21 December 2006
Key Points:
A balance needs to be achieved to meet international demands and domestic requirements.
In February 2006 the Western Australian Government released a consultation paper titled "WA Government Policy on Securing Domestic Gas Supplies". The Consultation Paper proposed that 15% of future gas production in WA should be reserved to meet growing domestic needs ("Proposal"). The Consultation Paper called for responses from relevant stakeholders and response has been mixed. We take a look at the Proposal and some of the responses below.
Policy rationale
WA has approximately 80% of Australia's total gas reserves, however, even with these significant reserves, WA is facing significant obstacles in meeting its domestic gas needs.
The Consultation Paper identifies the following three major obstacles:
Also, any current benefits which flow from these gas projects into WA are because LNG processing takes place onshore, so the emergence of offshore floating processing plants may impact on these benefits. The only way the WA Government is able to secure domestic gas reservations is through State agreements covering onshore processing of gas.
The State agreements granting the required approvals for the North West Shelf Gas project ("NWS") on-shore processing plants required a fixed amount of the gas reserves to be set aside for domestic purposes. This created an incentive for gas to be sold into the domestic market, even when the price obtained was less than that obtainable for exported LNG, because the gas would otherwise have been left in the ground, providing no return at all.
The domestic reservations under the NWS agreements have been used, and with the recent escalation in demand (and prices), there is little incentive for the NWS joint venturers to sell into the domestic market. Also before any new agreements going beyond 2010 are entered into, the NWS joint venturers must obtain ministerial approval, providing some opportunity to meet demand, however the WA Government's position is that without being able to reserve any more gas from the NWS effectively, WA faces the risk that, without any new major sources, prices could rise significantly which would have an adverse effect on the WA economy.
The WA Government suggests that in the climate of growing international demand, where financial returns are greater, domestic gas supplies need to be ensured. Having a clear position should ensure consistency for joint venture parties as well certainty for future investors and WA gas users.
Operational framework
The Consultation Paper highlights that in order to meet the growing demand for domestic gas in WA, up to 2 Tcf of gas will need to be sourced from existing and proposed export gas projects. The issue for the government, as outlined in the consultation paper, is the method to be used to ensure supply will meet domestic demand, while creating certainty for investors, and at the same time being equitable to project participants.
A market forces approach to the supply of domestic gas would need to factor in the higher prices for LNG on the export market and the high cost of setting up appropriate infrastructure in light of the small, but essential, demand from the domestic gas market. The WA Government argues that leaving the supply of gas up to the market will expose the economy to risk and uncertainty as to the long term supply of gas, and that in the alternative WA Government intervention is preferred to avoid such uncertainty.
The possible mechanisms for reserving gas outlined in the Consultation Paper are for:
The Consultation Paper outlines the merits and otherwise of each of the proposals, with key considerations being the certainty to producers, government, and investors; as well as the need to be equitable, with the fixed proportion approach being preferred.
Stakeholder responses
The response to the Consultation Paper has been mixed. One of the most significant arguments against the proposal is that it will place into doubt the viability of any future large scale projects. For example, it was widely reported that the proposed Pluto project was in jeopardy after the project parties were advised to factor in a 15% reservation policy. Negotiations on this are continuing, however it is the need to enter into such negotiations that some have argued will stall projects and diminish the attractiveness of WA as a place to do business. Other responses have indicated a preference for allowing the market to determine the response, arguing that the market will find its own way to meet the demand, stimulating investment in domestic projects. Also of significance was the suggestion that the reservation policy acted as a tax, creating constitutional and taxation implications.
Another point of view is that the reservation policy will be good for local business as it ensures supply to domestic users, which is fundamental to maintaining the strength of the WA economy. However, the main contention in opposition to the proposal is the potential for market distortion and the effects that this will have on the competitiveness of Australian gas both intentionally and domestically. It is argued that government regulation will reduce incentives and jeopardise investment in developments for the local gas market, while stalling progress and investment on larger developments.
Conclusion
The challenge is on the WA Government to provide an appropriate solution that meets the expectations of all stakeholders. With the issue generating significant debate, and a divergence of opinions, it is unclear how the Government will achieve this. With increasing international demand, and Australia's access to abundant natural resources, we are well placed to enjoy the economic rewards for a while yet, but a balance needs to be achieved to meet international demands and domestic requirements.
We will keep you updated as to any developments in this field.
For further information, please contact Emma Covacevich.
