Energy > AG Speaking Energy > Everything You Need to Know About the Australian Domestic Gas Security Mechanism—What Does This Mean for Australian LNG Exporters and Corporations Importing from Them?
28 Jun '17

The Australian Domestic Gas Security Mechanism at a Glance

On June 5, 2017, the Australian government released draft amendments to the existing Customs (Prohibited Exports) Regulations 1958 (the “Amended Regulations”) that proposes a mechanism (the Australian Domestic Gas Security Mechanism or ADGSM) that calls for liquefied natural gas (LNG) export control restrictions in circumstances where the Resources Minister reasonably believes that there will not be sufficient gas supply for the Australian domestic market in any given year.

The ADGSM – When and Why?

The ADGSM is expected to be effective from July 1, 2017, with a five-year sunset clause (until January 1, 2023). There will be a review in 2019 to assess the overall effectiveness and efficiency of the ADGSM against its stated objectives.

The ADGSM is designed to be a short-term, targeted solution to ensure security of the gas supply at an affordable price. Many have seen this as a response to national energy security concerns as a result of the surging domestic gas price in Eastern Australia, evidenced by an 80 percent price increase over the past 18 months. LNG exporters drawing gas (in net terms) from the domestic market are therefore required under the ADGSM to limit export or find offsetting sources of new gas.

The Declaration – Consultation – Determination Process

Under the ADGSM, LNG export restrictions will be imposed in only a “domestic shortfall year.” In order to arrive at such a conclusion, the Resources Minister will have to:

  • formally issue a declaration to announce his/her intention to consider whether the forthcoming year will be a domestic shortfall year (the “Declaration”)
  • consult relevant market bodies, government agencies, potentially impacted industry players, other relevant Australian government ministers and other stakeholders to seek their view on the then-current and forecast gas market conditions and any potential for a gas market shortfall (the “Consultation”)
  • if he/she has reasonable grounds to believe that there is a domestic gas market shortfall after the Consultation, make a determination that gas export controls will apply in a particular year (the “Determination”).

The Declaration – Consultation – Determination process follows a statutory timeline. The Declaration should be issued before October 1, and the Determination has to be made no later than November 1 of the year preceding the domestic shortfall year.

Export Permissions in a Domestic Shortfall Year – the Licensing Regime

In any given domestic shortfall year, export controls will apply. Under the ADGSM, this means that LNG export activities are prohibited across Australia (even though the shortfall exists in only certain parts of the country) without an Export Permission. An Export Permission will take the form of either an Unlimited Volume Export Permission (a “UV Permission”) or an Allowable Volume Export Permission (an “AV Permission”).

UV Permission. This will typically be granted to an LNG project that is a net contributor to the domestic gas market and that is unable to deliver gas at a reasonable price to a market experiencing a shortfall. A UV Permission allows for the export of an unlimited volume of LNG from a particular project over the market shortfall year.

AV Permission. This will typically be granted to an LNG project connected to markets experiencing a shortfall, including an LNG project that is in net deficit to the domestic gas market. An AV Permission will set a maximum LNG volume that can be exported from a specific project over the market shortfall year. The maximum amount would customarily represent the difference between the in-net-deficit exporter’s forecast total export quantity and its allocated share of/contribution toward the gas shortfall amount to be met by export controls as determined by the Resources Minister under the ADGSM.

Net Market Position of an LNG Project. In any given domestic shortfall year, the Resources Minister will determine whether each LNG project is a net contributor to, or in net deficit to, the domestic gas market, based on its upstream tenements. According to this classification, different LNG projects will be entitled to a different type of Export Permission in such a domestic shortfall year. An LNG project is in net deficit if:

  • its total gas used is greater than the sum of gas produced by upstream tenements (i) owned by the LNG project, (ii) owned by the LNG project or third parties and is contracted directly to supply the LNG project and primarily developed for exports purposes, and (iii) owned by third parties and is contracted directly to supply to the LNG project and the contract was entered into before a final investment decision was made in relation to that LNG project or
  • its gas purchases from the domestic market are greater than its gas sales to the domestic market.

Conversely, if an LNG project is not in net deficit, it will be regarded as a net-contributor LNG project.

Enforcement of the Licensing Regime Under the ADGSM

Under the Amended Regulations, noncompliance with a condition of an Export Permission may lead to a revocation of the Export Permission. Alternatively, the Resources Minister may grant a replacement Export Permission with different conditions attached, such as granting a lesser LNG export volume or imposing a stricter information reporting requirement.

