Essay Critically Assessing the National Gas Access Regime in Australia in Terms of How It Influences the Behaviour of Gas Producers and Gas Consumers

Essay Critically Assessing the National Gas Access Regime in Australia in Terms of How It Influences the Behaviour of Gas Producers and Gas Consumers

Introduction

This essay will critically assess the effect that the national natural gas access regime has had upon the behaviour of producers and consumers. This undertaking, will first consider the:

1. Historical aspects of natural gas (NG) extraction and usage, it will then turn to the
physical attributes that provide monopoly and essential facility status.
2. How the many externalities come together to further promote the use of NG.
3. Governance by independent regulation and tariff establishment to provide a competitive environment will be discussed.
4. Subsequently how the National Gas Access Regime was established and its objectives.
5. With this in place we will then critically assess the effect upon the behaviour of gas producers and consumers.

Natural Gas and Government:

Exploration for petroleum, successful or otherwise has been an ongoing event from the mid 1800’s. Technology and handling made it a viable fuel at the time, yet on chance encounter drillers came across natural gas, which at the time was considered a nuisance and was flared to the atmosphere (Boyle et al, 2003, pp235-236 2003) & (Stevens, 2010, p1). In time, the technical and economic opportunities of NG manifested themselves, extraction, production and subsequent pipe carriage to regional markets was becoming feasible.

The exploration and production facilities involve considerable expertise, be it seismic research, exploratory well drilling, review and subsequent extraction/production, require not only capital but an understanding that an investment return will be possible (Lim et al, 2001, p61).

Two factors come into play, the first requires that Government is sympathetic to the extraction and either assist with subsidies else provides taxation that does not deter investment. Australian Commonwealth and State Governments provide incentives to firms to ensure that these energy resources are exploited for the benefit of all parties. In this vein, the use of a resource rent tax, first proposed by Garnaut and Clunies Ross has successfully been applied to most offshore petroleum and gas fields under Commonwealth jurisdiction (Garnaut, 2010, p7).

The second factor constitutes contracted or foundation markets that will ensure the long term sale of the product and so allow the actual return on investment. Initially these were the densely populated so easily reticulated metropolitan areas, however as energy usage patterns have evolved so has the NG market (Hausman, 2010, p 2)( PC, 2004, pp26-28).

Pipelines and anti-competitive behaviour:

To bring the NG to market and so ensure the second factor is realised, physical pipelines connect the gas field resource and the intra and inter State distribution areas. Appreciatively costly and requiring up-keep, upgrades and extensions to service new producing or consuming regions. Apart from investment, undertakings from within State jurisdictions and co-operation between States is needed to ensure feasible and equitable operation as energy is under State legislation.

Consider the Moomba – Sydney pipeline (MSP), exemplified here to present the forthcoming argument. Originally commenced by the Australian Gas Light Company (AGL) the early 1970s saw the Commonwealth Government acquire the asset, and complete it by 1976. Development of the pipeline continued until it was sold under legislation that included Government regulation to Eastern Australian Pipeline Limited (EAPL) in 1994, an entity owned by AGL Gas Networks 51% and 49% by Petronas (Malaysia) and NovaCorp (Canada). Yet by 2000 it was sold in its entirety to Australian Pipeline Trust APT. A single supply line initially operated by a private concern that serviced the NSW East coast (APT, 2003, p2) (Lawrey, 1998, p101).

During the 1980s and 1990s, AGL GasNet held a major interest in the MSP but also was the leading distribution entity in NSW. Notwithstanding it used this vertically integrated muscle to force situations unbecoming to competition and price reduction. Makholm et al. make reference to instances wherein monopoly power was used by AGL to keep competitors at bay and extract economic rent:

1/ AGL controlled the MSP and provided entry barriers where possible to new producers in the Cooper Basin (Moomba).

2/ Given the vested interests in the alliance with the Cooper basin, the opportunity provided to AGL by having a large share of the connection pipeline with Victoria. In addition to the difficult market carriage arrangements vested in that State, it was able to down rate the use of this NG source.

3/ Place considerable entry barriers to the Duke International’s Eastern Gas Pipeline (EGP) that would provide carriage of NG from the Esso / BHP Gippsland Basin via Longford to Sydney (Moran, 2003, p19).

4/ NSW’s IPART inability to provide sufficient effort to reduce let alone eliminate AGL's anti-competitive practices (Makholm et al, 2000, pp 1-8).

