April 17, 2014

The US and Australia are blessed with an abundant supply of natural gas – more than what is needed to fuel their respective domestic economies. Discovery and development of natural gas continues to be the engine of economic growth in Australia, just as it is in the US.

Manufacturing and petrochemical companies love natural gas. Why wouldn’t they? As a power source, it’s affordable, abundant and much cleaner than coal. As a petrochemical feedstock, it’s a required component of production.

In Australia, we are also familiar with the achievement of the US in reducing greenhouse gas emissions to their lowest levels since 1994 – largely through a shift from coal to natural gas for power generation.

Yet some manufacturers, like Incitec Pivot, continue to blame gas producers for their competitive woes in Australia. Now it seems they are intent on opening up a new front of debate – in the United States. It might seem like an Australian company pursuing business opportunities in the US would be pulling your leg if it argued that the US should not pursue business opportunities offshore. But that is exactly what they are doing when it comes to gas.

Incitec Pivot makes claims of extraordinary jobs losses and an untenable pricing structure in Australia because the Australian oil and gas industry (foreign owned and Australian companies), is exporting LNG to Asia.

The real story is that the Australian economy is benefiting from an extraordinary growth phase in development of its natural gas resources. Over $200 billion – much of it from US oil and gas companies – is being invested in that development. In recent years, in an economy about one-tenth the size of the US economy, this has amounted to as much as a third of all private sector investment. As a result, oil and gas will grow from 2.1% GDP to 3.5% GDP by 2020 just from current projects under construction – a huge contribution from one sector of the economy.

Australia’s gas supply industry is focused on both domestic and export markets. Manufacturers are among its most important customers. Producers therefore have a stake in the sector’s success.

But despite claims to the contrary, energy costs are not the nemesis of manufacturing in Australia. Structural adjustments within the global and Australian economies have had a concentrated impact on Australian manufacturing due to the sector’s trade exposure, small scale, relatively high costs, and the recent strength of the Australian dollar.

Yes, gas prices are rising in Australia’s eastern states – reflecting increased costs of supply as low cost deposits become increasingly depleted and production shifts to higher cost reserves but also in response to the export driven economic incentive for the massive development that has taken place. The size of the eastern Australian gas market is tripling in a little over two years – driven by export opportunities not domestic demand which is essentially flat. Development on this scale has provided the incentive for further investments in traditional (declining) domestic supply sources such as the Cooper Basin. While prices may be rising from historic lows, contrary to Incitec Pivot’s claims, they are heading to middle of the pack by world standards.

Therefore, a policy driven by the self-interest of gas buyers such as Incitec Pivot – that would manipulate the domestic gas market to deliver below-market gas prices – will not alleviate the many challenges facing Australian manufacturers. But it will drive away investment in the gas market and hurt the wider economy.

Incitec claims that in Australia 100,000 manufacturing jobs would be lost as a result of gas exports yet they fail to disclose the flawed basis of these projections – based on assumptions, for example, that anyone who loses a job in manufacturing will be permanently unemployed. The reality is that resources and people will move from declining sectors to thriving ones. The current wave of Australian LNG developments alone has generated in excess of 100,000 jobs across the economy, and by 2025, building and operating these projects will have added more than $260 billion to Australia’s GDP1. The benefits will last well beyond the current project construction phase through the 30-plus year operational phase.

Locally, the manufacturing sector has asserted its superior value-adding qualities – similar to the pricing uplift benefit claimed by Incitec Pivot in relation to its fertiliser products. But essentially what these arguments do is treat downstream processing as synonymous with increasing value added. Once costs of materials and services are taken into account, the “value-added” from downstream processing may be small or even negative.

In fact, Australia adds significant value to its gas resources by converting to LNG for export. According to the Australian Bureau of Statistics, the highest value adding ratio in the Australian economy is actually in the oil and gas sector (0.7).

The average value –added ratio for Australian manufacturing, by comparison is 0.29. As the sum of the value added of all firms in all sectors makes up Australia’s gross domestic product (GDP), this has clear implications for policy-makers. Australia gets higher net economic benefits for each unit of effort in the oil and gas sector.

What that means for us in Australia is that government policies that support and do not inhibit a viable oil and gas sector, create the most net economic benefit across the Australian economy.

Curtailing LNG exports via the kind of “preferential pricing” policies that Incitec Pivot advocates locally are protectionist and bad for the economy as a whole. They act as a tax on domestic gas production and a subsidy on domestic consumption.

Like all taxes and subsidies, restricting the free trade of gas distorts economic decisions and generates an unequivocal economic loss – one which compounds over time as future investment decisions are affected. It would be like the natural gas industry calling for cheaper prices for domestic steel to build pipelines – a proposition as unacceptable to government as it should be to any company that benefits from free markets and international trade.

And contrary to Incitec-Pivot’s assertions, Australia does in fact have a rational energy policy. That policy is based on allowing gas prices to be determined by demand and supply forces and negotiations between willing buyers and willing sellers. Only then do you extract the maximum value for natural gas resources to the benefit of the whole Australian economy.

The Australian gas industry is already delivering great benefits to Australians and is capable of doing much more. It offers a product wanted by both domestic and international customers, particularly in Asia.

In a country where available gas resources are far greater than local market needs, the international LNG market provides the opportunity to match Australia’s need for secure energy demand with the world’s need for secure energy supply. And it is proving to be a boost to the economy that is vital and enduring.

[1] Deloitte Access Economics: Advancing Australia, June 2012