Gas market reforms – a step too far? Australian Government proposes further reforms in its “need for intervention” in the Australian gas market

On 9 February, the Australian Government announced proposed changes to the Australian Domestic Gas Security Mechanism (ADGSM) and requested feedback from relevant stakeholders. This is the latest development in the sweep of reforms by the Australian Government to address rising energy prices. Whilst on their face the various amendments appear to increase domestic supply and manage pricing for new contracts in 2023, they have the effect of:

• constraining new contracting in the domestic gas market, through operation of the price cap, the anti-avoidance provisions and uncertainty in respect of further changes to the regimes
• at the very least, prompting a pause in the medium to long term investment decisions in respect of new supply in the domestic market through the operation of the temporary price cap and the uncertainty of the mandatory code
• causing significant uncertainty for international exporters and purchasers of, and investors in, Australian LNG (in terms of long term supply, existing contracts, further investment and existing equity valuations).

In this insight, we explore the proposed ADGSM reforms and other recent controls that the Australian Government has announced or implemented. Read on to find what you need to know.

Background of the ADGSM

The ADGSM has been in effect since 1 July 2017. ^[1] Its key objective is to ensure a sufficient supply of natural gas to meet domestic consumption needs. Under the existing regime, the ADGSM works by requiring, if necessary, LNG projects ^[2] to limit international exports or find offsetting sources of new gas. ^[3] Any shortfall is determined on an annual basis in advance based on forecasts for the upcoming year.

The ADGSM is intended to act as a ‘last resort mechanism’ and to date has never been used to impose export controls.

Proposed reforms to the ADGSM

The proposed ADGSM reforms will, following consultation, replace the existing rules and commence on 1 April 2023. ^[4] Key proposed changes include:

• Quarterly determinations: giving the Minister more control by allowing the Minister to determine an anticipated shortfall on a quarterly basis (rather than annually)
• Liability for shortfall split equally: changing the way a shortfall is distributed among LNG projects so that the volume of the shortfall is to be split equally amongst LNG projects based on the number of “allowable volume” permissions granted to LNG projects
• Protection of some long-term contracts: implementing new rules around protecting long-term contracts. These rules may have limited practical application. We explain this more below.

The Minister may exercise discretion and judgement in considering relevant and available information to determine a domestic shortfall quarter but must have reasonable grounds for its belief that there will be a domestic shortfall unless exports of LNG are controlled, and that exports of LNG would contribute to that shortfall. ^[5]

If a designated shortfall quarter has been determined, Australian LNG exports are prohibited unless the LNG project obtains a permission (which may be for an unlimited volume or an allowable volume). Unlimited permissions will only be granted to projects in a part of the market where Australian consumers are unaffected by the shortfall (for example, the West Coast of Australia). Permissions for an allowable volume may be traded.

Reform provisions protecting long-term contract gas

The proposed reforms add a separate regime aimed at protecting contractual supply obligations under “protected long-term contracts”. "Protected long-term contracts" are contracts which underpinned the final investment decision (FID) of the LNG project and were executed before or 12 months after FID. ^[6]  

LNG projects may apply to the Minister to increase the quantity that an LNG project is permitted to export in order to meet contractual supply obligations under a protected long-term contract. However, the scope for relief under this mechanism is relatively narrow. Notwithstanding the Australian Government’s commentary that the reforms will protect long term contracts, ^[7] when determining whether to increase a permission volume, the Minister will only take into account (i) whether the LNG project has exhausted all available commercial solutions to fulfil its contractual obligations and (ii) the economic and social impacts of a shortfall in Australia equivalent to the increase in the allowable volume under consideration. For example, a seller may be expected to procure expensive spot cargoes, purchase additional quantities via trading allowable volume permissions from other projects or exercise and / or exhaust its downward flexibility rights (if any). This will have important ramifications for existing LNG sales arrangements.

Other recent reforms to protect domestic energy prices

The proposed ADGSM reforms come in addition to various other developments aimed at preventing a domestic gas supply shortage and combating energy prices, being:

