Submissions close next week 8 min read
With the recent release of the final Australian Domestic Gas Security Mechanism Guidelines and a consultation paper and exposure draft regulations on the proposed Mandatory Code of Conduct for the East Coast Gas Market, we look at their key elements and potential impact on industry participants.
Key takeaways
- The Federal Government's willingness to intervene in the domestic gas market in light of potential supply challenges continues. Market participants should be on notice for any additional changes going forward, particularly in the event of any domestic gas shortfall.
- The proposed Mandatory Code of Conduct for the East Coast Gas Market (the Code of Conduct) and the final Australian Domestic Gas Security Mechanism Guidelines (the Final ADGSM Guidelines) include some incremental protection for producers, compared with the original proposals. However, we expect that these protections will not entirely alleviate gas producers' concerns.
- Significantly, the proposed Code of Conduct extends the $12/GJ price cap on Australian gas supply (initially proposed to remain in place for one year only) until 1 July 2025.
- Both the Code of Conduct and Final ADGSM Guidelines remain limited in application to the east coast of Australia.
- Submissions on the proposed Code of Conduct close on 12 May 2023, with large producers invited to make them by 8 May 2023 on the supply and price commitments they would be prepared to make in the context of the proposed exemption framework .
Mandatory Code of Conduct for the east coast gas market
In December 2022, it was announced that a Mandatory Code of Conduct was to be prepared for the east coast gas market to 'facilitate a well-functioning … market with adequate supply at reasonable prices and on reasonable terms for both producers and consumers'. The Government has now released a consultation draft of the Code of Conduct, with large gas producers being requested to make submissions by 8 May 2023 in relation to the supply and price commitments they would be prepared to make in light of the proposed exemption framework. Other submissions on the consultation draft of the Code of Conduct are due by 12 May 2023.
The key elements of the proposed Code of Conduct are summarised below.
The gas price cap will be continued until at least 1 July 2025. It is initially set at $12/GJ and will be reviewed by 1 July 2025. The Australian Competition and Consumer Commission (the ACCC) will be responsible for setting future prices. It was originally proposed that the price cap would remain in place for one year only.
Some conditional exemptions to the price cap are available:
- at the discretion of the Minister for Climate Change and Energy and the Minister for Resources (acting jointly), to large producers (ie those who produced at least 100PJ of gas in the preceding financial year) and small producers who supply some of their supply for export, who have given satisfactory voluntary enforceable domestic supply commitments. This goes further than the existing Heads of Agreement with east coast LNG producers, which requires producers to offer (rather than supply) gas; or
- automatically, to small producers (ie those who produce less than 100PJ of gas in the previous financial year) who exclusively supply the domestic market.
However, it is not clear to us whether, in actuality, these exemptions will provide a great degree of practical comfort to producers. Buyers may be unwilling to pay higher prices for gas from these producers if it is available from others for a price of $12/GJ or less, and so, in reality, all gas prices may be limited to $12/GJ. It is also not clear from the exposure draft regulations or the consultation paper whether production is measured across a corporate group or on an entity by entity basis, nor is it clear whether production is measured from east coast projects only.
Mandatory 'conduct requirements' have been introduced, which establish minimum conduct and process standards for commercial negotiations. These standards apply for sales involving a tender process with buyers being invited to make expressions of interest to purchase gas (EOI processes) and general bilateral negotiations. These conduct and process standards have the potential to significantly impact upon both producers' and buyers' commercial discretion in relation to negotiations, insofar as they regulate not only what the price must be but also the framework within which commercial negotiations take place.
EOI processes: The requirements applying to EOI processes include:
- mandatory publication of EOIs on producers' websites, which must include details in relation to proposed volume and period of supply, delivery point, tenement information, and other key terms and conditions;
- a minimum 20 business day 'EOI open period'; and
- a maximum 25 business day 'EOI response period'.
