Capping Gas Profits Is Not a Good Idea for These Reasons

China Sinopec's Tianjin terminal receiving its first liquefied natural gas (LNG) cargo from Australia on Feb. 6, 2018. VCG via Getty Images

Commentary

Australia’s key decision-makers seem intent on making the worst decisions that they can for the energy sector.

The latest federal government plan is to cap gas prices to $12 (US$8) per gigajoule (GJ). Simplistically they think that forcing gas companies to sell at a lower price will combat the increasing cost of living that is burdening Australian families.

The government speaks about prices like they are set by greedy gas companies. But the situation is much more complicated as prices are determined by consumers as well as suppliers.

The gas spot market is a perpetual auction—yes, sellers present to the market the lowest price they are willing to accept. But purchasers also present a bid to purchase the gas at the maximum they are willing to pay.

Fundamental economics says that price increases are caused by one of two things: a decrease in supply, or an increase in demand. Both of these factors impacted prices in Australia in 2022.

• The decrease in supply was a global problem primarily caused by Russia’s deliberate move to hold back gas sales from Europe (which began a year before they attacked Ukraine). It is secondly caused by the post-COVID pendulum swing of economic activity, which has affected many markets, including the labour market.
• The increase in demand was a local problem caused when Australia lost a large portion of its coal-fired electricity generators during a cold winter.

To better understand gas prices, four factors that complicate the market are worthy of consideration.

Gas Pricing Much More Complicated Than Portrayed

Firstly, there is not just one single gas price. Many gas sales are through longer-term purchase contracts, rather than the short-term “spot” markets.

This is true both internationally, where gas is sold in liquefied form (LNG) and in Australia’s east and west coast domestic gas markets where the resource is delivered through a pipeline system.

Whenever there is a change in the supply or demand of gas in any of these markets, the long-term purchase contracts are protected, and hence the entire problem is concentrated in the spot markets. This makes the spot market especially volatile.

On the whole, this means that the frequently reported high gas price is exaggerated. Prices are high, and this will be reflected in energy bills, but for many purchasers, it is less severe than the spot market.

An Origin Energy power bill is pictured in Brisbane, Australia on June 8, 2018. Dan Peled/AAP Image

For example, at the end of November, major gas producer Santos signed a 10-year supply deal with manufacturer Brickworks at just $12/GJ, though the wholesale spot market would have delivered double that over the last year.

Some retailers deliberately purchase through the spot market—they take the risk of price volatility, and in a normal year are consequently able to provide the best prices. These retailers, however, are the first to collapse in a crisis as they disproportionately bear the brunt of the supply imbalance.

This happened to Weston Energy in May, which was suspended by the market operator, and subsequently another half-dozen smaller energy retailers have been suspended and their customers and contracts transferred to major retailers.

Other retailers such as Electricityinabox, ReAmped, and Discover Energy sent letters to customers, asking them to leave.

Consumers Unable to Respond Quickly to Price Fluctuations

Secondly, the residential energy market has a perpetual flaw—consumers are unresponsive to the spot price. Even though the gas price changes on a three-hourly basis, households only pay for it on a three-monthly basis. By the time they get the energy bill, it is too late to adjust their usage.

This puts retailers in a difficult position. No matter what the price is, households will use the gas, so retailers must purchase the gas on their behalf.

On a longer timescale, the residential market will be responsive, because, after one or two large bills, households will adjust their usage or will switch away from gas. In the short term, however, the price can be driven very high very quickly without users being able to adjust their behaviour.

Price caps won’t address this perpetual problem. In the electricity sector, it can however be addressed using “demand response” technologies, which are likely to become increasingly popular. In the gas sector, the better solution is that retailers purchase gas for residential users under longer-term contracts rather than the spot market.

A kitchen gas stove burner at a residential property in Melbourne, Australia, on June 16, 2022. Joel Carrett/AAP Image

Local and Overseas Gas Buyers Competing Against One Another

Thirdly, on Australia’s east coast, the domestic gas price and the international LNG price are now linked.

The three main producers, accounting for over 90 percent of gas production, are all capable of exporting their product. Hence, they each face a choice with uncontracted gas—either sell it internationally as LNG, or sell it through the domestic pipelines.

The decision is made by whoever pays better. They present to the domestic market whatever return they have been offered on the international market.

Gas producers sell to the highest bidder, and overseas consumers have the opportunity to bid against our domestic market.

If the federal government caps the domestic gas price, then they are not only tying the hand of producers but consumers. They prevent domestic consumers from bidding against overseas offers.

In reality, this means that the federal government will be unable to impose a price cap without also triggering a domestic gas reservation policy.

In 2022, European countries have been desperate to shore up their gas supplies for the coming winter. They have been scouring the planet trying to gobble up any skerrick of gas available anywhere.

Due to their very real desperation, they have been offering good money for Australian LNG at prices at least three times higher than the proposed domestic price cap that the government is offering.

Yet There Is a Silver Lining

Fourthly, though it drives up domestic prices, for Australia, high international energy prices are a net benefit.

Australia is a resource supplier to the world. Our nation’s balance of trade was mostly negative prior to 2017; now in June, we hit a record-high trade surplus of over $17 billion (US$11.5 billion).

That is a lot of money flowing into Australia—almost $700 per person in one month.

A general view of The Yallourn Power Station in Yallourn, Australia, on Aug. 16, 2022. Asanka Ratnayake/Getty Images

Two additional perspectives are valuable. Firstly, Europe’s needs are very real. We may begrudge our high cost of living prices here, but in Europe, they are facing “eat or heat” decisions over winter.

It is also important to note that our domestic price for this gas is still competitive internationally—unlike overseas purchasers, we don’t have to pay the cost of liquefaction, shipping, and re-gasification. We have an inherent advantage in the market: physical proximity to the source.

Prices are not arbitrary numbers that a producer puts on their products. High prices achieve two important functions: They are a signal that tells producers about increasing demand, and they also provide the necessary money to meet that demand.

Price caps interrupt both of these functions.

Today, the most important need for the energy sectors across the world is that they increase supply. Supply, supply, supply. But who will want to invest in the energy sector if the government imposes a price cap and prevents them from making money?

As the end of year approaches, the season for industry dinners and Christmas lunches has descended. In all the conversations I’ve been having, there seems to be near unanimity among my peers.

All the successive energy crises of this year point in one direction and all the government decisions are pointing in another.

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.