The examples provides several instances wherein corporate self interest to profit foregoes the broader community benefit. In an effort to ensure greater equity, the Australian Commonwealth and State Governments reviewed and established a format to act for the welfare of the community at large.

Monopolies, essential facilities and access:

The Hilmer Report, was a response to the Commonwealth Government's request for an inquiry into national competition policy. Referring to Hilmer section 11, the necessity for competitors to have access to facilities that provide connection between producers and consumers, such facilities are seen to exhibit monopoly characteristics as they cannot be duplicated in an effective way, these are referred to as “essential facilities”.

Consider the supply of electricity to the community, initially provided by a vertically integrated parastatal owned monopoly. The size of infrastructure required from power station, switch yard, transmission lines with subsequent distribution networks allow for a considerable low marginal cost of the electricity supplied. On disaggregation, competitive producer generation facilities can economically operate alongside the large State controlled thermal power stations. Similarly, downstream incumbent distribution networks give way to other private entities facilitating the competitive distribution of electricity. The transmission towers and wires along with switch-yards however are not that simply duplicated, yet critical to connecting the source with the consumer and inherently pose a “bottleneck” (Hilmer, 1993, pp240-242) (Maddock et al, 1996, 71).

In the current context, the gas carriage pipeline from producer to consumer region is seen as a monopolistic essential facility. In some cases as with the MSP, they are identified as being vertically integrated with either producer fields else consumer distribution.

Such integration has been observed in Australia and the UK to be Government owned else as in the US privately run; both formats though where regulated by a Government branch. For economic efficiency the world trend moved to disaggregate these incumbent structures during the 1980s through to the 1990s. However, the essential facilities needed to remain, these brought on new regulatory requirements by independent parties. The privately funded and owned NG transportation pipelines are viewed in exactly that way (Maddock et al, 1996, p73) (McHugh, 2012).

In providing competition within the contestable gas market, necessitates opportunity for all third parties to have unhindered or open access to that essential facility. Legislation has been written for such a purpose under the Trade Practices Act 1974 Part IIIA to allow “…for a service to be declared by the Commonwealth Minister as open access service” (Harman, 1996, p4).

Harman indicates that measures needed to ensure open access functionality are:

1/ remove conflicts from upstream and down stream concerns, by way of ensuring complete disengagement of previously associated interests, including the assurance of “ring fencing” to stop uncompetitive information flow;

2/ provide a regulator, independent of the private interests or of Government that may oversee the operation. If left on its own, self interest and profit will underpin any public interest;

3/ administer a tariff, that works as best to what may result if left to a contestable market force;

4/ acknowledge that in time the format will evolve and policy design should allow for this.
(Harman, 1996, pp 4-8)

Considering Harman's second point, not to preclude Government from self interest, competition to the Dampier to Bunbury Pipeline in Western Australia came about from California‘s Pacific Gas and Electric Company (PGE) yet was thwarted by the Western Australian Government. In so doing, it maintained the pipeline monopoly and hindered competition (Moran, 2003, pp3-4).

Pipe access and tariffs:

The disaggregation would require that the regulator who is independent of Government yet has no affiliations with the pipeline, the office would set about establishing tariff rates that individual pipeline will charge for access to their facility. The rate needs to reflect a competitive position yet allow the pipeline to function economically. Several suggested formats appear, yet Hilmer et al. note that one of the problem areas is the establishment of access price (Hilmer, 1993, pp243-244) in this respect several authors suggest options.

Harman observes that use of short run marginal cost (SRMC) lacks sufficient return to cover overheads yet this may be improved by use of Ramsey format. (Harman, 1996, p7). Lawrey, goes further by discriminating between the large gas users that require constant supply tied to long running contracts that in turn reflect the life of the physical pipeline, therein suggesting that the LRMC cost is appropriate. With regard to interruptible supply and spot sales a tariff that allows coverage of marginal costs yet provides for allocative efficiency (Lawrey, 1998, p 97 & pp102-103) to this end the use of SRMC with an element of capital depreciation (Lawrey, 1998, citing Kahn, 1998, p103) Maddock looks at three options; restricting the rate of investment return regulation of prices, so either setting the price level or capping thereof revenue capping (Maddock, 1997, pp69-70).

Given tariff options and variation pipeline circumstance, it would suggest that legislation would require an element of flexibility to adjust tariffs as the situation develops.

