Connecting the dots: the Northern Territory enters the eastern gas market

The Northern Territory (NT) government recently announced that Jemena, a company that owns and operates major Australian electricity and gas infrastructure and is owned by a combination of Chinese and Singaporean interests, will construct a gas pipeline from Tennant Creek in the NT to Mt Isa in Queensland.

The North East Gas Interconnector will connect NT gas pipelines with the eastern market for the first time.

This announcement was welcomed by proponents and supporters as an essential addition to Australia’s gas infrastructure but by others as an inferior solution to a big problem. So, how good is this news and for whom?

The central and eastern states and territories of Australia have a gas pipeline network that has grown steadily over several decades and connects major supply sources with demand centres. However it still falls short of providing a highly liquid or transparent gas trading market, with a small number of producers, pipelines and large customers.

In this market, supply and demand have been in balance and steady for several decades. Long term contracts were periodically renewed and prices have been stable.

Then in the late 1990s, the opening of a major new source of gas, using new technologies to extract gas from coal seams (CSG), represented a major change. This new and large gas source offered a cleaner source of electricity generation and an alternative to a steadily increasing cost outlook as low-cost, conventional gas resources were consumed.

Change afoot in the gas market

Big changes rarely fail to have big consequences.

An energy-hungry Asia, in which Japan had lost its nuclear power supply, provided a potentially huge market for Australia’s CSG. This led to the development of export facilities in Queensland costing over A$60 billion. The gas volumes involved dwarfed the domestic market, but connected that market to a wider, regional market.

Enthusiasm from domestic gas consumers for more supply was rapidly overwhelmed by alarm as the gas producers followed the higher prices on offer in Asia, leaving the domestic market to contemplate doubling or even trebling of historical prices.

Even worse, a real concern developed that the east coast would face a shortage of gas as the producers ensured that the lucrative export market was supplied. The concern was sufficiently intense to trigger a formal review of the gas market by the ACCC, with its report expected in early 2016.

For some while the Northern Territory government had been seeking opportunities to capitalise on its own gas resources. The Power and Water Commission (PWC), the supplier of electricity and gas to NT consumers, had long-term contracts with gas producers but opportunities to sell that gas were thin on the ground.

An attempt to save Rio Tinto’s aluminium smelting operation at Gove by supplying it with gas had failed, and so the government saw the emerging dynamics on the east coast as an opportunity.

A tender for bids to connect NT gas with the east coast market resulted in the recent announcement of Jemena as the winner. Yet, while big on hyperbole, the announcement was small on details.

Connecting north and east

The key points are that Jemena will build an A$800 million, 622 kilometre pipeline. The gas will be sold by PWC to Incitec Pivot’s fertiliser plant in Mt Isa under a 10-year contract

On the surface, this deal should be good news. The pipeline provides a significant expansion of gas transport infrastructure. It has the capacity to transport considerably more gas into the east coast than covered by the initial contract and will be financed without government funding. It demonstrates that markets can find ways to solve problems with little government funding. So, what’s not to love?

At a national interest level, concerns have been raised that a pipeline that came further south to Moomba would have added much greater value. The argument seemed to be that the market was blind, and governments should have intervened to support the southern route. However it is difficult to see how government would have come up with a better solution.

Risk to shareholders?

It is not uncommon for major infrastructure projects to be financially challenging. This is no exception. The fertiliser plant in Queensland, Incitec Pivot, have indicated they will save A$55 million on annual gas consumption of around 10 petajoules (see above link).

This implies a very low transport tariff, or a very low gas price from PWC, or both. At the announced capacity of around 40 petajoules per year, the $A800 million investment would initially be only 25% utilised. This suggests lean early years for Jemena, or some very attractive deals to attract new customers.

There are many other potential gas buyers on the east coast who will buy gas at the right price. Yet there is great uncertainty as to the size of the NT gas resource that could be developed and delivered at such a price. Also the NT may see its own version of anti-CSG campaigns that have plagued the sector on the east coast.

Failure to resolve these issues will create serious financial stress for someone. But given the low level of public finance, it presents less of a risk from a public policy perspective.

In a 2013 report, Getting gas right, we suggested that the eastern gas market was not fundamentally short of gas and that commercial forces offered the best path to resolving market stress created by the CSG-LNG juggernaut.

It is early days yet, but the NT pipeline deal seems to confirm that proposition, regardless of whether the commercial players have done great deals or exposed their shareholders to ugly risks. The public is likely to be well-served either way.

Tony Wood has financial intrests in a number of companies that operate in ht eenergy and resources sectors via his superannuation fund.