Federal Government releases review of the Australian Domestic Gas Security MechanismJan 2020 | Energy & Resources
In response to concerns associated with rising prices for the domestic supply of natural gas, coupled with concerns about potential supply shortfalls, the Malcolm Turnbull led Coalition Government introduced the Australian Domestic Gas Security Mechanism (ADGSM) with much fanfare in July 2017.
The ADGSM gives the Federal Minister the power, via the Customs Act 1901 (Cth), to restrict exports of liquefied natural gas (LNG) in a 'domestic shortfall year'. A domestic shortfall year is one in which it is considered that:
- there will not be a sufficient supply of natural gas for Australian consumers during the year unless exports are controlled; and
- the exports of LNG would contribute to that lack of supply.
Since the introduction of the ADGSM, the Minister has engaged the mechanism’s investigative powers, but has not enlivened export controls by declaring a domestic shortfall year. In late 2017, however, the Federal Government and east coast LNG exporters signed a Heads of Agreement committing the exporters to, among other things:
- not offer gas for export until it has been offered for sale domestically; and
- offer uncontracted gas to the domestic market, on reasonable terms, in order to meet any shortfall; and
- discuss with, and provide information to, AEMO and the ACCC on issues regarding the market balance and sales of gas.
The ADGSM regulations require a review of the ADGSM during 2020. The review is required to assess the ADGSM against a number of terms of reference, including:
- the effectiveness and efficiency of the ADGSM in ensuring a sufficient supply of natural gas for Australian consumers with minimum disruption to Australia’s natural gas export industry;
- whether improvements can be made to the ADGSM, and whether there are appropriate alternatives; and
- whether the ADGSM should be repealed.
In August 2019, the government announced its decision to bring the review of the ADGSM forward. Although the ADGSM can be applied nationally, in light of the fact that only the east coast gas market has experienced recent supply concerns, the review focussed on this market.
The findings from the review of the ADGSM were published by the Department of Industry, Innovation and Science on 24 January 2020.
In releasing the review, the Minister for Resources and Northern Australia, the Hon Matt Canavan, said '[that it] confirms the measures taken by the Government in 2017 have been instrumental in stabilising the domestic gas market and keeping a lid on gas prices'.
Submissions to the review ranged from the general view of gas producers that the ADGSM is no longer required, to calls from domestic consumers that greater intervention is required.
While noting that there has been continuous change in the eastern gas market since the introduction of the ADGSM, the review states that 'given the aim of the ADGSM is to ensure sufficient supply of gas to domestic markets and that, to date, no gas shortfalls have eventuated, the ADGSM should be considered as largely achieving its objective'.
The review points to the ADGSM and the Heads of Agreement signed in 2017 as factors behind the elimination of the shortfalls in the east coast gas market originally predicted by AEMO.
The review also claims that the ADGSM has played a role in lowering domestic gas prices. According to the review, offers of supply are now being made at prices that are approximately half of the peak prices that were seen in 2017 prior to the introduction of the ADGSM.
The review nevertheless acknowledges that the gas market is complex and can be affected by a range of factors, making it difficult to determine with any level of specificity the effectiveness of any single factor. The overall conclusion appears to be that the ADGSM can be credited at least in part for the improvement in gas market conditions.
AEMO’s 2019 Gas Statement of Opportunities projected an increase in production on the east coast and the Northern Territory from 1818 PJ in 2018 to 2072 PJ in 2021.
The review points to a number of developments since the implementation of the ADGSM that have contributed to the improvement in the long term outlook for the east coast markets, including:
- the removal of the moratorium on exploration and hydraulic fracturing for onshore gas by the Northern Territory Government in the Beetaloo Basin;
- the development of the Northern Gas Pipeline connecting the Northern Territory to the eastern gas market;
- development of the Reedy Creek to Wallumbilla Pipeline, the Atlas Gas Pipeline, and the Galilee Gas Pipeline (which is expected to open in 2022); and
- the release of tenements dedicated to domestic supply by the Queensland Government under its Prospective Gas Production Land Reserve (PGPLR) Policy.
The review highlights AEMO’s forecasts that supply will meet demand until 2023, but notes that concern remains about declining production in southern gas fields and potential constraints in north-south pipeline capacity.
The review makes three key recommendations in respect of the ADGSM.
