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FEATURE ARTICLE: INTRODUCING THE PRODUCER PRICE INDEXES, DOMESTIC GAS EXTRACTION SERIES
Natural gas is a major fuel source in Australia used widely across the economy for various purposes, from power stations for electricity generation to industrial manufacturing processes to household heating and cooking.
The Australian natural gas industry is separated into three distinct markets, based on location of gas basins and pipeline networks. Each market has different pricing dynamics for the sale of natural gas domestically. The three gas markets are:
Over recent years, the natural gas industry in Eastern Australia has transitioned from mainly producing natural gas for domestic consumption, to increasingly becoming a major exporter of liquefied natural gas (LNG) following the establishment of three LNG export facilities operating in Queensland (AEMC 2015, p. 1). The first facility began exporting in January 2015, with all three facilities fully operational by the end of 2016. The rapid expansion of export capacity in eastern Australia has had downstream effects on domestic supply and prices across the East coast market (ACCC 2017; AEMC 2015).
Western Australia has the largest gas reserves in Australia (AER 2015, p. 90). It supplies natural gas for domestic consumption within the state, but primarily converts natural gas to LNG for export. The first LNG shipment occurred in 1989 from the North West Shelf venture. It is the largest LNG facility in Australia by production capacity. Three subsequent LNG facilities have been opened in WA in the last five years, with a fifth facility nearing completion (DSD 2017).
Northern Territory is currently the smallest market, producing natural gas for export and also for domestic consumption in the Northern Territory. A pipeline project to link the Northern Territory to the East coast market is due for completion in 2018 (AER 2017, p. 66).
Australia is projected to become the world's leading exporter of LNG by 2018 (AER 2017, p. 81; Cassidy & Kosev 2015, p. 35).
The PPI series for domestic gas extraction are output price indexes, measuring the average price change received by producers for natural gas sold on the domestic market only. Prices are measured at basic prices, which exclude taxes and subsidies, transport costs and trade margins.
The new series intend to measure price change of all market transactions. Sampled prices reflect a representative mix of market transactions, with the dominant mechanism in the market for the sale of natural gas currently being medium-to-long term bilateral contracts.
The indexes fulfil the principal purpose of the PPIs to support the compilation of National Accounts through alignment with ABS statistical frameworks for index design and compilation. However, the indexes have some unique classification features that reflect efforts to meet specific external user information requirements for the natural gas extraction industry.
The lowest level of dissemination for output PPIs is usually Class level in the Australian and New Zealand Standard Industrial Classification 2006 (ANZSIC). The domestic gas extraction indexes are disseminated at the lower Input-Output Product Classification (IOPC) level to provide a measure of price change in domestic use natural gas only.
The ABS has produced a further disaggregation of domestic natural gas extraction price change on a geographic basis, with separate indexes to measure price change for the East coast and Western Australian markets. This level of disaggregation reflects the two largest natural gas extraction markets in Australia and will allow users to observe the different price dynamics in each market. The East coast market includes gas extraction in Queensland, Victoria, South Australia and New South Wales.
There is a third gas market in the Northern Territory. The development of a gas pipeline linking the Northern Territory to the East coast market commenced in July 2017. The ABS will continue to monitor if the Northern Territory becomes a significant producer of natural gas for the domestic market, and then include it in the East coast market classification.
The PPI time series begins in the September quarter 2015. Index numbers are calculated on the index reference period 2015-16 = 100.0.
Graph 1 shows that up until the June quarter 2016, prices remained relatively stable. From this point, there is divergence between prices received by producers on the East coast and Western Australia. Approximately 70 per cent of domestic natural gas use is on the East coast (AER 2015, p. 90), so the price rises in that market also drive the overall price increases in the Australia index.
East Coast Market
There are a number of factors that have contributed to the price rises in the domestic gas extraction East coast market. The natural gas market is complex, and the factors are often interconnected and therefore cannot be considered in isolation from each other.
Supply side factors include:
On the demand side, an increase in gas powered electricity generation as a replacement for coal powered electricity generation has contributed to upward pricing pressures (ACCC 2017, p. 32).
In response to the above factors, the domestic natural gas spot prices on the East coast have increased significantly since 2016.
While the increase in spot prices has been larger in recent times, the PPI time series produced by the ABS is designed to measure all market transactions. There is often a lag in the price received by producers through bilateral contracts, with prices updated to reflect spot prices at the stage of contract renewal.
The PPI for domestic gas extraction, Western Australia has observed a decrease in natural gas prices for most of the published series, although there is a slight price rise in each of the last two quarters.