General requirements: The following requirements apply to both EOI processes and bilateral negotiations instigated outside of an EOI process:
- a requirement to make an 'initial offer', which would not constitute a full executable gas supply agreement, but rather form the basis of subsequent negotiations. An 'initial offer' must remain open for a minimum of 15 business days, and must include details in relation to the quantity of gas proposed to be supplied, intended degree of flexibility in determining that quantity, time period over which gas is proposed to be supplied, proposed delivery points, price and whether the producer intends to provide transportation or storage services;
- an 'initial offer' may not be withdrawn by a producer unless the buyer decides to withdraw from negotiation, there is mutual agreement between producer and buyer to end negotiations, or the producer cannot reasonably continue with the sale as a result of a material change in its circumstances such that the regulated gas in the EOI could not be supplied in the proposed time period; and
- mandatory requirements also apply to issuing a 'final offer' in relation to contracts of 12 months of longer, including:
- a producer must issue a final offer within 30 business days after a buyer confirms it wants to receive one;
- the final offer must contain information in relation to the quantity of gas intended to be supplied, the terms and conditions in determining that quantity, the intended degree of flexibility in determining that quantity, the time period over which the gas is intended to be supplied, the price and any price escalation mechanisms, any intended transportation or storage services to be provided, circumstances in which the terms of the agreement may be varied and procedures for resolving disputes;
- a minimum time period of 15 business days within which a buyer must accept the final offer or seek further negotiation; and
- a requirement that a producer not withdraw a final offer unless there is mutual agreement to do so, the buyer decides to withdraw or the producer cannot reasonably continue as a result of a material change in its circumstances such that the gas could not be supplied and the producer has made reasonable efforts to make the supply possible, or a material change in the producer's financial circumstances or business structure that will affect supply and it has made reasonable efforts to make that supply possible.
The proposed requirements (particularly in relation to timing) for the making of initial offers and final offers significantly constrain the commercial discretion of both producers and buyers. We anticipate strong feedback to be provided by industry through the consultation process, as we expect that regulatory intervention in commercial negotiation processes will be seen by many as a step too far.
The consultation draft of the Code of Conduct also proposes a severe penalty regime, to be enforced by the ACCC, to ensure compliance with the Code of Conduct and the conditions of any supply commitments entered into by producers. Maximum penalties for breaches of the Conduct of Conduct are $2.5 million for individuals and, for companies, the greater of:
- $50 million;
- if the court can determine the value of the benefit obtained, three times the value of that benefit; and
- if the court cannot determine the value of the benefit obtained, 30% of the body corporate's adjusted annual turnover during the breach turnover period of the offence, act or omission.
Finally, the consultation draft of the Code of Conduct proposes to introduce a requirement for gas producers to publish details about available uncontracted gas, including information relating to when this gas will be brought to the domestic market.
Key changes to the ADGSM since publication of the Draft Guidelines
While the draft ADGSM Guidelines published on 9 February 2023 represented a substantial shift in the operation of the ADGSM from previous iterations, the amendments made in the Final ADGSM Guidelines are incremental rather than substantial. The key changes are that some additional protections are provided to long-term contracted LNG, and that the Minister's consultation remit is slightly clarified so that LNG tollee exporters may also be consulted.
In summary, the key changes to the draft Guidelines are as follows.
- More detail has been provided in relation to the protection contemplated in the draft Guidelines for long-term contracts that underpinned a final investment decision for an LNG project, with provision made for LNG projects to write to the Minister seeking recognition of their protected long-term supply agreements. Following a request from an LNG project, if the Minister determines the relevant agreement to be a protected long-term contract, they will cause Schedule 2 of the Final ADGSM Guidelines to be updated to reflect details of the contract, including the LNG project, its buyer, and the long-term contracted gas under the agreement. It is unclear whether LNG producers will be comfortable with details in relation to their long-term contracted gas volumes being made public through inclusion in the Guidelines.
- Further clarity has also been provided in relation to how the minimum supply volume under a protected long-term contract is determined, with the relevant test being whether or not the LNG project has discretion to supply a volume in the relevant period. For example, if a buyer exercises optionality to increase volumes under a contract and this is accepted by a seller, the increased volume will be counted towards the minimum supply volume under that protected long-term contract.
- The Final ADGSM Guidelines also explicitly allow the Minister to consider the likely impact on Australia's reputation as a reliable trade and investment partner when deciding whether or not to increase an allowable volume export permission. While this may provide some comfort to LNG producers and buyers, the Minister will also consider the economic and social impact of a projected shortfall, and it can be expected that those domestically focused considerations may well be more heavily weighted as part of that consideration process.
Actions you can take now
- Large gas producers that will be impacted by the Code of Conduct should familiarise themselves with the draft Code and make submissions by no later than 8 May 2023.
- LNG producers should consider writing to the Minister to seek recognition of the long-term contracted LNG under their key LNG sale agreements that underpinned final investment decisions.
- All gas producers should consider what mechanisms need to be put in place to ensure compliance with the Code of Conduct.
- Market participants should continue monitoring the Federal Government's announcements in case of any additional regulatory action .
Please contact any of the people below if you need advice, or require more information about the Government's recent regulatory intervention in the domestic gas market.