By Senior Economist Tom Walker

A new way of trading gas pipeline capacity starts this month – implementing an important part of the AEMC’s gas reform package. The progressive redesign of Australia’s eastern gas markets has been underway since our comprehensive 2016 review.

Since then the COAG Energy Council’s gas market reform group has developed the details of the gas pipeline capacity reform changes recommended by the Commission, and the Australian Energy Market Operator (AEMO) has implemented them.

What’s changed at a glance

From 1 March:

• users of transmission pipelines will be able to trade pipeline capacity on an electronic trading platform operated by AEMO
• users of transmission pipelines will also be able to access certain transmission pipeline capacity that is not going to be used the next day through a daily auction
• transmission capacity contracts will be partially standardised
• there will be a compulsory reporting framework for capacity trades.

These changes are important because being able to effectively trade gas transportation capacity is a crucial element of a well-functioning gas market. They are part of a wider program of regulatory reforms in the process of being implemented which are aimed at improving eastern gas markets.

Making it easier to buy and sell gas in redesigned gas markets will increase competition, lower costs and help support gas-reliant industries, with flow on effects to the economy as a whole. Ultimately, the changes should enable lower prices for gas consumers, and, because gas is an important fuel for electricity generation, lower electricity prices as well.

Context for these gas market reforms

The east coast gas market is an interconnected system that links all of Australia’s eastern and southern states and territories. Since January 2019 it also includes the Northern Territory with the commissioning of the northern gas pipeline linking the territory to Queensland. The development of Queensland’s LNG export industry has transformed the eastern Australian gas markets, tripling east-coast gas demand. By the end of 2018 around 61 per cent of eastern Australian gas production was being exported as LNG. This has had flow-on effects for the level and variability of gas flows and wholesale prices in the domestic market. The electricity market is now more reliant on gas-powered generation following the closure of several coal fired generators this decade, with around 29 per cent of domestic demand for Australian gas being for local power generation.

How these most recent reforms work

The reforms are an interrelated package.

Firstly, the Australian Energy Market Operator will run an electronic trading platform for capacity. Buyers and sellers will be able to go to this exchange and anonymously post bids and offers for standard types of capacity trades, which will be automatically executed if a buyer and seller have both indicated they are willing to trade at a particular price. There will also be a listing service for more unusual types of capacity. This means that buyers and sellers should be able to find each other more easily, and at lower cost.

Secondly, certain capacity that isn’t going to be used by its holder the next day will automatically go into an auction (also run by the Australian Energy Market Operator), and sold to the highest bidder. This means less capacity will be wasted. And because the original holder of the capacity will not receive the revenue from this sale (the pipeline operator will instead), this provides an incentive to sell capacity ahead of time (using the electronic trading platform, for example).

Thirdly, traded capacity contracts will be partially standardised. This will enable trade through the exchange and bilaterally – reducing the cost of entering into a trade because there is no need for buyers to work out all the terms and conditions of a trade on a case-by-case basis. It should also increase the number of potential buyers and sellers of capacity.

Finally, various information relating to trades, including the price of trades (including but not limited to those conducted through the trading platform) and relevant non-standardised terms and conditions that might influence the price, will be published. This should allow buyers and sellers to better understand fair market value and other important information relating to the trade.

Collectively, the Commission expects that this suite of reforms should better enable market participants to trade transportation capacity by:

• using market based processes to allocate capacity on a non-discriminatory basis to those that value it most highly
• improving the incentive on capacity holders to trade capacity that they do not intend to use
• reducing the search and transaction costs associated with capacity trades
• informing buyers and sellers of an appropriate price for capacity
• lowering barriers to entry – enabling  smaller or new market participants to compete on a more equal footing with incumbents.

In turn, improvements to capacity markets should improve the functioning of the gas market itself.

What were the past problems with pipeline capacity markets?

Throughout most of eastern Australia (Victoria is the exception), market participants need to purchase gas and separately purchase pipeline capacity to transport it from wherever it is to wherever it is needed. The reforms that come into effect today address the latter of these – pipeline capacity markets.

Until recently, market fundamentals were more predictable and long-term contracts were relatively effective in allocating transportation capacity between market participants. However, with the changes currently underway in the market – with less predictable and more variable flows of gas – it is increasingly important that transportation capacity is effectively allocated between market participants in a more dynamic manner.

Currently, market participants can trade capacity: those who have more capacity than they want can sell it to other market participants that value the capacity more highly. Unfortunately, it has previously been difficult to readily and seamlessly conduct this trade. In our review of east coast markets we found that:

• prospective buyers and sellers of capacity struggled to find one another
• terms and conditions of the capacity were often bespoke, meaning it would take time and money to work out exactly what was being traded and the terms and conditions of the trade - thereby limiting the pool of potential buyers and sellers and making it difficult to understand what a reasonable price was.
• there was little public information on the prices paid for transportation capacity, again making it difficult to assess the market value of capacity.

These arrangements meant that capacity wasn’t always being used by the party which valued it the most. At worst, it could result in “contractual congestion”: where capacity goes unused even though it is valued, because the capacity is held by a party which doesn’t want to use it, but it hasn’t been able to sell it.

Next steps

The Commission monitors the health of various gas and transportation markets through a review every two years. The next, in 2020, will consider the effectiveness of the reforms implemented this month.