Gas Reservation In Australia Is Counterproductive

[hr]Written By Damian Dwyer[hr]

Australia has vast gas reserves and resources. But relatively few Australians understand the remarkable economic opportunity offered by the country’s gasfields.

The development and expansion of Australia’s liquefied natural gas industry presents an unprecedented opportunity for national income growth. Committed investment in new Australian LNG projects stands at more than $190 billion.

The new projects scheduled to come into production in the next few years will transform this country into the world’s largest gas exporter by 2017 and could generate $53 billion in export earnings between 2013 and 2017.

One of the drivers behind the expansion of Australian LNG is the development of the east coast gas export industry. Exporting gas from eastern Australia will deliver substantial and widespread economic benefits. The gas industry’s economic linkages are not only broader and deeper than commonly appreciated, but its operations also have wider, welfare-enhancing economic spill-overs.

Regions of Queensland — such as Gladstone, Toowoomba and the Western Downs — are already experiencing employment and income growth thanks to onshore gas developments driven by the LNG sector.

While this is happening, the Australian gas market, particularly on the east coast, is going through a period of transition. Several factors — including changing cost structures, demand and supply interactions, and restrictions on the gas industry’s ability to access resources — have changed market dynamics facing both producers and customers.

These changes are affecting local industries that use gas in their production processes. This has led to calls for some gas production to be reserved for local use, at prices below those prevailing in the export market, or for other forms of market intervention.

Such calls have seen the establishment of a domestic gas reservation in Western Australia. While the impact of the WA scheme is still unfolding, experience from that State and from similar interventions overseas indicates that such policies have unintended adverse economic consequences.

In effect, domestic gas reservation simultaneously places a tax on domestic gas production and a subsidy on domestic gas consumption. Like all taxes and subsidies, it distorts economic decisions and generates an unequivocal economic loss – one that compounds over time as future investment decisions are affected.

— The economic impacts of a domestic gas reservation — shows that introducing a domestic gas reservation in eastern Australia would come at a significant cost to the nation’s economic welfare.

The report’s lead author, Deloitte Access Economics partner, Professor Ian Harper, found that introducing a domestic gas reservation in the eastern states would cost the Australian economy substantially. The amount would build over time and by 2025 would reach $6 billion a year in foregone GDP at 2025.

Go for growth without reservation

In recent decades, successive Australian governments have recognised the benefits of freer markets and freer trade. Their steady removal of market distortions has delivered significant economic benefits to the nation.

A domestic gas reservation would only serve to reverse these gains, according to Professor Harper.

“The implicit tax a reservation policy would impose on local gas producers would discourage investment in developing otherwise profitable gas deposits. This would perversely reduce supply for both domestic use and export,” Professor Harper said.

“The implicit subsidy to domestic gas users, on the other hand, would encourage inefficient use of gas where other energy sources would be more efficient.”

Using such a policy to interfere in the operation of the market comes at significant cost to the economy.

Many of the arguments for a domestic reservation scheme are based on inappropriate use of input-output modelling that fails to account for the opportunity cost of the inputs used in domestic production. A loss of economic value — or opportunity cost — occurs when gas is used in ways that generate less economic value than would be delivered by allowing the market to determine the use of that gas. This is a net loss of economic welfare to all Australians.

The Deloitte Access Economics report finds that when the flow-on effects are analysed comprehensively — in an economy-wide, general-equilibrium context — the economic losses are unequivocal. Every 1 per cent of future gas exports artificially re-directed towards the domestic market reduces GDP by an estimated $150 million per year.

Bad idea, bad timing

Australia’s economic growth and government revenue growth are faltering. Questions are being raised over what industries will drive the next phases of Australia’s economic development. This is a particularly bad time to further weaken the market-based policy framework that has underpinned our prosperity over the last two decades.

It is difficult to mount a compelling economic case for providing support to Australia’s manufacturing sector under any circumstances, let alone when this support comes at the direct expense of export income in other sectors.

The best way to enhance local gas supply is to use market-based energy policies to provide incentives for gas exploration and production. Laws that dictate where and how gas can be sold invariably deter the very investment needed to develop untapped gas reserves. And diverting resources from their highest and best use seldom — if ever — enhances prosperity.