Australia needs a windfall profit tax on gas producers

This should have been done in 2022 when the Russian invasion of Ukraine caused the last price shock.

Such a tax should be levied at the rate of 100 per cent of revenue on sales above, for example, the average domestic contract price for the last 12 months. In effect it will deter the opportunistic pricing and would not be expected to raise any significant revenue for the government. Real emergencies, such as occurred in 2022, would justify exemptions to the tax. The producers will receive commercially acceptable revenue on domestic sales and will be free to earn whatever windfall profits they can on exports.

And this measure should be an ongoing backstop in a world where destabilisation is the new norm.

Equally urgently, the Government needs to settle on an effective design for the domestic gas reservation scheme it announced in December — before the Iran war — in a bid to ensure Australians have access to the gas we need at affordable prices.

Australia began exporting liquefied natural gas (LNG) from Queensland more than 10 years ago. The result has been that about three-quarters of east coast gas production is exported. Since then, justifiable concerns have arisen that LNG exporters are drawing excessively from the domestic market and exposing Australian gas users to what have become high and volatile international prices.

Successive policies introduced by the former Coalition and current Labor federal governments ensured that the domestic market has been supplied, despite falling production from offshore Victoria. The most recent intervention, after the beginning of the war in Ukraine, was to impose a $12/GJ cap on the price of gas supplied to the domestic market. Exemptions have meant that domestic contract process haven’t fallen that low, but sit around $14 – partway between the international prices and the price cap.

The Government’s decision to move to a gas reservation scheme is driven by frustration that earlier interventions have not delivered the desired results with prices remaining higher than consumers or governments want. The reservation scheme is intended to ensure that a country blessed with enough gas to be a major global exporter also supplies domestic needs at a reasonable price.

This should be a no brainer – and yet there is intense debate about how this mechanism should be designed, and no detailed model has yet been proposed.

The central concept is that LNG exporters will be required to reserve and supply a specific proportion of their planned LNG production to slightly oversupply the domestic market, before they will be granted a licence to export. The government has committed to respect existing contracts, but the scheme will cover new contracts and extensions initiated after the date that the scheme was announced in December.

Grattan Institute has identified two main problems with the government’s proposal, and we have outlined a model to address those problems and meet the government’s objectives.

The first problem is that deciding the domestic market will get a fixed percentage of production is both arbitrary and static in a rapidly changing market. Supply and demand are both expected to move a lot over the next few years.

The second problem is that reserving enough gas on the east coast to drive down the price significantly is also highly speculative and assuredly will lead to over or under supply.

A better solution would be based on the following design elements:

• An annual Domestic Gas Supply Obligation (DGSO) should be determined by a scheme regulator based on best forecasts of the balance of demand and supply.
• The DGSO should include a modest volume above any projected shortfall, to create downward pressure on prices.
• The DGSO should be allocated to the individual LNG exporters based on their total planned LNG production.
• Licences should be required for exports above the current long-term contracts and should be issued only when the exporters have demonstrated that they have covered their DGSO with contracts.
• To provide reasonable certainty for buyers and sellers in the domestic market, the DGSO should be based on a forward projection of three-to-five years, with the first year being firm and the later years subject to annual updates and rolled forward every year.
• The regulator must be able to impose appropriate penalties for breaches of the DGSO.

A detailed model built on our proposal could provide the clear and predictable market arrangements under which buyers and sellers could make their long-term investments with confidence.

Beyond the Iran and Ukraine conflicts, there will almost certainly be another international gas price spike sooner or later. When that happens, we will be glad to have a super-profits tax, and a well-designed reservation scheme.