The future of domestic gas reservation in WA

Key Points:
The WA Government will maintain its policy of seeking a 15% domestic gas reservation from all WA gas projects, but will continue to apply it flexibly and consider the project's commercial viability.

On 9 August 2011 the Western Australian Government announced plans to continue its policy of seeking domestic gas reservation from all WA gas projects (Domestic Gas Reservation Policy). This announcement followed from the recommendations of the Economics and Industry Standing Committee's "Inquiry into Domestic Gas Prices" of March 2011.

WA Premier Colin Barnett said that the Government aims to maintain a flexible approach to how the Domestic Gas Reservation Policy is applied and will take into account the "commercial viability" of a project.

We take a look at the Committee's report and the Government's response.

Domestic Gas Reservation Policy

Under the Domestic Gas Reservation Policy, project proponents are required to reserve up to 15 % of production for domestic supply to WA energy markets. The Domestic Gas Reservation Policy is flexible and allows for negotiations with project proponents on a "case-by-case basis".

How are domestic gas reservation requirements established?

Domestic gas reservation requirements are established between project proponents and the Government as a pre-condition to allowing on-shore processing facilities on State land.

In the past, the WA Government has used State Agreements to facilitate domestic gas reservation requirements. State Agreements are essentially contracts between the Government and proponents of major resource projects that are ratified by an Act of Parliament. For example, domestic gas commitments can be found in the State Agreements for both the North West Shelf Project and the Gorgon Project.

The Domestic Gas Reservation Policy was introduced in WA in 2006 by the former State Government. Emma Covacevich discussed the proposed introduction of the policy at the time.

Woodside's Pluto Project is the first project to fall under the Domestic Gas Reservation Policy. Woodside has agreed that, after an initial start-up period, it will supply the equivalent of 15% of production from Pluto to the domestic market. Negotiations between the WA Government and Woodside on the exact details of this domestic gas reservation requirement are continuing.

Notably, the domestic gas reservation requirements imposed on the Gorgon Project under State Agreement, and the requirements imposed on the Pluto Project under the Domestic Gas Reservation Policy, are both subject to "commercial viability" provisions. However, as discussed below, it is not entirely clear what "commercial viability" means.

Productivity Commission Report and Commonwealth Government response

WA's Domestic Gas Reservation Policy has been a contentious issue among policy-makers and industry. In its report Review of Regulatory Burden on the Upstream Petroleum (Oil and Gas) Sector, the Commonwealth Productivity Commission examined WA's Domestic Gas Reservation Policy and said:

"[a]lthough such a policy itself might not impose a regulatory burden... the lack of a comprehensive statement of the policy and its guidelines, has the potential to create uncertainty and be subject to varied interpretation and inconsistent application." ( Finding 5.6, page 100)

In its response, the Commonwealth Government accepted that domestic gas reservation in WA was a matter for the State Government, but noted that:

"the lack of transparency in WA domestic gas policy does increase uncertainty for offshore facilities, domestic gas users and the WA gas market." ( page 32)

Inquiry into Domestic Gas Prices

Last year the WA Legislative Assembly asked its Economics and Industry Standing Committee to investigate domestic gas prices for industry and broader consumers and make recommendations on any measures that could be implemented to reduce the price of gas in WA.

The Committee released its report Inquiry into Domestic Gas Prices, on 24 March 2011, finding that:

• Gas represents 56% of the primary energy fuel source in Western Australia, which is significantly more than in the other States and Territories where gas averages just over 20% of the energy mix.
• The supply side of the WA market is highly concentrated, with the North West Shelf Project supplying over 65% of the domestic market.
• WA's domestic gas prices are trading at a significant premium to interstate markets.
• Domestic gas reservation is an essential policy instrument for ensuring that an appropriate level of gas is supplied into the domestic market to achieve reasonable price outcomes.
• The imposition of a rigid (rather than flexible) 15% domestic reservation requirement risks flooding the domestic market with more gas than it needs, negatively effecting the economics of new and existing projects and impacting on competing fuel industries.

The Committee made the following significant recommendations:

• The flexibility in the Domestic Gas Reservation Policy should be maintained unless an independent cost-benefit analysis demonstrates that a strict 15% reservation represents a more valuable and efficient use of the resource.
• The Department of State Development should refine, and publish a list of, general parameters that are deemed to satisfy the "commercial viability" test as it pertains to the Domestic Gas Reservation Policy.

What does "commercially viable" mean?

After considering a number of options, the Committee recommended that acceptable parameters for commercial viability might include, but should not be limited to, a price that covers the cost of production and provides an industry-recognised reasonable rate of return.

The WA Government's response to the Committee's report

The WA Government's response to the Committee's report stated that:

• the Government would continue to conduct negotiations with proponents based on the flexibility within the Domestic Gas Reservation Policy; and
• the Department of State Development would be charged with developing a framework to provide more clarity as to what "commercial viability" means.

What happens if gas is processed offshore?

New developments in technology mean that:

• gas projects which previously had to be processed onshore can remain entirely in Commonwealth waters; and
• gas can be transported large distances through a subsea pipeline for downstream processing in other jurisdictions.

In these instances the WA Government has no formal ability to enforce the Domestic Gas Reservation Policy.

Premier Barnett has stated that the WA Government has approached the Commonwealth Government to include a domestic gas requirement as a condition for the grant or renewal of offshore petroleum leases in Commonwealth waters. It is so far unclear whether the Commonwealth Government is open to such a requirement.

Conclusion

Five years after the former State Government released a consultation paper proposing that 15% of future gas production in WA should be reserved to meet growing domestic needs, the issue of domestic gas reservation continues to generate significant debate. The WA Government's response demonstrates that it remains committed to a 15% Domestic Gas Reservation Policy, albeit applied flexibly and imposed on a project-by-project basis.

As the WA Government seeks to strike a balance between the consistent demand for LNG exports and domestic gas requirements, it will be interesting to see how it refines its policy in this area. Industry will keenly await further clarity from the Government as to what "commercial viability" means.

You might also be interested in ...

• Responses to WA Domestic Gas Reservation Policy
  

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.