Turnbull Twisting Arms Over Natural Gas Is A Zero Sum Game

malcolm turnbull having a gas

Don’t believe the hype. Domestic gas prices have very little effect on retail electricity prices. Someone should tell Turnbull.

According to the mainstream media, Prime Minister Malcolm Turnbull has been busy twisting the arms of natural gas producers. He wants Australians to pay less for Australian gas. Specifically he wants us to pay less than overseas customers pay for Australian gas.

This has upset gas producers because, like most companies, they would prefer to sell stuff for more money rather than less.

If Turnbull succeeds in cutting domestic gas prices, either through a voluntary agreement or forcing compliance through regulation, it will reduce electricity prices, but not by a lot.  They may fall by a couple of cents per kilowatt-hour. But these days prices are so high that’s only about 5% off a typical electricity bill here in Adelaide.

If it represented a genuine reduction in cost then even a tiny decrease would be better than nothing.  But the problem with Turnbull’s approach is there are no real savings for the nation as a whole.  It’s not making the country any money, it just redistributing it.  It’s a zero sum game that does nothing to address the basic problem that gas powered generators often determine the wholesale price of electricity.  By keeping the price of natural gas down, Turnbull’s approach will weaken market forces.  It will discourage energy efficiency and less renewable generation will be built1.

Turnbull has already partially nationalized the gas industry by forcing them to supply as much gas for domestic use as they export.  Now he’s insisting gas producers lose money on gas sold domestically.  I’m not surprised export restrictions were introduced, but I am surprised that the Coalition is now openly acting against the interests of a large resource extraction industry that may soon eclipse the coal export industry in size.  I don’t know what this means for the future, except that we live in interesting times.

It’s A Zero Sum Game

If Turnbull lowers domestic gas prices, either through persuasion or regulation, then Australians as a whole will benefit from slightly lower electricity prices and gas using industries2 will certainly benefit.  But if one gigajoule of gas is sold in Australia for $4 instead of the $7.30 or so it is currently worth in China or Japan, then we miss out on the extra $3.40 we could have got from selling it overseas.  So overall, what the country gains in lower domestic gas prices, it loses in lower foreign revenue.

Lowering the cost of natural gas is more likely to smear the benefits over the whole country than if gas producers are allowed to keep charging high prices in Asia, but it still means wealth is being redistributed rather than created.

A Gas Shortage Merely Means It’s Expensive

The Coalition introduced gas export restrictions in June in order to prevent a gas shortage, but a gas shortage does not mean it is unavailable, it just means it might get really expensive.  Since we now produce far more gas than we consume:

Gas Production

Eastern Australia’s natural gas production has increased over 250% in the past three years. (Image Source: Australian Energy Regulator.)

We can’t really run out provided provided we are willing to pay more for it than countries such as China, Japan, and South Korea are.  Unfortunately for our wallets, they are willing to pay a lot.  Early in 2014 gas was being sold in Asia for over $25 a gigajoule, which is more than three times its current price.  It is unlikely to reach that price again, but it is still possible.

While I am not surprised the Coalition introduced export restrictions, since the cost of electricity is likely to be a major issue in the 2019 Federal election, I have to admit I am not entirely comfortable with gas companies being required to sell at below market prices, even though I’m not especially fond of that bunch of seamy frackers3 that run our gas industry.

It Won’t Lower Electricity Prices By Much

Lowering gas prices should definitely lower electricity prices.  But it won’t lower them by much. Currently the price of natural gas is around $7.30 a gigajoule in Asia.  But because gas consumed in Australia doesn’t have to be compressed into a liquid and shipped, I’ll use a nice round figure of $74.  Australian natural gas used to cost roughly $3.50 a gigajoule.  So let’s say Turnbull forces the price down to $4.  Even if Australian electricity was entirely produced from gas, which it’s not by a long shot, that 43% decrease would only lower the price of electricity by around 3 cents a kilowatt-hour.

