Is energy just like pumpkins? In this report the Executive Director of the Australian Petroleum Production and Exploration Association, Barry Jones, who will address the AIE National Conference on the theme Liquid Hydrocarbon Production — Where to? looks at what Australia needs in a national energy policy. And he says why COAG’s efforts to develop an energy policy have missed the mark.

Ronald Reagan once famously, and rhetorically, asked: “We don’t have a policy for pumpkins.  Why do we need one for energy?”

More recently, George W. Bush’s succinct summary of his far-reaching energy policy was that “it addresses all three key aspects of the energy equation: demand, supply and the means to match them”.

Who was right? What is energy policy? What should an energy policy consist of?

On one view, there is no such thing as energy policy. It is tax policy, competition policy, environment policy, native affairs policy and so on. Energy is just another service or commodity.  It’s just like pumpkins.

On another hand, the sum of these policies, their interaction to influence energy supply and demand and the consequences of this interaction for the nation is critical.
 
• Energy is the basic underpinning of our international trade competitiveness. It is a key element in our export income. It is a major factor in budget revenues. It underpins regional development.

• Equally, energy is a key factor in our social mobility. It underpins our recreation. It is central to the comfort of our habitat and our sustenance. It is a key to safe medicine. It is vital to tourism. It underpins resource processing and manufacturing. Without reliable energy supplies we have no IT industry and suspect communications.

It is therefore vital that a country such as Australia has a coordinated strategic energy policy.

And therein lies a fundamental problem for governments —and everyone else. The various component parts of energy policy are compartmentalised. Tax is a matter for the Treasury and the Tax Office. Environmental approvals are the sole domain of the environment department. Dealing with native title is the responsibility of the aboriginal affairs department. Any residual that might generically be called energy is left for the energy department.

And all this comes into play before we consider the small complications that arise because of the different roles of the Commonwealth and the various State/Territory jurisdictions. Who said we were one nation?
Australia has had major energy policy statements in the past—but they have always emanated from the energy minister and the energy bureaucracy. They all suffered from compartmentalisation—the things the energy bureaucrats weren’t allowed to touch.  Treasury would say ‘no’ to changing tax, the States ‘no’ to addressing State issues and so on through the rest of the vested interest bureaucratic groups.

So it was with degree of surprise and expectation that energy enthusiasts read the 8 June announcement by the Council of Australian Governments (COAG) that would present a coordinated, strategic long-term energy policy that broke through all these compartments.

Yes, there were cynics who said this apparently dramatic step had only come about because politicians recognise two things:

 • the electorate won’t stand rising energy prices; and

• the electorate won’t stand having supplies of energy interrupted—hot beer and cold pies at the cricket and melting ice cream and bad strawberries at the tennis are not on.

These cynics said the previous COAG meeting started the energy policy process merely because it wanted to defuse high petrol prices as a political issue. They went on to argue that now petrol prices had dropped the real driver was the concern of Victoria and South Australia that their electricity systems might collapse, coupled with the paranoia of a couple of governments that the Commonwealth was really on about forcing them to sell their electricity utilities.

But for some hope ruled eternal that this time it could be different. After all, here we had the Prime Minister and the Premiers taking charge.  And it was bipartisan—a conservative Federal Government and five Labor State Governments were acting in concert.  Surely we would break through the compartments and the inter-jurisdictional jealousies?

Then, reality dawned.  Expectation was replaced by depression.  Disappointment gradually set in.

The COAG announcement

Of course, there were some positives as one started reading the COAG communiqué. The announcement clearly recognised the importance of energy to Australia. In addition it:

• set a goal of ensuring a reliable and competitively priced supply of energy for the Australian economy;

• noted that Australia would be reliant on fossil fuels for its energy supply for the foreseeable future and that energy underpinned Australia’s international competitiveness;
• recognised that energy cost was critical to international trade competitiveness; and

• recognised that in the future gas would need to play a greater role in the Australian energy mix.

These were all welcome developments. On the other hand, the announcement had a number of significant deficiencies. It:

• failed to address many of the issues about the need to avoid an over-reliance on imported supplies of liquid fuels;

• did not address the links between the upstream and the downstream sectors, particularly in relation to ensuring a greater role for gas in energy supply;

 • gave scant attention to what needs to be done to increase energy exports; and

• it did not grapple with the problem that any rational greenhouse policy probably meant raising energy prices—3 cents a litre to 6 cents a litre for petrol—a 25 per cent increase for retail electricity prices—an 8 per cent to 11 per cent increase for domestic natural gas prices.

It was possible there might be some positives in COAG’s establishment of the Ministerial Council on Energy and the strategic review of medium-to longer-term energy market directions. But closer examination of the communique and subsequent actions suggests that they have been set up in a way that is deeply flawed as far as advancing a comprehensive energy policy is concerned.

