Securing Australia’s domestic gas supply: issues paper

22 August 2022

Consultation Hub
Department of Industry, Science and Resources
CANBERRA ACT 2601

Consultation on the Australian Domestic Gas Security Mechanism

Thank you for the opportunity to provide a submission on the government’s review of the ADGSM to identify improvements that could be made and consider other options to strengthen the security of Australia’s domestic gas supply.

As an Australian company with a long history of supplying the gas needs of the nation, Santos supports the government’s objectives to ensure the domestic market has access to adequate and competitively-priced domestic gas supply.

However, the current mechanism targets only LNG exporters and risks requiring them to breach their contractual obligations.

Any changes to the mechanism must avoid sovereign risk and ensure the preservation of international contracts to maintain Australia’s reputation as a country that can be relied on to honour trade and investment agreements that we have entered into with foreign investors and customers who did so in good faith to support their own energy security.

As stated in Santos’ submission regarding the extension of the ADGSM, we will work constructively with the government to navigate a pathway with industry to achieve the dual outcomes of increased domestic supply and investment certainty.

There is no shortfall
The consultation paper notes that the Australian Government expects a shortfall of gas in the east coast market in 2023. This is in reference to the latest ACCC report, which, despite showing that gas production will exceed gas demand, forecast an artificial 56PJ shortfall in 2023 by assuming that all 167PJ of uncontracted gas produced by LNG exporters would be exported. This would represent a 65 per cent increase in spot cargoes relative to 2022.

There is no evidence to support the ACCC’s position that LNG exporters would leave the domestic gas market in a shortfall position and it is demonstrable that they have always ensured the market is adequately supplied since the east coast LNG industry has come online. The east coast LNG exporters have always stepped up to the plate to ensure domestic supply has been maintained even though these projects were never developed to become swing producers into the east coast market. When the LNG industry ramped up, it was expected that there would be additional gas supply projects in New South Wales and Victoria. Despite the best efforts of the private sector to

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develop these projects, they were thwarted by the actions of state governments to prevent new gas supply development, which is the fundamental reason for the tight supply and demand balance today.

More supply must be developed to address long-term, fundamental issues in the market. The
ADGSM will lead to less investment in new gas supply, not more as foreign investors withdraw support for investment in Australia because of sovereign risk. Without governments publicly recognising that natural gas must play a critical role in the Australian economy for decades to come, investors have, and will continue to form, the view that natural gas supply developments are unwelcome in Australia. Natural gas is essential to enable the Australian electricity grid to decarbonise, while also supporting reliability of supply for Australia’s manufacturing and agricultural sectors as well as 4.5 million homes and businesses.

Current mechanism
As noted by the ACCC in the latest gas inquiry report, the current mechanism “could see export controls only applying to one LNG Project, and this may be to the LNG project with the least amount of excess gas (requiring them to breach their contractual obligations)”.

The mechanism currently targets Santos and our partners in the GLNG project. No other exporters would be materially impacted. The ADGSM, if implemented, would intervene in long- term gas contracts with GLNG customers in Korea and Malaysia, countries with which Australia has free trade agreements. Ironically, the export of uncontracted, spot LNG cargoes by other
Gladstone LNG projects could still occur.

Most importantly, the current mechanism would not address the issues that the electricity and gas markets experienced recently and which are likely to occur again. These issues fundamentally arose because of unforecast, unplanned and unexpected extreme peaks in gas demand in the electricity sector during high winter demand periods, high levels of unplanned coal-fired generation outages and lack of variable renewables at the times when supply was needed.

The gas industry and LNG exports were demonised as politicians and energy consumers looked for someone to blame for insecure supply and both high electricity and gas prices.

There was no recognition that domestic gas prices have been well below the LNG netback price except for short periods of time in July 2021 and longer periods in May, June and July 2022 that coincided with the lack of availability of coal generation for electricity. Throughout August 2022 prices have returned to levels lower than the LNG netback price:

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Chart 2.3 of the ACCC’s recent report also shows this to be the case and is reproduced below.

Potential changes to mechanism

Contracts
Any changes to the ADGSM, including extension, must maintain investment confidence in
Australia and the key trade and investment relationships we have developed over generations with customers in Asia.

If the mechanism is to be retained, it should focus on uncontracted gas referred to in the ACCC
Report and not contracted volumes. Santos considers that exports up to the nameplate capacity of the LNG plants at the time of final investment decision should be permitted as of right because those volumes were the basis of those decisions, however, the government could require any volumes over these nameplate capacities to be permitted on an annual basis, taking into account the forecast supply and demand balance for the following year. This would ensure that it had the least impact on Australia’s reputation as a reliable exporter of resources and not damage
Australia’s reputation with investors and customers in Asia, or with Asian countries with which
Australia has free trade agreements.