The reason why is Australia’s gas power stations range in efficiency from 25% at Quarantine Island to 50% at Pelican Point.  If the average efficiency of gas generation is assumed to be 33% then it will take 10.8 megajoules of gas to generate one kilowatt-hour of electricity.  So a $3 decrease in the cost per gigajoule will reduce the cost of one kilowatt-hour of electricity by 3.2 cents.

Normally this kind of decrease would be wonderful, but as mentioned, it’s not a real saving and comes at the cost of getting less money from China and other countries.

In reality a $3 fall in the cost of gas won’t result in a 3.2 cent per kilowatt-hour fall in the cost of electricity.  This is because gas only provides around 9% of Australia’s grid electricity.  While natural gas punches far above its weight when it comes to setting wholesale electricity prices, it does not entirely control them.

Why Isn’t Turnbull Attempting To Lower The Price Of Coal?

Last financial year 9% of Australia’s electricity was produced from burning natural gas while 77% was produced from burning coal.  So you may be wondering why Turnbull isn’t twisting the arms of coal producers to lower the cost of electricity.

There are three reasons why this isn’t happening:

  1. Natural gas has a stronger influence on raising wholesale electricity prices than coal.
  2. Even if Turnbull somehow managed to halve the domestic cost of coal it would only lower electricity prices by a little over 1 cent a kilowatt-hour.
  3. The Coalition has a toxic love affair with the coal industry.

Gas And Hydro Often Determine Electricity Prices

Gas has a big influence on the wholesale price of electricity because, along with hydroelectric power, it is dispatchable.  This means it can easily be switched on and off as needed.  In addition, most gas generators can operate at a small portion of their total capacity without a problem.

But coal power is very inflexible.  Australia’s ancient coal power stations can usually only operate from 60% to 100% of capacity and their operators are loathe to shut them down because the resulting changes in temperature and pressure causes significant wear and tear that shortens the life of the power station and increases the need for expensive maintenance.  Shutting down is so costly coal power stations will often continue producing electricity even when its price is negative.  This means they have to pay for each kilowatt-hour they supply to the grid instead of being paid.

Because coal power is inflexible its owners often bid in a low price to make sure its electricity will be used, while hoping their low bid won’t be the one that determines the actual wholesale price of electricity.  They do this because bids are accepted from the cheapest to most expensive with the highest priced electricity that is used setting the price for all those who bid less.

But gas and hydro are flexible which lets them bid in higher prices than coal and sit out periods of low electricity prices.  So when other generation can’t meet demand they end up setting the wholesale price.

In the case of hydroelectricity, which provided 8.1% of Australia’s grid electricity last financial year, if they bid too high the water remains in the dam and can be used later.  As the dam approaches its maximum capacity they will lower their bids and increase generation, but generally hydro charges around the same as gas generation for its electricity.  This is because if it tried to charge more, gas would be used instead and eventually the dam would overflow.

Gas generators will obviously bid in a price high enough to cover the cost of natural gas they have to burn.  But neither gas nor hydro power aim to just cover their costs.  Their goal is to charge as much as they can get away with to maximize their profits.

Normally competition means that at current gas prices they can’t bid in more than 7 to 10 cents a kilowatt-hour if they want to sell their electricity at all.  But when demand is high and there is little spare generating capacity, they can bid in and receive prices of over $10 a kilowatt-hour.  Under the rules which our National Electricity Market operates, it is perfectly fair and reasonable for them to do this.

So while a 3 cent decline in the average per kilowatt-hour cost of gas will lower the average price both gas and hydro generators bid in, it will have no effect on electricity prices when neither of them set the price, and it will have an insignificant effect when demand is very high and bids go over $1 a kilowatt-hour.

The frequency with which gas and hydro set electricity prices varies.  In the past coal would often set the price, but with the shutdown of a considerable amount of coal capacity including the permanent closure of the large Hazelwood brown coal power station in Victoria, combined with the Coalition’s doing all it can to slow investment in renewable energy, gas and hydroelectricity are now setting the price of wholesale electricity most of the time.

