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COMMONWEALTH OF AUSTRALIA TRADE PRACTICES ACT 1974
CATCHWORDS TRADE PRACTICES - authorization of long-term gas supply agreement - review of ACCC determination revoking an earlier authorization and granting a further authorization in substitution - whether material change of circumstances - whether benefit of supply agreement continues to outweigh detriment Re Queensland Independent Wholesalers Ltd (1995) ATPR 41-438 Alliance Petroleum Limited NL v The Australian Gas Light Company (1995) 64 SASR 346 Australian Gas Light Company (1986) ATPR (Com) 50-114 Media Council of Australia (No 4) (1996) ATPR 41-497 Re Queensland Co-operative Milling Assocation Ltd, Defiance Holdings Ltd (1976) ATPR 40-012 Telecom Corporation of NZ Ltd v Commerce Commission (1991) 3 NZBLC 99-239 Re 7-Eleven Stores (1994) ATPR 41-357 Hatrick Chemicals Pty Ltd (1977) ATPR 40-044 Broken Hill Pty Co Ltd v Koppers Pty Ltd (1981) ATPR 40-203
Trade Practices Act 1974 Cooper Basin (Ratification) Act 1975 (SA)
ALLIANCE PETROLEUM AUSTRALIA PTY LTD, BASIN OIL N.L., BORAL ENERGY RESOURCES LIMITED, BRIDGE OIL DEVELOPMENTS PTY LTD, CRUSADER RESOURCES N.L., DELHI PETROLEUM PTY LTD, REEF OIL PTY LTD, SANTOS LIMITED, SANTOS (BOL) PTY LTD, SANTOS PETROLEUM PTY LTD, VAMGAS PTY LTD
RE: APPLICATION FOR A REVIEW OF A DETERMINATION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION MADE ON 27 MARCH 1996 REVOKING AUTHORIZATION NO A90424 AND GRANTING A FURTHER AUTHORIZATION (AGL COOPER BASIN NATURAL GAS SUPPLY ARRANGEMENTS) VG 1 OF 1996 LOCKHART J (President), DR M BRUNT, DR B ALDRICH SYDNEY 14 OCTOBER 1997
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COMMONWEALTH OF AUSTRALIA TRADE PRACTICES ACT 1974
IN THE AUSTRALIAN COMPETITION TRIBUNAL
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ALLIANCE PETROLEUM AUSTRALIA PTY LTD BASIN OIL N.L. BORAL ENERGY RESOURCES LIMITED BRIDGE OIL DEVELOPMENTS PTY LTD CRUSADER RESOURCES N.L. DELHI PETROLEUM PTY LTD REEF OIL PTY LTD SANTOS LIMITED SANTOS (BOL) PTY LTD SANTOS PETROLEUM PTY LTD VAMGAS PTY LTD Applicants |
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RE APPLICATION FOR A REVIEW OF A DETERMINATION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION MADE ON 27 MARCH 1996 REVOKING AUTHORIZATION NO A90424 AND GRANTING A FURTHER AUTHORIZATION (AGL COOPER BASIN NATURAL GAS SUPPLY ARRANGEMENTS) |
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WHERE MADE: |
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THE TRIBUNAL ORDERS THAT: the Determination of the Australian Competition Commission revoking Authorization No A90424 and granting a new authorization be revoked.
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COMMONWEALTH OF AUSTRALIA TRADE PRACTICES ACT 1974 |
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IN THE AUSTRALIAN COMPETITION TRIBUNAL
VG 1 of 1996
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TRIBUNAL: |
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REASONS FOR DECISION
1. INTRODUCTION
This is an application for review of a determination of the Australian Competition and Consumer Commission (“the Commission”) made on 27 March 1996 revoking an earlier authorization and granting a further authorization in substitution therefor.
The applicants in this matter (“the Applicants” or “the Producers”) were not the applicants for the authorization which the Commission revoked. Their interest in the matter is as parties, together with the Australian Gaslight Company (“AGL”), to an agreement known as the Letter of Agreement, amendments thereto, and certain associated deeds, that AGL had been authorized to give effect to by a determination of the Commission on 5 May 1986. The Letter of Agreement is critical to the matter before us because giving effect to it constitutes the relevant conduct the subject of the 1986 Authorization and of this review. The authorized conduct concerned primarily the implementation of the terms and conditions of a contract of sale of gas to AGL as the purchaser. The Producers are producers of gas in the South Australian sector of the Cooper Basin, who formed a joint venture known as the South Australian Unit (“SA Unit”) for the purpose of supplying gas to Sydney in accordance with the Letter of Agreement, and for the parallel purpose of supplying gas to Adelaide.
The Cooper Basin is a geological structure of a type known as a sedimentary basin. Such structures can carry reservoirs of petroleum hydrocarbons, viz. oil and natural gas, in certain of their strata; but not all sedimentary basins contain oil or gas, and some basins tend to be rich in one or the other. The Cooper Basin, which is predominantly gas-bearing, lies beneath north-eastern South Australia and south-western Queensland, and is approximately 640 kilometres long and 240 kilometres wide at its widest point. It lies beneath another, geologically younger sedimentary basin, the Eromanga or Great Artesian Basin, which is of far wider extent, and which contains some oil in its strata. The Cooper and Eromanga Basins are among several such structures in Australia and in off-shore waters; and in some of these structures significant reservoirs of gas and oil occur.
Before the connection of natural gas to Australian markets, which began in 1969, many urban centres were supplied with reticulated “town gas” that typically was manufactured from coal. Natural gas has now supplanted town gas in all major cities on the Australian mainland and in many other centres.
Natural gas supply in Australia developed as a series of regional business systems, in each of which a single joint venture typically produced gas that passed through a single transmission pipeline to one buyer that then reticulated gas to end-users. These separate business systems largely persist, and the gas supply systems to the major centres of demand in Australia are not so interconnected that trade in gas between them can readily occur. This form of the Australian gas industry is one consequence of a number of characteristics of the industry that are here listed briefly, and that are described and discussed more fully, later in these reasons.
First, high risks and large capital expenditure are associated with exploration and production. The common use of joint venture structures for exploration and production enterprises is a response to this.
Secondly, gas is most economically transported from the gas fields by high-pressure transmission pipelines, before local distribution to end-users by means of low-pressure gas reticulation pipeline systems.
Thirdly, most users of gas have a choice between gas and other sources of energy, with competition occurring typically when the equipment or appliance that is designed to use one form of energy is chosen or replaced.
Fourthly, other considerations mean that governments are inevitably involved in some sectors of the industry, and have been commonly disposed to extend this involvement, whether by way of direct financial participation or by regulation. We shall say more of this later; but it is sufficient by way of introduction to note, for example, that gas is owned by the Crown until extracted for processing and sale. Hence, governments must determine the terms on which firms explore for and produce gas. Governments have also involved themselves in issues about whether and on what terms gas might be traded between jurisdictions and the purposes for which it is consumed within jurisdictions. The natural monopoly characteristics of gas transmission and distribution create both economic and political rationales for government involvement.
The gas industry is regulated by both the Commonwealth and the State governments. The Commonwealth regulates interstate trade in gas, and exploration and production off-shore, beyond the three-mile limit. The States regulate on-shore exploration, and production, transmission and distribution of gas within their jurisdiction.
The Council of Australian Governments (“COAG”), comprising the governments of the Commonwealth, States and Territories, has in recent years agreed on significant changes in the policy framework governing the gas industry, with the express objective of encouraging “free and fair trade” in natural gas across Australia. This framework of competition policy and its consequences are described more fully, later in these reasons.
2. PARTICIPANTS AND WITNESSES
The Applicants, together with AGL, are the present parties to the Letter of Agreement of 26 May 1971, as amended from time to time, and to the two deeds of 21 December 1976 and 17 May 1974. Most of the Applicants were original parties to the Letter of Agreement and the two deeds of 17 May 1974 and 21 December 1976; though some of the present parties to these contractual arrangements were not parties to the original agreements - their predecessors were.
The Applicants were represented by senior and junior counsel. AGL was separately represented by counsel. The Commission was also represented by senior and junior counsel.
The Council of the City of Wagga Wagga (“the Council”) applied to the Tribunal pursuant to s 109(2) of the Act for leave to intervene in the proceeding. Leave was granted. Its interest in the matter stemmed primarily from the fact that it is a party to an agreement of 16 February 1988 with AGL to purchase gas from AGL for a term expiring in the year 2006. At present AGL is the only supplier of gas to the Council which is the only supplier of gas to consumers within a 25 kilometre radius of the Wagga Wagga post office. The Council later withdrew from the proceeding.
Statements from 50 witnesses were received into evidence by the Tribunal. Some of these witnesses were cross-examined; others were not. A large body of documentary material was also before the Tribunal. The hearing occupied 16 days and we had the benefit of full submissions both in writing and orally from counsel and solicitors for the parties and for the Commission. The principal witness called by the Applicants was Mr McArdle, the Executive General Manager - Commercial of Santos.
2.1 Role of the experts
Three expert witnesses in the field of economics furnished statements and were examined orally before the Tribunal at the hearing. The Tribunal adopted the same procedure with respect to these witnesses as it has done in other cases.
We gained considerable assistance from the evidence of the experts. The experts submitted written statements prior to the oral proceedings, but after the reception of written non-expert evidence and documentary material. Their oral expositions and examinations occupied a little over one day’s hearing.
The procedure adopted at the hearing was as follows:-
It was explained to the experts before they gave evidence that they should feel free to modify the views expressed by them in their reports as little or as much as they wished, because the Tribunal wanted the benefit of their present views, having had access to all of the evidence.
At the conclusion of all the evidence (other than the evidence of the experts) and before the commencement of addresses, each expert was sworn or affirmed immediately after the other. Each expert in turn gave an oral exposition of his opinion with respect to the relevant issues arising from the evidence. Each expert then in turn expressed his opinion about the opinions expressed by the other experts.
Counsel then cross-examined the experts, being at liberty to cross-examine on the basis:
(a) either that questions could be put to each expert in the customary fashion, one after the other, completing the cross-examination of one before proceeding to the next; or
(b) that questions could be put to all or any of the experts, one after the other, in respect of a particular subject; then proceeding to the next subject.
Re-examination was conducted on the same basis.
Members of the Tribunal sometimes intervened with their questions.
The advantages of this system are as follows:
(a) Experts are required to prepare written submissions which are set down as a connected argument, and when giving oral evidence the same connected thread runs through it, rather than being a series of disconnected responses to questions by counsel.
(b) It achieves the result of the experts defining for their purposes points of agreement and disagreement.
(c) It takes the expert as far away from the adversarial field as possible.
The practice is recorded generally in QIW (re Queensland Independent Wholesalers Ltd (1995) ATPR 41-438 at 40,925) and in other decisions of the Tribunal. In QIW four economists appeared. The total time required for their evidence was only three-and-a-half hours, but their contribution was immensely helpful to the Tribunal.
At the conclusion of the evidence of the experts the President asked them what they thought of the procedure. Two of the experts were distinguished American economists and the third was a distinguished Australian economist. They were unanimous in their support of the system. They said that at the end of their evidence they felt they had said everything they wished to say; and did not have the feeling (that they invariably have when examined in the customary adversarial way) that only a portion of their views had been given, the statement of the remainder being constrained by the adversary system.
Whilst we do not suggest that the new system is free from difficulty or criticism, we think it is an excellent system and works well. The principal benefit derived from it is that at the end of the exercise the Tribunal knows what the economists perceive as being the real issues, and the areas of agreement and disagreement between them. This is very helpful to the Tribunal’s task of refining the real issues and deciding the matter.
The witness box is, of course, too limited a space for all experts to be in at the one time, so they usually sit at one end of the Bar table.
When we use the expression “the adversary system” (and like expressions) we do so in the sense that lawyers understand, namely, the system of litigation in force in Australia, New Zealand, the United Kingdom, the United States of America and other countries as distinct from the inquisitorial system of litigation adopted in European and other countries.
3. THE LETTER OF AGREEMENT
The Letter of Agreement entered into on 26 May 1971 (“the Letter of Agreement”) is a contract for the sale of gas by the Producers who were parties to that agreement with AGL. By the time of the grant of the authorization in 1986 the Letter of Agreement had been amended a number of times. Through change of name and disposal or acquisition of assets and companies, these parties ultimately became the eleven parties who presently have interests in the Letter of Agreement. The Letter of Agreement was the culmination of discussions and negotiations which commenced in about 1968 between the original Producers and AGL. The Letter of Agreement constituted the agreement between the Producers and AGL whereby the Producers undertook long term obligations to prove up gas reserves, to supply gas and to hold ready capacity to supply contract quantities, whilst AGL undertook to purchase specified quantities and assumed other obligations.
The Letter of Agreement was amended by a number of letters subsequent to 1971.
