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Interview

John Pierce – Chairman, AEMC, Australia

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The chairman of the Australian Energy Market Commission, John Pierce, describes the organization’s push for liquid wholesale gas trading hubs, secondary trading of pipeline capacity, and enhanced market intelligence, and how these recommendations will help the domestic market seamlessly adjust to upward pricing pressures.

The East coast gas market is largely seen as going through a significant transformation, especially as the Queensland LNG export facilitates come online. Can you start off by elaborating on the implications that these changes will have on the domestic gas market?

There are primarily two. The first is the huge increase in demand on the East Coast that we haven’t previously experienced, and with that comes linkages between the domestic gas market and the international markets.

Secondly, one of the consequences of that is a market that is a lot more dynamic, fluid, and potentially more volatile. As a result, the government had tasked the AEMC with reviewing the mechanisms used to buy and sell gas, and provide recommendations on how they might be improved to adjust to those new dynamics.

What is the extent of the AEMC’s role in facilitating the nation’s energy transition?

The commission has two roles. The first is to make the statutory rules that govern the domestic gas and electricity market—these are then applied by the Australian Energy Market Operator (AEMO) and the Australian Energy Regulator (AER).

The second function is to advise our governments on the strategic direction and development priorities of our energy markets. In recognition of the changing dynamics on the East Coast gas market, the Australian Government decided on a destination, a vision for a liquid wholesale gas market and asked the AEMC to design a roadmap to get there.

The AEMC recommended three key reforms: changes to wholesale gas trading markets concentrating trading at two hubs to reduce complexity and enhance liquidity; changes to improve accessing transmission pipeline capacity by introducing market pricing mechanisms and trading platforms; and disseminating real-time market intelligence information to the public through an expanded information Bulletin Board.

Two locations in particular were identified as having enough market participants to create the necessary liquidity and establish effective trading hubs: one in the North around an existing hub in Wallumbilla, Queensland, and one in the south in Victoria. Though, both locations exhibit widely different characteristics. The north is currently dominated by LNG exporters and possesses an intersecting pipeline while in Victoria gas is largely consumed by residential and small industrial customers—mostly fuelled by offshore production. The overall objective is to be able to move gas to wherever it needs to be within the interconnected network so it arrives at the place where it has the most value, thereby making a greater contribution to the value of Australia’s economic output. The way the prices are calculated and the nature of those trading platforms are all factored into the design.

However, the demand for gas trading is largely rendered useless if there is no capacity for transporting the asset. Traditionally, the investments required for transmission pipeline infrastructure has been mostly funded on the basis of long-term contracts between the pipeline owners, shippers, and major consumers. That aspect of financing is something we wish to preserve. But the incentives to trade contracted but unutilized pipeline capacity hasn’t been as strong as it could be. So, our recommendations focus on providing the flexibility required for secondary trading of unutilized pipeline capacity.

The third element refers to the information available on the “gas bulletin board”—designed as a one-stop shop to help people understand what is happening in the market at a particular point in time whether that’s in regard to gas flows, demand, pipeline loads, storage facilities, etc. Essentially, we want to equip participants with all the information they need to determine the value of a trading opportunity.

What is the implementation timeline for these recommendations?

In December 2015 we published draft recommendations, which were subject to comment and submissions from a wide range of stakeholders. The final report will be presented to Governments in May 2016. In the event that the roadmap is accepted by the Council of Australian Governments (COAG) Energy Council, the focus would then shift to implementing those recommendations endorsed by the Council. In reality there would be several staged phases to guide the development of the market and we have carried out a great deal of work on the implementation mechanisms necessitated by any changes in law, rules, and management structures. We don’t have any specific timelines, but we do have a sequence that runs to the horizon of a three to five year period. Obviously there will be a lot that needs to be done if governments accept the recommendations, but the market should anticipate material changes within that window of time.

Feedback to us suggests that the need for these reforms has already been widely recognized by the market participants—especially given all the structural changes that have occurred.

What type of feedback has the draft report garnered from the community so far?

Response has been quite positive so far. In recognition of the need to preserve the fundamental incentives for transmission investments, the head of the Australian Pipeline and Gas Association (AGPA), Cheryl Cartwright, recently expressed support for the proposed reforms. Pipeline owners, and the wider stakeholder community, are interested in further exploring the details of secondary trading.

How can we expect traditional energy retail models to shift in response to the changing supply and demand dynamics, if at all?

Previously, the gas market had been quite insular and fundamentally stable in nature typically with long-term contracts between producers and users. These contracts usually spanned long periods upwards of 10 years or more with fixed volumes and pricing schemes—creating somewhat of a “set and forget” mentality. Partly out of necessity, as well as the opportunities that a more volatile market dynamic can provide, I suspect a lot of the customers will move towards a portfolio approach in the way they purchase gas. In this scenario, they will have a long-term contract that underpins a certain amount of their demand, but ultimately a series of shorter-term contracts based on wholesale spot prices and coupled with derivatives to mitigate that risk. The management of those purchasing costs now effectively becomes a more active task—which is no different from what has happened with our domestic electricity market in the last 15 years.

From a regulatory perspective, how do you anticipate that the needs of the market will evolve as technology and innovation become more of a mainstay—especially in light of Prime Minister Turnbull’s recently announced USD 1 billion innovation package?

Indeed, a lot of that funding will inevitably flow into energy technologies to help meet climate change objectives. Our efforts pursue a technology neutral approach, which places an unbiased view on specific technologies such as renewables or gaseous fuels—effectively letting the market freely decide which is more suitable. We’re not in the business of creating policy frameworks that are dependent on a particular view of how the future pans out. Our core interests lie in the mechanisms that are used in the market and their ability to adjust and send the right signals irrespective of future developments. There are various expectations about the deployment of particular technologies in the gas sector and commercial businesses. But our emphasis lies in ensuring that the information that customers obtain about prices, the associated transaction costs, stability of the regulatory arrangements can adjust to any of technological development. Essentially, we’re more concerned about the flexibility and adaptability of the market mechanisms, rather than predicting the future.

How do you go about incorporating that level of flexibility given the level of uncertainty that new technologies entail?

Five years ago, we started a major reform program called the Power of Choice, which dealt with the way distribution network prices were structured, information was provided to consumers, and the line between what needs regulated and what needs to be governed by market dynamics. These emerging technologies require us to redraw where that line is: what can be provided through competition and what needs to be managed by normal regulatory frameworks.  Technology is becoming disaggregated and therefore more in the control of and closer to the consumer—which provides the opportunity for competition to free up the different options that consumers have so they can decide what technologies to employ. Ultimately, we want to put consumers in a position where they can decide whether the value that they get from using energy in a particular way is greater than the cost of producing it. Fundamental building blocks like tariff structures, liquidity, ease of transactions, and flow of information will be the indicative factors of steadfast progress moving forward.

Looking at the next three to five years, what are the main priorities that the organization will focus on?

In gas market development, the next three to five years will be crucial if Australia’s domestic gas market is going to evolve to meet the changing dynamics associated with LNG exports. Our reform process is therefore very focused on this key window of opportunity to deliver the COAG Energy Council’s vision for reform. In this timeframe we will be working closely with government and industry to enhance the amount of information available to the market as well as getting reforms to the pipeline access arrangements in place. These are all important precursors to the important goal of delivering liquid trading hubs and meaningful wholesale reference prices. Hopefully within that five year window the Australian gas sector will be well on the way to achieving that objective.

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