A change relevant to all industry participants 5 min read
As part of its proposed package of reforms to respond to increased gas prices and a forecast shortfall of gas supply on the east coast of Australia,1 the Australian Government has fast-tracked amendments to the Australian Domestic Gas Security Mechanism (ADGSM).
A draft of the 2023 Australian Domestic Gas Security Mechanism (ADGSM) Guidelines (the Draft 2023 Guidelines) was released on 9 February 2023. The Draft 2023 Guidelines represent a substantial shift in the operation of the ADGSM from previous iterations, resulting in a stronger and more responsive mechanism.
The Government has shown an increased willingness to intervene in the domestic gas market, and the Draft 2023 Guidelines follow the recent imposition of an emergency gas price cap and proposed introduction of a mandatory code of conduct for gas producers. While a strengthened ADGSM may be of particular concern for LNG projects, all participants in the gas industry should take note of this latest development, given the potential impact of an activated ADGSM on the domestic gas market.
Key takeaways
- Activation of the ADGSM is now to be considered on a quarterly basis, rather than annually.
- All LNG projects are to share the liability for any shortfall equally in volumetric terms, rather than in accordance with the pre-existing Total Market Security Obligation (TMSO), under which export allowances were determined depending on whether an LNG project was considered to be a net-contributor to the domestic gas market, or in net-deficit.
- LNG export permissions are to be made tradeable, in order to improve the economic efficiency of the ADGSM by maximising flexibility in the market while ensuring domestic supply.
- Long-term export contracts which were entered into to underpin a final investment decision are offered some protection under the Draft 2023 Guidelines, but this protection is qualified by a requirement for a producer to exhaust all available commercial solutions before it will be granted an increase to its export permission.
- The Government is currently seeking feedback on the Draft 2023 Guidelines, with consultation closing on 23 February 2023.
Key changes to the ADGSM
The ADGSM was first introduced on 1 July 2017, and allows the Government to restrict LNG exports as a measure of last resort in the event of a domestic gas supply shortfall, to ensure there is sufficient supply of natural gas to meet the forecast needs of the Australian domestic market. It has not been triggered to date.
The Draft 2023 Guidelines introduce three key changes to the prior iteration of the ADGSM guidelines, published in 2020:
The changes are broadly consistent with previous announcements by the Government, except that the protections for long-term foundational LNG export contracts which underpinned investment in the Australian gas industry are more qualified than many industry participants had expected them to be.
- Activation of the ADGSM is now to be considered on a quarterly basis, rather than annually. This change is intended to allow the Government to respond to threats to domestic energy security in a more timely manner than previous iterations;2
- All LNG projects are to share the liability for any shortfall equally in volumetric terms,3 rather than in accordance with the pre-existing Total Market Security Obligation (TMSO), under which export allowances were determined depending on whether an LNG project was considered to be a net-contributor to the domestic gas market, or in net-deficit. This change is intended to address concerns that under the current TMSO design, net-deficit producers may be unable to fulfil forecast shortfalls alone.4 The Government considers that by making the supply burden equal amongst LNG projects, the Draft 2023 Guidelines will better equip the ADGSM to ensure there is adequate supply in the event of a shortfall; and
- LNG export permissions are to be made tradeable to improve the economic efficiency of the ADGSM by maximising flexibility in the market while preventing impacts to domestic supply. The introduction of tradeable LNG export permissions allows LNG projects with insufficient export permissions to purchase them from other LNG projects that hold a surplus, thereby ensuring that the amount of gas being redirected to the domestic market to meet the shortfall remains unchanged, but is drawn from the most economically efficient source of supply.5
The changes are broadly consistent with previous announcements by the Government,6 except that the protections for long-term foundational LNG export contracts which underpinned investment in the Australian gas industry are more qualified than many industry participants had expected them to be.7
Previous government announcements had noted that any revisions to the ADGSM should respect the global perceptions of Australia as a trusted energy supplier and attractive foreign investment destination, and honour existing commercial agreements.8 The Draft 2023 Guidelines allow an LNG producer to apply to the Minister for increased export permissions if activation of the ADGSM results in an LNG project's allowed export volume being restricted to an amount that is less than the minimum supply volume it is obliged to supply under a protected long-term contract.9 However, this protection is only available where:
- the contract in question underpinned the final investment decision of the LNG project;10 and
- the LNG project has exhausted all available commercial solutions to fulfil its contractual obligations, including but not limited to its protected long-term contracts.11
Examples of commercial solutions included in the Draft 2023 Guidelines that an LNG exporter must pursue include purchasing export permissions from other LNG exporters under the newly introduced trading mechanism, and purchasing LNG on the global spot market to then on-sell in order to meet its contractual obligations. The result is that even for foundational long-term contracts which underpinned the final investment decision of LNG projects, these protections will only be available in limited circumstances on the current version of the Draft 2023 Guidelines. LNG projects may be required to resort to costly commercial solutions to fulfil their contractual obligations to existing long-term foundation customers.