The Trade Practices Act commenced operation on 10 October 1974. An Act of the South Australian Parliament, namely, the Cooper Basin (Ratification) Act 1975 (SA) (“the Ratification Act”) commenced operation on 11 December 1975. Amongst other things, that latter Act by s 16(b) authorized and approved the Unit Agreement and “all contracts, arrangements, understandings, practices, acts or things made, given effect to, carried on or done thereunder or in relation thereto” for the purposes of the Trade Practices Act. Thus, the Ratification Act in essence exempted arrangements including the Letter of Agreement from the operation of the Trade Practices Act. It is not entirely clear to us that all relevant documents amending the Letter of Agreement of 26 May 1971 are before us; but it seems that the material ones are in evidence and certainly the parties have conducted their cases on the basis that what has been described as a “clean copy” of the Letter of Agreement as it was in force at the time of the authorization in 1986 may be assumed to be the relevant Letter of Agreement. We have acted on this basis.
By reason of the Ratification Act the parties assumed that no question of possible contravention of the Trade Practices Act arose from the critical clauses (that is critical so far as the operation of the Trade Practices Act is concerned), namely, clauses 12, 18, 20 and 24 of the Letter of Agreement, until advice was received concerning the conduct of a price arbitration outside South Australia in 1985. Hence, the application for authorization was initially confined to the price determination clause (clause 24); but extended at the suggestion of the then Producers to the whole of the Letter of Agreement and to the Deed of Covenant and Release of 1976 and the Deed of Covenant and Consent of 1974.
We shall turn first to the Letter of Agreement and then to the two deeds as all three documents were relevant to the Commission’s 1986 authorization.
Although this is the first occasion on which the Letter of Agreement has been considered by the Tribunal, certain of its provisions were considered by the Full Court of the Supreme Court of South Australia in Alliance Petroleum Limited NL v The Australian Gas Light Company (1995) 64 SASR 346 where Olsson J (with whose reasons for judgment Morh and Bollen JJ agreed) described the Letter of Agreement as “a lengthy and, to some extent, complex document” (at 347). Olsson J noted that it was the original intention of the parties to the Letter of Agreement to replace it with a more formal instrument, but this was never done; instead the Letter of Agreement was from time to time varied by other documents.
We shall refer to the interpretation placed upon certain of the clauses of the Letter of Agreement by the Full Court of the Supreme Court of South Australia when we are considering those particular clauses.
The introductory clauses of the Letter of Agreement stated, amongst other things:-
· that although AGL contemplated reselling natural gas to other undertakings in the Sydney/Newcastle/Wollongong region, some proportion of the natural gas to be taken by AGL under the agreement proposed in the Letter of Agreement will be purchased by AGL as a principal and as sole buyer under such agreement and no other user or consumer of gas will be a party or privy to such agreements.
After the prefatory statements of a general nature, the Letter of Agreement then recorded the terms of the agreement in 32 clauses and schedules (lettered (A) to (F) inclusive).
Clause 1 required that the Producers establish reserves at a level of 2.8 trillion (US) cubic feet of proven and provable natural gas reserves of sales gas from the Cooper Basin before the agreement took any effect (see also clause 2). Clause 1 is described in its opening words as a condition precedent to the whole of the agreement.
Clause 7 provided that upon the due fulfilment of the condition precedent set out in clause 1 the agreement will become unconditionally binding on AGL and on the Producers; and within a period of two-and-one-half years from 12 September 1973 or such longer period as may be agreed:
(a) AGL would become obliged and would proceed, without cost to the Producers, to construct and complete a pipeline from the Sydney region to the Producers’ treatment plant with sufficient capacity to carry AGL’s requirements so that it will be completed and ready for use before the expiration of the agreed period;
(b) the Producers would become obliged and would proceed, without cost to AGL, to drill and equip production wells and install facilities between wells and a treatment plant sufficient to produce and deliver the sales gas quantities at the rates required for the time being by the terms of the agreement and would deliver such sales gas at a particular defined point.
Clause 8 imposes obligations on the Producers to supply and AGL to take gas at certain annual volumes.
The South Australian Full Court in Alliance Petroleum considered clause 8 and said that it in effect stipulated that, in the events which happened after 20 September 1976, the Producers were obliged to supply natural gas to AGL up to maximum annual volumes specified in Schedule A to the document. AGL was to be entitled to take gas up to those volumes.
Clause 10 provides that, subject to certain other clauses, the title to all sales gas delivered by the Producers shall pass to AGL at the point at which it enters the pipeline provided by AGL and the gas will as from that point be the property of and at the risk of AGL.
Clause 11 provides that the Producers reserve the right (or any of them does) to establish a processing plant or plants at any point or points along the pipeline outside the Sydney region for the recovery to the account of the participants in such plant of LPG and other hydrocarbon fractions.
Clause 12 is an important provision. It provides that AGL will give to the Producers the first right of refusal for supply of its requirements of gas over and above the volume specified in the relevant schedules provided that the Producers’ prices and terms of sale are no less favourable than those upon which AGL could obtain sales gas of the same quality and quantity from some outside supplier. This clause is referred to as the first right of refusal clause. Clause 12 states that the supply of sales gas to AGL shall be on a firm basis and not subject to curtailment or interruption except in the case of force majeure.
Clause 12 reads as follows:
“A.G.L. will give to the Producers the first right of refusal for supply of its requirements of sales gas over and above the volumes contemplated in this Agreement provided the Producers’ price and terms of sale are no less favourable than those upon which A.G.L. could obtain sales gas of the same quality and quantity from some outside supplier. The supply of sales gas from time to time to A.G.L. up to the volumes set out in Schedules A and B and C attached hereto shall be on a firm basis and shall not be subject to curtailment or interruption except that caused by force majeure as described herein or operating conditions beyond the Producers’ control and deliveries of sales gas from time to time up to the volumes set out in Schedules A and B and C attached hereto shall at all times have priority over all other commitments for the sale by the Producers of natural gas through the transmission system installed by A.G.L. referred to in Clause (7)(a).”
Clause 16 provides that the Letter of Agreement shall be initially for a period of 30 years from the commencement of supply. We say “initially” because provision is made by clause 18 for the extension of the Agreement in the circumstances there provided, but for no more than five years.
Clause 18 is important. It was construed by the Full Court of the Supreme Court of South Australian in Alliance Petroleum and Olsson J referred to it as the clause which has “colloquially been referred to as the “take-or-pay” clause”.
Clause 18 reads as follows:
“A.G.L. shall be bound in each contract year after the date upon which the Producers first become bound to supply sales gas under this contract to take or pay for a minimum of eighty per cent (80%) of the total annual volume specified in Schedule A for such contract year provided that any sales gas paid for but not actually taken by A.G.L. in a particular contract year may be taken by A.G.L. without any additional charge or cost in any subsequent contract year (but without counting as part of the sale gas which A.G.L. is otherwise bound to take in that same subsequent contract year) subject to Clause (21) and provided further that any additional contract which A.G.L. may hereafter enter into with the Producers for the sale and purchase of sales gas over and above the sales gas to be supplied under this Agreement shall in the first instance be fulfilled by the supply by the producers without cost of sales gas paid for but not taken by A.G.L. under this Agreement and provided further that if by the end of the thirtieth contract year A.G.L. has not taken (either under this Agreement or under some other agreement) all sales gas which it has paid for under the provision of this Clause the term of this Agreement shall at the option of A.G.L. (to be notified before the beginning of the thirtieth contract year) be extended so that the Producers will be obligated to supply and A.G.L. shall be entitled to take sales gas to the extent of that paid for but not previously taken provided that such sales gas shall be taken at volumes declining at the rate of ten per cent (10%) per annum in each year for a period not exceeding five contract years over and above the thirty year term of this Agreement.”
Mr McArdle gave evidence that he did not believe that clause 18 had been amended at any time during the contract. Yet in the judgment of Olsson J in Alliance Petroleum his Honour said at 348 that clause 18 was by deed dated 24 May 1991 varied by the parties over a limited span of time. The effect of the amendments made by that deed were described by Olsson J at 348-349. They do not appear to us to be material for present purposes. We note that Olsson J’s recital of the relevant provisions of the deed of 24 May 1991 include clause 6 thereof which provides:
“Nothing in this Deed shall change AGL’s obligation under Clause 18 of the Letter of Agreement (as amended by Clause 2 above).”
Clause 2 is not set out in the judgment of Olsson J.
Olsson J summarized the essential structure of clause 18 in these terms at 349:
“. In each contract year AGL was bound to either take or pay for 80 per cent of the prescribed annual volume of gas.
. To the extent that it paid for gas but did not take it, this gas could be taken free of charge in some later year (this, in the jargon of the parties, was known as “banked gas”).
. When banked gas was taken in a particular year it was not to be counted as portion of the 80 per cent for that year.
. Any gas taken by AGL over and above the prescribed annual volume was, in the first instance, to be taken from any current banked gas entitlement.
. Any residual banked gas credit remaining at the end of the 30-year term had to be supplied over the next five years without cost to AGL, subject to a prescribed supply formula.”
We note that in the judgment in Alliance Petroleum in the South Australian Supreme Court at first instance the trial Judge (Lander J) referred to a decision Diamond Shamrock Exploration v Hodel 853 F2d 1159, 5th Cir, 1988 where “take-and-pay” clauses were discussed. His Honour’s recital of the relevant parts of that decision appear at pp. 10 and 11 of his judgment, unreported, 23 December 1994.
Mr McArdle in his statement said that take or pay provisions are not merely a feature of gas supply contracts, but they exist in many businesses. He said that such clauses in long term natural gas contracts are not merely a local phenomenon but are common world wide. Clauses of this kind allocate the risk of revenue fluctuations between parties; they are a means of dividing the risks of demand fluctuations in the market. To satisfy a long term large volume contract the Producers must invest substantial upfront capital in exploration, production and perhaps pipeline investments. Take-or-pay clauses permit the financing of this investment and such a provision is a necessary feature of long term, high volume gas supply.
Clause 19 of the Letter of Agreement gives AGL the right from time to time to reduce the total remaining volume of gas for the term of the contract subject to certain restrictions and conditions.
Clause 20 is important. It reads as follows:
“Notwithstanding the provisions of Clause (18) A.G.L. shall not at any time during the term of this Agreement or any extension thereof take or purchase natural gas from any supplier other than the Producers except to the extent by which its requirements exceed the maximum amount which for the time being it is entitled to take and the Producers are able to supply under this Agreement.”
It was described in the case as the “exclusive dealing” clause.
Clause 24 is also important; it is called the “price and price review” clause. Clause 24 provides as follows:
“(24)(a) The price for sales gas delivered and taken or which should have been taken under this Agreement shall as from and including the first contract year be thirty cents (30c) per MMBtu and that price shall (subject to the provisions of sub-Clauses (b), (c) or (d) of this Clause (24)) prevail during the first four contract years. As from the commencement of the fifth contract year the price for all sales gas delivered and taken or which should have been taken shall be increased during that fifth contract year by one-quarter cent (0.25c) per MMBtu and a further one-quarter cent (0.25c) per MMBtu shall be added to the price in each subsequent contract year until and including the twenty-fifth contract year. Payments shall be made on a monthly basis.
(b) Both the Producers and A.G.L. may at any time and from time to time (but not more than once in any period of three consecutive calendar years) require a review to be made for the purpose of adjusting the prices (which for the time being would be payable thereafter under this Agreement) either upwards or downwards but so that in no case shall any resulting price be less than the price of sixteen cents (16c) per MMBtu plus the increases referred to in sub-Clause (a) of this Clause (24). In carrying out such review regard shall be had to all economic and other relevant factors existing at the time and in particular but without in any way limiting the scope of the review to the effects of inflation and any increases in capital and operating costs. Notwithstanding the foregoing it is hereby agreed that both A.G.L. and the Producers may in any one or more of the first three contract years (but not more than once in any such contract year) require a review of price to be made for the purpose of adjusting the prices and in carrying out any such review regard shall be had to the matters referred to in the preceding sentence of this Clause (24)(b) provided however that in respect to any review held during the first contract year any adjustment to the price by reason thereof shall not take effect until the commencement of the second contract year, and provided further that any review held in the third contract year shall be considered as a review pursuant to the provisions of the two sentences of this Clause (24)(b) immediately preceding this sentence.
(c) In the event of either the Producers or A.G.L. requiring an adjustment of price in accordance with the foregoing provisions of this Clause they shall consult together in good faith and use their best endeavours to reach agreement on an adjustment or on a formula to be applied in establishing such an adjustment.
(d) If the parties fail to agree upon a price or upon a formula for fixing a price within three calendar months from the date of the requirement of the Producers or A.G.L. the matter shall be referred to arbitration by two arbitrators one of whom shall be appointed by A.G.L. and one by the Producers. Such appointments shall be made within one month after expiry of the three calendar month period hereinbefore referred to.”
Clause 24(a) thus establishes the price which AGL has to pay for the gas or make the take or pay payment. The clause has been amended more than once to insert the new prices resulting from agreement or arbitration. The clause has not been changed every time there is a price increase. Mr McArdle gave evidence that it was obvious that following any review of price, settlement of a review or agreement not to proceed with the review, clause 24 would require amendment to reflect any agreement or settlement in any new price which was thereafter to apply.
Clause 24(b) is the price review clause.