The Fuel Cost Of Coal Is Low

The fuel cost of coal is low, so even if Turnbull forced down its price it would have little effect on electricity prices.  In Victoria the cost of stranded brown coal5 is only around 0.3 cents per kilowatt-hour and most of that is royalties to the Victorian government, while in NSW and Queensland the price of black coal is quite high at the moment at $95 a tonne, but that still comes to only around 3.4 cents per kilowatt-hour.  Because brown coal is so cheap and coal now supplies less than 77% of grid electricity generation, lowing its price won’t provide much relief.

The Coalition’s Toxic Romance With Coal

Strangely enough, the Coalition is still in love with coal.  I thought by now they would have seen it has no future and their thoughts on it would be similar to those of rats towards sinking ships.  But the Coalition is still calling for new coal power plants to be built.

They are so well known for for being head over heels in love with toxic rocks that when I first heard Turnbull wanted to lower the cost of domestic gas I assumed he was doing it to delay the construction of renewable generating capacity in order to benefit the coal industry.  But because coal power has been massively benefiting from higher gas prices thanks to increased wholesale electricity prices, Turnbull is actually doing something that is against the interests of the coal industry, despite the fact he was just recently saying he wanted a new coal power station to be built and a crap old one to be kept open.

Just to be clear, proposed new coal power stations in Australia are complete fantasy.  The Coalition is building castles in the smog.  New coal power stations can’t compete on price with renewable energy, banks won’t touch them, Australia’s major power generators say renewables are the future, and with every country in the world that isn’t in the Middle East producing less greenhouse gases per head than we do, building more coal power stations puts us at risk of trade sanctions in the future.

Part of the Coalition’s delusions about the future of coal is an attempt to convince other nations to build more coal power stations so there will continue to be an overseas market for Australian coal.  But convincing other countries they should do something that kills people so we can make money is not something I think Australia should be doing.  I’d even be of this opinion if I thought it would actually work, rather than just make us look like villains from an episode of Captain Planet.

Reducing Gas Prices Does Nothing To Reduce Its Influence

To me it seems clear Turnbull’s goal is to get a voluntary concession from the gas industry so he can call it a victory, regardless of the actual effect it has, and boost his chances of winning the next election.  Or, more accurately, simply increase his chances of still being Prime Minister when the next election rolls around.

The gas industry may try to take the easy way out and offer him a superficial victory that has little real effect on either electricity prices or their bottom line.  Alternatively, they may spit the dummy and refuse and hope this weakens the Prime Minister enough for him to be replaced by someone more gaseous who would never harm the interests of a fossil fuel industry, even if it’s one that doesn’t involve digging up coal.

But let’s say Turnbull has a clear victory and either extracts a major voluntary concession from gas producers or regulates it into submission and there is a clear reduction in the price of natural gas in Australia.  This will do nothing to change the frequency with which natural gas sets the price of wholesale electricity and it will do nothing to reduce the CO2 released from burning natural gas that causes climate change that kills people6.

By keeping the price of natural gas low, Turnbull is blocking market forces from reducing the amount of natural gas Australia uses through  improved energy efficiency and the construction of additional renewable generating capacity.

Increasing Renewable Capacity Reduces Electricity Prices

Increasing the amount of wind and solar generating capacity will reduce the amount of time that power from gas and hydroelectricity are required, which will reduce the amount of time in which they can set the wholesale electricity price.

In addition, while wind and solar capacity cost money to build, they have zero fuel cost.  As a result they are willing to accept any price the market offers, no matter how low.  This is very effective at putting downward pressure on wholesale electricity prices.

Rooftop solar has managed to lower average wholesale cost of electricity during the day throughout Australia, and we can see the effects of wind and solar generation in South Australia when their output is high.  South Australia recently had a prolonged period of low wholesale electricity prices thanks to high renewable output when demand was low due to mild spring time weather.  On the 17th of this month rooftop solar supplied 48% of all electricity use at around 12:30 Adelaide time.

