The oil and gas industry, with federal government support, is fervently hoping New South Wales will follow Queensland down the path of rapidly developing its coal seam gas reserves.

As Crikey showed yesterday, this is driven partly by uncertainty over a possible supply shortage to the massive export liquefied natural gas projects under construction in Gladstone, which swing into production from late this year, adding a massive new source of demand to the east coast gas market.

Two long-delayed CSG projects in NSW are on a knife edge: Santos’ $2 billion Narrabri gas project, the first stage of which will involve drilling some 850 wells into the Gunnedah Basin, in the Pilliga State Forest and the Liverpool Plains, and the $200 million-plus stage one of AGL’s Gloucester gas project, to drill 110 gas wells in the Hunter Valley.

The NSW government has designated both as “strategic energy projects” and has guaranteed fast-track assessment, but it remains divided on CSG. Against the express wishes of his former energy minister Chris Hartcher (who is now under investigation by the Independent Commission Against Corruption), a year ago Premier Barry O’Farrell clamped down on the CSG industry, introducing a draft state environmental planning policy that imposed a two-kilometre no-drilling buffer zone around urban areas (just as Queensland had done), and extra protections for strategic agricultural land, especially equine and viticulture clusters in the Hunter Valley.

CSG development stopped almost overnight, with projects cancelled from Lismore to the Southern Highlands. AGL wrote off $344 million against the book value of its Hunter, Camden and Gloucester CSG projects, reducing them by almost half, to $443 million.

CSG policy now is in suspense, pending a review of health and environmental impacts by NSW chief scientist Mary O’Kane, to be completed later this year. A NSW parliamentary inquiry into downstream gas supply in NSW has taken 64 submissions and held hearings last November, but it is yet to report.

Santos is in a bind. Its $20 billion-plus Gladstone LNG project is widely considered to be short of gas, with analysts scratching their heads at a lack of reserve growth and further contingent resource downgrades in its latest accounts. Extra supply from Narrabri would be heaven-sent. But its campaign to pressure the NSW government to overhaul its CSG policy is all about the state’s energy security, so it has to commit to supply at least some of the Narrabri gas to the domestic market. There is no firm supply commitment, but in its submission to the NSW inquiry Santos said the first stage of the Narrabri project could supply NSW with more than 100 terajoules per day or about 25% of the state’s gas needs. That’s half the 200TJ/day Santos expects to produce from stage one of the Narrabri project. It is not clear whether all of this gas would be supplied to NSW, or if some could go to Gladstone.

As I argued yesterday, the supply from Narrabri alone would be more than enough to address the relatively minor potential NSW gas supply shortfalls identified by the Australian Energy Market Operator, of 50-100TJ/day on peak winter days from 2018 (and fresh questions were raised in The Sydney Morning Herald yesterday about AEMO’s bullish domestic demand forecasts, which overlook the impact of rising prices). AEMO modelling suggests 400-1300TJ/day could be supplied from an expanded Gunnedah Basin project. Assuming a comparable drilling rate to Narrabri stage one, that would require some 1700-5500 wells. Clearly, there is much more gas in Santos’ Gunnedah Basin acreage than is needed in NSW. Getting that gas out will be slow and expensive, with an 180-kilometre pipeline across prime farmland needed to feed Narrabri gas into the Moomba-Sydney pipeline. Assuming an approval by January 2015 — the deadline for a NSW decision, announced last Friday — Santos would have to move extremely quickly to finish stage one by the target date of 2017, just two years after a final investment decision. Mid-last year Santos told Parliament the project could be finished as early as 2017 — i.e. four years away — if construction started today.

The track record of the Narrabri project is not encouraging. Since paying $934 million for Eastern Star Gas, then chaired by former Nationals leader John Anderson, roughly two years ago, Santos has drilled just five new pilot wells in the Pilliga. Santos had to shelve the old Eastern Star application to drill some 550 wells in the Pilliga after a damaging spill raised questions about environmental management. To its credit, Santos went back to the drawing board — it is still to lodge a revised development application — and also committed itself to a generous landholder access regime, giving landholders a tacit veto, by promising never to drill on land where it wasn’t wanted. But Santos has not been able to muster much farmer support in the intervening period, though the company says negotiating access has not been a priority recently. Santos has just 45 landholder access agreements in NSW, compared with 10 times that in Queensland. And being armed with a government approval does not guarantee plain sailing, as Santos is already finding in the Pilliga, where protesters against its approved pilot drilling program are locking onto trucks and rigs in classic civil disobedience action. Analysts now value the Narrabri project at between $400 million and $550 million.