Clause 24(c) contemplates that the parties may from time to time agree upon a formula to be applied in the then current or subsequent price adjustments either in lieu of or in addition to the formula mentioned in clause 24(a). Thus clause 24(c) does contemplate additions or modifications to the formula which is prescribed in clause 24(a).
Clause 24(d) is the arbitration clause.
Following the grant of authorization by the Commission in 1986, clause 24 was further amended, specifically on 12 May 1988 and 24 May 1991. It is convenient to consider these two amendments now.
The first amendment was made by deed of 12 May 1988 between the Producers and the then Secretary of AGL. Counsel for the Commission relied on the deed of 12 May 1988 to found the submission that in 1986 the Commission authorized the conduct of the parties to the Letter of Agreement in carrying on arbitration pursuant to clause 24 of that document. As clause 24 was amended by the two later deeds, in particular the deed of 12 May 1988 to which the parties gave effect, then the original clause 24 became a dead letter and since authorization was not sought for the new clause 24, which was substituted by the 1988 deed and indeed the other deed of 24 May 1991, the conduct of the parties pursuant to those two deeds, insofar as it involved clause 24 and the arbitration clause, concerned conduct which was not authorized by the Commission.
Counsel for the Producers made a contrary submission.
In our opinion what was authorized by the 1986 authorization so far as relevant to this point was the “conduct of the parties in carrying on arbitration pursuant to clause 24 of the Letter of Agreement”. Most of the changes made to the Letter of Agreement by the two deeds concerned the new price formula for that originally set. In substance, the amended clause 24 retains the same basic price review mechanisms that were originally prescribed by paragraphs 24(b), (c) and (d). Indeed, those paragraphs are substantially identical to the paragraphs bearing the same letters in the original clause in the Letter of Agreement. We reject this argument of the Commission. The conduct of the parties in carrying on arbitration pursuant to the amended clause 24 is substantially the same conduct as was carried on before the amendments and had the benefit of the protection of the authorization.
No other clauses of the Letter of Agreement are presently material.
The arbitration clause 24 of the Letter of Agreement has been invoked and was the subject of an arbitration conducted by Mr R L Hunter QC and Mr B M Debelle QC (as they then were) in 1985 and the reasons for the award, including a separate volume of confidential reasons, were in evidence before us as exhibit 53 and confidential exhibit 54.
4. THE 1986 AUTHORIZATION
AGL applied to the Commission for authorization to give effect to the provisions of the Letter of Agreement and the two deeds of 17 May 1974 and 21 December 1976 respectively between AGL and the Producers. The first of the deeds dated 17 May 1974 is between AGL, its then Secretary, the then Producers and the Pipeline Authority, a statutory body formed by Commonwealth legislation. Under that deed the Pipeline Authority covenanted with AGL and the other parties to construct and complete in accordance with AGL’s obligations, expressed in clause 7(a) of the Letter of Agreement, that part of the pipeline referred to in clause 7(a) from the Producers’ plant to Wilton in New South Wales. It also covenanted to receive and transmit through that pipeline “in absolute priority” the natural gas and related products which AGL purchases or receives from the Producers pursuant to the Letter of Agreement. The remaining provisions were of a consequential kind. In substance the Pipeline Authority assumed the obligations of AGL expressed in clause 7(a) of the Letter of Agreement to construct and complete that part of the pipeline referred to in that provision from the Producers’ plant to Wilton in New South Wales. Effectively, by the deed of 1974 the Pipeline Authority undertook to fulfil all the obligations of AGL under the Letter of Agreement for the construction and performance of the pipeline to allow the supply of natural gas from the Cooper Basin to the New South Wales market.
The deed dated 21 December 1976 between AGL, its Secretary, the then Producers, the State of South Australia and the Pipelines Authority of South Australia (“PASA”), recognized that AGL released and discharged the Producers which had interests in the Cooper Basin from their obligations under the Letter of Agreement related to dedication of natural gas reserves to AGL. That is to say, by notice of dedication delivered to AGL pursuant to the Letter of Agreement on 12 September 1973, the Producers dedicated to it certain of their respective reserves of natural gas within the Cooper Basin region. Hence the deed (Recital E) provided that, in order to rationalize the development and production of the natural gas reserves so dedicated to AGL within the Cooper Basin and certain other reserves within that Basin, the Producers and the State of South Australia requested AGL to release and discharge the Producers from their respective obligations relevant to dedication.
In essence the Deed of Release of 1976 freed from dedication the reserves located in the Cooper Basin.
The Commission, in its authorization determination, accepted that there were significant public benefits in making available, by efficient reticulation, natural gas from the Cooper Basin; and that those benefits accrued to the public as a result of the producers being able to negotiate freely about various matters. One of the matters was the price at which the gas would be sold to purchasers, who in this case were AGL (clause 71). It noted in paragraph 72 of its determination, that, although the regulation of the initial sale and distribution of natural gas from Cooper Basin had an anti-competitive effect, that detriment to competition was outweighed by the public benefit which the Commission was satisfied had been demonstrated.
The terms of the Commission’s determination are as follows:
“74. In terms of Application A90424 now before the TPC, the TPC authorizes AGL to give effect to those documents titled:
(a) Letter of Agreement;
(b) Deed of Covenant and Release; and
(c) Deed of Covenant and Consent,
as amended up until the date of this Determination and set out at folios 14-112 and 304-318 of the TPC’s public register. This authorization extends to successors and assigns of AGL.
75. The TPC also authorizes the conduct of the parties in carrying on arbitration pursuant to clause 24 of the Letter of Agreement.”
There was discussion before us as to what the Commission did in fact authorize by its 1986 determination. It did not authorize the making of the Letter of Agreement and the two deeds; they had already been made. What it did was to authorize AGL to give effect to those documents. It also authorized the conduct of the parties in carrying on arbitration pursuant to clause 24 of the Letter of Agreement. Thus it was the conduct of AGL in giving effect to the documents and the conduct of the parties in carrying on arbitration pursuant to clause 24 that was authorized. The report of the authorization is Australian Gas Light Company (1986) ATPR (Com) 50-114 at 55,374.
The Commission could not authorize the entry into of the Letter of Agreement and the two deeds as they had been entered into before the Trade Practices Act came into force. It could authorize parties only to give effect to existing contracts (s 88(1)) in the form which it then took (and this is exactly what the Commission did). The reason for the authorization being granted only to AGL to give effect to the Letter of Agreement and the two deeds together with its successors was presumably that the relevant conduct of the Producers was carried on in South Australia and was exempt from the relevant provisions of the Trade Practices Act by virtue of s 51(1)(b) of that Act and the Ratification Act. The authorization granted concerning conduct under clause 24 was granted to all parties because that conduct was not confined to South Australia.
It is of particular relevance for present purposes that, by its 1986 authorization, the Commission authorized AGL to give effect to the first right of refusal clause of the Letter of Agreement (clause 12), the take or pay clause (clause 18), and the exclusive dealing clause (clause 20).
5. 1996 REVOCATION OF THE 1986 AUTHORIZATION
On 21 September 1994 the Commission issued a notice pursuant to s 91(4) of the Trade Practices Act to initiate a review of the 1986 authorization in the light of what appeared to it to be material changes of circumstances since the authorization was granted.
When the notice of review was issued, AGL and other interested parties were invited to make submissions. At the same time, pursuant to a request from the Commission, the Industry Commission commenced a study of changes in the gas industry. The Industry Commission Study was released in March 1995. Following consideration of the Industry Commission’s Report, the Commission released an Issues Paper in June 1995 and invited interested parties to make submissions in the light of the Industry Commission Report.
The Commission in its Determination of 27 March 1996 stated that it was satisfied that three material changes of circumstances had occurred since the 1986 authorization was granted, namely:
(1) Sales of gas under the Letter of Agreement have since 1988 occurred at a price collectively fixed by the parties under a new clause 24 which was substituted for the authorized clause 24 in the Letter of Agreement.
This harks back to the questions which we have already dealt with. The Commission noted on page ii of its Determination that clause 24 as authorized established a price for the sale of gas to AGL and provided for the negotiation of new prices and arbitration of price disputes between AGL and the Producers. In 1988 the authorized clause 24 was deleted and a revised clause 24 inserted. The Commission stated that it had obtained legal advice that sales of gas pursuant to the revised clause 24 are not protected by the authorization on the basis that the revised clause 24 as it now stands was not before the Commission at the time the authorization was granted. In the absence of authorization, protection for the new clause 24 which is the fundamental purpose of the authorization, namely, protection for price reviews and arbitrations conducted in New South Wales, is not being achieved. Hence, the Commission said that the deletion of the authorized clause 24 and the substitution of a new clause 24 must therefore be regarded as a material change of circumstances.
(2) AGL is no longer the sole actual and potential source of metered gas to both domestic and industrial consumers in Sydney, nor in Newcastle, Wollongong and other regional centres.
(3) Since 1986 it has become less difficult for producers from the Gippsland Basin, in particular, to compete in the market for the supply of gas to distributors and end-users in New South Wales.
The Commission said that it was satisfied that the anti-competitive detriments of the authorized agreements now outweigh their public benefits.
The three clauses of the Letter of Agreement identified by the Commission as having anti-competitive effects are the first right of refusal clause (clause 12), the take or pay clause (clause 18) and the exclusive dealing clause (clause 20). The Commission recognized (page iii) that there are public benefits associated with the use of long-term contracts in underwriting significant capital expenditure in production, exploration and transportation infrastructure. However, in the current market circumstances, the Commission said it believed that any positive benefits associated with the long term nature of the Letter of Agreement and the current take or pay provisions are now outweighed by their anti-competitive effects in restricting the entry of a third-party producer to the market in New South Wales.
The Commission was satisfied that the anti-competitive detriments now exceed the public benefits of the authorized arrangements and that there are sufficient grounds to revoke the authorization.
Notwithstanding that decision the Commission said (page iv) that it was satisfied that the new clause 24 in its current form results in public benefits of substance.
The Commission therefore decided to revoke authorization number A90424 and to grant a new authorization in substitution for the revoked authorization. The terms of the new authorization were that authorization was granted in respect of clause 24 of the Letter of Agreement in the form in which that clause appears in the deed of 12 May 1988 between the producers, AGL and the then Secretary of AGL, as amended by the deed of 24 May 1991. The Commission said at page 38 that the authorization was granted to AGL (and to the Producers pursuant to s 88(6) of the Trade Practices Act):
“to give effect to the provisions of the said clause 24 of the Letter of Agreement. The authorization extends to conduct by the parties in reviewing, negotiating and arbitrating prices for gas in accordance with the provisions of the said clause 24.”
The authorization was granted for:
“(a) the period of time until the said clause 24 of the Letter of Agreement ceases to be exempted from the operation of the Trade Practices Act 1974 by the provisions of the Cooper Basin (Ratification) Act 1975 of South Australia; or
(b) the period of three years commencing on the day this authorization comes into force,
whichever period of time is the shorter.”
The Commission said (at p 38) that if no application for review of its determination is made to the Tribunal under s 101 of the Trade Practices Act, then the Commission’s determination will come into force on 18 April 1996; but if an application for review is made to the Tribunal (as it was) the determination would come into force either on (a) the day that the Tribunal makes the determination on the review and grants authorization; or (b) where the application for review is withdrawn - on the day that the application is withdrawn.
In summary, the Commission has revoked the 1986 authorization which authorized AGL to give effect to the provisions of the Letter of Agreement and the two deeds and permitted the parties to conduct arbitration pursuant to clause 24 of the Letter of Agreement. What remains in its place is a limited authorization to the Producers and AGL to give effect to the new clause 24 of the Letter of Agreement (that is the Letter of Agreement as amended by the two deeds).
6. THE ACT AND THE APPROPRIATE TESTS (ESPECIALLY s 91(4))
In Media Council of Australia (No 4) (1996) ATPR 41-497 the Tribunal analyzed s 91(4) of the Act at 42,238-42,241 and 42,260-42,261.
It is unnecessary to recite here what we said there; but it is useful to refer to the principal findings made by us in Media Council (No 4) especially with particular relevance to the present matter.
Section 91(4) provides as follows:
“91(4) If, at any time after the Commission has granted an authorization, it appears to the Commission that the authorization was granted on the basis of evidence or information that was false or misleading in a material particular, that a condition to which the authorization was expressed to be subject has not been complied with or that there has been a material change of circumstances since the authorisation was granted -
(a) the Commission shall give notice accordingly to the corporation to which the authorization was given and any other persons who appear to the Commission to be interested and afford them a reasonable opportunity of making submissions to the Commission in the matter; and
(b) where, after so notifying the corporation and other persons (if any) and considering any submissions made by those persons, the Commission is satisfied that the authorization was granted on the basis of evidence or information that was false or misleading in a material particular, that the condition has not been complied with or that there has been such a material change of circumstances, the Commission may make a determination revoking the authorization and, if it considers it appropriate to do so, granting a further authorization in substitution for the authorization so revoked.”