Because large industrial users pay electricity prices based on its wholesale price, increasing renewable energy will lower what they pay for electricity, which is something that is apparently very important to politicians.

What Turnbull Could Be Doing

Malcolm Turnbull has decided to put his effort into reducing gas prices, and that’s his choice to make.  But we should be aware that regardless of how successful he is at achieving this, it will:

  • Not create wealth but only redistribute it.
  • Only have a small effect on electricity prices.
  • Do nothing to reduce the ability of gas generation to set wholesale electricity prices.

I would much prefer it if he spent his energies acting to reduce the influence gas has on electricity prices and by expanding renewable generating capacity, but until I perfect my mind control technology, I guess there is nothing I can do about it.

 

Footnotes

  1. High natural gas prices also encourages the building of new coal generating capacity, but because new renewable generating capacity is more cost effective, coal cannot compete.
  2. Gas is commonly used in industry for processes that need heat.  This is given the imaginative name “process heat”.
  3. Around 85% of Australia’s unconventional gas production, which is gas that doesn’t want to come out of the ground by itself if you drill into a deposit, comes form coal seam gas, while 15% is from fracking.
  4. Just because I am using a price of $7 doesn’t mean gas spot prices are consistently around this level.  If you look at the left side of the AEMO site you can see there is considerably variation from day to day and city to city and at times prices have been over $10 a gigajoule.
  5. Victoria’s brown coal is stranded in the sense that it can’t be exported.  It is bulky and dangerous to transport and once you got it somewhere no one is likely to want the filthy stuff.
  6. The CO2 emissions from burning natural gas to generate electricity are much less than from burning coal, but are still substantial and leaking natural gas that results from its extraction and use is a major environmental problem, as methane, which is what natural gas mostly is, is a powerful greenhouse gas.
About Ronald Brakels

Many years ago now, Ronald Brakels was born in Toowoomba. He first rose to international prominence when his township took up a collection to send him to Japan, which was the furthest they could manage with the money they raised. He became passionately interested in environmental matters upon his return to Australia when the local Mayor met him at the airport and explained it was far too dangerous for him to return to Toowoomba on account of climate change and mutant attack goats. Ronald then moved to a property in the Adelaide Hills where he now lives with his horse, Tonto 23.

Comments

  1. Lawrence Coomber says

    Thanks Ron there is a lot of stuff in your post to digest, but the key take away for ordinary Australians is your particularly relevant good news: “Lowering gas prices should definitely lower electricity prices”. That’s an important step forward no doubt – don’t despair over the quantum.

    Lawrence Coomber

  2. This whole political show is to gain support for more water polluting CSG drilling for gas, nothing else. Look how the farked up the water in USA and now they want to spread there evil to us down under. IT MUST BE STOPPED!!!

  3. The ith the exports Ronald is that we are getting virtually nothing for them. The companies have such good depreciation deals with the gov that we are giving our gas away.

  4. Ronald,
    Are you sure of the gas pricing differential between export and domestic wholesale?
    Sadly, I have lost the source to quote from but I seem to recall quite the opposite. That is, domestic wholesale prices are around three times what China pays. The gas producers are contractually obligated to supply their foreign buyers first.

    As always, I’m happy to stand corrected.

    • Ronald Brakels says

      The situation is a little confusing. In Asia at the moment it should be possible to be buy one gigajoule of LNG at an LNG terminal for a spot price of around $7 or more. But that is probably not what Australian LNG is being sold for. The price Australia is receiving is probably much higher due to good long term contracts. I don’t know what our LNG exporters are being paid (it’s a secret), but apparently it is good.

      But, the spot price in Asia determines the price in Australia. If the Australian gas price goes above the spot price in Asia then Australian exporters will sell more gas in Australia and export less and buy gas in Asia to meet their contracts.