The Energy Ministerial Council is one of two ministerial councils, the other being the Ministerial Council on Mineral (and maybe Petroleum) Resources—even the name is not yet finalised. The precise responsibilities of the two councils have not yet been made public, but will have serious implications for dealing with the issues of oil and gas supply.

Maybe the Mineral Resources Council will deal with exploration and title issues and presumably the mess that is environmental, native title and cultural heritage approvals processes. Maybe it will also deal with production taxes, including the petroleum resource rent tax regime.

And what about the effective life of assets being reviewed by the Tax Office, which has the potential to set back the whole gas production and transmission industry?

So there might be one ministerial council responsible for the downstream energy market and another responsible for many of the issues determining the primary energy supply to that market. And nobody has been able to explain how these two councils will interface.
This not only perpetuates, but even extends the compartmentalisation of issues. It gives no confidence that a holistic energy policy will result and that important issues will not fall between the cracks because they are someone else’s responsibility.

The terms of reference for the strategic review of energy market directions—or at least the way they are being interpreted—also give grave cause for concern. There is no explicit recognition of the policy issues central to finding and producing more oil and gas.

Liquid fuel supplies, upstream oil and gas issues, exports and tax don’t even rate a direct mention. The assumption seems to be that the supply will be there. Let’s not forget that markets are about demand and supply, and matching the two.

What does the upstream oil and gas industry want from an energy policy? Energy policy should set the national strategic framework within which the oil and gas and other energy industries operate. The objectives of national energy policy should be to ensure:

• a commercially viable, indigenous energy sector based as far as possible on the effective utilisation of Australia’s energy resources and expertise; and

 • the service of community needs through the provision of a reliable supply of   energy, produced at internationally competitive prices and under world’s    best practice safety and environmental management regimes.

As part of this, it is essential for energy policy to address:

 • the projected decline in Australia’s domestically produced supplies of crude    oil and condensate;

 • the need to ensure that gas plays a greater role in the fuel mix, and that the    gas required can be found, produced and delivered; and

• the fiscal and other issues impacting on the competitiveness of Australia’s current and potential gas exports.

In other words, a critical component of energy policy must be about finding more oil and using more gas—
balancing supply and demand to provide a reliable supply at competitive prices.

Liquid fuel supplies

The Government’s own estimates of future production of oil and condensate indicate that without further exploration activity, production rates will decline 30 per cent by 2005 and 50 per cent by 2010. (Figure 1.) And this is against the background that some time between 2020 and 2050, total world supply is likely to decline.

If governments don’t do something about it, Australia will be importing much of its oil in the future. The geopolitical developments of the past weeks have highlighted the fact that a liquid fuel supply strategy based on imports is highly questionable, at the very least from a national security viewpoint.

Australia is also a signatory to the International Energy Program of the IEA which places on us the obligation to maintain a level of liquid fuel stocks equal to 90 days of net oil imports to ensure mutual security of supply in an international supply emergency.

Our high level of self-sufficiency insulates us from this requirement at present but, if we import more, someone will have to pay the direct and additional high cost of significantly increasing stocks to meet our treaty obligations. And military stocks don’t count towards this obligation.

And of course there are the balance of payments and government revenue implications. What needs to be done? Australia needs to:

•  facilitate enhanced levels of exploration for oil, particularly in under-explored and frontier areas;

 • enhance oil recovery from existing fields;

•  facilitate the development of competitively priced alternative sources of liquid fuels; and

•  promote demand management (although this is not an area where producers have a direct involvement).

What are some of the specific requirements?

There must be a firm long-term commitment to adequate funding of pre-competitive research in Australia, be it in bodies like the Australian Geological Survey Organisation, State geological surveys, CSIRO or our universities.
 
There is a looming education and training problem facing the industry and the nation because fewer and fewer students are choosing geoscience-related courses at university and other tertiary institutions. Whether this is a funding problem or whether it is a problem of perceptions, it needs to be addressed if the supply of talent needed for the future of the industry is to be assured.

Governments need to talk to the industry and develop more efficient, timely, transparent and coordinated approvals processes relating to exploration acreage releases, the environment, native title and cultural heritage. To highlight the depth of this problem, let me give two examples:

• Delays in issuing exploration permits because of unresolved native title issues range from two to five years and still counting. In one State, no new exploration permits in areas subject to native title have been issued for five years and no exploration has been done in those areas in that time.
Some 70 permit applications are outstanding and the State government   hasn’t had a clue how to deal with them.