Implications for Australian LNG Exporters

  • The ADGSM is of nationwide application. If a given year is determined to be a domestic shortfall year, all LNG exports will be prohibited, unless exported in accordance with an Export Permission, and all in-net-deficit LNG projects will be allocated a gas shortfall amount that will be counted toward the reduction in the allowable LNG export volume in the relevant exporter’s Export Permission. As such, an in-net-deficit exporter located in a gas surplus region (e.g., Western Australia) will still be affected, since the ADGSM will impose on it an obligation to offset a portion of the country’s gas shortage amount to be met by export controls. Conversely, if an LNG exporter is classified as a net contributor, regardless of where it is situated geographically, it is still very likely to be granted a UV Permission and therefore can export an unlimited volume of LNG from gas produced from its upstream tenements even in a domestic shortage year.
  • The Rise of Resource Nationalism. The ADGSM follows a new wave of resource nationalism around the Asia-Pacific region in the name of national energy security. Earlier this year, Indonesia banned exports of unprocessed copper ore in a mining dispute, and the Philippines restricted open pit mining and curbed nickel ore shipments. It remains to be seen whether the ADGSM will be an effective means to deal with the gas shortage in Australia or whether it would be a mechanism adding complications and uncertainty to the Australian domestic gas market. The enforcement of the ADGSM also has some clear World Trade Organization (WTO) and Australia-U.S. FTA angles, since countries are generally prohibited under these trade rules from restricting imports/exports except through duties. While (albeit limited) exceptions do exist in the WTO for purposes of preservation of natural resources and ensuring domestic supply, with respect to the former, there is recent WTO case jurisprudence (e.g., China—Measures Related to the Exportation of Rare Earths, Tungsten and Molybdenum (WT/DS431-433)) that make clear that such restrictions are permissible only if there are also effective restrictions imposed on domestic production and consumption. With respect to the latter, countries would essentially have to establish that the restricted products are “critical” to the exporting country and that the restrictions are “temporary” for the stated purpose only. Finally, while the ADGSM hints at potential national security concerns, it is unclear whether this is, in fact, an argument being put forward by the Australian government, since such positions—while mostly self-judging—will only encourage other trading partners to arbitrarily invoke the same with respect to certain of their export products.
  • Wide Government Discretion in the Decision-Making Process. The ADGSM contains two decision points: the Resources Minister’s determination that (i) a particular calendar year shall be classified as a domestic shortfall year, and (ii) an Export Permission shall be granted to a particular LNG exporter during such a domestic shortfall year. In each case, even though the Resources Minister is obliged to consult various stakeholders in the industry and across the government within certain statutory time frames, he/she has considerable discretion during the decision-making process. The consultation period may be as short as 30 days before the Resources Minister can formally announce such radical export control measures with far-reaching implications.
  • Ability for LNG Projects to Adjust Commercial Operations in Response to Government Decisions. Under the ADGSM, the Declaration process will be made prior to October 1, and the Determination process will be made no later than November 1 of the year preceding the domestic shortfall year. In addition, the Resources Minister may, at any time, revoke his/her decision that a particular calendar year is a domestic shortfall year. LNG projects may not have sufficient time to adjust commercial operations around these government decisions/determinations, which may eventually lead to an even more volatile gas market domestically.
  • Implications on LNG Supply Obligations Under Long-Term Offtake Arrangements. Most Australian LNG volumes are exported under long-term supply contracts, where failure to supply in a non-force majeure scenario triggers a seller obligation to procure replacement LNG cargoes with incremental costs borne by the seller. Although “acts or omissions of a Government Authority” are often within the scope of a “force majeure” event, a failure to supply resulting from the lack of economically recoverable reserves from a seller’s upstream tenements would (under most long-term LNG supply contracts) disqualify a force majeure argument. This suggests that a force majeure argument would be difficult to raise in response to an export restriction imposed under the ADGSM, meaning that any LNG exporters that cannot meet their LNG export obligations will need to procure replacement LNG cargoes and incur any incremental replacement costs. How significant these shortfall amounts will be as a result of the application of the ADGSM remains to be seen, but some analysts have suggested that the impact will be limited to Australian suppliers having to buy just one or two additional cargoes a year to make up the shortfall.1

1  https://www.ft.com/content/73c11a9c-2bf0-11e7-bc4b-5528796fe35c