      Or at least that’s how it’s supposed to work.

      What is actually paid by homes and businesses for gas will depend on individual national policies and distribution costs. In China, as with electricity, industry is charged more for natural gas than households, which is the opposite of what we do here.

      In 2015 industry in China paid 17% more for gas than homes, but this figure may have changed since then. One reason for the lower cost of natural gas for homes is China has been discouraging household coal use, which has many negative health effects that are even worse than burning it in a power station.

  5. Your article should make it clear that Australia has been sending vast quantities of Natural Gas overseas (to countries who are still the principal contributors to the solution problem, so our generosity is not having much effect on world pollution by coal burning), AT PRICES WHICH ARE A SMALL FRACTION OF WHAT THE AUSTRALIAN COMMUNITY ARE FORCED TO PAY.

    Level up the pricing and we either have:

    1. a happier local community which does not see itself as being exploited; or,

    2. an even greater beneficial economic effect on Australia’s economic status, thru parity pricing of the product and the flow on effect of reducing our national debt.

    • Ronald Brakels says

      Natural gas producers sell gas for as much as they can get for it. As restrictions on exports won’t begin until the start of next year, that is the same price here as in Asia. (Less the cost of liquification and shipping.)

      Natural gas that is piped to Australian homes is a regulated monopoly. While households in China pay less for natural gas than Australian households do, this is due to domestic policy. For example, Chinese industry pays more than gas then residential users while in Australia it is the opposite.

  6. Dudley Marks says

    Our government represents us, the owners of the resources we so casually allow companies to mine in whatever quantities they choose. Little regard is given to remaining reserves or the price obtained for these resources. We have now forgotten the rock bottom prices obtained for coal, iron ore, and gas only a few years ago and are probably still selling NW Shelf gas under long term contracts signed with the Chinese when John Howard was Prime Minister.
    Why anyone would think burning gas in a power station was a good idea is beyond my comprehension but in de-industrialised Australia, we haven’t much other use for this premium fuel. How many years ago would we be facing blackouts but for this de-industrialisation?
    Energy policy and resource policy are a real mess which we need to fix as fast as possible. I don’t think Malcolm Turnbull’s fiddling around the edges will get Australia anywhere.

  7. Hi,

    We use NG for heating, cooking & HW, so a reduction is a benefit to us regardless of what effect it has on power prices.

    dRdoS7

  8. Kenneth Higgs says

    My latest power bill is a shocker..where once my investment in Solar gave me reduced power bills, in the order of $38.00 CREDIT, now I have, for a similar usage, a bill for $494.59..DEBIT!

    Obviously I would need to expand my existing Solar array, and consider additional equipment to go off grid.. or find a company with a better deal..my grid input is now worth only 6c per kW/hr.

    Another consideration would be: Is there likely to be further Govt. interference at the behest of the large foreign-owned energy companies? Also will it be worth the trouble and expense to save on bills but heavily invest in upgrading to do this?
    Your comments welcomed

    KE Higgs

    • Ronald Brakels says

      Hello Kenneth.

      The first step it to work out what has changed to cause such a huge increase in your electricity bills. Then you can fix that problem or if it is unfixable or you don’t want to fix it, you can consider investing in more solar. Since $494 a quarter is more than what most people without solar pay, then it definitely sounds like additional solar capacity could be of benefit. Rather than expanding your current system, it is generally easier to add a second, independent, system.

      But the first thing you may want to do is find a better retail electricity plan that pays a feed-in tariff of more than 6 cents a kilowatt-hour. You can use our retail plan comparison tool to try to find yourself something better:

      https://www.solarquotes.com.au/energy/

    • Lawrence Coomber says

      @Kenneth Higgs

      Your higher power consumption might be about to hit the ‘sweet spot’ for considering a rearrangement of how you might better manage and optimise your power production and usage.

      The devil is always in the detail of course, but pending a closer inspection of your lifestyle and consumption patterns and some other aspects relating to your property, you might be a good candidate for a dual power source ’smart system’ strategy to be evaluated.

