Helping you make sense of the Australian energy sector.


Correlation does not imply causation: the story of GPG demand

“Gone are the days of $4/GJ gas”. This is a phrase that many following the Australian energy markets have heard numerous times and believed to be true since the advent of the Liquified Natural Gas (LNG) industry in Queensland. For years, this phrase held true with the gas spot price in Victoria (a key producing region south of Queensland) averaging well above $8/GJ between 2016 and 2019. However, the linkage with the international LNG market, which has largely been responsible for this bullish trend, is now also a key driver for the softening in spot prices seen in recent months.

As shown in figure 1, Victorian gas prices for the current financial year has seen a 43% drop in their monthly average between July last year and May 2020. This trend is not too surprising given oil-linked Asian LNG prices – which can be seen as a sort of upper bound for gas prices through netback pricing – have also been quite bearish. Gas demand in Australia also peaks over winter months (June to August) when the fuel is used for heating. What is rather interesting however, is the (lack of) correlation between these low gas prices and gas demand for electricity generation (GPG) (see figure 1). In this Chart of the Week, we provide commentary and insights into underlying market drivers behind this outcome, and factors that may well change this trend in the near future.

In the current financial year, GPG demand in Victoria peaked last August with our estimates showing a total of ~3.9PJ consumed to generate electricity at an average spot price of $8.4/GJ. Fast forward to April 2020, GPG demand across the eight gas-powered stations in the state has dropped by 83% from the August peak to ~0.7PJ even with the spot price averaging $4.5/GJ. For the same month last year, GPG demand was 4.6PJ with an average price of $9.8/GJ. What are the drivers behind these trends and what does this mean for the role of gas as a transition fuel?

Firstly, whilst spot gas is a good indication of general market economics, it is mostly employed to balance the market with most (take-or-pay) volumes traded on pre-agreed multi-year contract prices north of current prices seen in the spot market.

Secondly, given GPGs are largely peaking assets in the NEM, their dispatch depends on where they fall in the bid stack with other technologies. As discussed in Issue 31, GPG in Victoria is being increasingly displaced by coal and renewables (predominantly wind) especially across the evening peaks when they are typically expected to run (and in some cases set the price). This has also consequently resulted in lower electricity prices with April power prices in Victoria averaging $34/MWh; well below the expected short-run marginal cost of most gas units.

It is hard to say exactly how long this rather interesting trend will last. However, if current global demand/supply dynamics in the oil market continue into domestic gas contract renegotiation periods, we may well see a trending up in GPG demand. This of course, depends on the market situation in the NEM with coal availability (maintenance and outages), weather, and portfolio movements all playing a role in determining how truly viable gas is as a transition fuel in the NEM. For now, the days of $4/GJ gas are back, but for how long?

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