Even assuming Santos could pull out all stops and complete stage one by 2017, with no community opposition, the Bureau of Resources and Energy Economics (BREE) expects uncertainty over the gas supply to the new LNG projects at Gladstone will be largely resolved by then.

“Given agriculture is going to be there forever, longer than the gas, I think the farmer should be given some consideration.”

AGL is equally in a bind at Gloucester, where it has state and federal approval for its concept plan and stage one of 110 wells, but its Waukivory pilot project is awaiting approval, which is unlikely this year. Gloucester, with proven and probable reserves of 454PJ capable of supplying 15% of NSW’s domestic gas demand, is by far the most valuable of AGL’s CSG assets. Earlier this week, however, Credit Suisse analyst Sandra McCullagh downgraded her valuation of Gloucester to $88 million — well under the book value of $388 million, citing strong local opposition and uncertainty over approvals. AGL chief executive Michael Fraser stood by its book value during its earnings presentation this week, insisting it already had approvals, was not going to be impacted by the new state environmental planning policies when they are, and was “critical” for NSW energy supply.

The taskforce appointed by federal industry minister Ian Macfarlane to break the NSW CSG logjam may yet deliver a surprise. Fund manager David Paradice, founder of Paradice Investment Management, is a member of the taskforce, which also includes former NSW coal association chief Nikki Williams. Paradice, a significant landowner and racehorse breeder from the Hunter Valley, told Crikey there was “some merit” in giving landholders the right to veto any CSG development on their property. “Given agriculture is going to be there forever, longer than the gas, I think the farmer should be given some consideration,” Paradice says. “If it is going to destroy aquifers that are used for agriculture, I’m not sure it should be allowed to go ahead.” Paradice’s own properties are not affected by CSG.

Gloucester is certainly critical to AGL, if not to NSW. While AGL does not have an LNG project to feed, it is the standard gas retailer for Sydney, and its main wholesale contract, sourcing gas from Moomba, rolls off in 2016. At this point AGL is unable to say where it will get gas for the Sydney’s commercial and household customers thereafter. Fraser was hammered by McCullagh on Wednesday over how long the renegotiation was taking.

Last week AGL lodged an application to lift its gas prices in Sydney and inland NSW by 20% in 2014-15, charging households an extra $182 a year, and a typical business an extra $857 a year. Prices would rise another 6% the following year. AGL’s justification of the price rise makes interesting reading.

AGL makes abundantly clear that export pricing has arrived and is here to stay, with domestic buyers including retailers already paying the LNG “netback” price in the wholesale market — that is, the international price minus the costs of transport and liquefaction. NSW customers would need to pay the Cooper Basin gas price — i.e. the price AGL can achieve by selling gas into Queensland. On Wednesday AGL said that price was now around $10/GJ.

In its Independent Pricing and Regulatory Tribunal submission AGL warned the price increases were “not transitory in nature … It is unlikely that there will be a significant shift away from LNG netback prices at Moomba at any time before 2020.”

AGL clearly does not believe Santos can substantially bring on its Narrabri project any time soon: “Other than AGL’s Gloucester basin project, which will not become operational [before mid-2016], material quantities of NSW [CSG] or other unconventional gas production is subject to an extended period of appraisal and development and unlikely to be available prior to the end of this decade.”

None of this bodes well for the production cost of the NSW CSG projects, which BREE estimates at roughly $5/GJ. Energy Quest’s Graeme Bethune thinks the Narrabri and Gloucester projects could produce gas for less — perhaps as low as $3/GJ. Being closer to the Sydney there would be lower shipping costs, maintaining an advantage over gas from Victoria’s Gippsland Basin, which has high CO2 and Mercury and costs $7/GJ to produce.

It would be interesting to see the various cost assumptions, but regardless of production cost, the gas will be sold at the market price. Santos argues increased supply should lead to lower prices, or at least put downward pressure on prices that would otherwise be higher. But as Ross Gittins argued powerfully, there is no evidence that bringing on new supply will lower the gas price. “Any new gas producers in NSW won’t be willing to sell to locals for anything less than the equivalent price they could get by selling to foreigners,” he wrote.

The proposed CSG projects at Narrabri and Gloucester should be decided on their merits, not on the basis of dubious arguments about a gas shortage in NSW or their ability to lower prices.

*Paddy Manning is author of What the Frack: Everything You Need to Know About Coal Seam Gas. Tomorrow: in the third and final instalment in our series: opaque and anti-competitive — why the gas industry needs reform.