Australia's Capital Challenge and the Role of Gas

On 13 December 2011 the Federal Government released the Draft Energy White Paper – Strengthening the Foundations for Australia's Energy Future (Draft White Paper).

The Draft White Paper attempts the herculean task of setting the framework for enhancing Australia's domestic and export growth potential in, as the above extract indicates, this most vital of industries.

This article addresses only two of the many inter-related aspects of the energy supply chain developments that need to occur for that goal to be realised:

• the emphasis on retaining and attracting domestic and foreign capital
• the increasingly important role of gas in Australia's energy mix and the need to improve the upstream regulatory environment in order to expand gas exploration and production.

There are of course many other aspects which are addressed by the Draft White Paper outside the scope of this article.

Capital markets

The Draft White Paper recognises that the capital requirements to enhance Australia's energy resource base will mean that our debt and equity markets will be tested like never before.

The Draft White Paper notes the following key drivers for such capital requirements:

• size – the level of investment required in our energy supply sectors is huge and reflects the scale of transformation that is required. By way of example, the Draft White Paper notes that only around A$12 billion has been invested in new electricity generation since 1998 compared to approximately A$80 billion that will be required over the next two decades. By contrast since 2007 $140 billion capital expenditure has been committed on major new LNG exports which will put Australia on a par with Qatar as one of the world's largest LNG exporters. Additional investment needs in the broader electricity and gas sectors could exceed A$240 billion by 2030
• foreign – given the relatively small domestic capital base, much of this capital will need to be sourced from overseas
• equity – the fact that debt markets are also, at least in the short term, experiencing volatility, uncertainty and a lower risk appetite means that foreign equity investment must take an increasing share of these capital requirements.

The Draft White Paper stresses that the competitive nature of foreign capital means Australia must maintain attractive and stable investment and policy frameworks to ensure the energy markets provide the opportunity for sufficient commercial returns.

While short on detail, the Draft White Paper notes a range of broad policy implications of these drivers including:

• privatisation – of government-owned energy infrastructure on the basis that continued government ownership of energy businesses impedes greater competition and efficiency and reduces market confidence by creating uncertainty and risk for private sector investor
• deregulation – of retail energy prices where effective competition exists. This will support an appropriate return on equity investment. With the introduction of carbon pricing legislation, the Draft White Paper notes there is an opportunity for "no further market-distorting non- complementary interventions" such as state-based feed-in tariffs. In this context, the Commonwealth Government has also announced it will no longer proceed with emission standards or carbon capture and storage requirements for new coal fired power stations.
• regulatory reform – of upstream gas markets and in particular:
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  • those elements within the Commonwealth Government's immediate influence (ie offshore gas exploration and production)
  • those aspects which are currently politically sensitive (coal seam gas exploration and production).

These aspects are explored in greater detail below.

There are of course many other broader, non-energy market specific policy implications of such investment requirements which will need to be explored but which are outside the scope of the Draft White Paper. These include improving transparency in foreign investment regulation and reform of fundraising laws (although recent initiatives in promoting the corporate debt market are welcome).

The importance of gas

The Draft White Paper notes that "gas is expected to experience a golden age with growth increasing by 50% over the period to 2035 and equalling global demand for coal." This projected growth is attributed to its attractiveness in terms of lower prices and environmental benefits relative to some other non-renewable energy sources. It means that gas will increasingly replace liquid fuels in domestic and international electricity generation, transportation and fuel or feedstock for downstream industries. The need to develop Australia's significant gas reserves and to reverse Australia's declining share of international resource exploration expenditure has lead to a couple of headline regulatory initiatives by the Commonwealth Government.

1. Offshore petroleum regulatory reform

While onshore resource related activities are generally the responsibility of state and territory jurisdictions through relevant government departments, offshore petroleum activities in Australia are regulated by Commonwealth, State and Northern Territory Governments. Like the onshore petroleum regulatory regime, this offshore legislative framework aims to provide an orderly exploration and production of petroleum resources and sets out the rights, entitlements and responsibilities of government and industry. The legislation provides for a system of petroleum exploration, retention and production licence arrangements as well as core environmental, operation and safety regulation.

