Independent Review into the Future Security of the National Electricity Market Blueprint for the Future, Jun 2017

4.4 Long-term gas supply certainty is essential

As has been discussed, an increase in gas prices affects both the cost and reliability of electricity supply and is largely a reflection of changes in supply and demand. For gas-fired generation to contribute to electricity supply now and in the future, gas supply certainty is required.

In the past ten years, the east coast gas market has fundamentally changed, introducing new dynamics to the gas market and flow-on effects for the NEM.

Coal seam gas (CSG) exploration has been occurring in Queensland since the late 1970s.²²⁷ The depletion of conventional gas resources and increased LNG prices in the mid-to-late 2000s encouraged further exploration and development.

The surge in international energy prices in 2007, together with the identification of large CSG resources led to three LNG projects in Queensland proceeding to final investment decision based on CSG from the Bowen and Surat basins. A fourth LNG project, proposed by Arrow Energy, has not proceeded. In 2016, the Queensland LNG industry exported around 16 million tonnes with an estimated export value of $7 billion.²²⁸

However, production from CSG fields carries a greater degree of uncertainty in the development and production phases compared with conventional gas. CSG wells are depleted faster and as a result, wells need to be drilled on a continuing basis to access the gas and to make the development of a CSG field economically viable. This requires a continual investment of capital.²²⁹

The three LNG projects have entered into long-term LNG export agreements, with strict gas delivery conditions, requiring sufficient levels of production to meet export obligations. Whether the LNG projects continue to make investments sufficient to sustain production will depend on the economics of new developments. Some LNG projects have experienced difficulties in extracting reserves and higher than expected costs of production.²³⁰ Restrictions on exploration and production have also been a significant factor. As a result, significant volumes of gas originally intended for the domestic market are being exported.

As demonstrated in Figure 4.6, compared with the demand from the three LNG projects, the size of the domestic gas market (residential and commercial, industrial and gas-fired generators) is relatively small. In 2016, the annual demand for LNG was more than double that of the domestic market, with gas-fired generators consuming just 22 per cent (121 PJ) of domestic demand (excluding LNG).

Figure 4.6: Total annual gas consumption by sector (historical and forecast) 2011 to 2036, PJ²³¹

AEMO anticipates that unless new production is incentivised, total gas production for the domestic market will decline from 600 PJ in 2017 to 478 PJ in 2021, with most of this decline projected to occur in the offshore Victoria gas fields.²³²

AEMO has projected that in the absence of new sources of supply, the NEM faces a potential shortage of gas for electricity generation between 2019 to 2024.²³³

AEMO notes that constraints on the availability of gas for electricity generation could result in average electricity shortfalls of an estimated 80 to 363 GWh between 2019 and 2021. AEMO predicts that these shortfalls would result in a breach of the NEM reliability standard.²³⁴ This comes at a time when flexible gas-fired generation will be relied on to balance intermittent renewables as some ageing coal-fired generators retire.²³⁵

Other than in Victoria, AEMO does not have the power to direct the flow of gas into or within the NEM to maintain and improve the reliability of gas supply. While AEMO can take short-term operational measures in Victoria, including the controlled interruption of gas demand, ultimately those measures are limited by the available supply of gas and transportation capacity.²³⁶

Gas market reforms

Since this Review commenced, a number of initiatives (in Box 4.1) have been announced to address supply tightness in the east coast gas market and ensure gas-fired generators have access to a reliable and affordable gas supply. LNG proponents have also announced a number of measures to address any supply shortfalls in the short-term, including committing to supply gas-fired generators.²³⁷

Box 4.1 – Current work to improve the east coast gas market

Energy for the Future package: gas supply and affordability measures: as part of the FY2018 budget, the Australian Government announced a number of measures to address supply tightness in the east coast gas market. These include:

$19.6 million over four years to accelerate reform through the Gas Market Reform Group to improve transparency and access to gas markets.

$30.4 million over four years for new combined geological and bioregional resource assessments to assess the potential impacts on waterways and aquifers in three onshore areas that are underexplored but prospective for unconventional gas.

$5.2 million to examine the costs and benefits of constructing pipelines to link Northern and Western Australia gas reserves to the east coast, through Moomba in South Australia.

$2.0 million to allow AEMO to improve publication of real time assessment of gas flows and market analysis to make it easier for the market operator, businesses and investors to make informed decisions about gas market operations.

$0.5 million in FY2018 to examine the constraints impinging on increased gas supply on the east coast of Australia, including regulatory barriers and inconsistent policies.

$6.6 million for the ACCC to conduct a wide-ranging inquiry into gas prices, transport and supply. The ACCC will report regularly on the supply and pricing of gas over the next three years.

$28.7 million over four years for measures to increase the supply of gas, including a grants program to accelerate projects and work to improve community and landowner acceptance of gas projects.

