LNG May 2017
Australian Government Export Controls

The Australian Government has imposed an export control on LNG producers to ensure supplies in the domestic market. We expect Santos’ 7.8Mtpa GLNG facility to be mainly affected by this new regulation, because over 60% of its feed gas comes from the domestic market. Going forward, the regulation will force LNG exporters to increase their investment into domestic gas sources despite their relatively high cost.

Export Controls to Hits Some Harder than Others

Australian Prime Minister, Malcolm Turnbull has imposed an export control, the Australian Domestic Gas Security Mechanism, on Australia’s LNG exporters. The regulation is designed to secure Australia’s east coast gas market and reduce prices that have almost doubled since 2016.  LNG exporters that draw gas from the domestic market must fill the shortfall from other assets. Exporters that are unable to meet this requirement will have their LNG export capacity limited. The new regulation will come into effect from the 1st of July 2017.

This new regulation is unlikely to greatly affect Origin’s APLNG and Shell’s QCLNG. APLNG is already a net supplier to the domestic market whilst QCLNG has agreed to supply 10% of the east coast market with a new AU$500m drilling campaign. The third LNG facility in Queensland, Santos’ GLNG will have much greater difficulty meeting this new regulation.

 

 

The Difficulties of Complying to Changes

In 2010, GLNG’s environmental impact statement concluded that the facility would “not divert gas from local markets to export markets" and that it would have “no direct implications for domestic gas prices". However, since then, a moratorium on gas exploitation in Victoria and New South Wales has locked away 1,200PJ of potential supply. Compounding to these woes, some of Santos’ Queensland assets have performed poorly. The Roma gas field was expected to produce up to 300TJ/day and was critical in sanctioning additional investment into export capacity in 2015. The field is currently estimated to be producing 25–70TJ/day despite over 300 production wells. We estimate that the field will require over 1,000 additional wells to reach target rates.

This has forced Santos to divert gas resources from its Cooper basin assets as well as purchase gas from other producers’ east coast portfolios. The GLNG Joint Venture (JV) is currently sourcing approximately 60% of its gas from third party sources. Santos is estimated to be purchasing approximately 450–500TJ/day for export. In comparison, Queensland, New South Wales, Victoria, and Tasmania combined need approximately 1,250TJ/day. It is the combination of increased LNG gas demand, limited gas supply in the southern states, and reduced production from coal-fired electricity that has driven up gas and electricity prices in the eastern markets.

 

Can Exporters React to the New Environment?

Currently, the Santos and its joint venture partners are suppling 39% of the feed gas to GLNG. Whilst the new regulations have not been defined, we are assuming that Santos would only be able to draw upon an additional 33TJ/day (4% of GLNG demand) from other domestic sources. This limited drawdown is because the GLNG JV currently contributes 33TJ/day to the eastern gas market. Therefore, Santos must provide the government with a plan to supply an additional 550TJ/day to maintain current operations or restrict their LNG facility’s output to 390TJ/day. 

 

 

The Australian government has not specified how a company must reduce its exports. Exporters could potentially use gas swap contracts and sales of the spot market to get their gas to their overseas customers. Similar to carbon credits, exporters with lower domestic contributions could sell their gas to those with higher domestic contributions, and therefore higher export capacity, to get their gas to overseas customers.

However, we expect producers will need to increase their investments into domestic production to meet the regulation’s requirements. Even if NSW and Victoria unlock acreage, we expect the bulk of new production will come from relatively expensive coal seam gas (CSG) wells in Queensland. Santos’ average cost of completing a CSG well in 2016 was AU$4.2m per well. A thousand extra wells at their Roma assets would already total over AU$4.2bn and still not produce enough to cover GLNG’s excess drawdowns. These developments would require a gas price of around AU$7/GJ. Such a price level was what originally drove the Australian government to enact these export measures. The Prime Minister’s plan guarantees we will be unlikely to ever see prices reaching as high as AU$30/GJ as they did last June. However, the days of AU$3–4/GJ gas seem to be long past.