As we observed in Media Council (No 4) at 42,238, the Tribunal’s jurisdiction to review the Commission’s determination revoking the earlier authorization is derived from s 101 of the Act, subsection (1) of which requires the Tribunal to review the determination of revocation; and a review by the Tribunal is a rehearing of the matter that was before the Commission (s 101(2)).
We observed at 42,239 that there was no section in the Act which is specifically directed to the functions and powers of the Tribunal when conducting a review of a determination of the Commission revoking authorization, apart from s 101. We found (at 42,239) that to perform its statutory duty to review the Tribunal must, by implication, have the same powers as those specifically vested in the Commission by s 91(4)(b), namely, to revoke the authorization; and if the Tribunal considers it appropriate to do so, grant a further authorization in substitution for the authorization so revoked.
We observed (at 42,239) that questions of public benefit and detriment (including anti-competitive detriment) are at the heart of the Tribunal’s functions and powers; and that it is at the core of the Tribunal’s task (as it is for the Commission) to enable a conclusion to be reached pursuant to s 91(4) that revocation of an authorization is justified on the basis that there has been a material change of circumstances since the authorization was granted. Consideration of matters going to public benefit and detriment to the public are fundamental.
The Tribunal’s task is a three stage process. The first stage is for the Tribunal to ask itself whether there has been a material change of circumstances since the authorization was granted. The second stage, if the first question is answered in the affirmative, is whether the authorization should be revoked. The third stage is whether, if the answer to the second question is yes, should there be granted a further authorization in substitution for the revoked authorization (at 42,239 and 42,240 and 42,261).
To determine whether there has been a material change of circumstances since the authorization was granted, the Tribunal must commence by examining the circumstances as they existed at the time the authorization was granted (at 42,240). From that point the Tribunal then moves forward to the circumstances as they exist on the material before it at the time it conducts the rehearing. Circumstances is a word of wide import which includes all facts, matters and conduct relevant to an authorization and to a revocation.
The Tribunal must examine for itself the circumstances as they existed at the time of the 1986 authorization. It is not limited to the circumstances as found by the Commission at the time of granting the authorization in 1986. The material before the Tribunal at the present time may (although in fact it does not in this case) reveal circumstances that existed in 1986 that are material to the inquiry and yet were not before the Commission at the earlier time. Nevertheless, as a practical matter, the reasons for decision of the Commission in 1986 are the starting point for the Tribunal’s consideration at the present time. It is impermissible for the Tribunal today to go behind the reasoning expressed by the Commission in its 1986 determination and conclude that the authorization should not then have been granted or would not be granted on the same facts today. But that is entirely different from saying that it is for the Tribunal today to consider and assess the facts as they appear to us to have existed in 1986. However, as we observed at 42,241, in the course of examining for itself the circumstances as they appear to have been in 1986, the Tribunal would be fully justified in accepting the Commission’s earlier findings of fact expressed in the 1986 determination if no challenge, reasonably based, is made to them in this review before the Tribunal.
We should add that in fact no party or the Commission has pointed to any circumstances that existed in 1986 beyond those discussed and determined by the Commission in its 1986 determination.
We noted at 42,241 that a material change of circumstances includes a change of circumstances which has a significant impact upon the benefits to the public or upon the detriment, including anti-competitive detriment, arising out of the conduct of the provisions in question.
If the Tribunal is satisfied that there has been a material change of circumstances in the intervening period, then it must determine, in the exercise of its discretion, whether or not such change of circumstances is of a kind or of such magnitude or significance as to warrant the Tribunal revoking the authorization previously granted. The determination of public benefit and detriment is germane to both tasks of the Tribunal, namely, when first determining whether there has been a material change of circumstances and, secondly, if so, whether such change warrants the Tribunal’s revocation of the authorization.
We also observed at 42,241 that in the course of determining relevant public benefit and detriment the Tribunal must compare the position which would or would be likely to exist in the future, on the one hand if the authorization were to continue, and on the hand, if it were absent: The “Future With-and-Without” Test.
If the Tribunal is satisfied that the authorization should be revoked, the third question then arises whether a further authorization should be granted in substitution for the authorization so revoked. That exercise involves the Tribunal in comparing the position which would or would be likely to exist in the future with the previous authorization revoked and no further authorization granted, with the position in the future that would or would be likely to exist if the further authorization were to be granted in substitution for the previous authorization.
The Tribunal now proceeds to apply these principles to the facts and circumstances of the case.
7. THE CASES OF THE APPLICANTS, AGL AND THE COMMISSION
Counsel for the Applicants first made submissions on the first of the three stages of analysis as to whether there has been a material change of circumstances since the date of the original authorization. Counsel first dealt with the question of market definition and argued that the market had four dimensions: product; functional; geographic and temporal. Whilst they did not contend for a market in which all energy sources compete unfettered against each other in all circumstances, their case was that the market includes at least natural gas, but extends to include energy sources in addition to natural gas.
The relevant functional market was said to be wholesale and retail; the relevant geographic dimension was argued as being south-eastern Australia which includes the southern part of Queensland. As the argument progressed, counsel for the Applicants accepted the view that on the temporal dimension we are dealing here with an unusual situation of a market that expands over time.
Turning to the take or pay clause (clause 18), counsel argued that there were distinct public benefits associated with the clause and no anti-competitive detriments; and the position had not changed since 1986.
As to clause 20 the position was said to be the same; similarly concerning the right of first refusal (clause 12). Counsel argued that there had been a change to clause 24 from its original form as authorized in 1986, the relevant amendment being in the deed of 12 May 1988. It was argued, we think correctly, that the amendment did not alter the basic structure of the pricing clause. The price review process provided for in the new clause 24 remained intact.
Counsel submitted that there had been no material change of circumstances; that there had been no significant decrease in net benefits nor had there been a significant increase in detriments. The argument then proceeded to deal with the future with-and-without test and it was argued that this must be answered in favour of the applicants.
Counsel for AGL maintained a basically neutral stance until he cross-examined the experts towards the conclusion of the evidence. Counsel correctly in our view identified the two provisions of Part IV of the Act mainly in point in this case, namely, s 45 and s 47. Counsel argued that there had been a material change of circumstances since 1986 which he described comprehensively:
“as the progress in opening up the gas market to competition by the action of governments and the commercial responses to that progress, including proposals for new pipelines, third parties seeking access to pipelines, and proposals for supply to AGL’s customers by new entrants. This process is far from exhausted but it is sufficiently advanced to be material.”
Counsel said that AGL faces a very different climate from that which it faced in 1986 when it was the sole, actual and potential source of gas in New South Wales. It faces uncertainty as to its source of gas after 2006; and in the final five years of the Letter of Agreement concerning the quantities it may need above contract quantities, it faces great uncertainty as to demand.
Counsel for AGL joined issue with counsel for the Applicants in the latter’s contention that it is not open to the Tribunal to reassess risks of long-term contracts ex post facto or that to do so creates dangerous precedents. Counsel for AGL submitted that, apart from the obvious rejoinder that business cannot expect to be insulated from risk at the expense of consumer welfare where legislation has been introduced to secure that objective after the risk has been assessed, the argument makes a number of other implicit assumptions which are at least questionable. Counsel said that there is no evidence as to the way in which the 30 year term was arrived at; and it should not be assumed that in the absence of evidence it was the appropriate period for amortization of the parties’ expenditure required to meet their commitments. Also, the Letter of Agreement has not remained in its original form, but has already been amended on several occasions, doubtless to take account of the parties’ perceptions of their respective risks and changes to them caused by intervening events, that is change of circumstances. It was argued that there clearly had been a material change in circumstances going to both benefits and detriments. The nature of competition itself has changed in the relevant market.
Counsel for the Commission relied on the material changes of circumstances identified by the Commission in its determination of 27 March 1996 to which reference has already been made. Additional matters were relied on as constituting material change of circumstances in final argument. They were identified as follows:-
(i) infrastructure reforms including, in particular, legislative provisions for third party access to gas pipelines and the development of access regimes to give effect to the legislation;
(ii) the initiation by the South Australian government late in 1996 of a process of review of the Cooper Basin (Ratification) Act 1975 (SA);
(iii) actively pursued proposals to interconnect the Victorian and New South Wales gas pipeline systems, namely, the Eastern Gas Pipeline Proposal and the link between Albury and Wagga Wagga. These links potentially extend the geographic scope of the market in which gas is supplied under the Letter of Agreement from New South Wales to south-eastern Australia;
(iv) resolution of the resource rent tax dispute between the Victorian Government and the Gippsland producers, thus removing a significant impediment to competitive interstate sale of Gippsland Basin gas.
(v) the agreement between the Applicants and the South Australian Government that there will be no restriction on the ability of the Applicants to sell gas in South Australia or elsewhere, which is significant in allowing the Applicants to sell uncontracted gas in the future without restriction;
(vi) increased environment restrictions, favouring the use of natural gas over coal and oil as an industrial fuel, and the likelihood of further increase in such controls;
(vii) reform of the electricity market, in particular, the introduction of a national grid and pool which allows small generators to supply electricity and makes co-generation an attractive activity;
(viii) likelihood of the emergence of alternative gas aggregators as in competition with AGL in New South Wales;
(ix) increase in the demand for gas, and the forecast demand, so that in the absence of a competitive supplier of gas in New South Wales there would be little or no practical possibility that AGL would fall below its take-or-pay obligation during the remainder of the period of operation of the Letter of Agreement;
(x) the ability of the Applicants to sell gas to consumers, particularly industrial consumers, in competition with AGL, by taking advantage of third party access to the Moomba-Sydney Pipeline;
The argument, especially the written submissions of the parties and the Commission, was extensive and we have not attempted to do other than summarize certain of the salient features of it; but we have taken all of the argument into account.
8. THE AUSTRALIAN GAS INDUSTRY
The Australian natural gas industry is a substantial and complex industry, with numerous participants engaged in its several functional parts. The customary commercial practices of the industry are correspondingly complex, and in certain respects particular to the industry’s circumstances. Much evidence was directed to assisting the Tribunal’s understanding of the purposes and practical justification of these practices.
8.1 Natural gas and liquids
Natural gas is a mixture of gaseous hydrocarbons (compounds of hydrogen and carbon) that occurs naturally in certain rock strata, not uncommonly associated with the corresponding liquid hydrocarbons known as oil. Suitable rocks are sandstone sediments in the geological structures known as sedimentary basins, but not all such basins contain oil or gas.
Naturally occurring gas and oil are not chemically pure substances, but are a mixture of hydrocarbons distinguished from each other by the number of carbon atoms in the molecule. Natural gas is predominantly methane, always with some ethane. Methane has one carbon atom in its molecule, and ethane has two.
Raw natural gas also contains (according to the reservoir from which it is drawn) varying proportions of “liquids”, hydrocarbons with more than two carbons in their molecules. Propane (3 carbons) and butane (4 carbon atoms) are liquid under pressure or refrigeration, and are together described as “liquefied petroleum gas” (LPG) when sold commercially. The hydrocarbons with 5 to 7 carbon atoms are volatile liquids at ordinary atmospheric pressure and are called “condensate”. Gas fields that are rich in propane, butane and condensate are known as “wet” fields. Liquid hydrocarbons with higher numbers of carbon atoms than condensate are considered to be “oil”.
Gas processed to a specification for sale is termed “sales gas”. Processing typically involves the removal of carbon dioxide and any water from the raw gas that flows to the surface, the separation of liquids and condensates for separate sale, and the substantial separation of ethane, which can be separately valuable as a petrochemical feedstock.
Natural gas is used as a fuel by domestic, commercial and industrial customers. Such use has in recent years been strongly encouraged by governments on the advice of environmental authorities, on the grounds that gas is a “clean” fuel. Unlike coal, fuel oil and other alternative fuels, the use of gas generates neither particulate or other socially unacceptable emissions, nor solid or liquid wastes. Substantial quantities of liquefied natural gas (LNG) are exported from Australia.
8.1.1 Cooper Basin natural gas The Cooper Basin reservoirs typically contain gas rather than oil, and only some gas reservoirs are “wet”. Oil reservoirs have been found in rocks in the Eromanga (or Great Artesian) Basin.
Cooper Basin natural gas is processed in substantial facilities close to the producing gas fields in the Central Australian Desert some 800 km north of Adelaide, at Moomba. The Moomba facilities process not only the gas of the joint venturers who own the facilities, but also gas produced by other ventures in the Cooper Basin, under tolling arrangements. Two pipelines are in place which enable sales gas from Moomba to be transported either to Adelaide or to Sydney.
Propane, butane, condensates and other liquid hydrocarbons from Cooper Basin and Eromanga Basin fields are transported by a separate pipeline built from Moomba to Port Bonython on the South Australian coast. At Port Bonython, the liquid hydrocarbons are separated into fractions for sale to export and domestic customers, notably as LPG. Since June 1996, a gas fraction called “ethane concentrate” has been transported to Sydney by means of a second, dedicated pipeline from Moomba to the ICI petrochemical plant in Sydney, for use as a chemical feedstock in substitution for ethane manufactured from imported naphtha.