• Quite apart from the obvious direct costs and opportunity costs of such delays, they are having an even more deleterious impact. Recently, smaller onshore explorers in all States and the Northern Territory were surveyed to assess the impact of native title and environment approval processes on their activities. Of those surveyed, a staggering 25 per cent reported that native title processes and delays were the dominant factor in their having already decided to shift their future investment to other countries (and in two cases also to offshore Australia).

The tax system needs to aid in reducing the risks for exploration in remote and frontier areas (which is in many cases more akin to R&D) as well as overcome the inability of small-and medium-sized explorers to utilise the deductibility of exploration costs.

There needs to be an announcement of effective lives of assets for depreciation purposes under company tax which will ensure that Australia is an attractive place to invest in petroleum extraction.

And there needs to be a strategy for alternative liquid fuels development, especially for transport. As well as making more use of natural gas, which I will talk about shortly, Australia should be making more use of the alternatives already available—LPG and the 20 billion barrels of shale oil sitting in the ground.

Using more gas

The commitment to using more gas is the most promising element of the COAG policy.  It will use more of an abundant resource and bring environmental benefits. But there is no evidence that governments understand how to address the supply side of the equation.  There is a risk that the independent review of energy market directions will focus narrowly on the demand side of the equation.

In saying that, I don’t want to underestimate the importance of the downstream reforms that have taken place. The decisions that governments have made on privatisation, competition policy, contestability of markets and pipeline access have been critical.
These downstream market reforms and removal of barriers to gas market development provided an incentive for the gas market to develop in response to market forces without government mandating the outcome. Of course, increased diversity of supply, contract lives and market opportunities also played a role.

And a competition policy drive to the lowest possible prices in the short term is not necessarily a good outcome in the long term.  Australian gas prices are among the lowest in the world. What are needed are economic gas prices that will ensure a long-term sustainable and reliable supply at competitive prices.
The bulk of Australia’s gas resources tend to be remote from the market —the substantial resources of Gippsland and the Otway Basin notwithstanding. A vision for the greater use of that gas includes the ability to find and produce it economically, to export more LNG, to build gas-to-liquids (GTL), methanol and petrochemicals plants and to construct the pipelines needed to deliver gas to distant markets. (Figure 2.)

How will that vision be realised?

Finding more gas would help—again, requiring support for pre-competitive research, and sorting out the approvals mess. Then it has to be developed and produced —again, requiring a fiscal regime conducive to attracting the capital needed for such huge investments. And it has to be delivered to markets—again, more fiscal certainty needed.

There needs to be an immediate movement to fiscal arrangements that ensure tax is not a distorting factor
in investment decision making processes. This must include addressing the PRRT parameters for natural gas projects. In particular, the carry forward rate for undeducted general project costs, which is currently set at the long-term bond rate plus five percentage points, is insufficient to respond to the project hurdle rates applied by project developers.

As a matter of high priority, the company tax write-off periods for plant and equipment used in gas production (including platforms), onshore processing (including for LNG) and pipelines should be made certain.
 
The present Australian Taxation Office review of effective lives of assets is creating tremendous investment uncertainty. As an absolute minimum, the Government needs to give a commitment that there will not be an increase in the write-off periods that currently apply.

There needs to be a research and development strategy for GTL, methanol from gas and related technologies to ensure that these promising developments do not bypass Australia. This strategy needs to resolve the fiscal disincentives for such high risk, capital intensive projects in a world where quite a few gas-rich countries are competing for this investment.

The problem for Australia is that the first players in the game may secure for themselves an unassailable long-term advantage, cutting out the possibility of future Australian  participation.

Many of the same issues that apply to the supply of gas into the domestic market also apply to exports, doubly so given the huge capital investments required for LNG plants.  Yet the industry can get no guarantee that the COAG review will examine exports. Quite apart from the importance of LNG exports for the national economy in their own right, they are integrally tied to the domestic gas supply.

A significant export market will provide economies of scale and defray infrastructure costs, without which some gas projects may not go ahead for domestic supply alone.

Where to Now?

COAG has raised the prospect of a bipartisan national energy policy. Will it be a mirage and fall victim to the compartmentalisation of the past?

What Australia needs is for governments to start with a vision of our energy future and then ask what policies are needed to get us there.  To be setting up boundaries between ministerial councils and around independent inquiries as to the issues they might or might not be allowed to consider does not seem like a profitable way forward.

Ignoring links between primary energy production and the end user is not constructive.  Failing to consider innovation and technological change suggest we go nowhere. Ignoring the impacts on consumers invites disaster.

We need governments that will look seriously at all the issues impacting on energy supply and demand and how to balance the two. Then we can optimise the domestically produced supply of crude oil and condensate rather than become totally dependent on imports.

We can ensure that supplies of gas can be delivered to expand the role of gas in the energy market. We can achieve technological change and demand side management We can enhance national prosperity through expanded gas-related exports.
 
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