Securing Australia’s domestic gas supply: issues paper

22 August 2022

The Hon Madeleine King MP
Minister for Resources and Northern Australia
Parliament House
Canberra ACT 2600

Submitted online: https://consult.industry.gov.au/securing-australias-domestic-gas-supply

Dear Minister

Securing Australia’s domestic gas supply – Issues Paper

Origin Energy Limited (Origin) welcomes the opportunity to provide comments on the Commonwealth
Government’s Issues Paper examining options to secure Australia’s domestic gas supply.

The current review follows a period of significant volatility across energy markets, and the release of the
ACCC’s July Interim Gas Inquiry Report which raised the prospects of a gas shortfall in 2023.
Understandably, both events have led to questions around the robustness of the regulatory framework and the suitability / capability of instruments like the Australian Domestic Gas Security Mechanism
(ADGSM) in helping to ensure efficient market operations.

In considering these issues, it is important to examine the nature of these events, the role of the ADGSM, and the likely effectiveness and potential unintended consequences of the changes to the mechanism that are now being contemplated.

The recent uplift in domestic gas demand and subsequently prices, has been driven by a broad range of factors that extend well beyond the east coast gas market. A series of plant outages, coal supply constraints, and reduced renewables output in the electricity market led to a material increase in the reliance and consequent utilisation of gas-powered generation (GPG). This occurred at a time when broader geopolitical issues were already putting upward pressure on fuel prices, with the onset of cooler weather and associated seasonal uptick in gas demand further contributing to higher spot pricing outcomes.

In our view no single mechanism, (even accounting for the proposed changes to the ADGSM) can reasonably be expected to deal with such a varied and diverse set of issues. Instead, a holistic approach is required with a focus on the effective management of the energy system. This should involve progressing any necessary reforms in the electricity market to ensure the avoidance of any future similar supply disruptions, and adoption of a well-designed capacity mechanism that would facilitate timely new investment.

In the gas market, the ADGSM should be reserved as a last resort framework that could be used to address a forecast shortfall in supply in an upcoming calendar year, only if all other options (including market led solutions) have been exhausted. Such an approach would acknowledge the ADGSM is an extreme form of intervention where even the contemplation of its use has the potential to distort market outcomes; and that other more suitable, less distortionary options should be first given a chance to work.

With the above in mind, Origin does not support more frequent activation of the ADGSM to deal with any short term supply risks in operational timeframes, that are likely to be primarily driven by inherently variable GPG demand. The ACCC in its July Report, noted the tighter supply / demand balance forecast

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Origin Energy Limited ABN 30 000 051 696 • Level 32, Tower 1, 100 Barangaroo Avenue, Barangaroo NSW 2000
GPO Box 5376, Barangaroo NSW 2000 • Telephone (02) 8345 5000 • Facsimile (02) 9252 9244 • www.originenergy.com.au
for 2023 is largely attributable to a 52 PJ increase in forecast demand for GPG relative to 2022.1 The report also highlighted there is 167 PJ of uncontracted supply from LNG producers, which essentially means there is sufficient volumes to satisfy demand. However, it is the disconnect between uncontracted supply and potentially higher operational demand that has led to concerns around a possible shortfall of 54 PJ.2

In Origin’s view, this disconnect is not necessarily surprising and largely reflects the nature of GPG contracting, which can rely more heavily on shorter term gas supply agreements (GSAs) and spot purchases in operational timeframes (closer to real time) to manage the innate variability in demand requirements for gas plant. Given this, we consider it unlikely a shortfall will occur in practice. Where there is potential for deficit in an operational timeframe, more flexible and dynamic mechanisms like the
Gas Supply Guarantee (GSG) and Heads of Agreement (HoA) are better suited to addressing any such risk (in contrast to activating the ADGSM at short notice). These instruments can be operationalised closer to real-time as required, and rely on facilitating a market-led response. This has been reinforced by the successful use of the GSG on two separate occasions in recent months.3

In keeping with the ADGSM’s role as a back-stop mechanism, we do not consider price based activation to be appropriate. As identified in the 2019 ADGSM Review, a price trigger would give rise to a range of distortionary impacts and exacerbate moral hazard issues, potentially discouraging users from contracting supply on a forward basis in anticipation of the mechanism being activated. These impacts would be particularly acute under any approach that established a fixed price threshold (e.g. based on some arbitrary measure of cost of production, margin, or capacity of purchasers to pay) and / or relied on facilitated gas market sport prices to determine a domestic reference price. Spot prices are not representative of what most users pay and are subject to seasonal variance which is not necessarily indicative of any inefficiency.