8.1.2 The Cooper Basin Producers The applicants for review in this matter are the several companies that comprise the particular joint venture, the SA Unit, that owns the Moomba facilities, that has supplied sales gas under contract to Adelaide since 1969, and that entered the Letter of Agreement with AGL in 1971 for supply of sales gas to Sydney. In evidence and argument to the Tribunal, these companies termed themselves the Cooper Basin Producers (the “Producers”), and this usage is adopted also by the Commission in their determinations in regard to Cooper Basin gas.
The Tribunal adopts this terminology in these reasons, where it can be used without introducing confusion as to the particular joint venture, among others that operate in the Cooper Basin, which is being referred to. The scope for such confusion arises because many of the same companies are participants in other, separate exploration and production joint ventures in the Cooper Basin. It is not to be inferred that, in these other respects, such companies have the same rights and are subject to same obligations that apply to them in this present matter, which relates to the particular joint venture that entered the Letter of Agreement.
Further aspects of the Cooper Basin gas tenement ownership structures, and of their significance and consequences, are described later in these reasons.
8.1.3 Units of measurement of gas The parallel use of imperial and metric measures in Australian gas industry, and the expression of quantities of gas alternatively by volume or by energy content, requires that these reasons describe the units of measurements adopted. The Australian natural gas industry follows American convention in defining a billion as a thousand million, i.e. 109, and a trillion as a thousand billion, i.e. 1012. We adopt this convention in these reasons.
The Letter of Agreement expresses gas quantities in trillions of cubic feet (Tcf), billions of cubic feet (Bcf), and millions of cubic feet (MMcf). However modern Australian practice is to express gas quantities in terms of the energy units petajoules (PJ), terajoules (TJ), and gigajoules (GJ), where:
1 PJ = 1,000 TJ = 1,000,000 GJ,
and 1 PJ = 1.08 Bcf.
Mr McArdle of Santos, who provided the Tribunal with much undisputed factual evidence about the gas industry, suggested that the Tribunal would find it sufficient for its purposes to consider a billion cubic feet (Bcf) of gas as approximately equal to a petajoule (PJ) of gas.
The provisions of the Letter of Agreement specify the initial price charged for gas at the commencement of the contract on the basis of the imperial unit, the British thermal unit, specifically as a price per million British thermal units (MMBtu). In this respect, Mr McArdle suggested that one MMBtu unit might be considered by the Tribunal as approximately equivalent to one GJ unit.
In the event, the Tribunal found that PJ and GJ units of measurement were employed pervasively in evidence and argument, reducing the scope for confusion.
8.2 Reservoir depletion and gas deliverability
Because natural gas exists in underground reservoirs under high pressure, it flows to the surface when it is tapped by a well drilled into the rock stratum where the gas is. From the head of a production well, the raw gas is piped away to be combined with production from other nearby wells for processing and eventual transmission to market.
The quantity of gas in any reservoir is of course finite. When natural gas is produced and sold from a gas reservoir, the reservoir is depleted as to quantity, so that eventually the gas in a reservoir will be exhausted, or (more precisely) the flow of gas will be so reduced that economic production of gas from the reservoir is no longer possible.
Because natural gas is not readily stored, it is typically produced and processed only to meet immediate demand, and the underground natural gas reservoirs in effect serve as the raw product storage. The consequent requirements are that production and processing facilities at the gas fields have the capacity to supply gas at the average and maximum delivery rates required to satisfy market commitments, and that production rates should be managed to directly match demand.
It is possible, at a cost, to pump surplus gas back underground into depleted reservoirs or other suitable geological structures, for later recovery, and this has been done in the Cooper Basin for the storage of ethane. The use of gas storage as a limited device for the management of supply and demand imbalances is said to be integral to natural gas infrastructure in North America and Europe, but such capabilities are poorly developed in Australia at this juncture.
The production arrangements for Cooper Basin gas supply to AGL are typical in the above respect, in that useful sales gas storage is unavailable in the normal course. The consequential requirement is that installed production capabilities should be sufficient to meet contractual obligations as to annual sales volume and peak demand, and that total gas reserves available for sale to AGL should be sufficient to meet contracted quantities.
Evidence to the Tribunal pointed to the practical significance of gas “deliverability” in the management of production to match contracted delivery quantities. The quantity of gas that can be produced by any well depends on the underground pressure that drives gas to the surface, and the porosity of the rock that contains the gas that is being tapped. Rock porosity varies widely, so that correspondingly the maximum gas flow to the surface also varies widely between one gas well and another. Further, the gas flow from a reservoir will fall as the reservoir is depleted. It follows that estimates of the total gas reserves in a basin are not useful as a measure of the feasible economic rate of production of those reserves. The rate of production from a particular reservoir can be increased by drilling more wells into the reservoir at a cost, and can be evened out to some degree over time by various production techniques.
The total output from a gas production operation drawing from several reservoirs and numerous producing wells is typically managed so as to yield a steady rate of production over several years, pitched to suit projected demand, and capable of short‑term adjustment to meet demand shifts and fluctuations. Within the total production volume, the source of gas changes over time, as particular reservoirs are depleted and eventually exhausted, as additional wells are drilled to accelerate production from other reservoirs, and as any newly discovered reservoirs are brought into production. As the field as a whole approaches exhaustion, production will eventually fall off sharply, although the “tail” of limited and declining gas production may persist for many years.
In the Cooper Basin generally, gas reservoirs usually do not exhibit a high deliverability, as the relevant rocks do not have a high porosity; the rocks are said to be “tight”. Further, the depth of the gas reservoirs, which can be as much as 3000 metres, discourages the drilling of numerous wells into a reservoir. In one known structure, quite substantial reserves exist in rocks that are so tight and deep that no economically viable method has been yet devised to extract them for sale at present gas prices. Available reserves in the Cooper Basin as a whole have long been known to be substantial, and have been added to by exploration since the early discoveries were proved, but practical considerations of deliverability have required Producers in the Cooper Basin to limit the scale of sales contracts, and to schedule contracted deliveries to accord with considerations of gas deliverability.
Evidence to the Tribunal demonstrated amply that, since production of gas from the SA Unit areas began, both the Producers and the buyers of gas, and interested governments, have been in frequent contention (including contention among the Producers) as to facts and likelihoods pertaining to:
• the quantity of economically recoverable natural gas reserves within the areas controlled by the Producers’ venture, as these reserves have been depleted by sales and increased by discoveries,
• the practicality of contracted gas volumes being delivered at an economic price, and
• the priorities to apply in allocating production among alternative buyers.
The evidence also demonstrated amply that, as the relevant gas reservoirs of the SA Unit become so depleted in the future that production declines seriously (as it eventually must), and as the Producers explore the possibility of additional gas sales at the margin of feasible production, this contention will not abate.
8.3 The development of natural gas industry in Australia
Brisbane became the first Australian city to use reticulated natural gas in 1969, following the commissioning of a gas pipeline from Roma in the Surat Basin.
The introduction of natural gas in Victoria was proceeding in parallel, following discovery of natural gas in 1965 in Bass Strait, where the major oil and gas producing structure known as the Gippsland Basin lies off‑shore from south‑eastern Victoria. Natural gas piped from the on‑shore processing plant at Longford in Gippsland had completely supplanted coal gas in Victoria by the end of the 1960s. Bass Strait gas is produced by a joint venture of companies associated with Esso Australia and BHP Limited, with the Esso company as operator of gas and oil production.
Natural gas was introduced in Western Australia in 1971 when a privately‑owned pipeline carried gas to Perth from the small Dongara field in the Perth Basin.
Tasmania is not connected to any natural gas supply, although the Bass Basin, in Bass Strait adjacent to the north coast of Tasmania, prospectively contains some natural gas.
Gas fields of commercial significance had been found during the 1960s within the Cooper Basin. Santos Limited, incorporated in South Australia in 1954 with the explicit aim of finding petroleum in that state, was a prime mover in looking for oil and gas in the Cooper Basin. Santos entered an agreement in 1958 with Delhi Australian Petroleum, under which, by substantial expenditure on exploration, Delhi earned a 50% interest in Santos exploration licences in South Australia and south‑west Queensland, with Santos retaining an overriding royalty right. Further “farm‑out” agreements were later arranged in respect of defined “blocks” within the overall exploration permit area, so that several other companies also funded exploration effort to earn an interest in oil or gas produced from any discoveries in those blocks. The commercial risk of what was for Australia a substantial and novel venture, was thereby shared; but a complex pattern of rights by particular companies to particular sales revenues from production of hydrocarbons discovered on particular blocks was a consequence.
In 1967, the South Australian Government constituted the statutory authority later known as the Pipelines Authority of South Australia, with the function of constructing and operating a natural gas pipeline from Moomba in the South Australian Cooper Basin to Adelaide. Long‑term contracts were signed for the supply of gas to major customers in the Adelaide area from fields in South Australian Cooper Basin. The first deliveries of Cooper Basin gas through the Moomba-Adelaide pipeline commenced in November 1969.
No significant natural gas reserves were discovered in NSW, or have been discovered since. In Sydney, AGL had long supplied manufactured town gas to retail customers in the Sydney region through its extensive local reticulation network. AGL entered discussions around 1969 with gas producers in the two sedimentary basins nearest to NSW where natural gas was being produced, and from which a sufficient supply of gas might potentially be piped to Sydney, viz. the Cooper Basin and the Gippsland Basin. AGL sought to undercut the cost of fuel oil and other fuels then used in NSW industry and thus to expand the gas market in NSW. Producers in both basins were on their part eager to sell such potentially substantial quantities of gas to AGL, subject to practical considerations and agreement on a suitably priced contract. In the event, following competitive negotiation, AGL selected the Cooper Basin as its preferred long‑term source of supply of natural gas to Sydney, and negotiated the Letter of Agreement with the Cooper Basin Producers.
Other discoveries of gas have been made in other Australian sedimentary basins:
• the Amadeus Basin, south of Alice Springs in the Northern Territory, where the limited quantities of gas are sufficient to supply power stations in Alice Springs and Darwin by pipeline
• the Bowen Basin (including the structure known as the Denison Trough) which lies to the north of the Surat Basin in Queensland, and which contain reserves of gas of a size sufficient to supply Rockhampton and Gladstone, and in particular the alumina plant at Gladstone
• the Adavale Basin in central western Queensland, where a small gas reservoir supplies a nearby power plant at Barcaldine
• the Otway Basin, predominantly off‑shore from south‑western Victoria, contains gas, but the size of its commercial gas reserves and its future significance to gas supplies in Victoria and South Australia both seem, on the evidence, to be in doubt; a small on‑shore field at Katnook near in South Australia supplies gas to Mount Gambier, and another on‑shore field at Port Campbell in Victoria supplies six towns in western Victoria comprising only 2% of Victorian demand.
• the Carnarvon Basin, often known as the North West Shelf, where very large reserves of natural gas lie off‑shore from Western Australia; gas from this source is exported as LNG, and has also been transported by pipeline to serve general markets in Perth and Bunbury since 1984.
• recent gas discoveries further north, off‑shore in the Bonaparte Basin and the Timor Sea, which have not yet been developed, and are currently the subject of major exploration activity; these reserves are also apparently very large.
The progressive introduction of natural gas supplies into the major centres of population and energy demand on the Australian mainland has been followed by dramatic growth of the industry, which attained the output of 731 PJ of natural gas in 1993‑94 from all producing areas. Natural gas accounted for 7% of Australia’s energy consumption in 1973‑74, 15% in 1983‑84, and 17.6% in 1993‑94.
The gas reserves of the Gippsland Basin, and their contiguity to large potential markets, have together allowed Victoria to develop the use of natural gas in industrial, commercial and household use to a greater extent than in any other state. In Victoria, natural gas accounted in 1993-94 for 21% of energy consumption, and 56% of non‑transport energy consumption. However Victorian gas has not been supplied to markets outside Victoria.
The Australian gas industry expects further substantial growth in demand in the future, subject to the availability of gas, particularly to large industrial energy users, at prices that would justify gas use in substitution for other sources of energy. Relevant demand projections are discussed later in these reasons.
8.4 The functional structure of natural gas industry
The conventional sequence of transactions for natural gas has the producer sell gas to a gas distributor that acts in effect as a wholesaler, with the gas then on‑sold to (effectively retail) customers who are gas users. The gas transmission pipeline provides a haulage service between the seller (the gas producer) and the primary gas purchaser (the distributing company) with haulage costs paid by either the producer or the primary buyer, depending on whether the terms of sale are ex‑field or “city‑gate” (i.e. delivered to the entry point to the buyer’s gas reticulation pipe system).
The gas industry is also usefully considered as a sequence of four distinct physical operations:
• exploration for gas and the appraisal of any discoveries as to the feasibility of commercial production
• production of the raw gas, and processing to remove impurities and separately saleable fractions, yielding dry sales gas of a defined specification that can be sold commercially
• high‑pressure transmission of sales gas by pipeline from the gas‑fields to points adjacent to significant gas markets
• low‑pressure reticulation of gas to domestic, commercial and industrial customers in population centres where there is substantial local demand; the sellers of gas to retail customers from such reticulation systems are often known as “aggregators”.