Externalities:

Reticulated gas began with the supply of town gas, manufactured from coal, by small local monopolies. However, the inherent pollution from coal, aided in embracing the cleaner natural gas, once discovered and proved viable it was readily accepted by the broader community. This occurred in the 1890s in the US and 1960s in Europe (Boyle, et al, 2003, pp267-273) (Stevens, 2010, p1 & pp6-7), Australia began its pipeline programme in the late 1960s.

The last 5 decades has seen major movements regarding environmental and pollution issues. Governments have responded accordingly, either by substituting energy formats as well as rearranging infrastructure to move pollution sources away from the populated centres.

In this regard the advent of gas turbine generation technology that is only recent yet provides for many benefits in contrast to its fossil fuel cousins – petroleum and coal. Low investment, rapid installation, lowest pollution levels if used in a combined cycle with either additional electricity generation or heat production technical efficiencies of 50% have been realised (Boyle, 2003, p321).

In acknowledging these combined positive externalities for the community, producers, consumers and subsequent new electricity facilities, the Government needed to provide a sound means of NG supply. Lim et al. notes that some economists suggest that investment in infrastructure is a consideration of all the possible benefits that may be achieved, if then these cumulative benefits that include aspects not obvious to the private concerns exceed the cost of the project, there is then merit to proceed with the infrastructure along with Government subsidies (Lim et al. 2001, pp56-57).

Access Regime:

The National Gas Access Regime is a result of the Australian Commonwealth Government reviewing National Competition Policy with the Hilmer Report in 1993. The Council of Australian Governments (COAG) through a series of meetings in the early 1990s resolved to remove restrictions in NG competition, allow interstate NG trade and bring about an access arrangement for all third parties, so develop a national competitive market. The mid 1990s saw all jurisdictions (States) provide for new legislation that would lead to a national goal. The Australian Competition and Consumer Commission (ACCC) noted that NG competition required additional conditions to that of the general provisions as it was observed that there was considerable monopoly market strength in the gas transportation arena that existed between basin sources and metropolitan consumers. The Gas Code was approved by all Ministers in November 1997, from which all States signed an agreement to enact the Gas Code as law the objectives of which cover:;

1/ national marketing of NG;
2/ allow for monopoly misuse;
3/ allow for competition at both the upstream and downstream sectors;
4/ provide for access to carriage pipelines on terms that are reasonable to
facility owner and user;
5/ arbitration of issues
(PC, 2004, pp 61-67)

The transitionary period after implementation of the Gas Code, saw by way of the requirement for steep price reductions, a dichotomy of events. The Government owned gas distribution entities, in which considerable industrial strength was held by union labour force, saw little change with regard to its profit. So placing sentiment with the regulators decision on setting access prices to that of competition.

Transport pipelines however had a different story, the Victorian pipe line run by GasNet and the Dampier to Bunbury EPIC line, faced considerable losses with the forced price reductions. EPIC purchased the pipeline from the WA Government with State Government tariff assurances, yet as the Gas Code took effect the prices set by the independent regulator had devastating effects (Moran, 2003, pp5-6 & 9-10) (Lim et al. 2001, p58).

Upstream of pipeline, Producers:

The effect of the Gas Code may be considered in terms of the number of operators undertaking full cycle (from geological review to production) gas production requiring about 5 years. Lim et al. notes that the assurance of product carriage since the Gas Code was adopted in 1997, has seen a rise in the number of Victorian concessions (exclusive license by Government to explore and develop). Citing Encom Technology, a software supplier to oil and gas exploration, a successive increase from 78 concessions in 1996 to 108 in 1999. These have increased although oil prices where not moving, suggesting that the Gas Code alone placed exploratory incentives (Lim et al. 2001, citing Encom Tech. pp59-61).

The Cooper Basin operates on company partnerships and feeds the Moomba facility is provided in a more contemporary sense. Unlike frontier fields offshore, it provides easier opportunities for exploration, the field began as a result of South Australia Northern Territory Oil Search (Santos) exploratory efforts during the 1950s and 1960s, seen as economically feasible in 1966 (Santos, 2012). Subsequently a pipeline to Adelaide was constructed in 1969 and the MSP connection in 1976 (Perl et al.2008).

The Basin entails 45 fields with 130 wells feeding the Moomba facility. This success, along with knowledge of pipe access to markets has allowed other companies to continue to drill in search of new fields. To date Origin Energy’s 2007-2008 drilling program has provided 18 producing wells from 20 exploration holes. Beach Petroleum efforts yielded 25 successful exploratory holes out of 27 drilled. Other companies include Innamincka Petroleum and Great Artesian Oil (Perl et al.2008).