The core principle of attributing any shortfall to LNG projects in net deficit should also be retained. This approach provides the most effective way to incentivise LNG projects to voluntarily contribute to domestic supply; limit actions that may otherwise contribute to a shortfall; and source additional supply that could support their domestic contribution and exports. It is also crucial to ensuring those parties positively contributing to domestic supply are not required to subsidise the impact of other LNG producers.

We recognise part of the rationale for considering revisions to the shortfall allocation is also to reduce the prospects of disruption to existing contracts and minimise sovereign risk, consistent with Principle 4 in the Issues Paper. However, allocating shortfalls to net contributors could also exacerbate this risk as it may still result in disruption to shorter term supply contracts held by those producers. It is therefore crucial consideration of sovereign risk is not limited to concerns around the potential for producers in net deficit having to disrupt longer term GSAs.

Having regard to the above, it is clear ongoing resource development will be key to ensuring efficient domestic gas supply across the east coast over time. Capital constraints will always be a factor that can limit the ability of any entity (large or small) to ultimately progress inherently risky exploration and development activities. Commonwealth and State / Territory governments therefore have a critical role to play in ensuring regulatory frameworks are suitable to create a positive investment environment and support the development of new reserves / resources.

1
ACCC, ‘Gas Inquiry 2017-25 – Interim Report’, July 2022, pg. 9.
2
Ibid., pg. 11.
3
1 June 2022 and 19 July to 30 September 2022 respectively.

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We have provided further comments on aspects of the Issues Paper in Attachment 1. If you wish to discuss this submission further, please contact Shaun Cole at shaun.cole@originenergy.com.au or on
03 8665 7366.

Yours Sincerely,

Steve Reid
General Manager, Regulatory Policy (Acting)

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Attachment 1

1. Strengthening the ADGSM

1.1 Activation at short notice

Any short-term supply risks are best addressed through the GSG and HoA where necessary

The role of the ADGSM should be limited to addressing any forecast shortfall in supply over future time periods (i.e. an upcoming calendar year as currently prescribed), and only after all other available options have been exhausted.

The tighter supply / demand balance forecast for 2023 is largely attributable to a 52 PJ increase in forecast demand for GPG relative to 2022.4 This reflects an upward revision of AEMO’s GPG forecasts in the 2022 Gas Statement of Opportunities (GSOO), where unlike previous central scenario estimates, the availability of coal-fired generation was adjusted to account for unexpected events that can impact the NEM generation mix and drive higher GPG utilisation.5 The ACCC also notes the main risk that could lead to an unexpected increase in demand above forecast levels in 2023 is demand for GPG,6 which is highly variable and dependent on imprecise factors such as weather and output from other generators in the NEM, that can be difficult to predict.7

Due to the variable nature of their fuel requirements, gas plant operators are likely to rely more heavily on the spot market or shorter term GSAs for supply. Where this is the case, contracted supply for GPG will inherently be lower than forecast demand for that market segment, creating the perception of a supply shortfall under the ACCC’s current approach in assessing the supply / demand balance. This could lead to continual projections of a shortfall in circumstances where much of the marginal demand is attributable to gas generation, and conservative forecasts are applied.

Given the above, we consider it unlikely a shortfall will occur in practice in 2023. Going forward, the nature of any possible supply gap should therefore be examined prior to making a notification of intent to consider triggering the ADGSM, both with respect to the likely drivers and location of the shortfall.
Where a possible deficit is likely to emerge in an operational timeframe due to GPG usage it would be prudent to acknowledge that this should not warrant a triggering of the ADGSM.

More flexible mechanisms like the GSG and HoA are better suited to addressing any short term supply gaps due to intra-year changes in marginal gas demand (primarily due to generation). The GSG was successfully utilised on two occasions in response to recent events, demonstrating it can support supply during periods of system stress. A key attribute of the GSG framework is that it enables all relevant parts of the of the supply chain to be brought together at the direction of the Australian Energy Market Operator
(AEMO) with a view to facilitating an industry-led market driven response.

In contrast, the ADGSM is not an appropriate or efficient means of resolving any supply issues at short notice. Unlike the GSG and HoA, the mechanism is not market driven and may not adequately account for key variables that could materially impact its effectiveness (e.g. the location of the shortfall and availability of transportation capacity to move gas where it is needed). Expanding the circumstances under which the ADGSM can be triggered (e.g. in response to short-term events, and potentially prices, as discussed further under Section 1.2 below) could also discourage some users from contracting and instead incentivise reliance on spot purchases in anticipation of export limits being applied. While shorter term supply agreements and spot purchases play an important role in allowing users to flexibly manage their supply requirements (both with respect to volume and price), recent retailer failures highlight the

4
ACCC, ‘Gas Inquiry 2017-25 – Interim Report’, July 2022, pg. 9.
5
AEMO, ‘Gas Statement of Opportunities’ March 2022, pg. 17.
6
ACCC, Gas Inquiry 2017-25 – Interim Report’, July 2022, pg. 24.
7
AEMO, ‘Gas Statement of Opportunities’, March 2022, pg. 73.