The first two of these stages are characteristically conducted by the same enterprise, in Australia often a joint venture. Exploration for commercial deposits of oil and gas is an uncertain activity, so that investment in exploration is necessarily speculative. An investor’s reward for exploration effort is dependent on the discovery of a commercial oil or gas field, from which production can yield sales revenue. Because the reserves of gas in a reservoir are finite, so that development of a gas reservoir to produce gas for sale is a terminating venture; the sunk and capital costs associated with exploration, appraisal, development and processing need to be recovered from sales revenue during the life of the reservoir if venture is to be viable.
8.5 The role of governments in gas industry
The pervasive role of government in gas industry has already been referred to. Governments regulating extractive industry typically issue exploration permits that may be converted to production permits subsequent to discovery, with the intention that those interests that conducted the exploration should thereby be able to recover the costs of exploration.
Gas exploration and production in the Cooper Basin fall under the jurisdiction of either the South Australian or Queensland governments, and both adopt similar licensing practices in regard to the oil and gas industry. The South Australian government will issue a Petroleum Exploration Licence (PEL) in respect of a designated area for a period, subject to exploration expenditure obligations, and subject also to requirements that parts of the original area are from time to time relinquished. If a discovery is made, the relevant area can be excised from the PEL and secured by a production licence, usually with a term of 21 years renewable. The corresponding exploration licence in Queensland is termed an Authority to Prospect (ATP).
The PEL that currently applies to the gas producing areas that supply AGL from the South Australian sector of Cooper Basin expires in February 1999. The Producers can apply to have the PEL renewed after expiry, but cannot be assured that they will be awarded a new PEL ahead of some other applicant. The Producers thus have a strong incentive to discover all the gas that they can in the relevant area, and establish production rights for it, prior to February 1999.
Beyond the role of government in the allocation of exploration and production permits, the intervention of governments in the strategic and operational decisions of the Australian natural gas industry has been characteristic of the industry since its inception. State governments have by long custom exercised a degree of legislative and regulatory direction over the gas industry, since before the time when natural gas replaced town gas. Because of the general domestic use of gas, and a view that gas supply is a public utility, gas pricing has been considered a politically sensitive issue. Also, the discovery of natural gas reserves within their borders has encouraged particular state governments to direct that “their” natural gas should as far as possible be used within their state rather than “exported” to another state, and gas availability has been used to foster industrial development within the state.
The gas distribution companies that reticulate gas to users are public authorities in some instances. For example GASCOR in Victoria (trading as Gas and Fuel) distributes gas supplied by the Gippsland Basin producers and delivered to the Gas and Fuel reticulation systems by another government entity, Gas Transmission Corporation (GTC), through pipelines that it owns and operates. In South Australia, SAGASCO, a government corporation that held interests in the Cooper Basin joint ventures as well as reticulating gas in Adelaide, was privatised in 1993, being sold to Boral. The Moomba-Adelaide pipeline, owned and operated by PASA, was sold to Tenneco in 1995
In NSW, AGL has historically been the sole distributor and retailer of gas to users. (For the purposes of this matter, we leave aside two small local gas distribution operations, that of the Wagga Wagga City Council, and the subsidiary of GASCOR that reticulates Victorian gas in Albury.) AGL presently receives all its natural gas supplies through the Moomba-Sydney Pipeline System (MSPS), which was constructed, owned and operated by the Pipeline Authority, a Commonwealth statutory body, until it was privatised under the Moomba-Sydney Pipeline System Sale Act 1994 .
Gas transmission pipelines in Australia are typically owned and operated separately from either the producer or the purchaser of gas, and typically constitute a natural monopoly in that alternative pipelines connecting seller and buyer do not exist. In recent years the application of National Competition Policy to the gas industry (which is elaborated later in these reasons) has addressed the possibility of undue market power being exercised by gas pipeline companies, particularly if they should be vertically integrated with either the producer or with a downstream gas buyer.
The purchaser of MSPS was East Australian Pipeline Limited (EAPL) in which AGL has a 51% interest with subsidiaries of Nova Corporation of Canada and Petroliam Nasional Bhd of Malaysia as the other shareholders. However in accordance with National Competition Policy, the component operations of EAPL are “ring‑fenced”, so that AGL cannot exercise control. Similarly, with the privatization in 1995 of the Moomba-Adelaide pipeline, PASA’s existing gas supply contracts with the Cooper Basin Producers were assumed by the Natural Gas Authority of South Australia (NGASA) which on‑sells gas to SAGASCO for reticulation, and to ETSA, the power generation company. It follows that Tenneco, the new owner of the Moomba-Adelaide pipeline, cannot exercise market power as a monopoly reseller of gas to end‑users, and is confined to the function of gas haulage.
8.6 Geographical fragmentation of Australian gas industry
Over the less than 30 years since a significant Australian natural gas industry came into being, an industry structure has emerged where the major producing gas basins are widely separated, and where the systems of supply of sales gas to the major population centres are and remain physically distinct from each other, and are governed by separate commercial arrangements that impact on each other only indirectly.
Brisbane and other towns in eastern Queensland receive sales gas from a system of pipelines that tap gas from the contiguous Surat Basin, Denison Trough and Bowen Basin. With the impending exhaustion of the gas reserves of the Surat Basin, the Cooper Basin gas reservoirs in south‑west Queensland have lately also been connected, coupled with the construction of on‑field processing facilities, by a pipeline (owned by Tenneco) to the existing pipeline to Brisbane (owned by AGL). A pipeline is being built by AGL to Mt Isa from the south‑west Queensland Cooper Basin. These same reservoirs have in recent years also sent raw gas by a dedicated pipeline to Moomba, for toll processing there and sale to PASA (and more recently to NGASA). However the Queensland sales gas pipeline system is not connected to other sales gas pipeline systems supplying NSW, South Australia, or the Northern Territory.
The limited gas fields of the Amadeus Basin south of Alice Springs, from which sales gas is piped to Darwin, are not connected to delivery pipelines to Sydney and Adelaide from Moomba. The Moomba‑Sydney pipeline is not connected directly with the Moomba‑Adelaide pipeline, despite their both drawing sales gas from the same processing facilities at Moomba. The sales gas supply pipeline from Moomba to Sydney has no present connections with the pipeline system that comprehensively supplies the Victorian market from the Gippsland Basin.
It was freely remarked in oral evidence to the Tribunal that the major gas reserves of Australia’s north‑west must inevitably be linked eastward by pipeline in the long term, perhaps in fifteen to twenty years, to serve unsatisfied demand for gas in Sydney, Melbourne and Brisbane as the closer gas reserves are exhausted. However for the present, Western Australian gas industry is isolated from the eastern Australian market, as each of the eastern Australian gas industries are isolated from each other.
Current commercial studies that could result in natural gas discovered in Papua New Guinea being piped as sales gas to North Queensland were also mentioned in evidence.
The situation as described above plainly invites the progressive linking of the various production and pipeline systems of Australia, its continental shelf, and of Papua New Guinea, so that sales gas flows might be more flexibly and rationally directed, so that ample supplies of gas might be more generally available, and so that sales of gas are potentially exposed to wider market forces. The concept of a National Pipeline Grid underlay Commonwealth policy in the early 1970s, and received explicit mention in the Deed of 17 May 1974, under which the Pipeline Authority assumed responsibility from AGL for the construction of the Moomba-Sydney Pipeline. However physical linkages between the distinct natural gas supply systems in Australia, although long discussed, have not yet materialised.
8.7 Financing natural gas development projects
The discovery and development of a new natural gas field, so that it can produce sales gas and earn revenue from its sale, requires very large capital expenditure, particularly if the reservoirs are off‑shore. The cost of exploration and appraisal to the point where a development decision is possible is a sunk cost that is expended whether a commercial discovery is made or not. The drilling of production wells, the laying of the pipes to transport raw gas from scattered wells to a central point for processing, and the construction of treatment and processing equipment, require the expenditure of further large capital sums. The construction of gas pipelines, whether by a gas producer or by a separate gas transmission company, similarly demands substantial capital expenditure. These funds need to be found by the venturing companies, either by allocation from their internal resources, or by borrowing, or by issue of equity to new investors.
Capital funds for ventures in extractive industry are not easily available to small companies, such as most of the Cooper Basin companies were at the relevant time. In the early 1970’s, most of these companies had neither the strong corporate balance sheet needed to secure direct borrowings, nor a large existing internal cash flow, nor access to substantial equity funds. In these circumstances such companies - as even large companies did - resorted to limited recourse project financing, a device for borrowing substantial funds that continues to be used extensively today.
In limited recourse project financing, the borrower secures substantial long-term loan funds -commonly from a bank - against the assets of the specific project rather than against the total assets of the company, and more particularly secures the borrowed funds against the future cash flows to be earned by the project from the sale of its product over a period. Because the capital expenditure in major resource projects is usually amortised over long periods, perhaps 20 years or more, the lender requires that the relevant revenues should be sufficiently secured for a corresponding period, and repaid over that period, if the necessary borrowed funds are to be made available. The existence of an appropriately priced long‑term sales contract yielding substantial revenues from a creditworthy customer commonly provides the lender with the security required to underpin the repayment of borrowed funds, and the assurance that the project that is intended to generate the required revenues will be viable for the term of the borrowings. The borrowing company is correspondingly assured that it will not thereby become financially over‑extended. Confidential evidence as to a number of contracts for sale of gas and for pipeline haulage of gas over the last few years suggest that 15 years is not uncommon for a long term contract that underpins such financing.
Because the lender’s commercial risk is dependent on the sum of the commercial arrangements instituted at the outset of the project, the lender will ordinarily require that those arrangements should guard against subsequent commercial behaviour by any party that could impact adversely on the certainty of loan repayment. In this regard, it is common for the lender to require that the long‑term sales contract should include provisions directly binding the purchaser of product from the project to minimum purchase quantities, or more pertinently to making payments equivalent to minimum purchase quantities, thereby reducing the risk that the purchaser might renege on the contracted purchase, or otherwise fall short of contracted purchase performance.
The most common device employed is to include a “take‑or‑pay” provision in the long‑term sales contract that secures the project borrowings. Such a provision requires that the purchaser pay for a minimum quantity of the contracted product each year, whether or not the purchaser takes delivery of it. In the simplest case, the purchaser contracts, as a minimum, for payment for a substantial percentage (the “take‑or‑pay percentage”) of the annual contract quantity. The contract will also ordinarily provide for the purchaser to hold over for later delivery, without further payment, any product quantities that thereby are paid for but not delivered. Confidential evidence to the Tribunal instanced a number of recent contracts for gas sale and gas haulage capacity with take‑or‑pay provisions at 80% of contract quantities and higher.
Given that the purpose of a “take‑or‑pay” provision is to ensure a sufficient cash flow for the project, and to limit opportunistic behaviour by contracted purchasers, alternative contractual devices that serve the same purpose can be designed and used. A form of “two‑price” system is one such device, where the seller is assured of a substantial base price (which may be called a “stand‑by” or “reservation” or “capacity” charge) that is payable independently of the quantity supplied, with a supplementary price (which may be called a “commodity charge”) payable per product unit purchased. This system of pricing is seen to be economically preferable, in that it prices additional sales marginally, and thus facilitates higher demand, whereas “take‑or‑pay” arrangements offer no price benefit for sales at the margin. A two‑price system is capable of being constructed for inclusion in a long‑term contract, so as to give cash flow assurance to lenders corresponding to the assurance provided by a conventional “take‑or‑pay” clause.
The Tribunal heard evidence that major users of gas can also consider long‑term contracts for gas supply to be essential, in circumstances requiring substantial capital commitment on their part that could not be justified without the assurance of reliable gas supplies. Financing of major gas‑using projects also may require long‑term supply contracts to be written. Mr Corn of the ALISE co‑generation project in Sydney, and Mr Hardwick of the Sithe co‑generation ventures in Sydney, both gave evidence of gas supply agreements being usual for such projects, where the contract term is 15 to 20 years, and with take‑or‑pay or reservation charge provisions.
8.8 Gas pricing
Australian gas industry has customarily adopted pricing practices that reflect the structure of the industry. Gas prices in the large cities, which roughly coincide with the centres of substantial gas demand, are not set in any open market‑place, but are set by the seller in tariff schedules applying to small users, or are negotiated with large users by the seller, and incorporated into sales contracts. In the Sydney region, the seller is AGL. It is possible under the terms of the Letter of Agreement for the Cooper Basin Producers to contract to sell gas direct to (say) large industrial customers in Sydney, but in practice the Producers have entered any substantive discussions with major customers in conjunction with AGL as the established gas supplier.
Small users buying at tariff prices, including both residential and commercial users, have limited market strength, in that they can elect to use an energy source other than gas, for example by using electricity if they believe that gas prices are too high. They do not in the usual case have a choice among competing gas suppliers. In the absence of alternative gas suppliers, large industrial users of energy may have sufficient market strength to negotiate with a single supplier to achieve a contracted gas price that they find satisfactory, using various negotiating arguments, for example: that they may not construct a new gas‑using facility at all, or they may locate it elsewhere, or they may use electricity or another substitute fuel, or have the capability to transfer production to another facility located where energy prices are cheaper. In recent times, with the emergence of proposals to connect the Victorian and NSW gas supply systems, the industrial customer may be able to point in negotiations to the prospective existence of an alternative gas supplier.