While Santos agrees with the need to increase domestic gas supply to put downward pressure on prices, extended and increased government intervention in the gas market would have a negative effect on supply. The only sustainable way to increase domestic gas supply is to encourage investment in new gas supply developments, preferably as close as possible to east coast markets in order to keep supply costs as low as possible for customers.

It is not sustainable to intervene in long-term LNG contracts after final investment decisions have been taken and could impact the ~A$1 billion Santos and our GLNG partners are investing year

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on year drilling more wells and developing more gas fields in the Surat and Bowen Basins to supply long-term international contracts, and the A$430 million that Santos is investing in the
Cooper Basin each year to support both domestic and export supply.

Santos’ French, Korean and Malaysian investors in this joint venture are already cautious about investing in new supply following the 2017 introduction of the ADGSM which they regard as having raised sovereign risk in Australia. The continuation of the ADGSM in any form will continue to damage Australia’s reputation as a safe place to invest.

Electricity market
The ADGSM, as currently constructed, will not fix issues faced in the electricity market. Recent electricity market issues are primarily the result of unexpected, unplanned coal outages, including tight coal supply. Gas has been filling the gap left by coal in the electricity market with gas usage for power generation jumping 55 per cent in May 2022 compared to the same time last year. High wholesale electricity prices have meant that generators have been able to bid gas prices up to levels at which manufacturers and small business cannot compete. Despite only 10 per cent of the east coast market being sold on spot, this has caused significant problems for gas buyers and small retailers exposed to spot pricing.

Santos is willing to work with government and industry participants on sensible proposals to ensure the efficient operation of the gas and electricity markets and help to resolve recent pressures in the energy system. In addition, we continue to work to support the domestic market through ongoing investment in new supply, through trading and through time and location swaps to help other producers get gas to market efficiently. Santos also has storage options at Moomba which we are willing to make available to improve supply security, particularly in periods of peak demand or unexpected outages in the electricity sector that lead to unexpected demand peaks.

The ADGSM (in any form) would not have been able to fix issues experienced by the electricity market in recent months. In the short term, getting coal generators back online was essential to free up gas for businesses and manufacturers who were exposed to high spot gas prices and cannot afford the prices that electricity generators can. In the longer term, the development of more gas is critical to support the electricity market as renewables increase and more gas is needed for peak demand periods and firming of renewables.

The role of gas in firming the electricity market will only increase as the electricity grid continues to decarbonise. As such, government should consider differentiating gas for generation and gas for manufacturing and small business in any potential amendments to the mechanism. For example, excess gas could be put into storage and made available only to the electricity market in certain circumstances, in order to avoid manufacturers having to compete with electricity providers on the spot market.

Price
The discussion paper asks whether price should be factored into the mechanism. Santos opposes any form of price trigger, which would be a disincentive to new supply developments. At the moment, there are a number of small producers who are increasing supply in Queensland, for example Westside and Senex, and these investments and more like them would be put at risk if those producers believe their investment decisions could be eroded by price controls on domestic gas. Price is driven by supply and demand. Ensuring reasonable pricing could be achieved through the industry-led Code of Conduct, which was developed in consultation with gas buyers and the ACCC to address concerns identified by the ACCC such as transparency on price and reasonable notice periods to buyers. Both gas buyers and the ACCC now seem unprepared to give the Code a chance to work. The Code includes review provisions that would mean it could be revised over time to address issues that arise in relation to gas supply negotiations, pricing principles and other transparency concerns.

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State and Territory gas development
The discussion paper notes the large disparity between the level of gas produced within some jurisdictions and the volume of gas they consume, such as NSW.

Santos wished to re-iterate the position it made in the previous submission on the ADGSM extension –the ADGSM was brought in as a temporary measure while new gas supplies were developed for the domestic market. However, in the last five years, state and territory governments have implemented a variety of policies which have prevented or delayed the development of gas. They include:
• In 2017, the Victorian Government moratorium on onshore conventional gas production
until 20 June 2021.
• In 2020, the Victorian Government ban on unconventional gas extraction in the state’s
constitution, which includes hydraulic fracturing and coal seam gas.
• In July 2021, the NSW Government’s Future of Gas Statement, which effectively
compulsorily acquired exploration acreage, including areas where contingent resources
existed. The Statement effectively limits any new gas projects in NSW to the Narrabri Gas
Project.
There has been sufficient time since the ADGSM was introduced for new gas developments to move from investment decision to production, but there has not been a single onshore development in either Victoria or NSW to reach production stage.