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Origin Energy Limited ABN 30 000 051 696 • Level 32, Tower 1, 100 Barangaroo Avenue, Barangaroo NSW 2000
GPO Box 5376, Barangaroo NSW 2000 • Telephone (02) 8345 5000 • Facsimile (02) 9252 9244 • www.originenergy.com.au
risks and resultant disruption that can be associated with such an approach, as acknowledged by the
ACCC.8

There are also likely to be practical issues associated with imposing export controls on LNG producers with limited notice. It could compromise the ability of producers in net-deficit to manage any resultant disruption to existing export contracts, given there would be less lead time to manage the impact of any export restriction.

Reallocating large volumes of supply to the domestic market at short notice (which could be necessary in circumstances where export limits have the effect of restricting whole export cargoes) would also be challenging. A single LNG cargo can represent the equivalent of around 10 days of total domestic demand in Queensland.9 Assuming the volume of any domestic supply shortfall observed in operational timeframes would be relatively small in comparison, it is not clear the market would have the capacity to absorb the full export cargo given existing supply and transportation commitments in place, particularly in periods where north-south transportation capacity from Queensland is being fully utilised.
This is relevant given concerns around the tight supply / demand balance are largely confined to the
Southern States due to declining production and reserve levels in the region.

1.2 Price based activation

Price based activation of the ADGSM would be distortionary and should not be pursued

Origin is not supportive of establishing a price trigger under the ADGSM, as it would give rise to unintended consequences that ultimately outweigh any purported benefits. The issue of price based activation was considered as part of the 2019 ADGSM review process and ultimately not pursued. This was principally due to the range of associated issues identified, noting any price trigger could:10

▪ weaken incentives to invest in new production over the longer term;

▪ give rise to sovereign risk issues; and

▪ may not necessarily guarantee a particular price outcome for domestic supply.

There is also an inherent risk a price trigger would exacerbate moral hazard issues associated with the
ADGSM by discouraging users from contracting supply on a forward basis in anticipation of the mechanism being activated. As noted above, it would be a perverse outcome if a price trigger had the effect of incentivising users to rely more heavily on spot market purchases at the expense of prudent forward contracting, noting such an outcome would also likely entrench the role of the ADGSM.

Activation based on a fixed domestic price threshold being exceeded and linkages to domestic spot market outcomes should be explicitly avoided

Determining an appropriate price-based approach to triggering the ADGSM would be challenging. The distortionary impacts described above would be particularly acute under any approach that established a fixed reference price threshold. As is the case with price regulation generally, a fixed reference price would inherently fail to account for changes in underlying market dynamics and production costs, as it would be based on some arbitrary assessment of different components at a point in time (i.e. cost of production, margin and capacity of purchasers to pay, as suggested in the Issues Paper). Spot prices

8
Ibid., pg. 60-61.
9
EnergyQuest, ‘East coast energy market review’, Independent report for APPEA, pg. 14.
10
Department of Industry, Innovation and Science, ‘Review of the Australian Domestic Gas Security Mechanism’, January 2020, pg. 34-35.

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across the facilitated gas markets also could not reasonably be used to determine a representative domestic gas price for the purposes of triggering the ADGSM given:

▪ spot prices do not reflect what most domestic users pay – as noted by the AEMC, contract prices
are more relevant for gas consumers, given most gas is traded under GSAs;11

▪ spot prices are subject to seasonal variance which is not necessarily indicative of any market
failure – as facilitated gas market prices typically rise in winter months due to increased demand,
this could lead to the mechanism being consistently triggered over winter, regardless of any actual
supply need; and

▪ triggering based on spot prices would not be consistent with an approach where the ADGSM is
designed as a backstop for addressing shortfalls in an upcoming calendar year period, given spot
price outcomes in operational timeframes are generally not relevant to supply in future periods.

A less distortionary approach would be to first consider whether domestic GSA prices exceed LNG netback estimates for a sustained period, which could prompt further examination of the underlying reasons for the observed dynamic.

This approach would still require a representative domestic price to be determined, which would be challenging. A potential option could be to develop a weighted measure of offer prices for supply in the upcoming calendar year under GSAs with contract terms of at least 12 months, as reported to the ACCC.
However, a methodology for normalising the GSAs captured would need to be developed to allow for comparison with LNG netback estimates, given differing contract parameters and terms / conditions of domestic GSAs and the fact that some GSAs may be commodity linked. To ensure the measure is representative of price offers to the broader market, thresholds would also need to be established around the minimum number of GSAs and proportion of total forecast domestic demand represented by the measure.