Industrial users account for most consumption of gas, taking 81% of the gas consumed in Australia in 1993‑94. In NSW, 72.6% of gas consumption in 1993‑94 went to industrial use, 14.7% to residential use, and 12.7% to commercial use.
The prices paid for gas in Australia by end‑users reflect the differences in the market power of gas customers that have been noted above, and reflect also the cost effects of gas reticulation and customer administration between gas users who purchase greatly varying gas quantities. Evidence as to gas prices in NSW was not entirely consistent, but showed the same general pattern. For example, the average residential user of gas in NSW paid $12.14 per GJ in 1994‑95, commercial users on average paid $9.15 per GJ, and industrial users on average paid $5.04 per GJ. Confidential evidence from several industrial customers for gas in Sydney also indicated that contracted prices for delivered gas vary widely between industrial users.
These prices are properly to be viewed against the prices that are paid for gas earlier in the supply chain from the Cooper Basin. The price presently applying for sales gas delivered to AGL by the Cooper Basin Producers is confidential, but recent prices are available. For 1993‑94, the average ex‑field price for Cooper Basin gas sold to AGL, i.e. the price applying for the conduct that is the matter here under review, was stated in public evidence to be $2.21 per GJ. Haulage by pipeline to Wilton, near Sydney, where gas enters the AGL reticulation system, was stated to cost a further $0.84 per GJ, giving a “city‑gate” gas price for Sydney in 1993‑94 of $3.05 per GJ.
As already noted, the usual commercial arrangement applying to the primary supply of gas from major gas‑fields in Australia is a long‑term contract between, on one hand, the gas producer or producing joint venture controlling primary supply from a particular gas‑bearing basin (or in the case of the Cooper Basin, from a major sector of the basin), and on the other, single buyers in a major centre of gas demand, through a single pipeline connecting the two. The Letter of Agreement that presently binds the Producers and AGL is in this sense typical.
Given the lack of physical connection between the gas supply systems serving each mainland Australian state, given past interventions by state governments to protect local interests when the gas supply arrangements were being formulated, and given the need for substantial borrowed funds for the various gas production and transmission projects, with the lender requiring that repayment be secured against project revenues, the Tribunal finds it unsurprising and perhaps inevitable, that the primary supply and gas haulage contracts in Australia have been, in all cases up to the present on which evidence was submitted, long‑term contracts with a term of 20 years or more, incorporating some form of “take‑or‑pay” or similar provision.
Gas prices as contracted are thus not directly reflective of immediate market conditions. They are negotiated prices, agreed with regard to whichever market and other considerations the parties consider commercially appropriate. Because negotiated prices become unacceptably out‑dated in due course as a consequence of shifts in the market environment, long‑term contracts typically make provision for price review, at prescribed intervals or triggered by a defined event. Such reviews again involve negotiations that pay regard to whichever considerations the parties to the contract consider commercially appropriate.
In the event of a dispute between the parties that leaves a price review unresolved, the typical long‑term contract provides for some form of independent arbitration of the dispute, and the determination of the applicable price by the arbitrator. Subject to the precise terms of the governing contract, the factors that are paid regard to in an independent arbitration, and their relative weight, are matters for the arbitrator to decide, so that it is possible for the price awarded by an arbitrator to be viewed by one or other of the parties as commercially damaging and even eccentric. Such arbitrations also, by dint of their considerable commercial consequences, invite the numerous interested parties, including governments and end‑users, to make substantial submissions that can have the effect of extending the time taken for the arbitrator to develop a conclusion, and that can add to the cost of the process.
9. COMMERCIAL AIMS OF THE LETTER OF AGREEMENT
Evidence to the Tribunal made plain the commercial purposes which the Letter of Agreement was intended to achieve, and these purposes appear to have been largely achieved.
9.1 A long‑term gas supply contract
The Letter of Agreement committed AGL and the Producers to a long‑term contractual obligation, with a term of 30 years.
The merits or otherwise of natural gas being supplied at the present day under an extended commercial arrangement with settled terms, rather than according to more flexible and more directly competitive market processes, were the subject of expert evidence and argument before the Tribunal. It suffices here to note that the form of the Letter of Agreement in this and other respects reflects the circumstances of a period when the Australian natural gas industry was taking its initial shape.
The Letter of Agreement was initially negotiated some 26 years ago and modified during the years immediately following, with the close involvement of interested governments, taking a form that accorded with common business practice. It relates to a formidable commitment by the parties that was to bind them over 30 years. Quantities of natural gas, prospectively huge by the standards of that time, were to be supplied from a single basin that also was the source of gas supply to Adelaide, transported long distances through a single high‑capacity pipeline of (for Australia) unprecedented size and length, to a single buyer in Sydney, for retail sale to domestic, commercial and industrial customers who would need have their equipment converted to use the product.
The Producers who entered the Letter of Agreement undertook to discover and produce natural gas from the licensed areas in which they variously shared interests, and to process it as required, sufficient to deliver sales gas over 30 years, of a defined specification, at scheduled annual quantities and up to scheduled daily maximum rates, into the Moomba inlet of a new Moomba-Sydney Pipeline, which AGL, for its part, was committed to construct under Clause 7 of the Letter of Agreement. (This AGL commitment was assumed by the Pipeline Authority in 1974 under the supplementary deed of 17 May 1974.) The purchaser of the sales gas was to be AGL, and title to the gas would pass on delivery into the pipeline at Moomba.
9.2 Assurance to AGL as to gas supply quantities
A condition precedent to the Agreement (clause 1) was that the Producers should establish natural gas reserves within the bounds of their licence areas, to the minimum amount of 2.8 Tcf in proven and probable reserves, reasonably able to yield 2.0 Tcf of sales gas over 25 years, according to a schedule of annual quantities (Schedule B), which would have deliveries rise to 86.5 Bcf for the 8th year and each year thereafter.
After deliveries of gas commenced, the Schedule B quantities were to apply in the interim, until further reserves were discovered sufficient to allow delivery of a further 800 Bcf of sales gas, allowing a commitment by the Producers to the delivery of the full annual contract quantities (ACQs) as tabulated in Schedule A to the Letter of Agreement, amounting to 2.8 Tcf (more precisely 2802.3 Bcf) over 30 years. The ACQs in Schedule A rise to a level of 112.5 Bcf (about 120 PJ) for the 13th contract year until the 25th year, and thereafter declining. AGL with the consent of the Producers may decrease or increase the ACQ applying in any year by no more than 5% (clauses 19 and 25).
The Agreement tabulates peak daily quantities of gas (Schedule C) that the producers must be able to deliver on demand for each of the 30 years of the contract. The daily peak quantities are set at rates 20% above the corresponding ACQ rate; specifically at 381.36 million cubic feet (MMcf) per day between the 13th and 25th year.
The original Letter of Agreement envisaged acceptance of its terms by the governments of both South Australia and Queensland. However the Queensland Government decided that discoveries by the Producers in the south‑west Queensland sector of the Cooper Basin, made subsequently to the original agreement of 26 May 1971, should not be dedicated to supply NSW via the Moomba-Sydney pipeline, but should rather be reserved against possible demand within Queensland. In consequence, only three small south‑west Queensland fields could be included in the reserves being assembled to satisfy the AGL contract.
When the Agreement was initially signed in 1971, AGL could not have been entirely confident, despite the geological likelihoods, that reserves of natural gas would be established in the Cooper Basin, sufficient to supply projected demand in the Sydney region. The subsequent unwillingness of the Queensland Government to permit significant gas quantities from the south‑west Queensland sector of the Cooper Basin to be contracted to AGL exacerbated the difficulty, in that the required additional reserves were then necessarily to be discovered within the South Australian sector. In the event, the minimum reserves required by clause 1 were established, and the Agreement became unconditional, on 12 September 1973.
However in the early 1980s, the South Australian Government was becoming concerned that exploration in the South Australian sector of the Cooper Basin was not discovering new reserves sufficient to maintain gas supplies to South Australia as well as to AGL. Indeed the additional reserves required to fulfil the Schedule A obligations under the AGL Agreement had still not been found, and AGL had first right to new discoveries in the relevant area until its contractual volumes were fully available. The South Australian Government was further concerned that access by industry in South Australia to the potentially valuable ethane side‑stream should be secured. The South Australian Government talked of corrective legislation, which could have affected the priority of AGL’s contractual rights to available Cooper Basin gas. The Natural Gas (Interim Supply) Act, enacted by the South Australian Parliament in November 1985, laid down that all proposed sales from the South Australian Cooper Basin outside the provisions of the Letter of Agreement should require ministerial approval, and reserved maximum quantities contracted to PASA for the ensuing three years for use within South Australia. A new sales agreement between the Producers and PASA had to be negotiated in consequence.
However these measures were still not deemed adequate to assure forward supplies of gas for South Australia. Complex negotiations eventually secured additional forward supplies for PASA from other joint ventures in the South Australian sector of the Cooper Basin in 1989, and later from south‑west Queensland producers also, so that the original venture of the Producers became one of four Cooper Basin ventures supplying gas to South Australia.
In 1985, AGL disputed the validity of a previous Notice from the Producers that reserves existed sufficient to deliver Schedule A quantities. An independent expert appointed to resolve the issue confirmed in April 1987 that the necessary reserves existed. In this context, the terms of the Letter of Agreement in regard to delivery of full Schedule A gas quantities were able to continue.
9.3 The South Australian Unit; organising production to assure contract performance
The Letter of Agreementas amended to 1976 requires (clause 4) that the Producers execute a Unit Agreement by December 1976, binding the Producer parties to the extent of their interests to the performance of the obligations of the Producers. This provision was insisted on by AGL, so that they could be assured that the performance of the contract on the supply side was well‑managed, by being made the responsibility of a single entity.
In December 1976, the South Australian Unit Agreement was executed by the Producers. It constituted a joint venture, the South Australian Unit (“SA Unit”), to consolidate the production function, both for gas contracted by the Producers to PASA for sale in Adelaide, and also for gas contracted to AGL under the Letter of Agreement. The Unit aggregated relevant strata in all the farm‑out blocks in the South Australian sector of the Cooper Basin with reserves that had then been contracted or dedicated to either sales contract. The scope of the operations of the SA Unit was designed to be coincident with the agreed contractual obligations of the Producers to AGL and to the supply of South Australia. The SA Unit Agreement was accepted by AGL as satisfying the clause 4 requirement.
One effect of the Unit Agreement was to distinguish areas of South Australia dedicated to the performance of the PASA and AGL contracts from other “Non‑Subject Areas”, where any discovered gas would need to be sold separately. Gas from the Patchewarra South West and Murta Blocks, both Non‑Subject Areas, was separately contracted to PASA in 1989.
The Unit Agreement provides that Unit Operators should be appointed to manage exploration, appraisal, production and processing operations, on behalf of the relevant producing interests as a group, subject to their policy assent according to specified voting rights. (The joint ventures for each Non‑Subject Area block appoint Operators similarly.) Capital and operating expenditures undertaken for the Unit, and sales revenues earned by the Unit, are pooled, with each participant assuming costs and sharing income according to “participation factors” derived according to certain rules. In December 1996, the Producers agreed to simplify these cost and income-sharing arrangements by fixing the “participation factors’ applying to the SA Unit. These factors equate to the present ownership shares of the Producers in the relevant gas fields, and reflect shifts in ownership of relevant companies since the Unit was originally formed:
Participation %
Santos Group 59.75
Delhi Petroleum Pty Ltd 20.21
Boral Energy Resources Ltd 13.19
Crusader Resources NL 4.75
Basin Oil NL 2.10
_______
100.00
The Producers also appointed an Operator to conduct the corresponding marketing functions on their joint behalf, although this appointment is not a provision of the SA Unit Agreement. Initially Delhi was the Unit Operator in respect of all exploration and production functions, with Santos handling the marketing. Later Santos assumed further Operator roles, until in 1992 Santos eventually became Operator of the SA Unit in respect of all functions, and remains so.
9.3.1 Considerations arising from the operation of the SA Unit Evidence and argument by the Applicants characterised the joint marketing arrangement that the Producers, i.e. the companies comprising the SA Unit, have adopted as a response to practical considerations. They contended that the workings of Unit production, where the various Producers share the rights to sales revenue from all gas as it is produced, and where it is not economic in the normal course to store gas so that one venturer can physically dispose of its gas while another does not, would make separate selling of gas outputs difficult, or at best would require cumbersome administrative processes to maintain revenue equity among the Producers. Such administrative processes, known as “borrow and loan” contracts between joint venture producers, are in use in the North American gas industry.