Continual support of the Independent Expert Scientific Committee on Coal Seam Gas and Large Coal Mining Development in providing advice to Australian governments on the water-related impacts of coal seam gas and large coal mining development proposals, to strengthen the science underpinning regulatory decisions.

In April 2015, the Australian Government released the Domestic Gas Strategy, which sets out the Australian Government’s role and expectations of governments and industry in responsibly developing unconventional gas. Following this, the Energy Council released its Gas Supply Strategy in December 2015. The Energy Council then developed the Gas Supply Strategy Implementation Plan for Collaborative Actions (released in August 2016) which sets out 14 actions for jurisdictions to collaboratively improve efforts on scientific and regulatory issues associated with onshore gas. Energy Council Ministers can agree to additional collaborative actions at any time.

The Australian Government’s Australian Domestic Gas Security Mechanism will give the Government power to impose export controls on companies when there is a shortfall of gas in the domestic market.²³⁸

Further consideration by governments is warranted on the future of gas-fired generation if gas is not available at the end of contract periods. Given the current gas market conditions, it is possible that new technologies such as battery storage systems may be more cost-effective in providing security and reliability in the NEM in the near future.

The initiatives driven by the Energy Council and the Australian Government will assist in improving gas supply security and affordability. The Energy Council should recommit to the Gas Supply Strategy Implementation Plan as a matter of urgency.

Over the last several years, a number of large users, including gas-fired generators, have made the commercial decision to on-sell their gas supply to take advantage of high wholesale gas prices.²³⁹ Stanwell withdrew its Swanbank E Power Station and sold its contracted gas.²⁴⁰ ENGIE is also believed to have on-sold some of its contracted supply of gas to GLNG in 2015.²⁴¹ Currently, generators are only required to notify AEMO about whether a generation unit will be physically available at a point in time. There is no requirement to report to AEMO whether a generation unit has sufficient fuel to run.

While managing their supply contract positions is a commercial matter for generators, greater transparency of the fuel resource adequacy of generators (including gas and coal) over the medium term would enable AEMO to plan its response and mitigate any potential fuel shortages in the NEM. In addition, gas producers and major gas consumers should produce and provide to AEMO a rolling monthly look ahead for six months and an outlook for three years. Increased visibility of forward gas supplies will allow AEMO to plan in an informed manner and better assess if there is sufficient fuel available.

Measures announced by the Australian Government and the gas industry to guarantee that gas will be available to meet peak demand period in the NEM include AEMO being given the power to direct the market.²⁴² This should also include AEMO having a last resort power to procure and enter into commercial arrangements with existing gas-fired generators to make them available to maintain reliability in the NEM. However, the right to use this power should only be exercised if certain conditions are not met in the market. Appropriate parameters will need to be established.

Recommendation 4.1

By end-2017, the Australian Energy Market Operator should require generators to provide information on their fuel resource adequacy and fuel supply contracts, to enable it to better assess fuel availability.

Recommendation 4.2

By mid-2018, the Australian Energy Market Operator should be given a last resort power to procure or enter into commercial arrangements to have gas-fired generators available to maintain reliability of electricity supply in emergency situations.

Ensure appropriate regulatory regimes

While investment in exploration and appraisal has been slowed by falling oil prices, this has the potential to increase again if the oil price rises. The economics of developing any new supply outside established production areas is yet to be fully demonstrated. Increases in domestic gas contract prices are expected to be driven by higher costs of production as new gas is sourced from higher-cost fields.

Increasing gas supply will relieve supply tightness and assist in mitigating gas price rises. This will go some way to improving the economics of gas-fired generation. Without further and extensive investment in undeveloped gas reserves, there may be significant unfilled demand and continuing high prices on the east coast.

For this reason, government and industry should prioritise the exploration and development of gas reserves to build long-term supply certainty, given the timeframe of five or more years to bring new supply to market.

The exploration and development of onshore unconventional gas fields gives rise to a number of socioeconomic challenges.²⁴³ Unconventional gas has a large development footprint as it occurs across a large subsurface area, requiring a range of infrastructure, including gas wells, access roads, pipelines, processing plants and dams.²⁴⁴

Regulation of onshore gas is the responsibility of state and territory governments. In response to community concerns, some governments have put in place restrictive regulations and moratoria on the exploration and development of gas reserves. While it is vital that regulatory regimes are in place to ensure community safety and environmental protections, and to protect landholders’ economic interests, regulatory restrictions not based on evidence have long-term detrimental impacts on gas exploration and development and disrupt the flow of gas.

Stakeholders have advised the Panel that these regulatory restrictions have exacerbated the current supply tightness. The interconnected nature of the east coast gas market means decisions made by states in isolation have national consequences and impacts for multiple markets – including the NEM. The consequences of these interventions are now being felt. Any disruptions to the flow of investment will impact the availability of gas for the domestic market, leading to higher prices and consequent risk to the economy and jobs.