The continuation of the ADGSM runs the serious risk of states and territories continuing to believe they can rely solely on Queensland LNG producers and/or federal government intervention to solve their energy needs.

States and Territories need to develop their own gas reserves, particularly as Bass Strait fields continue to decline. Gas is an extremely important transition fuel and development of new projects is desperately needed. However, in Santos’ experience, the development of new projects is increasingly difficult, and fraught with delays. Our Narrabri Gas Project has been delayed for the best part of a decade because of moratoriums, inquiries into the environmental safety of the industry, lengthy approval processes and judicial challenges to approvals.

The best way to bring more gas to market is to remove bans or restrictions on gas developments, such as in Victoria and New South Wales, and foster a supportive policy environment which gives companies certainty and enables them to bring gas to market more quickly.

Santos is committed to developing local gas supplies in NSW. Since 2012, Santos has spent more than A$1.5 billion on getting the Narrabri Gas Project approved and developed – a project that is 100 per cent committed to the domestic gas market.

More low-cost supply is always the best way to put downward pressure on prices and the cheapest gas supply will always be the gas on your doorstep because it reduces transport, storage and other handling costs.

Santos has also acquired Hunter Gas Pipeline Pty Ltd which owns an approved underground gas pipeline route from Wallumbilla in Queensland to Newcastle in New South Wales. The route passes close to the Narrabri Gas Project and our goal is to work with infrastructure developers and owners to construct the pipeline and deliver much-needed gas to east coast domestic markets in the shortest timeframe possible. The pipeline also has the potential to provide a second route to southern markets for Queensland gas, removing supply constraints in existing pipelines which occur at exactly the times when supply is most needed.

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Santos is working with the NSW Government to get the Narrabri Gas Project to a final investment decision as soon as possible. Santos is very keen to get Narrabri developed and we will try to exceed our base case of 2026 for first gas to southern domestic markets.

Important considerations

More supply is needed to address market issues
The consultation paper notes that the ADGSM and HoA appear to have had a diminishing effect as the net contribution of gas to the east coast domestic market by LNG exporters has declined in recent years. Santos does not agree with this observation. There is no regulatory condition on any LNG exporter to make a “net contribution of gas to the east coast domestic market” and this was never contemplated by governments or investors at the time when LNG final investment decisions were made. What was contemplated was that there would be many new gas supply developments from producers other than the LNG exporters, in New South Wales (eg Narrabri,
Gloucester), onshore Victoria and in Queensland where gas supply development has in fact continued and added supply to the domestic market. In some cases, the LNG exporters have underwritten the ability of new domestic gas producers to take final investment decisions on these projects by providing foundation contracts to support project financing, something domestic gas buyers were unwilling to do.

There is only one sustainable, long-term solution to east coast gas – more supply. Despite having resources sufficient to supply domestic demand and Australian LNG exports for over 40 years, there is a scarcity of gas projects in the development pipeline in Australia. Measures which aim to increase domestic supply like the HoA and the ADGSM are band-aid solutions for the fundamental problem of insufficient investment in new supply development.

The consultation paper asks how the ADGSM could be amended so that stronger incentives exist for LNG exporters to increase domestic supply during a shortfall year. The question ignores the reality that LNG exporters have always supported the domestic market to ensure adequate supply, and for the majority of times, at prices that are well below the LNG netback price.

In the Northern Territory, moratoriums and inquiries have delayed exploration and development of the highly prospective McArthur Basin for more than half a decade. Around 14 independent, scientific inquiries into hydraulic fracturing, water and environmental safety of the industry have universally concluded that gas extraction can be done in a safe and sustainable way without harm to water resources or the environment, yet regulation continues to increase in a way that is adding to both the difficulty and cost of developing more gas supplies without adding to environmental protection.

It is vitally important to now rebuild public confidence in the upstream gas industry which has been demonised by government(s) for a number of years, whether in relation to gas price, supply volumes or carbon emissions. The industry has a very important role to play in guaranteeing domestic energy security, enabling the energy transition to occur in an orderly way and in maintaining Australia’s reputation as a country that can be relied on to meet the international contracts that we have entered into to support the energy security of our customers in Asia.

No single point-of-truth in forecasting
Market analysis and forecasting to fundamentally important to the ADGSM mechanism and the overall regulation of the market. Forecasting of gas market conditions is currently undertaken by numerous government and regulatory bodies including the ACCC, AEMO and the Department of
Industry. The multitude of different bodies conducting analysis and forecasting can lead to confusion about the state of the market.

