated like a black box, similar to Qatar, Russia, Saudi Arabia & Malaysia. It’s not as bad as Malaysia but light-years away from Norway, which has excellent transparency.  Thailand is much more transparent than Australia.  I suspect that Australia does not view transparency as being in the national interest. If better information helps attract additional investment it is indeed in the national interest. The worst offender in this regard is the Commonwealth Government, which has jurisdiction over offshore waters beyond the three-mile limit but information on activities in Commonwealth waters is deteriorating, not improving, immersed in a fog of confidentiality.

Arrow Energy reserves

Sitting quietly in the background on the east coast is a large undeveloped resource of 9,000 petajoules of coal seam gas in Surat and Bowen Basins in Queensland, owned equally by Shell and PetroChina following their takeover of Arrow Energy. These reserves would be enough to supply east coast demand for 15 years at current levels of demand. They were originally earmarked for a fourth LNG project in Queensland but the high costs of development put an end to that. Shell and PetroChina have been silent on development of these reserves, but would be closely monitoring the domestic gas prices and working out the best way to play their hand. It has not worked out well so far. They have spent billions of dollars and all they have to show is lots of feasibility studies but only modest levels of gas and electricity production. Should they throw more good money after bad or just get out?

Does the east coast gas market work?

Yes, after a fashion but it isn’t the well behaved market of general equilibrium econometric models. It is a manic depressive market of booms and busts, irrational exuberance followed by creative destruction. At the end of the day demand has to equal supply but at this stage it is demand that is adjusting, not supply.

(Contributed to Watt Clarity, 7 March 2017)