For long-term gas supply certainty, governments and industry need to invest in earning community confidence in onshore unconventional gas. In particular, the LNG projects in Queensland will need to continue to develop CSG fields over the long-term. In other states, diversity in gas supply would increase their energy security.

One of the key differences between CSG and other mining activities is that CSG wells cohabit with other land uses such as agriculture. There is a strong need for sustainable co-existence between the gas industry, landholders and communities.²⁴⁵

The Australian Government’s three principles for the development of CSG are:²⁴⁶

Agricultural land should only be accessed with the farmer’s agreement, and farmers should be fairly compensated.

There must be no long-term damage to water resources used for agriculture and local communities.

Prime agricultural land and quality water resources must not be compromised for future generations.

South Australia has announced that 10 per cent of royalties will be provided to landowners whose property overlies an unconventional gas field that is brought into production. In Queensland, landholder and resource companies must negotiate a legally binding Conduct and Compensation Agreement that outlines compensation for landowners for the effects and impacts of authorised activities.²⁴⁷ The Queensland Government has established a Land Access Ombudsman to deal with disputes between landholders and resource companies in relation to Conduct and Compensation Agreements.

The NSW Chief Scientist and Engineer’s independent review into CSG activities in New South Wales found that CSG extraction and related technologies are mature and Australia is well equipped to manage their applications.²⁴⁸

The role of governments and industry is then to provide leadership and establish community trust while ensuring legitimate concerns are acknowledged and addressed. Listening to and responding to diverse community segments is absolutely necessary for any new industry wishing to operate successfully within communities.

The Panel considers that governments should avoid blanket restrictions and bans on gas projects and instead encourage the safe exploration and development of the industry. Evidence based regulatory regimes enable the risks of individual gas projects to be managed on a case-by-case basis. A number of submissions to the Review support this approach.

Recommendation 4.3

Governments should adopt evidence based regulatory regimes to manage the risk of individual gas projects on a case-by-case basis.

This should include an outline on how governments will adopt means to ensure that landholders receive fair compensation.

Improve access to transparent and informative gas industry performance data

Key concerns for communities relate to the potential impacts on aquifers and the use of chemicals as part of the hydraulic fracturing process. Concern has been expressed about information disclosure, the absence of baseline monitoring, inadequate testing of chemical additives, and the recovery and disposal of used hydraulic fracturing fluids.

Not all CSG wells require hydraulic fracturing. Generally, only wells that intersect lower permeability deeper coal seams require hydraulic fracturing. According to the Gas Industry Social and Environment Research Alliance around 20 to 40 per cent of CSG wells in Australia use this technique.²⁴⁹

It is worth noting that Australia has a robust environmental regulatory framework to manage the risks associated with these activities. The Australian Government protects water resources from the impacts of CSG development through the ‘water trigger’ provisions of the Environment Protection and Biodiversity Conservation Act 1999. This Commonwealth regulatory regime is designed to work in concert with state and territory governments, which have primary responsibility for water resources and regulating environmental impacts associated with the resource sector.

The water quality of CSG water varies greatly, though it is generally rich in salts and other minerals. Where properly managed and treated, which typically involves desalination through reverse osmosis,²⁵⁰ CSG water can be reused in a range of different ways including irrigation.²⁵¹

Concern has been expressed that the level of fugitive emissions (from infrastructure leaks and minor venting) associated with unconventional gas production has the potential to diminish the emissions reduction benefits of CSG utilisation for gas-fired generation. However, recent empirical research²⁵² into fugitive emissions of methane from Australian CSG fields, commissioned for the National Inventory Report 2015,²⁵³ do not support this concern. In 2013, the Australian Council of Learned Academies looked at international comparative life cycle emissions per MWh by fuel and found that gas emissions were generally significantly lower than coal emissions.²⁵⁴ Ongoing monitoring is required.

While most of the information on the management of risks associated with CSG extraction is available in some form, it is not easily accessible or in a format that can be readily understood. Industry performance data should be transparent, clear and convenient to access by the public.

Types of data that should be publicly available include seismic activity, fracking fluid composition, aquifer purity and fugitive emissions. For example, the University of Texas at Austin’s TexNet research portfolio includes a seismic monitoring program²⁵⁵ to monitor impacts of the injection of fluids on underground geological formation. The data are made available on a public web site. In the United States, a not-for-profit publicly accessible website, FracFocus, provides information about the chemicals used in hydraulic fracturing fluids, which can be found for individual wells in the majority of jurisdictions.²⁵⁶

Robust information from a trusted source, such as an academic institution or not-for-profit organisation, would go some way to increasing transparency and improving community trust of gas exploration.

Recommendation 4.4

By mid-2019, the COAG Energy Council should bring together relevant regulatory and scientific data on gas in an informative and easily accessible format.