Different shareholdings of the various companies within each Cooper gas field have provided an artificial means in avoiding the formation of Cartels. At the same time these firms that include Exxonmobil, Santos and BHP along with smaller concerns work in a consortium to reduce risks from their exploration through to marketing (Moran, 2003, p18).

The Gas Code's competition efforts, have hence brought on alliances to increase exploratory knowledge and so reduce risk in a gas field with many participants. At the same time, no parallel pipeline development was forthcoming, however of greater benefit has been the pipeline construction from separate gas fields to supply regions such as Sydney and Adelaide. Developments took place to provide NG via Albury from existing Victorian pipe systems, as well as the significant independent move to construct the Duke International Eastern Gas Pipeline (EGP) from Longford, Victoria. Both feeding Sydney from the Bass Strait field operated by Esso - BHP. Similarly a second supply to Adelaide from the South Eastern Australian Gas Pipeline taking gas from the Otway Basin operated by BHP-Santos and Bass Strait Basins (Moran, 2003, p18-19)

Additional comments from the Productivity Commission’s inquiry indicating upstream improvements and growth include;

Queensland Government: “… the rapidly developing coal seam gas industry is providing field on field competition” (PC, 2004, p 94).

BHP Billiton: Noted that gas reserves increased by 102% between 1990 and 2001 (PC, 2004, pp 93-95).

Downstream of pipeline, Consumers:

The effect of the Gas Code may not be transparent to the metropolitan users whom have been accustomed to uninterrupted supply, this unseen energy security has been brought about by the increased efficient operation of the pipeline system. Moran indicates an increase in labour productivity, given NG sales have increased by 50% in the ten years to 2001, yet employment in that sector has declined, therein the unit of NG sale per employee has more then trebled suggesting that the firms are working competitively. Industry development through a maturing period was prevalent in the early 1990s as gas consumption was seen to increase with a 20% rise in national consumption from the early 1990s to 2001, consequently this levelled off (Moran, 2003, pp 9 -11).

Given the cost to provide infrastructure for regions distant from metropolitan centres, opportunity to “tap” into an existing trunk line provides for an assortment of societal benefits. If this access to gas is the marginal cost it ensures that it is accomplished economically (Lim et al. 2001, pp76-77). Subsequently Local Governments have been pursuing the viability of adopting a branch from the main trunk lines, to service their country localities (PC, 2004, citing Energy Users Association of Australia, p95)

Gas fuelled turbine power stations have emerged, Tallawarra, close to Wollongong that tapes into the lateral Eastern Gas Pipeline (Tallawarra, 2007, p6) and the Uranquinty station that connects to the Victorian-NSW interconnect (Uranquinty, 2009). Moran cites, as traditional usage would constitute gas usage during winter for heating, demands for summer cooling entail daily peak periods that gas stations are well placed to accommodate given the spot price of energy at these peak periods. Hence, although they operate at marginal cost in contrast to coal fired base stations, their immediate start up and very low emissions coupled to secure carriage of the NG make for sound investments. One down side, is the ability of the pipelines to provide the gas quantity required during peak periods, an issue that will develop as more gas turbine stations come onboard (Moran, 2003, pp11-12)

To aid profit given the competitive field established, Envestra Ltd the South Australian gas distributor has noted that retailers are developing value-added services for their consumers (PC, 2004, p96).

Conclusion:

The marketability of NG along with physical pipe requirements that lend themselves to anti-competitive company behaviour was investigated at the outset. The concept of an essential facility operating as a monopoly was then introduced and how this requires regulation and tariff prices akin to competitive markets so as to maintain upstream and downstream competition viability.

The acknowledgement of pollution as well as several positive externalities were then highlighted as a prelude to how the COAG went about to develop an industry specific National Gas Access Regime. The Regime’s purpose and objectives were touched upon at which point a review of outcomes was considered.

Firstly from the producer side, it was observed that exploratory operations increased on account of the Code, partnerships developed in the Cooper field to reinforce information flow yet curtail anti-competitive formation of cartels. The advert of different fields feeding markets so ensuring competition was then discussed.

The second outcome dealt with changing downstream customer markets reflecting energy usage, productivity in the gas sector was presented as an indicator of competitive effectiveness. Then physical improvements were shown, including the advert of gas turbine electrical generation, country local governments embracing the opportunity to provide NG to their townships.

In summarising, the Commonwealth and States Government’s intent on national competition improvement certainly provided results in the natural gas field.

Bibliography:

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