With the objective to remove the duplication and inconsistent administration of offshore and onshore petroleum activities, the following new agencies have commenced operations from 1 January 2012:

• National Offshore Petroleum Safety and Environmental Management Authority (NOPSEMA) – which regulates occupational health and safety and the day-to-day operational and structural integrity of facilities and wells in Commonwealth waters
• the National Offshore Petroleum Titles Administrator (NOPTA) – which has responsibility for the administration of all offshore petroleum titles.

Offshore retention leases serve a critical function to encourage explorers to work in commercially challenging areas by providing a longer window of tenure security in which to bring discoveries into development. However, the Draft White Paper recognises that reform is needed to promote greenfields exploration in an environment of volatile and rising energy prices, game-changing technologies such as deep-water drilling and floating LNG and highly capital-intensive and long-term LNG developments. While noting that retention leases should not lead to warehousing of petroleum resources, the Draft White Paper clearly recognises that tenure certainty and security will be increasingly important to attract investment.

It is expected that the establishment of NOPTA will:

• increase certainty on approval timeframes, parameters for ministerial decisions, commerciality tests (for the grant and renewal of retention leases) and triggers for review
• provide consistent work programmes and monitoring to ensure barriers to commercialising resources are addressed
• enhance transparency of the retention lease system and provide access to non-confidential information to better facilitate third party comments on applications and the promotion of alternative development options if projects are not progressed in a timely manner.

Further, the Draft White Paper flags the Commonwealth Government's willingness to explore a "project title" concept to provide reserve certainty for highly capital-intensive projects over long time-frames (30 years plus).

2. Upcoming reform of coal seam gas

The emphasis on gas development is likely to focus on the opportunity afforded by significant coal seam gas deposits in New South Wales and Queensland. In this context, the Commonwealth Government is currently working with those states (and others) to harmonise the coal seam gas regulatory regime nationally.

It is well known that there are significant community concerns regarding coal seam gas which largely centre on exploration and extraction access rights and the actual or potential adverse effects on agricultural production and water resources including subterranean aquifers.

The Commonwealth Government has initiated a programme to harmonise coal seam gas regulations through the Standing Council of Energy and Resources (SCER). The SCER is a body of Australian state and territory energy and resources ministers who, on 9 December 2011, released a work programme for such national harmonisation. The harmonisation is focused on six key criteria:

• early advice to, and consultation with, all stakeholders
• transparency of process, information and standards to all stakeholders
• most efficient use of collected information within and between jurisdictions
• the equitable representation of the rights and interests of all parties
• incorporating appropriate review mechanisms for decisions
• communication, explanation and education on the leading practice that arises from the application of these criteria to all stakeholders, including industry.

The work programme for this harmonisation process can be summarised as follows:

• in consultation with state and territory governments, develop and agree on the proposed policy statement, work programme, summary of activities in place or being progressed by such governments and the community engagement and communications strategy
• a stock take of existing Australian regulatory regimes of coal seam gas wells in each jurisdiction and a stock take of current Australian Government and industry practices, procedures and reporting requirements to determine common ground and where gaps may exist within and between jurisdictions
• use this baseline approach to address each of the six criteria noted above
• actual drafting of the harmonised framework (expected to conclude by June 2012) to address:
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  • engineering and design issues (including commissioning, operational practices, decommissioning, hydraulic fracturing)
  • water use, production, re-use and discharge including treatment, analysis and testing, storage and containment, discharge, run-off, salinity, reinjection and waste management.
• evaluation and consultation with various stakeholders and prepare final paper and recommendations to the SCER to address any gaps in existing arrangements. This is expected to occur by September 2012.

The Draft White Paper invites public submissions on its contents before 16 March 2012 and open information sessions will be held in state and territory capital cities.

We will keep you informed of regulatory developments throughout 2012. Finalisation of the Draft White Paper, the SCER harmonisation of coal seam gas regulation and the upcoming Productivity Commission review into non-financial barriers faced by exploration companies, all point to 2012 being a year which promises significant change in the functioning of our energy markets.

Source: mondaq