Governing gas markets without a scientific lens has been an abject failure

By Geoff Edwards

July 14, 2022

energy market
Recent gas market performance should put paid to simplistic characterisations forever. (namning/Adobe)

Almost every introductory textbook of economics presents a definition of the discipline like: “Economics is the study of how scarce resources are allocated”, with some follow-up waffle about the inexorability of the laws of supply and demand.

It’s naïve.

As are assertions of the superiority of private property rights over incompetent government regulation as a mechanism for rationing a scarce resource so that waste is avoided and availability prolonged at least cost.

The recent performance of the Australian gas markets should put paid to these simplistic characterisations forever. Their shallowness should be obvious if we phrase the present situation in the following terms:

A cold weather front on the east coast and a war on the other side of the planet have triggered the suspension of the electricity market because Australia, producer of the largest annual volume of flammable gas in the world, has insufficient gas to squander in turbines at prices that will allow the corporations who have been gifted the gas to continue to book windfall profits, tax optional.

So how do our policy leaders react when demand reaches a supply constraint? They argue to overturn the supply constraint. In other words, to raid some other source outside the market.

Deeply embedded in mainstream economics is the assumption that there are always sources outside the arena of the market being studied – somewhere on planet earth – obtainable at a price. That is, there is no such thing as absolute scarcity. Financial capital can substitute for natural capital, with price being the mediator.

To science, this is nonsense. Only ecological processes can generate natural capital. The stocks are rapidly depleting and the processes are everywhere in serious decline.

Thermodynamics trumps economics, always

Almost every introductory textbook of science presents an explanation of the laws of thermodynamics. These state that energy dissipates and cannot be aggregated without expenditure of energy. The earth’s stocks of fossil fuels are absolutely limited, so homeowners who burn gas to heat their houses are making a once-off withdrawal from a finite stock.

The laws of thermodynamics are inviolate and there would be no life on the planet, and indeed no planet, if this were not so. The dicta of economics, by contrast, are politico-legal creations of the society in which they operate, according to mores and political forces at the time.

Markets are supposed to balance demand with whatever supply is legitimately available. The blind spot of pro-growth economics is to assume that demand does not need to be trimmed because supply is indefinitely elastic. But if the market is not functioning properly with supply A, there is no reason to assume that it is going to function properly at supply twice A: it is more likely to misallocate twice as much resource.

The absence year after year of an understanding of the science of energy from the rhetoric emanating from people we have elected to govern society’s affairs is depressing. Take for example the newly minted resources minister, lawyer Madeleine King, who in June advocated opening the Narrabri field: “It avoids a crisis…”. No minister, it doesn’t avoid a crisis, it merely delays resolving it.

It is not clear that any faction within the parliament other than the Australian Greens understands the limits to the extraction of resources and if the other factions continue to ignore those cascading limits, they will put horsepower into future Greens’ campaigns.

Australian Competition and Consumer Commission

Consider the touching naïveté of Australian Competition and Consumer Commission (ACCC) leader Rod Sims in March 2021: “We can see no end to the increasingly complex and difficult environment we are in, unless LNG producers and other gas suppliers, pipeline operators and governments all work together.” Good luck with reconciling the public interest obligations of government with the commercial interest of international corporations; this was an admission that the atomised markets that the ACCC is supposed to be enforcing cannot effectively ration gas.

An inability to reconcile the ACCC’s confidence in competitive markets with the reality of a market that isn’t satisfying society’s needs is evident in the ACCC representative’s submission to the 2022 Domestic Gas Outlook Conference: “It goes without saying that the gas market needs more supply.”

This is great cause for despair: the ACCC made the same claims in 2018. Markets have not solved the problem that was abundantly obvious then, the advisers have not conceived of any different approach, and four precious years have been lost. Let’s examine what was said then.

The speech about the east coast gas market by ACCC economist Nicole Ross at the Domestic Gas Outlook Conference in Sydney in February 2018 neatly encapsulates what is wrong with so much contemporary public policy: a reliance upon private firms within imperfect markets to resolve complex, fuzzy and conflicting policy objectives.

Ms Ross opined that “The market is just not operating as it should”, because prices were double those available historically, industrial users could not secure supply and gas that domestic consumers might have used was being sold overseas. Sound familiar?

The transcript describes high domestic prices as exceeding an “appropriate benchmark”, but given that “volatile” international spot prices set domestic prices (an artefact of trade policy), an appropriate benchmark does not exist.

Ms Ross continued: “The ACCC will not weigh into the debate about the environmental issues”, specifically restrictions upon exploitation of new fields, but then did precisely that by asserting that the “only real palatable choice” is to increase supply by removing environmental restrictions.

This was a remarkable intrusion by the ACCC into a raft of complex natural resource matters outside their recognised expertise and for which they have no official role. The allocation of onshore natural resources is the responsibility of sovereign state governments, who must weigh up multiple lines of technical evidence about land use, bore-drilling technology, aquifer configuration, saline water disposal and seismic risk, as well as community opinion, among many other considerations.

If the ACCC doesn’t have sufficient engineering, hydrological or geological knowledge to understand the colossal unfunded remediation liability that the coal seam gas industry is building up in Queensland alone and seems determined to impose in the Pilliga, it has no business making public statements about the unimportance of the environmental restrictions that wiser administrations have put in place.

The speech was also a gratuitous intercession on behalf of the gas industry. So much for the ACCC’s alleged ‘independence’.

If the market is not “a well-functioning and competitive market”, then the solution is to enforce or change the rules so that it is. Perhaps by preventing vertical integration, cartelisation and profit gouging by the players, all legitimate roles for the ACCC.

The ACCC’s position even flies in the face of economic orthodoxy. Since climate change has crept onto the policy agenda, the economics policy community has been virtually united in advocating for a price on carbon, as a mechanism to reduce demand and waste.

Yet the economics advisors who are advocating measures to ease the price of gas are ignoring the textbook-endorsed usefulness of price for reducing emissions, through squeezing more process efficiency out of manufacturing, retiring obsolete plant and transitioning to more renewable forms of powering our homes and factories. Of course, a markedly higher price for gas will render some manufacturers uncompetitive on international markets, but that is a consequence of a trade policy that refuses to countenance border tariffs as an instrument of industry policy, and should not be a concern of gas policy.

Environmental restrictions are soft targets. When the designers of the market don’t know whether to allow gas prices to rise to limit consumption as a de facto carbon tax, or to fall to encourage more consumption; and the rules police don’t know whom they want to mollify, it is unsurprising that the rules appear like a muddle. So it is not surprising that companies permitted by the rules to exercise pricing power continue to do so. What else does the Canberra policy community expect?


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