Reserving gas for domestic markets - Queensland's next step

In brief 7 min read

Both Queensland and Western Australia have mechanisms designed to ensure that, in the face of the competing demands of LNG exports, adequate gas is available for domestic use. Queensland is now looking to go a step further, by imposing a condition on identified petroleum authorities to the effect that the gas produced be used to supply domestic manufacturers. Partner John Greig and Lawyer Mark Young review these developments.

Background

The development of LNG projects in Western Australia and Queensland – and, to a lesser degree, the Northern Territory – were accompanied by concerns that too much gas would be diverted to offshore markets, leaving domestic markets short. Western Australia and Queensland,¹ the major gas producers in Australia, have each adopted measures to address those concerns.

Western Australia

The approach in Western Australia has been to maintain a domestic gas reservation policy. First adopted as part of helping underwrite the North West Shelf LNG project in 1979, the policy was formalised in 2006 and later clarified in 2012.

Its features are as follows:²

• The policy is implemented, at project inception as part of the project approval process, by negotiating and implementing long-term contractual arrangements with the developers of the LNG export sector. As such, domestic-only producers are not the subject of such arrangements.
• Those arrangements involve covered producers committing to make domestic gas available by reserving domestic gas equivalent to 15 per cent of LNG production from each LNG export project; developing and obtaining access to the necessary infrastructure to meet their domestic gas commitments; and acting diligently, and in good faith, in marketing gas to the domestic market.
• Covered producers may propose to offset their domestic gas commitments by supplying gas or other energy from alternative sources, rather than from the committed LNG projects.
• In order not to compel covered producers to 'dump' gas onto the domestic market at times when the domestic market is well supplied, covered producers may reserve unsold gas for when domestic market conditions change.

Queensland

In contrast, Queensland enacted the prospective gas production land reserve provisions in 2011.³  The features of that approach are:

• The Minister may⁴ grant petroleum authorities subject to the Australian market supply condition.
• The holder of a petroleum authority over such land (PGPLR land) must not supply gas produced from it other than to the Australian market, and must include in any contract or arrangement for the supply of that gas a condition that the gas must not be further supplied other than to the Australian market.⁵
• Breach of the Australian market supply condition is an offence for the holder and, if a corporation, each of its executive officers may also be taken to have committed the offence.⁶
• An entity that is supplied PGPLR gas similarly must not further supply that gas other than to the Australian market, and must include in any contract or arrangement for the supply of that gas a condition that the gas must not be further supplied other than to the Australian market.⁷ It is not a requirement that the entity obtain supply directly from the holder, meaning there may be a chain of affected entities if PGPLR gas is on-supplied more than once.

These requirements are known as the 'Australian market supply condition'.⁸

Recognising that technical, operational or market conditions may make it difficult, if not impossible, always to comply with all aspects of the Australian market supply condition, the legislation provides for safe harbours:

• The first is available to the holder of a petroleum authority as to PGPLR land. Relief requires the prior consent of the Chief Executive. The Minister may approve a suspension, for a stated period, of the application of the Australian market supply condition for that holder if market analysis indicates that, during that period, sufficient gas may be produced from existing and proposed petroleum authorities in Queensland to supply both the Australian market and export demand; or, alternatively, the holder has taken all reasonable steps to supply the gas produced to the Australian market but it is not commercially viable to do so.⁹
• The same safe harbour is also available (having obtained the Minister's approval) to an entity that has been supplied gas produced from PGPLR land.¹⁰ The onus in this instance falls on that entity, not the holder.
• The second is a safe harbour for an entity that is a consumer of PGPLR gas, and provides for relief from the obligation not to further supply other than to the Australian market.¹¹  If that entity encounters technical or operational problems precluding it from consuming the gas, it is excused if it has taken all reasonable steps to supply the gas to the Australian market (but it considers it is not commercially viable to do so) and it gives notice of all of these circumstances to the Chief Executive within five days after starting to supply the gas.¹² That no prior consent of, or notification to, the Chief Executive is required recognises that the technical or operational problems that prevent the use of the gas may be entirely unexpected.

Queensland, having enacted these provisions in 2011,¹³ has since granted, or selected preferred tenderers for the grant of, authorities to prospect subject to the Australian market supply condition.¹⁴  At least one holder has since announced that, following prospecting, a final investment decision has been made to progress with development of two production projects, indicating that the Australian market supply condition is not a break on investment.¹⁵

Domestic manufacturers condition

Queensland is now moving to a new phase.¹⁶ In November 2018, tenders were called for bids for the grant of authorities to prospect on terms that include not only the Australian market supply condition but also a condition that any gas produced must be supplied to manufacturers.¹⁷

Unlike the Australian market supply condition, the domestic manufacturers condition does not have specific legislative support. This has a number of implications:

• The manufacturers condition¹⁸ might be expected to be imposed as a condition of the petroleum tenure itself. As such, it will be binding on the holder but not, of itself, on any entity to whom the gas is supplied, not even an entity to whom the holder directly supplies the gas.
• A condition could be drafted that required the authority holder to require from the entity to which it supplies gas, contractual undertakings for the state's direct benefit to comply with constraints similar to the manufacturers condition imposed on the authority holder (including to obtain similar undertakings from any further entities who are further supplied that gas).¹⁹
• Neither breach of the condition nor of such a contractual undertaking would, of itself, constitute an offence.
• Breach of the condition could lead to noncompliance action being taken against the authority holder (after a show cause procedure is undertaken), the most severe of which is cancellation of the authority.²⁰
• Breach of the condition, even by complicit executive directors, will not constitute offences by those officers.²¹
• Breach of those contractual undertakings would give the state the usual remedies. Given the usual rules for quantifying damages following a contractual breach, it is difficult to see that other than nominal damages would be recovered. And an award for specific performance would be of little utility if the breaching party had already used the gas for non-manufacturing purposes, or on-supplied the affected gas without procuring from the next entity an undertaking for the state's benefit.
• Both the manufacturers condition and the contractual undertaking (or similar mechanism) deserve safe harbours equivalent to those available to PGPLR gas.

What's next?

Notwithstanding these differences, the current tender process is an interesting development, and one that both manufacturers and those gas producers whose business models target domestic markets can be expected to welcome.

Experience in the short term, both as to the Australian market supply and manufacturers conditions, will provide invaluable evidence whether any refinements of either scheme are warranted, and whether there is a need to provide a legislative backing for the manufacturers condition, akin to that already available for the Australian market supply condition.