Further, consideration would need to be given to a suitable time over which the relationship between domestic and LNG netback prices should be observed. In Origins’ view, transient instances of domestic price offers exceeding LNG netback estimates would not be representative of any market failure. Rather, such a dynamic would need to be observed over a sustained period. This is consistent with the
Australian Energy Regulator’s (AER) approach to assessing the effectiveness of competition in the NEM under its Wholesale Electricity Market Performance Report, which focuses on observing longer-term trends rather than instances of price volatility in isolation.12

1.3 Allocation of any shortfall

The core principle of attributing any shortfall to LNG projects in net-deficit should be retained

Origin strongly supports the core principle underpinning the current framework whereby any domestic supply obligation imposed by the Minister is allocated to LNG producers in net deficit. This approach maintains incentives for LNG projects to contribute to domestic supply; limit actions that may otherwise contribute to, or exacerbate the impact of, a shortfall; and source additional supply that could support their domestic contribution and exports. It also ensures those parties positively contributing to domestic supply are not required to subsidise the impact of other LNG producers.

11
AEMC, ‘Current trends in the operation of the east coast gas markets and next steps in enhancing the gas sector’, online article, accessed 12 August 2022.
12
AER, ‘Wholesale electricity market performance report 2020’, December 2020, pg. 5.

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As discussed above, the ADGSM does not operate in isolation of other measures. Given GPG is likely to be the marginal source of demand and key driver of any intra-year variability going forward, any supply shortfalls that emerge are likely to be more effectively addressed through flexible, market-led mechanisms like the GSG and HoA. This should help mitigate any concerns around the general need to trigger the ADGSM to facilitate the required level of supply in the event of a forecast shortfall. In this context, it is appropriate the ADGSM continues to operate as a backstop mechanism that allocates responsibility for resolving any shortfall to LNG producers in net-deficit if ultimately required.

Given the above, Origin does not agree the total market security obligation (TMSO) allocation needs to be revised, as suggested in the Issues Paper. The 2019 ADGSM Review’s arbitrary proposal to allocate
50 per cent of any shortfall to all LNG producers and 50 per cent to producers in net deficit would represent a material departure from the core principle discussed above. If a decision is made to revise the allocation of the TMSO, a less distortionary approach would be to allocate the TMSO to LNG producers in inverse proportion to the volume of gas they contribute to the domestic market. This would ensure the largest net contributors face the smallest liability and retain strong incentives for LNG producers to voluntarily support domestic supply. However, our strong preference is for the retention of the current approach for the aforementioned reasons.

Origin recognises part of the rationale for considering revisions to the TMSO is to reduce the prospects of disruption to existing contracts and minimise sovereign risk, consistent with Principle 4 in the Issues
Paper. However, it is important to recognise that allocating shortfalls to net contributors could also exacerbate this risk, given it may still result in disruption to shorter term supply contracts held by those producers, particularly if the mechanism is revised to allow for activation at short notice. It is therefore crucial consideration of sovereign risk is not limited to concerns around the potential for producers in net deficit having to disrupt longer term GSAs.

Further, it should not be assumed that producers in net deficit would necessarily need to interrupt export contracts if allocated a shortfall. LNG producers are permitted to meet their allocated share of the TMSO by reducing their export quantities or making additional gas available to the domestic market. In this circumstance, it should be possible for a net deficit producer to:

▪ purchase uncontracted gas to supply into the domestic market, noting the ACCC has indicated a
large volume of uncontracted supply is available; or

▪ divert the required volume of supply to the domestic market, and source additional supply (e.g.
through LNG spot cargo purchases) to ensure export commitments are also met.

2. State and territory measures to increase supply

Ongoing resource development, particularly in areas close to key demand centres, is the key to ensuring efficient domestic gas supply across the east coast as output from conventional Bass Strait fields declines over time. Capital constraints will always be a factor that can limit the ability of any entity (large or small) to ultimately progress inherently risky exploration and development activities. Ensuring regulatory frameworks are suitable is therefore critical to creating a positive economic investment environment that supports the development of new reserves / resources. Issues to address in this respect include:

▪ simplification / harmonisation of regulatory bodies – regulation of the gas industry is spread across
numerous state and federal departments and there is no overarching framework or specialised
assistance available to help individual proponents navigate the full set of requirements;

▪ removal of duplicative regulatory requirements – environmental and health / safety regulatory
processes should be independently reviewed to address duplicative requirements and better

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streamline project regulation, noting there is considerable scope to improve the application of the
Environment Protection and Biodiversity Conservation Act (EPBC Act) in this respect; and

▪ refining tenure release frameworks – tender processes and decision making around tenure
release and management more broadly have direct implications for the timeliness of supply, and
there is a clear opportunity to improve the transparency and efficiency of existing frameworks in
this respect.

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