There are good reasons why suppliers cannot offer long-term natural gas contracts at spot prices which have been temporarily depressed by a market surplus, Santos chief executive Kevin Gallagher says.

He said short-term prices for natural gas on the east coast are below the cost of supplying the fuel and not a realistic benchmark for long-term contracts.

His remarks will further fuel the suppliers’ debate on gas prices with manufacturers and the competition watchdog.

Prices in spot markets in Asia and on the east coast have been dragged down by the hit to demand from COVID-19, galling east coast manufacturers that are paying much more and say producers are unfairly taking advantage.

The Australian Competition and Consumer Commission this week sided with the buyers, saying they were “paying too much” considering the LNG equivalent price is so much lower.

But Mr Gallagher said that prices under long-term contracts needed to be higher to justify the capital intensive and risky business of exploring and developing fields to ensure enough reserves to meet contracts.

“The fact is that spot prices are below the cost of supply and no producer is going to enter long-term gas contracts below their cost of supply,” he told The Australian Financial Review, noting that Santos was investing about $US300 million ($415 million) a year just to maintain production in the Cooper Basin.

“Long-term contracts on the east coast have to be priced to support the annual capital investment programs that develop 2P [proven and probable] reserves.”

The dysfunction of the east coast gas market has been laid bare by claims by gas producers that cheap gas they have offered to local users has not been taken up, while manufacturers still argue they cannot access a choice of competitive supply.

Two of Queensland’s three LNG export ventures are understood to have offered surplus gas into the east coast market, finding buyers for only part of it before sending the rest to the Asian LNG market at rock-bottom prices, below what east coast buyers are paying.

In an apparent contradiction, fertilisers maker Incitec Pivot is seeking tenders for 10 years of gas supply for its Queensland operations, but is struggling to get more than a single offer.

Industry sources say the dislocation in sheer size between the huge LNG operations in Gladstone, in Queensland, compared with the relatively small demand from local manufacturers is part of the problem.

One single cargo of LNG shipped from Curtis Island contains 3.5 to 4 petajoules of gas, enough to supply all NSW’s gas needs for a week. The gas is delivered over two days, with the buyer required to take the full cargo.

In contrast, gas sales to local buyers are for smaller quantities, delivered over months or years, involving more risk and uncertainty on both sides and requiring complex contract terms to be negotiated, oil and gas industry association APPEA notes.

Also important is that industrial gas users need dependable supplies and so lock in term contracts up to 18 months in advance. That leaves them little flexibility to opportunistically buy cheap gas suddenly available on a one-off basis, given limited storage options.

Added to that is the overall lack of liquidity in the east coast market that restricts opportunities for players to manage the risks of changing prices, the small number of gas producers, and global oversupply in gas, which has driven down spot prices both in Asia and on the east coast.

The result is the situation spelt out in the latest ACCC report, where contract price offers to east coast buyers were still in the $8 to $11 a gigajoule range, although more recently sliding towards $7/GJ.

In contrast, spot gas prices were $4/GJ in Victoria on Tuesday, while the ACCC puts the latest “netback” price – the domestic equivalent of a spot LNG price in Asia – at just $2.36/GJ.

Industrial gas buyers are complaining about the price gap, while federal Energy Minister Angus Taylor urged producers to pass on price reductions fairly.

The public demand comes as the federal government considers its next move on LNG export controls in Queensland.

The Morrison government is poised to extend conditions that require Queensland’s gas exporters to make available surplus gas to domestic customers, even as producers argue that’s unwarranted. Some manufacturers, such as Incitec Pivot, are urging the government to do more and intervene to force down prices.

“I suspect the reality is that buyers don’t actually want the gas currently, they just want to use this as leverage for future price negotiations (at which time, in reality, today’s spot prices should be irrelevant),” said MST Marquee analyst Mark Samter.

He said domestic gas buyers would in any case be highly reluctant to lock themselves into contracts priced off the ACCC’s LNG netback price, given that price could surge above $10/GJ within two to three years as global gas markets tighten.

Mr Gallagher agreed: “Tying domestic gas prices to the LNG spot price netback could result in higher gas prices in the future as LNG spot prices increase once demand picks up,” he said.

“Already LNG spot prices are forecast to increase significantly over the months ahead.”

Source: Financial Review