23 Jun 2015

A few days ago, Australia exported its first liquefied natural gas to Egypt.

The shipment is another milestone in the growth of our LNG industry which is transforming Australia into an energy superpower.

It is also a cautionary example of how public policies can have perverse results, with lessons for Australia.

Egypt has been hailed by advocates of domestic gas reservation policies as an example for Australia.

The Egyptian government has diverted gas contracted for export into the domestic market and subsidised local prices.

The results are not what the policymakers intended.

Reservation and subsidies have reduced local gas supply, leading to supply shortfalls. Despite having almost 60 trillion cubic feet of known gas reserves, Egypt now imports gas at global prices.

Development of new reserves has stalled. A Reuters report has found that “exploration companies are not developing untapped finds in Egypt’s gas-rich waters, because the amount the government pays them barely covers their investment costs.”

As the case of Egypt shows, gas reservation is a counterproductive policy.

The usual solution to high prices is expanding supply – reservation policies have the opposite effect. Depressing gas prices discourages investment in developing new gas supplies.

Western Australia is the only state with gas reservation yet it has the country’s highest gas prices.

The state’s independent economic regulator has warned that reservation policies create uncertainty and discourages new investment.

The perverse outcomes of reservation policies are increasingly recognised. Many former advocates of gas reservation now accept that interventionist policies do not deliver a ready supply of competitively priced energy.

If gas reservation is a poor policy at the best of times, it is especially dangerous when decisions are being made on investment in new projects. There are more than twenty countries chasing the next wave of LNG projects needed to meet rising global demand.

Australia has built a solid foundation, in record time, to attract new investment. By 2020, 10 Australian LNG projects will be producing more than 85 million tonnes a year of LNG. The scale of the investment in each project dwarfs the Snowy Mountains scheme. Together, they have built a world-leading industry for the nation.

Australia now has the infrastructure and skilled workers to attract even more investment and jobs in domestic and export gas sectors.

Our undeveloped gas reserves are sufficient to support growth in local consumption and exports.

With world-leading innovation, such as floating LNG production, Australia is finding ways to tap hitherto uncommercial reserves.

Oxford University’s Institute of Energy Studies reported last year that, with the right business and regulatory environment, Australia’s LNG industry is well placed to capture its share of the growth in global demand.

The return to the community from developing our natural resources is huge. It has been estimated that one of the LNG projects now being developed will provide up to $90 billion in government revenues over its 20-year working life.

So how do we capture the opportunities ahead?

Companies are focusing on reducing their costs, finding opportunities for collaboration and investing in technologies to deliver more efficient operations. The sharp fall in international gas prices has seen businesses redouble their focus on being internationally competitive.

At the same time, the industry is devoting more of its time and energy to engaging with the broader community. No industry takes more seriously its social and environmental obligations.

Governments can also help. In some cases, such as the gas reservation debate, governments should simply respect the role of efficient markets. In other cases, governments can act to improve our prospects.

Poorly designed policies and regulation have the potential to make Australia an uncompetitive destination for investment.

Regulations that add unnecessary costs to exploration, construction of infrastructure and plant operation pose a cumulative risk to our competitiveness.

Prescriptive rules, vague and shifting regulatory objectives, and duplication between agencies and jurisdictions are recurring problems for Australian businesses generally and the oil and gas sector in particular. Governments often respond to problems, real or perceived, with new layers of regulation.

Governments always recognise – in principle – the need for minimum effective regulation which achieves regulatory goals at least cost.

But good intentions must be followed by effective action. Best practice regulation reduces the social cost of regulation, to the benefit of the community as a whole.

The priorities for reform should be to eliminate duplication, create consistent, outcomes-focused regulation, and conduct regular, independent reviews of major regulations.

The encouraging news is the commitment being shown by the Commonwealth and some State governments to tackle some of these problems. Creating a single national agency to regulate offshore operations, for example, was a major reform.

The gas industry is a major contributor to our national prosperity.

With global demand rising, the industry has the potential to contribute more investment, jobs and innovation to strengthen our economy. It is an exciting possibility well within our grasp.

This blog post was first published as an opinion piece in The Australian Financial Review on 24 June.