There is no protection afforded to long-term LNG sales contracts that did not underpin FID, or to spot sales of LNG.
It seems to us that if the Draft 2023 Guidelines are implemented in their current form, it will mean that any future long-term or spot sale (or series of spot sales) will need to include an explicit force majeure carveout related to the ADGSM being enlivened. This type of carveout is likely to reduce the price at which LNG from Australia can be sold (as against LNG from other countries) and thereby reduce the taxes on income derived from those LNG sales, but will simultaneously increase the perceived risk associated with purchasing Australian LNG.
Likely issues for Australian LNG producers
Based on industry reactions to date, at a minimum, we would expect to see Australian LNG producers raise the following types of issues with the current version of the Draft 2023 Guidelines during the consultation process:
- any long term or contractually binding LNG sales contracts should be afforded the same protections as contracts that underpinned the final investment decision of the LNG project, such that an LNG producer in Australia cannot be placed in breach of its international contractual obligations to key economic trading partners with Australia;
- the obligations to exhaust all available commercial solutions to fulfil an LNG producer's contractual obligations should be tempered to ensure that the LNG producer is not required to incur a loss in order to comply with the ADGSM (eg by an LNG producer being forced to buy spot cargos at double the price of its contractually binding LNG sales contract obligations so as to comply with the ADGSM); and
- there will be numerous practical difficulties associated with shortfalls being assessed and declared on a quarterly basis (eg contracts for purchase of LNG on the global spot market are typically entered into a number of months in advance of the delivery date, and it may be difficult for producers to manage their trading timetable when it is not clear whether an upcoming quarter will be a shortfall quarter or not).
Comparison of 2020 ADGSM Guidelines with Draft 2023 Guidelines
| 2020 guidelines | Draft 2023 guidelines |
|---|---|
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Shortfall calculated on a yearly basis. |
Shortfall calculated on a quarterly basis. |
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Prohibits exports during a shortfall year, unless written permission has been granted by the Minister or an authorised officer. |
Prohibits exports during a shortfall quarter, unless written permission has been granted by the Minister or an authorised officer. |
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The Minister’s Notification of intent to consider determining a domestic shortfall year will generally be issued:
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The Minister’s notification of intent to consider determining a domestic shortfall quarter must be issued at least three months prior to the commencement of the domestic shortfall quarter. |
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The Minister will consult with relevant market bodies and government agencies, LNG Projects, and other stakeholders to seek their views about the forecast state of the Australian domestic gas market, as well as other relevant Australian Government Ministers, including the Prime Minister and the Ministers for Energy, Trade, Foreign Affairs, and Industry, to seek their views about the forecast state of the Australian domestic gas market. |
The Minister will consult with LNG projects on whether to determine a domestic shortfall quarter. |
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Where practical, the Minister will allow at least:
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Those consulted will have 30 calendar days from the Minister’s notification to provide any information that would impact on the shortfall forecast. |
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The Minister’s Determination will generally be issued:
but may be made any time up to and including 1 November. |
The Minister’s determination will be made within 45 days of the Minister’s notification. |
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The Minister will issue provisional Export Permissions to LNG Projects on or about the date the Minister’s Determination is issued. |
The Minister will grant the initial permissions to an LNG project no less than 30 days before the domestic shortfall quarter commences. This may be followed by the granting of additional permissions, or variations to permissions. |
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An Export Permission will generally specify that it may be assigned to another person with the written consent of the Resources Minister or an authorised person. This is intended to allow an LNG Exporter to transfer its Export Permission to another party where circumstances permit. If the Resources Minister or an authorised person consents to the assignment of an Export Permission, the conditions of the Export Permission may be varied as appropriate in the circumstances. |
A permission can be traded on and from the date it is issued. |
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Where the Minister determines a year as a domestic shortfall year, export controls will apply Australia wide (rather than just to the part of the Australian domestic gas market which is identified as being in shortfall). |
Export controls apply Australia-wide. |
