Exposure Draft of Mandatory Gas Market Code of Conduct Released

On 26 April 2023, the Commonwealth Government released its proposed Mandatory Code of Conduct for the East Coast Gas Market (the Draft Code) for consultation.

With the facilitation of a well-functioning domestic East Coast gas market (with adequate supply at reasonable prices and/or reasonable terms) as its primary objective, the Draft Code is expected to be finalised by, and apply from, early June 2023. While the Draft Code will apply solely to wholesale level transactions, the Government has foreshadowed in its consultation material that it may introduce a code for retailers if gas is not offered at efficient or competitive prices at the retail level.

The Draft Code was based on the Voluntary Code of Conduct released in December 2021 which was drafted by JWS in its role acting for the Australian Petroleum Production & Exploration Association.

We set out below our comments on the Draft Code and an overview of its key features.

Key Takeaways:

• The Draft Code establishes an initial price cap of $12/GJ for commercial negotiations; both automatic and conditional exemptions from the price cap are available;
• The price cap will not be adjusted by the ACCC for a period of two years unless there are substantial changes in market conditions or the Minister authorises an adjustment;
• The price cap will not apply to:
  • supply contracts entered into before the emergency price order that commenced in December 2022; or
  • agreements made prior to the Draft Code which cover a period outside the emergency price order (for example, an agreement entered in March 2023 for supply after December 2023).
• Automatic exemptions will apply to small producers (less than 100 PJ produced in the previous financial year) who supply gas exclusively to the domestic market;
• Conditional exemptions will be available: eligibility depends on the negotiation of an enforceable domestic supply commitment;
• A further suite of deemed exemptions is included in the Draft Code, some of which we reference in greater detail below;
• The Draft Code imposes good faith obligations on parties in relation to negotiations for gas supply and their conduct under gas supply agreements;
• The penalty regime is significant: the maximum penalty for breach (for a body corporate) is the greatest of $50 million, three times the value of the benefit obtained, and 30% of adjusted turnover;
• Producers will be required to publish details of the availability of uncontracted gas supply available to the market twice annually (1 January and 1 July) to boost transparency; and
• Notably, the Draft Code replaces the binding arbitration process (as initially mooted by the Government in December 2022) with a conduct framework, the key provisions of which we discuss below.

Application of the Draft Code

The Draft Code is proposed to only apply to the East Coast wholesale gas market. The Draft Code is not intended to apply to gas transactions on the Declared Wholesale Gas Market, the Short Term Trading Market or anonymous or pre-matched trades on gas exchanges of three days or less. 

Price Cap

In attempting to strike a balance between ensuring affordable gas prices and maintaining a reasonable return for gas producers to continue supplying, the Draft Code establishes an initial price cap of $12/GJ (exemptions apply). The Draft Code creates offences not only if a gas producer and buyer enter into an agreement for a price in excess of $12/GJ but also if a gas producer and buyer enter into an agreement under which the price could exceed $12/GJ. Accordingly, it will be important for producers to consider whether any price escalation mechanisms included in supply contracts or other provisions such as take or pay clauses could result in a price exceeding $12/GJ.

The price cap is subject to a review by the ACCC within the period of two years after the Draft Code commences. As mentioned above, the price cap can be adjusted within that two-year period if there are substantial changes in market conditions or the Minister authorises an adjustment.

In making a determination to adjust the price cap, the ACCC will strive to promote:

• a workably competitive domestic market;
• the affordability and availability of domestic gas supply; and
• the production of, and investment in, natural gas to meet domestic demand.

Exemptions Framework

Small producers

Automatic exemptions from the price cap will apply to gas producers who:

• are small producers (produce less than 100 PJ of gas in the previous financial year); and
• provide gas exclusively to the domestic market.

A small producer will lose its exemption if it begins to export gas, or enters an agreement with a company that intends to export the gas supplied. Exempted small producers will therefore be under an ongoing obligation to inform the ACCC of any export, or intended export, of its gas as soon as practicable.

Small gas producers who had entered into a supply contract to export gas prior to the commencement of the Draft Code will retain their eligibility for an automatic exemption, unless:

• a further contract is entered into with an exporter following the commencement of the Draft Code; or
• the pre-existing volume commitments under the supply contract are increased.

Conditional Exemption

Conditional exemptions from the price cap will be available to both large gas producers (those that produced at least 100 PJ in the previous financial year), and small gas producers that sell some gas for export.

Eligibility will require the negotiation of an enforceable domestic supply commitment, which may require the inclusion of certain terms relating to domestic volume, price, and conditions. The consultation material contemplates that domestic supply commitments would need to involve firm commitments to supply gas.

The decision to grant a conditional exemption will be jointly made by the Minister for Climate Change and Energy and the Minister for Resources and the Ministers are given discretion in deciding whether to grant a conditional exemption. The Ministers may consider a broad range of matters in making their decision, including those matters that the ACCC will strive to promote in making a determination to adjust the price cap (see above).

Conduct Provisions

The Draft Code imposes good faith obligations on parties in relation to offers and negotiations for gas supply and their conduct under gas supply agreements. The Draft Code sets out various factors that will be used in determining if a party has acted in good faith, including:

• whether the party has acted honestly; and
• the extent to which the party has not acted arbitrarily, capriciously, unreasonably, recklessly or with ulterior motives.

The Draft Code also imposes requirements where a gas producer initiates an Expression of Interest (EOI) process. The Draft Code does not, however, mandate that gas producers must supply gas through an EOI process. Gas producers must nevertheless publish on their website information about intended EOI processes.

If a gas producer initiates an EOI process, then the Draft Code requires that the EOI contain specified information, that the process must involve an initial offer phase (and a final offer phase where the supply of gas will be for a period of 12 months or more), and that each of those phases remain open for a minimum period. Specific information requirements apply at the various offer phases.

Further, the Draft Code imposes certain obligations during the initial offer and final offer phases even in circumstances where bilateral negotiations have commenced outside of the EOI process (and the duration of supply exceeds 12 months).

As such, producers will need to ensure they adhere to obligations arising in the initial and final offer phases even where gas was not offered through the EOI process.

In a bid to increase transparency to the market, the Draft Code requires a producer to publish a range of information on its website, including information relating to how much uncontracted gas that the producer is likely to have available over the coming 12 month period. That information is required to be published by a producer on its website as soon as practicable after each 1 January and 1 July.

Penalty Regime

The Draft Code allows for the imposition of significant penalties for parties that contravene it – especially the requirements that are considered core to the Draft Code.

The default maximum penalty applying to certain contraventions will be (in the case of a body corporate) the greatest of:

• $50 million;
• three times the value of the benefit obtained (if the value of the benefit can be calculated); and
• 30% of the body corporate’s adjusted turnover during the breach turnover period of the contravention (if the value of the benefit obtained cannot be calculated).

Penalties are split into three tiers which reflect the severity of a contravention. The first tier, which attracts the default maximum penalty, applies to breaches relating to:

• good faith dealings in negotiations or in relation to an agreement;
• supplying gas at a price that exceeds the price cap (where no exemption applies); or
• failing to comply with a condition imposed as part of an exemption.

Second tier penalties relate to contraventions of the requirements of the Draft Code relating to EOI processes and other aspects of the conduct framework, while the third tier responds to breaches relating to publication of certain information, record-keeping and the provision of information to the ACCC.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).