• New Heads of Agreement (HOA): a new HOA (signed on 29 September 2022) between the Australian Government and three major Australian East Coast LNG exporters (HOA LNG exporters) which amends and extends the commitments in the previous 2020 HOA to 1 January 2026. The Government believes the HOA will lead to an extra 157 petajoules of supply for the domestic market in 2023. In particular, the HOA:
  • requires the HOA LNG exporters to give a right of first offer to the domestic market for uncontracted gas supply at prices competitive to international customers and on competitive market terms to the Australian domestic gas market. This commitment existed in the 2020 HOA but in a slightly different and less detailed form
  • introduces new transparency measures for HOA LNG exporters (such as the publication of information which provides domestic customers with visibility on uncontracted gas volumes)
  • requires HOA LNG exporters to provide information regarding (among other things) forecast volumes, contracted volumes and uncontracted volumes to the ACCC on request
• Implementation of new regulatory framework: in December 2022, the Federal Government passed the Treasury Laws Amendment (Energy Price Relief Plan) Act 2022 (Cth) which amends the Competition and Consumer Act 2010 (Cth) (CCA) to establish a very broad regulatory framework through which the ACCC can regulate the supply and acquisition of certain gas (CCA Amendments). The key reforms introduced are:
  • the Federal Government can now make “gas market instruments”, being:
    • temporary gas market emergency price orders made by the Minister
    • long-term mandatory gas market codes
  • emergency price orders and gas market codes may include provisions which are civil penalty provisions
  • the ACCC has investigation powers, can issue infringement notices and give public warning notices to companies who offend the civil penalty provisions
  • there is a comprehensive anti-avoidance regime in place, which applies to any person who participates in a scheme to assist a gas producer or its affiliates to circumvent a civil penalty provision (including the temporary price cap restrictions noted below). This anti-avoidance regime extends the application of the regime beyond gas producers and their affiliates
• Temporary price cap: on 22 December 2022, the Federal Government made a gas market emergency price order which implements a 12 month temporary gas price cap of $12/GJ on certain gas. ^[8] The temporary price cap commenced on 23 December 2022. ^[9]  Importantly, the price cap does not apply to LNG exports from Australia ^[10] and while the price cap is a mandatory cap, it only applies to new contracts and variations of existing contracts (involving price variations) entered into during the 12 month period.  In January 2023, the ACCC issued interim guidelines regarding compliance and enforcement of the price cap. These guidelines were recently updated on 3 March 2023
• Long-term mandatory gas market code: the CCA Amendments give the Federal Government legislative power to implement a long-term mandatory gas market code, and in December 2022 the Government indicated its intention to do so in early 2023. The potential scope of this code is very broad and could include (among other things):
  • the introduction of a “reasonable pricing provision” for domestic wholesale gas contracts
  • minimum standards for some terms and conditions in gas supply contracts
  • requirements for gas producers to publish or make offers broadly available to the domestic market.

Public consultation on the mandatory gas market code of conduct (a draft of which is not yet publicly available) concluded on 7 February 2023.  For more information on the CCA Amendments, see our insight here.

How do the various reforms work together to protect domestic energy supply and prices?

The package of reforms gives the Australian Government extremely wide ranging controls to protect domestic gas supply. We set out some examples on how these controls can collectively be used together below:

• If the Minister predicts a domestic shortfall and engages the ADGSM, LNG projects will be prohibited from exporting LNG without an unlimited or allowable volume permissions for the relevant quarter. Allowable volume permissions could be granted for quantities that are insufficient to meet an LNG project’s contracted export obligations and LNG projects only have an extremely limited ability to require the Minister to increase their permission amounts. It is possible that LNG projects in areas where consumers are affected by a shortfall (e.g. the East Coast of Australia) may need to use other means to meet their contractual obligations, such as purchasing spot cargoes or additional allowable volume permissions from other projects
• To the extent quantities of gas produced by LNG projects and intended for export are in excess of the quantities for which permissions have been obtained, the excess (Domestic Excess) can only be sold to the domestic market. In any event, any uncontracted gas produced by HOA LNG exporters must be offered to the domestic market before it is offered to international markets, pursuant to the HOA (whether or not the ADGSM has been triggered)
• During 2023, the emergency price cap will apply (with some exceptions) to new contracts, capping the price of gas sold on the domestic market at $12/GJ. In effect, this means that any uncontracted gas produced in 2023 by HOA LNG exporters (and, if the ADGSM is triggered, LNG projects with an allowable volume permission that results in a Domestic Excess), needs to be offered domestically for $12/GJ
• Additionally, the proposed long-term mandatory gas market code may, once introduced, set requirements that an LNG project must follow, including a “reasonable pricing” requirement on the sale of gas in the domestic market (which may not be limited to new contracts). These requirements would apply even if the emergency price cap does not apply.

The reforms work together to give the Australian Government more control to exercise pricing and supply restrictions should it need to. However, together they look likely to prompt a pause in medium to long term investment decisions in respect of new domestic supply and could even potentially worsen domestic shortfalls. The reforms will ultimately increase uncertainty in both the domestic gas and international markets.

Please reach out to our experts if you would like any assistance.