The gas reservation plan just might work

The document is convoluted, populated with apparent inconsistencies, and will lead to a high level of ongoing government intervention in the gas market. But it also contains elements that, with genuine consultation, could address the major concerns of producers and consumers.

The government began considering the viability of an east coast domestic gas reservation scheme in mid-2025, made a commitment before Christmas, and has now formally released a design framework. The aim is to impose a domestic supply obligation (DSO) on all Australian LNG producers, set at a level designed to deliver lower prices by oversupplying the domestic market.

Over the past few months LNG producers have declared their opposition to several basic principles of the government’s proposed reservation scheme. The producers claim that the proposed DSO of 20 per cent of LNG production would grossly oversupply the market, destroy the producers that solely supply the domestic market, and represent a breach of faith with the government’s assurances that existing long-term export contracts will not be affected.

The design has not addressed these concerns directly and is very loose in the way it describes the key mechanisms that will be used to create a regulated market that tries to emulate an active, competitive market. The veracity of these concerns will be tested during the consultation process that will run through to the end of June. But two major concerns can be identified and considered ahead of that process.

While the scheme will be legislated to apply nationally, most of the focus will be on the east coast market. The intent is for the DSO to be set at 20 per cent of LNG production. Based on current data, that would be more than 250 petajoules per year. The east coast domestic market consumes about 500 petajoules a year, and annual shortfalls of 10-30 petajoules have been met in recent years from the LNG producers’ production capacity above their long-term contracts. The design allows for ministers to adjust the annual DSO requirements to avoid a significant oversupply of more than about 10 per cent of consumption. This is a reasonable principle that would address a major criticism and should be codified, although it is puzzling why modest oversupply isn’t used to set the DSO in the first place.

The second key design element is to provide for the regulator to vary the DSO within a regulated year if the market is adequately supplied and the regulated entities have met obligations for transparency, liquidity and making gas available on reasonable terms. In principle, this could also be workable, but the language surrounding the market conditions and how much gas would be released for export will need to be more definitively codified to give buyers and sellers reasonable confidence that such a market could function effectively and would maintain incentives for investment.

There are at least three more issues that will need to more clearly addressed in the consultation process.

First, a process that sets and reviews the DSO on an annual basis fails to recognise that the LNG export industry works on long-term contracts. There is also a desire from all parties to re-establish confidence in the domestic market such that multi-year again becomes the norm. The government should include a forward indicator to frame future DSOs within a range or set of future conditions.

Second, the regulated entities may seek a variation to their annual DSO if they can demonstrate they have exhausted all avenues beyond breaching their export contracts. This should be a very high bar and looks more workable if the oversupply condition above is introduced.

Third, even a reduced DSO is clearly intended to oversupply the market as the way to reduce prices. This approach shifts the balance of commercial power towards buyers. But it could create distressed sellers with no commercial alternative. This issue needs to be further considered.

Can it work? The proposed model is based on the original clunky concepts of a reservation volume calculated on production and a shift in the balance of market power towards buyers. Gas producers and consumers would have hoped for less, rather than more, government regulation, and the producer consortiums will have a domestic obligation not contemplated when they were first established. Yet, with good will and genuine consultation, the proposed flexibility elements could just work.

This is an important market reform, so let’s hope so.