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Most recently, there has been a significant difference between the most recent ACCC and AEMO forecasts. The ACCC forecasts a contrived shortfall of 56PJ for 2023 by assuming that 167PJ of supply will be unavailable to the domestic gas market simply because it is being produced by
LNG exporters, while the March 2022 Gas Statement of Opportunities (GSOO) concludes
'existing, committed and anticipated supply is projected to meet declining domestic consumption until 2033' in its central Step Change scenario.

The ACCC noted the inconsistency between the forecasts, stating that: “the difference primarily stems from discrepancies between the forecasts provided by producers in the Cooper and Otway basins to AEMO and those provided to us”. Santos engaged with the ACCC to explain that the data provided to the ACCC and AEMO was consistent, but one data set included updated production figures for the Cooper as the requests were six months apart. The difference was the result of the Cooper Basin development program performance in 2021 impacting 2022 and 2023.

It is important to note that since that update, Santos has contracted a fifth drilling rig for at least the remainder of 2022 in order to recover its production targets in the Cooper. Santos is yet to make a decision on the number of rigs to be deployed in the Cooper in 2023.

Santos fully complies and responds transparently to data requests from many different regulators and government bodies multiple times each year. Each request has unique ‘terms of reference’, asking for slightly different data, packaged in different ways and gathered at different times in the year. It is time consuming to assemble different data for each request, but more importantly, it can lead to confusion and incompatibility for the government and regulators receiving the data.
For example, if inconsistent terms of reference are used, Santos’ supply of ethane to Qenos could be excluded from supply but included in domestic demand, or vice versa.

The below table shows examples of the various terms of reference used by Santos to respond to data requests in the last year. Each resulted in a different supply forecast being provided.

Santos supports the intention behind these requests and the need to be transparent with government and regulators regarding production and forecasting, but the number and variety of data requests received by producers creates a significant amount of complexity and burden.

Similarly, the gas transparency measures progressed through the South Australian Parliament in
June will further increase burden producers and potentially duplicate portions of existing reporting under the ACCC’s gas inquiry. Santos recommends the Department investigate the range and

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volume of reporting obligations producers are subject to, with the aim of increasing efficiency for all parties and improving the accuracy and consistency of forecasting.

Santos also believes that there should be a consistent methodology for the determination of a shortfall, as well as a consistent use of key terms (such as ‘production’ vs ‘supply’) by government and regulators. This would increase both clarity and efficiency for business in responding to requests as well as for regulators and government.

Accurate and aligned forecasting would provide the market with certainty and eliminate much of the need for short-term activation of the ADGSM, as market conditions (outside of genuinely unforeseen circumstances) will be known well in advance.

Supply and pricing forecasts developed and published by regulators have a significant adverse impact on market sentiment. Santos witnessed this in Q4 2021. AEMO forecasts were clear that there was no gas supply problem in 2022 and did not expect any issues in their various scenarios until winter 2023. As a result, customers declined to purchase firm gas at the market rate, instead taking the risk of the spot market. A large portion of gas was offered to the domestic market at that time and not purchased. It was then sold to export, and therefore gas did not flow to the southern markets.

Santos notes that we have observed the same adverse effect on the market as a result of the threat of government intervention. The east coast gas market experienced a buyers’ strike in late
2020 and early 2021 following the announcement by the federal government of a code of conduct requirement for gas sales negotiations and negotiation of a new Heads of Agreement under the
ADGSM with LNG exporters, citing an imbalance of power between buyers and sellers, and implying that domestic gas prices were too high. Gas buyers believes these two measures would lower gas prices and Santos’ experience was that some were unwilling to enter contracts as a result.

On the demand side, the reluctance of regulators to cast any doubt on the capability of variable renewables to grow their contribution to the electricity market, combined with reluctance to lend any positive support to fossil fuels in the electricity market, has led to underestimation of the importance of gas to firm renewables and replace ageing coal generators during the energy transition. A more realistic approach to the role of gas in the electricity market over the forecasting periods is essential to send proper signals to the market for new gas supply development.

Conclusion
Both the domestic and international markets are undergoing a period of significant turmoil and change. Santos encourages the government to take time to assess the current and future market conditions, consult meaningfully with market participants and fully canvas policy options before making substantial reforms.

Santos will work constructively with the government to navigate a pathway with industry to achieve the dual outcomes of increased domestic supply and investment certainty.

Please contact Rob Malinauskas at Robert.Malinauskas@santos.com for more information.

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