Rising gas prices in Eastern Australia – An opportunity for gas resale?

By HWL Ebsworth special counsel Franklin Morean and partner Andrew Bruton

With LNG exports from Queensland commencing in 2014, the Eastern Australia domestic gas market is undergoing a transformation driven by the market forces resulting from the flow-through of LNG export prices prevalent in the Asian region to the domestic market.

As reported in the media, long-term gas supply agreements (GSAs) – which have traditionally been negotiated by gas producers and domestic buyers to satisfy the domestic demand – have become virtually non-existent, given much of the gas produced from new and existing upstream developments will feed multiple planned LNG trains on Curtis Island at Gladstone in Queensland.

According to the Study on the Domestic Gas Market commissioned by the Commonwealth Department of Industry (Department of Industry) and the Bureau of Resources and Energy Economics (BREE) the “cost of gas supply has increased from $3-4/GJ a few years back and now sits between $4.4-5.6/GJ in the Bowen-Surat basins and $4.5/GJ from the Gippsland and Otway basins and $6/GJ from the Cooper-Eromanga basins”.

Market reforms

Market reforms have been undertaken including the creation of the Wallumbilla gas supply hub, the National Gas Market Bulletin Board and the Short Term Trading Markets in Queensland, New South Wales and South Australia to address the issues in connection with transparency. However, it remains to be seen whether those markets are likely to become, over time, sufficiently liquid to increase the displacement of bilateral supply arrangements.

Most recently, the Commonwealth Department of Industry and BREE released the Eastern Australian Domestic Gas Market Study, which outlined a series of policy options for further analysis by the regulators.

Despite any additional market reforms, it is certain gas currently destined for domestic consumption in Eastern Australian is competing with LNG exports and, therefore, further (and potentially significant) gas price increases are likely, based upon modelling under the IES Advisory’s study on the domestic gas market.

Resale of gas delivered under long term GSAs

This spike in gas prices has created opportunities for gas buyers with existing GSAs (and with the ability to switch to cheaper energy alternatives such as coal, for power generation or industrial purposes) to resell the gas and profit from the margin between their (lower) contracted gas prices and the current higher prices in secondary markets. Benefits from the current conditions may only be short-lived having regard to the actual term of relevant gas supply arrangement.

We have recently seen how Stanwell Corporation Limited has announced its decision to mothball its 385W Swanbank E Power Station and on-sell the gas feeding that power plant instead of using it for power generation, thereby taking advantage of the surge in gas prices.

Issues associated with the resale of gas

Buyers under GSAs may find it attractive to resell gas for a profit. Resellers should, however, carefully consider their obligations under their existing GSAs and negotiate the gas in secondary markets with such terms and conditions that, at a minimum, mirror the reseller’s obligation under their GSAs (except, obviously, for the price).

Particular attention should be given to:

1 Delivery point: Gas delivery should be made at the delivery point originally set out in the GSA so gas title and risk has passed to the reseller.

2 Nominations: Gas resale arrangements should contain provisions, which enable the reseller to receive nominations from the buyers matching the nominations periods set out in the GSAs. Forecasts represent a particular problem in some GSAs, as although they are non-binding, some provisions require the parties to provide such forecasts in good faith. It will be interesting to determine the extent of such good faith obligations when the forecasts are based on third party’s forecasts of consumption and how a gas producer could claim that a party is in breach of such a good faith obligation.

3 Take-or-pay and make-up gas: As reseller will be obliged to take-or-pay for quantities of gas not taken, gas resale arrangements should replicate the take-or-pay obligations for the resale quantities to gas buyers. Resellers should also consider including mechanism to use make-up gas matching with their rights under the GSAs.

4 Force majeure: This clause may be troublesome for resellers as an event of force majeure is always referred to as a circumstance beyond the reasonable control of a party to the GSA. As a buyer of the resale gas is not a party to such agreement it therefore may not be possible for a reseller to declare a force majeure event that affects its buyer. In short, there may be limitations on the force majeure provisions in the resale gas arrangements, which may not be attractive for potential buyers.

Where the on-supplier intends to sell gas to multiple buyers, more complex arrangements would need to be put in place to account for different gas volumes and terms. Resellers should also be careful that no restriction to on-sell gas exists in the gas supply agreement so as to avoid any potential breach of agreement.

Secondary markets

A reseller may also consider trading the gas in the short term trading market or the Wallumbilla gas hub. As discussed earlier, the opportunities to trade the gas in secondary markets will depend on the volume of those markets and the actual participation of buyers and suppliers. Resellers should be cautious, as provisions in some GSAs’ may not allow the flexibility required to trade the gas in this manner.

Effect on gas producers

Depending on the specific provisions of a relevant GSA, gas producers may not have the ability to prevent upside profits from being made by gas resellers. Gas producers may need to consider the following issues:

1 Price review mechanism: Depending on the availability for gas price reviews, the gas producer may use this mechanism to obtain a price increase on the GSA and participate in the upside price benefits obtained by the reseller.

2 Breach of material obligations by buyer: Gas producers may monitor a resellers’ compliance with obligations under GSAs by monitoring nominations and forecasts and force majeure notifications.

Although the current market conditions may provide some attractiveness for the resale of gas delivered under existing long term GSAs, in practice, the resale arrangements may attract some complexities derived from the current structure of certain GSAs, which may not have been envisaged for the resale of gas in the wholesale market.