Firstly, the review notes that while there has been improvement in the eastern gas market, longer term concerns remain. Accordingly, the review recommends that the ADGSM be retained until its prescribed sunset date of 2023.
From an effectiveness standpoint, the second and third recommendations of the review are:
- a change to the calculation of the Total Market Security Obligation (TMSO) to ensure the ADGSM can recover sufficient domestic gas to address any shortfall; and
- an amendment to the guidelines to expressly reference the ACCC’s LNG netback pricing series as a factor to be considered in determining a shortfall.
In a domestic shortfall year, each LNG export project is assessed to determine its 'net market position'. This is expressed to be a measure of whether a project is drawing from, or adding to, the quantity of gas in the relevant market.
A project will be considered to be in 'net deficit' if the total gas used for export is greater than the sum of its 'own gas' (including gas produced by the projects participants), and 'third party export compatible gas' (including gas contracted to the export project where that gas was developed for the purpose of supplying the export market).
The TMSO is that part of a gas shortfall in a market that the Minister considers is attributable to LNG export projects that are in net-deficit. Export restrictions are imposed only on those projects assessed to be in net deficit, in proportion to the deficit for each project.
The review identifies a concern that, as currently designed, the TMSO may not be able to recover sufficient domestic gas to address a shortfall. The review recommends consideration be given to a hybrid arrangement such that:
- half of any identified shortfall be allocated to LNG projects on a pro-rata basis according to their LNG production capacity; and
- the remaining half of any shortfall be 'split in a way that is inversely proportional to the domestic gas contributed by each project'.
The report stipulates that any change to the TMSO would be developed in consultation with industry and other affected stakeholders to avoid unintended consequences.
ACCC LNG netback price
The ACCC commenced publishing its LNG netback price series in 2018 as one of the measures to improve transparency of gas prices in the eastern market. The series is calculated by taking the Asian LNG spot price and subtracting the costs of getting the gas from Australia to its destination (including the costs of pipeline transportation to the LNG plant, liquefaction and shipping).
The review contends that while the ADGSM is not, and should not be, a mechanism to control price, if prices paid by domestic gas users is significantly higher than the ACCC’s LNG netback price, this would serve as an indication that the domestic gas market is not operating efficiently.
Accordingly, the review recommends that the guidelines be amended to include express reference to the ACCC’s LNG netback price series as a factor for consideration when assessing the likelihood of a shortfall.
The price trigger
In the lead up to the 2019 federal election, the Australian Labor Party campaigned in support of a change to the ADGSM to include a price trigger. A number of submissions to the review were made promoting the inclusion of some form of trigger which would enliven the mechnaism if domestic pricing were to either exceed a pre-determined fixed price, or becomes too expensive relative to international pricing benchmarks.
In contrast, a number of problems associated with a pricing trigger were identified by the review, including supply issues potentially caused by suspension or cancellation of high-cost production. Further, the review noted that a price trigger cannot guarantee that a targeted price level will be achieved. Prices would still be influenced by market forces outside the control of the ADGSM.
Various submissions also pointed to non-price factors such as ‘take-or-pay’ percentages, transportation arrangements and other contract terms that vary between gas providers and consumers that may impact pricing, making it difficult to compare domestic and international pricing.
These difficulties in comparing international pricing and domestic gas prices were considered, as was the potential impact on Australia’s standing as a reliable LNG supplier. Investors may be deterred by changes to regulatory or operating frameworks (such as the introduction of a price trigger) that undermine the certainty or stability of long term investments.
Ultimately, the review recommends against introducing a price trigger to the ADGSM.
The Federal Government is now likely to engage with impacted producers and exporters on implementing the review’s recommended changes to the ADGSM.
In addition, separately to the review of the ADGSM, Minister Canavan has indicated his desire to 'work with the States and Territories over the next 12 months' to consider options available to implement a national gas reservation policy.
Instead of securing domestic gas supply only in certain circumstances (courtesy of the ADGSM), a gas reservation policy would require a portion of eastern Australia’s gas supplies to be set aside for domestic use at all times (similar to the reservation policy already implemented in Western Australia).
While the Federal Government has resisted calls for a reservation policy to date, there is increasing support for the implementation of a prospective policy from regulators, politicians, gas users and certain parts of the oil & gas industry.
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