The Western Australia natural gas market has different pricing dynamics, with a number of conditions distinct from the East coast market. Western Australia has a more mature natural gas industry, with long-established LNG export capacity. There are fewer pressures upon supply in Western Australia, as the state produces approximately two-thirds of Australia's total gas, but only requires approximately one-third of its production for domestic use (AER 2015, p. 90). There are large gas reserves under development that will increase natural gas and LNG supply. The State government also has regulated to ensure 15 per cent of natural gas production is reserved for domestic use.
In Western Australia, the price changes in the domestic natural gas market can be explained by the timing of bilateral contract renewals where contracts are influenced by international crude oil prices. The decreasing price trend over the time series reflects bilateral contracts that were indexed at historically high crude oil prices of up to US$110 per barrel being renewed against much lower international prices since late-2014.
Comparison with other ABS Gas Price Indexes
Graph 2 shows the PPI time series compared to the Consumer Price Index (CPI) Gas and other household fuels series, and the Export Price Index (EPI) Gas, natural and manufactured series. The CPI and EPI have been recalculated on the index reference period to 2015-16 = 100.0 for the comparison.
The CPI measures the changes in the price of a basket of goods and services representative of expenditure by households. The basket is grouped into similar items, referred to as expenditure classes. The CPI expenditure class Gas and other household fuels is mainly comprised of natural gas consumption, but also includes bottled gas and less common fuel sources for household heating such as firewood and oil.
In the last two years, the price of gas for households has increased, although the levels of price change are not as significant as for producer prices. The price paid by households for gas reflects the price of gas extraction, but also downstream impacts such as pipeline transmission, wholesale distribution costs and retail margins. The retail gas market for households is also heavily regulated. In recent years, gas prices for households have declined in some states.
The EPI for Gas, natural and manufactured measures changes in the prices of goods exported from Australia. 'Natural' refers to natural gas transformed into LNG for export, and 'manufactured' is primarily liquefied petroleum gas (LPG) produced from crude oil. LNG is the dominant product in this industry. The main destinations for exported LNG from Australia are currently Japan, China and South Korea (Cassidy & Kosev 2015, p. 35).
The quarterly export contract prices for LNG are influenced by the international crude oil prices on a two to four month lag, and this relationship is reflected in the time series. The Western Australia domestic gas extraction PPI time series shows similar price movements over time, but is less volatile as domestic prices are primarily locked into longer-term bilateral contracts. Recent East coast market prices do not hold the same relationship with the international LNG spot price, and these observations are driving the divergence between the PPI and the EPI.
ABS (Australian Bureau of Statistics) 2012, Information Paper: Outcome of the Review of the Producer and International Trade Price Indexes, 2012, cat. no. 6427.0.55.004, ABS, Canberra.
ABS 2013, Australian and New Zealand Standard Industrial Classification (ANZSIC), 2006 (Revision 2.0), cat. no. 1292.0, ABS, Canberra.
ABS 2015, Information Paper: Developments in Producer Price Indexes for Natural Gas, Dec 2015., cat. no. 6427.0.55.008, ABS, Canberra.
ABS 2016, Information Paper: Update on the Development of an Oil and Gas Extraction Producer Price Index, Jun 2016, cat. no. 6427.0.55.009, ABS, Canberra.
AER (Australian Energy Regulator) 2015, State of the Energy Market 2015, ACCC, Melbourne.
AER 2017, State of the Energy Market 2017, ACCC, Melbourne.
ACCC (Australian Competition and Consumer Commission) 2017, Gas Inquiry 2017-2020, Interim Report, September 2017, ACCC, Canberra.
AEMC (Australian Energy Market Commission) 2015, East Coast Wholesale Gas Market and Pipeline Frameworks Review: Stage 1 Final Report, 23 July 2015, AEMC, Sydney.
Cassidy, N & Kosev, M 2015, Australia and the Global LNG Market, RBA, Canberra.
DoEE (Department of the Environment and Energy) 2017, Australian Energy Update 2017, DoEE, Canberra
DSD (Department of State Development, Western Australia) 2017, WA Liquefied Natural Gas Industry Profile March 2017, DSD, Perth.
Lowe, K 2013, Gas Market Scoping Study: A Report for the AEMC, July 2013, AEMC, Sydney.
NASDAQ 2017, Crude Oil Brent [online], available at: http://www.nasdaq.com/markets/crude-oil-brent.aspx [accessed 3 Oct 2017]
Sims. R 2017, Shining A Light: Australia's Gas and Electricity Affordability Problem, 20 September 2017 [transcript], Canberra.
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