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The Minister will calculate a Total Market Security Obligation (TMSO) in respect of a shortfall year. The TMSO is the proportion of the Australian domestic gas market shortfall that the Minister considers is attributable to LNG Projects that are in net-deficit and should be met by imposing export controls on those LNG Projects, to incentivise them to increase net gas supply to Australian consumers. The key issue for consideration in determining whether an LNG Project is in net-deficit is whether it sources gas for processing in its LNG facility from the domestic market rather than from tenements which were developed primarily to supply the particular LNG Project (whether those tenements are owned by the LNG Project or by third parties). The TMSO is then allocated pro-rata across all LNG Projects in net-deficit in proportion to the quantum of the LNG Project's deficit. The proportion allocated to a net-deficit LNG Project is its Exporter Market Security Obligation (EMSO). Unless notified otherwise by the LNG Project, the approved export volume for an LNG project will be allocated to each project participant in proportion to its participating interest in the project. Maximum exports under an export permission will typically be equal to an LNG Project’s EMSO subtracted from its proposed total export quantity. LNG projects 'will be permitted to meet their EMSO by reducing their export quantities, or making additional gas available to the domestic market'. |
Where the Minister determines a quarter as a domestic shortfall quarter, all LNG Exporters will receive one of two types of permissions, which enables a distinction between those LNG Exporters within the shortfall market, and those in other domestic gas markets. |
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The Minister may grant a UV permission to one or more LNG Exporters associated with an LNG Project that is physically unconnected to the part of the Australian domestic gas market that is experiencing a shortfall (eg it is located in a separate gas market). |
UV Permissions may be granted to an LNG project that is in a part of the Australian domestic gas market where Australian consumers are unaffected by the shortfall. |
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An AV permission may be granted to all LNG Projects connected to the parts of the Australian domestic gas market experiencing a shortfall. |
AV Permissions will be granted to projects not granted UV permissions. |
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Maximum exports under an AV permission will typically be equal to an LNG Project’s EMSO subtracted from its proposed total export quantity. |
The allowable volume in an AV permission will be:
The shortfall alleviation contribution is:
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The Minister may grant an Export Permission to an LNG Exporter subject to whatever conditions they deem necessary and appropriate. If an LNG Exporter does not comply with a condition attached to its Export Permission, then the Minister may do one or more of the following:
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The Minister may grant a permission to an LNG project subject to whatever conditions the Minister deems necessary and appropriate. If an LNG project does not comply with a permission condition, the Minister may in writing:
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The Minister will notify each LNG Project and LNG Exporter of a provisional Export Permission based on the Minister’s assessment of each Project’s net-market position. |
Not specifically addressed, however states that the Minister will grant the initial permissions to an LNG project no less than 30 days before the domestic shortfall quarter commences. |
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Where practical, the Minister will provide LNG Projects and LNG Exporters with 30 days to comment on the type of Export Permission the Minister proposes to grant, including (if applicable) the proposed volume allowance and any conditions the Minister proposes to apply to the Export Permission. At the conclusion of the 30-day consultation period, having regard to any comments received from LNG Projects and LNG Exporters, the Minister will issue Export Permissions to LNG Exporters. |
If the allowable volume in an AV permission is less than the LNG project’s long-term contract gas (ie the minimum supply volume under a contract which underpinned FID), the LNG project may apply to the Minister to increase the allowable volume in the AV permission. When considering an application to increase the allowable volume in an AV permission, the Minister will only consider the following criteria:
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Footnotes
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Customs (Prohibited Exports) (Operation of the Australian Domestic Gas Security Mechanism) Guidelines 2023, s 7.
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Ibid ss 9(8) – (9).
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Securing Australian domestic gas supply | Department of Industry, Science and Resources.
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Securing Australia’s domestic gas supply (storage.googleapis.com).
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Customs (Prohibited Exports) (Operation of the Australian Domestic Gas Security Mechanism) Guidelines 2023, s 10(1).
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Ibid s 10(3).
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Ibid s 10(8).