      Essentially this means having two independent (and isolated) power plants involved, in your case a solar PV system and an energy storage system, and forego the low FIT entirely, and ‘smarten’ up and optimise the energy storage management and controls instead, utilizing what would have previously been FIT grid output power.

      This level of system integration can deliver serious power management efficiencies and system reliability overall, in the hands of a skilled power solution integrator.

      The first step in the process though is to assemble in detail, all of the facts that relate to your specific circumstances.

      In general terms there is not much still to be learned about power electronics and energy systems concepts, but this contrasts with the widening gap between what can already, and should be embraced in modern power plant system designs, that isn’t being considered by designers.

      This fact exposes some fundamental knowledge gaps in the industry, and they are mainly because of the designer’s inability to design for a high level of ‘semi-intelligence’ coupled with dynamic system controls, to the overall system functionality. There is a heavy reliance normally on stock power equipment hardware alone to define the power plant functionality without regard for any dynamic feedback mechanisms, embedded processing power, and solid state controls to be considered in the design.

      Lawrence Coomber

  9. Hi Ronald,
    Thanks for all the work you put into these articles!
    I you were in a position to set the Austalian electricity strategy and policy, what would that be? (a complete plan would be great!)

    • Ronald Brakels says

      A practical plan? But that sounds like hard work and it’s so much easier to just complain!

      But, since you asked, on the not dying side side of things, I’d like to see the full cost of removing and sequestering CO2 released into the atmosphere from fossul fuel use built into its price. And health costs as well.

      As for how to run the grid, well that would depend on if it is going to re renationalized or the NEM will be kept. A big topic, and I will touch upon it in the future. Maybe at some point I’ll write an article on some problems and my thoughts on how they could be improved.

  10. MarkfromMelbourne says

    Your article is all over the shop. First you argue that lower the price of gas is pointless as it won’t impact electricity prices then you say “Gas has a big influence on the wholesale price of electricity”. Which is it?

    By the way, the main thing Turnbull is trying to do is ensure gas supply during a predicted shortfall. This is a good start even if the price might go up short term.

    Secondly they are trying to convince the gas companies to commit to selling at the overseas price less shipping and liquifying costs. This would be a significant win for Australian domestic customers. We currently pay more than the overseas price in many instances. In fact, I would think this should be the minimum requirement via regulation. i.e. Australia has first right of refusal at a price which means profits are largely protected. This is not the zero sum outcome you argue.

    Thirdly they are trying to open up new supply by putting pressure on States to be a bit more open to new fields. But still with environmental protections.

    And lastly they are looking at all sorts of ways to open up new “supplies” of dispatchable power, and still supportive of renewables but just turning off the subsidy tap – not a bad thing at this point as long as it is across the board.

    They are also trying to do this with as little government interference as possible but it’s clear that the market itself won’t solve this issue. BTW – subsidies of any sort (including tax breaks) are government intervention.

    I think one area which is not being looked at enough is usage. We all want to use as much power as we like, when we want to but squeal at the cost. Maybe we all need to re-jig our usage or our expectations re-cake and eating it.

    A less shouty debate about all the potential measures would be good.

    • Ronald Brakels says

      Hello Mark.

      Lowering gas prices will lower wholesale electricity prices but not by a large amount because gas and hydroelectricity often set the price of wholesale electricity. Even if gas suddenly became free gas generators would still demand $10+ for the electricity they supply whenever demand is high enough for them to get away with it.

    • “First you argue that lower the price of gas is pointless as it won’t impact electricity prices then you say “Gas has a big influence on the wholesale price of electricity”. Which is it?”

      #1 The wholesale price of gas has a small effect on electricity prices.

      #2 The way gas generators game the market has a large effect on electricity prices.

      As Ronald points out – #1 and #2 are two different ways gas affects the prices we pay. #2 is a much bigger influence than #1

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