In its 1996 determination that is the subject of this review, the Commission commented as follows:
“Such [separate marketing] arrangements are complex, involving costs and risks as well as potential benefits, and may therefore be less likely in Australia during the early stages of the establishment of a competitive gas market. However the ACCC understands that such separate marketing arrangements, often supported by borrow and loan contracts, are common among joint venturers in the highly competitive gas markets of North America. In such markets very few market power advantages are available from joint marketing but considerable technical efficiencies can be obtained from joint venture production.”
No corresponding “South West Queensland Cooper Basin Unit” was formed in 1976, because of Queensland Government concerns that gas from the south‑west Queensland Cooper Basin, where substantial further gas discoveries were expected, would be committed to supply Sydney, and not utilised with a primary regard to Queensland needs. A South West Queensland Unit (“SWQ Unit”) was formed later by relevant gas producers, with the assent of the Queensland Government, to facilitate production to meet a 1991 contract with PASA for supplementary quantities of gas to Adelaide. A raw gas pipeline was built to the SA Unit facilities at Moomba, where toll processing is performed before delivery. The interests of the several parties in the SWQ Unit are at present as follows:
Participation %
Santos Group 58.86
Delhi Petroleum Pty Ltd 23.20
SAGASCO Resources Ltd, Oil Co
of Australia NL (Boral subsidiaries) 16.74
Australian Hydrocarbons 1.20
______
100.00
In this connection the Industry Commission, in its 1995 report to the Commission Australian Gas Industry and Markets Study, commented:
“The numerous joint ventures arising from the “farming out” of Santos’ original interests have a strong commonality of ownership, with each joint venture being dominated by the collective interests of Santos and its first joint venture partner, Delhi.”
An important observation can be usefully made at this juncture. The Commission in argument and its expert witnesses in evidence and discussion referred to the desirability of fostering intra‑basin competition for gas markets as well as inter‑basin competition. In doing so, they appeared to assume in evidence and argument that the Cooper Basin gas industry, by assent of the several companies with relevant interests, presently constitutes a single monolithic commercial structure, such that independent marketing by the separate entities is to be encouraged. Certainly the position of Santos in the Cooper Basin, as the holder of the largest interest in every relevant block and the pervasive Operator of the various joint ventures, encourages that view, and indeed Mr McArdle of Santos in oral evidence not infrequently appeared to adopt the wider commercial perspective on the Cooper Basin gas industry.
However, the Tribunal is concerned in these reasons to maintain a clear distinction between the contractual and legal obligations of the SA Unit and the various commercial obligations of other joint ventures operating in the Cooper Basin. Despite the similarities in the pattern of interests across Cooper Basin ventures in both South Australia and Queensland, despite the use of common processing facilities at Moomba, and despite the extent to which Santos acts as Operator for other Block and Unit joint ventures as well as for the SA Unit, it remains crucially true that the Cooper Basin gas production industry does not constitute a single enterprise, or a single commercial entity in any legal sense. The Cooper Basin and the overlying Eromanga Basin are basins crossing the boundary between two states, where several oil and gas enterprises operate. Each enterprise is a joint venture, and each has separate rights to exploration, production and sale of hydrocarbon products from defined and different permit areas. One of these enterprises, in effect the original natural gas venture in the Cooper Basin, is the SA Unit, where the venturers are here termed the Producers, and which controls most (but not all) of the gas‑producing wells in the South Australian sector of the basin. The Producers that constitute the SA Unit have entered (among other obligations) into the Letter of Agreement with AGL. The other joint ventures in the Cooper Basin are not parties to the Letter of Agreement and are not bound by its terms.
The point is illustrated by the train of events during the 1980s, when the South Australian Government and its relevant authorities were vigorously pursuing assured long‑term supplies of natural gas from the Cooper Basin to meet projected demand in that State. Much detail in regard to these negotiations is in evidence, which need not be rehearsed here. In the upshot, the Natural Gas Authority of South Australia (NGASA), as successor to PASA, now has separate long‑term supply contracts for gas in place with the SA Unit, with the venturers of the Patchewarra South West Block and the Murta Block, and with the South West Queensland Unit, all of which are located in the Cooper Basin.
9.4 Assuring the Producers’ revenue
Clause 18 of the Letter of Agreement is a conventional “take‑or‑pay” clause, which requires that payment be made by AGL for delivery of 80% of the ACQ, whether that quantity of gas is delivered or not.
When the quantity schedules to the Letter of Agreement were being settled in 1976, at the outset of the contract period, natural gas had not previously been sold in NSW. The quantities of gas scheduled in the Agreement for delivery were presumably founded on market estimates by AGL as to the likely substitution of natural gas fuel for other fuels then used by industry. Neither the Producers not their lenders could have been confident that the scheduled quantities would prove accurate; actual demand might be lower, perhaps seriously lower, than the AGL estimates. In the event, AGL gas purchases proved to be significantly lower than the ACQs of Schedule A. Yet the Producers were to be committed to substantial future costs for exploration, and substantial capital costs to install the necessary production and gas processing capacity, on the basis of the scheduled ACQs. Further, the Producers were in effect obliged to set aside the corresponding gas reserves, and not to contemplate selling them elsewhere, on the presumption that the ACQ delivery volumes would be achieved.
In the event that AGL’s purchases of gas falls short of the take‑or‑pay commitment, AGL may “bank” the surplus gas for later delivery with no further payment (clause 18). The provision is somewhat obscure, particularly for any banked gas remaining undelivered at the conclusion of the 30‑year term of the contract. In this last respect the wording appears to contemplate extension of the term of the Agreement for up to five further contract years at AGL’s option. However the issues arising in this connection need not be pursued by the Tribunal, because evidence from AGL and the Producers agreed that no substantial quantity of banked gas is likely to remain undelivered after the contract period ends in 2006. Moreover, as we have described earlier, a decision on appeal of the South Australian Supreme Court in December 1995, which bears on the workings of the Agreement’s banked gas arrangements, has served to encourage AGL to take delivery of its banked gas at the outset of each contract year rather than to hold it for later delivery.
Clause 20,known as the “exclusive dealing” clause, appears to the Tribunal to have been also directed to ensuring that AGL should purchase contract gas quantities to the extent that NSW gas demand warrants it. It precludes the purchase of gas by AGL from any other supplier, until the ACQ has been delivered in full. Otherwise, as the Applicants pointed out in argument, AGL might be inclined to behave opportunistically, buying gas from an alternative supplier (should such a supplier exist) once their annual purchases exceeded the “take‑or‑pay” quantity at 80% of ACQ, while the Producers would remain obligated to hold reserves and production capacity ready to meet purchases up to ACQ, and peak demand at daily rates 20% above the ACQ rate.
These clauses 18 and 20 were both criticised in evidence and in argument before the Tribunal, as being anti‑competitive in their present effect. Dr King, an expert witness for the Commission, asserted that clause 18 had served its initial purpose, and that any benefits from it had been gained, so that it could be deleted from the contract without disadvantage. He asserted also that clause 20 is now of no commercial consequence, having regard to evidence that rising NSW gas demand will require AGL to purchase full contract quantities for the remainder of the contract period.
On the other hand, AGL argued that the take‑or‑pay provision of the Letter of Agreement is a reasonable provision, and that a take‑or‑pay provision of a contract can be no more anti‑competitive than a firm contract for a corresponding quantity.
9.5 Setting prices and resolving price disputes
The relevant provision that is directed to this purpose is clause 24. The price of gas to be delivered ex‑field in the first year of the contract is stated, with this price to be escalated annually. However the Letter of Agreement contemplated this initial price being superseded by periodic price review procedures, to be conducted at the option of either party no more frequently than once in three years. Price reviews were to have regard to “all economic and other relevant factors existing at the time and in particular to the effects of inflation and any increases in capital and operating costs”. Final resolution of any dispute following price review would be by arbitration, with each party appointing one of two arbitrators.
Three arbitrations were conducted under this rule, in 1979, 1982 and 1985. The evidence suggests strongly that both AGL and the Producers have found the successive arbitrations an unhappy experience, in part because of the time taken to achieve an outcome and the considerable expense involved in proceedings that were not disciplined by time limits. Both parties also exhibited concerns when an arbitration award did not appear to give due weight to factors that one or other of them considered commercially significant. When prices separately arbitrated under the South Australian contract came to exceed prices arbitrated under the AGL contract, South Australian concerns emerged, already referred to, that were a factor in the passage by the South Australian Parliament of the Natural Gas (Interim Supply) Act 1985.
The cost and inconvenience of conducting arbitrations in Adelaide rather than (say) Sydney, so that they were protected by the Cooper Basin (Ratification) Act 1975, was an immediate reason for AGL’s application to the Commission in December 1984 for authorisation of the Cooper Basin gas supply arrangements. The problems experienced with clause 24 culminated in the 1985 arbitration, which took over two years to complete, at a total cost estimated at $20 million. The cost of this arbitration was the subject of complaint by the NSW Government, as being an impost on gas users in NSW. The large increments in NSW gas price consequent on the reviews being necessarily three years apart also aroused both customer and political complaint, as causing industry dislocation.
The three-yearly price review that fell due in January 1988 found AGL and the Producers in agreement that a further arbitration was to be avoided, the 1985 arbitration having been completed only a few months previously. A short negotiation led to a new price being agreed, with annual price escalation at 95% CPI thereafter, and price reviews continuing to be available at the option of either party no more frequently than three‑yearly. This settlement was incorporated in the Letter of Agreement in May 1988, by deed revising clause 24 accordingly, as already described in Section 3 of these reasons.
9.6 First right of refusal
Clause 12 is a provision of the Letter of Agreement which (unlike the provisions described above) does not seem to be directly consequent on any evident purpose of the Agreement. Itrequires AGL to give the Producers first right of refusal for any gas purchase requirements beyond the Schedule A quantities for the term of the Agreement, on terms no less favourable than those offered by the alternative supplier.
Evidence and argument submitted to the Tribunal from AGL and statements from witnesses for the Gippsland Basin producers, asserted that clause 12 had been of no commercial consequence until lately, but now was proving to be anti‑competitive. They pointed to the need in the near future for AGL to secure new gas supplies to meet forward demand in NSW, because the scheduled ACQs decline substantially prior to 2006, when the Cooper Basin contract will terminate, prospectively leaving significant shortfalls in gas supply to the Sydney region, beginning perhaps in 2000. They claimed that the clause 12 provision intrudes on proper negotiations for deliveries of gas from other sources to make up the shortfall, and to secure supplies after 2006 when the Letter of Agreement will have lapsed.
The Commission’s substituted authorisation of 27 March 1996 deleted this provision, and the Commission argued before the Tribunal for this course to be adopted in the Tribunal’s determination. The Applicants defended Clause 12 in argument as a element in a concluded contract, that should not in equity be selectively disallowed.
10. FREE AND FAIR TRADE IN GAS
Comprehensive evidence before the Tribunal described a sequence of cooperative actions by the Commonwealth Government and the Governments of the Australian States and Territories during the 1990s, consequent on agreed common competition policy, and explicitly directed to the development of a national market for natural gas in Australia that would be characterised by free and fair trade.
In pursuing this agreed objective, the governments envisaged the substantial inter‑connection of existing gas supply systems as demand for gas grew, and sought to address the competition problems that could be expected to follow. Consequent initiatives focussed on:
• the structure of the gas industry, and in particular the potential for anti‑competitive conduct by the owners or operators of gas transmission pipelines that connect natural gas production areas with regions of substantial demand
• the identification and removal of government‑imposed impediments to free and fair trade in gas.
10.1 The Council of Australian Governments
Issues of fostering better competition in national markets, including the market for natural gas, have been regularly addressed by the Council of Australian Governments (“COAG”) since they met in Perth on 7 December 1992. The communique for that meeting noted inter alia previous steps towards removing barriers and impediments to trade within Australia, and explicitly referred to barriers to trade in natural gas that were seen to exist. Reference was made also to the proposed National Electricity Grid, and to the principle of separating the generation and transmission elements in the electricity sector.
In respect of gas, the relevant council of government ministers, the Australian and New Zealand Minerals and Energy Council (“ANZMEC”), was asked to prepare a report for the following COAG meeting in June 1993 that included identification of existing legislative and other government‑imposed impediments and barriers to free and fair trade, and a recommended basis for third party access to gas transmission pipelines.
In May 1993, ANZMEC reported to COAG that they had been unable to achieve unanimous agreement on the means of removing government‑imposed impediments to free and fair gas trade, notably because a number of States had concerns about how their gas resources were to be developed. Three relevant conclusions of the agreed report were as follows:
“1.4 Australia has abundant gas reserves and long term contracts are expected to remain the main means of bringing large tranches of gas to markets. The current gas market is not yet mature nor very competitive. Pressures are growing for a more flexible approach to gas marketing, including improved pipeline access to third party users, and removal of impediments to gas trade, including interstate trade.
1.6 Additional interstate sales of gas will be required in the medium term, especially after the year 2000. Unrestricted interstate connection of the principle markets in southern and eastern Australia is likely to confer significant economic benefits.
1.8 It is recommended that COAG agrees that:
(i) there is a need for a pro‑competitive framework that facilitates gas supply and maximises market opportunities for natural gas, irrespective of the nature of ownership of gas transmission and distribution pipelines
(ii) this would be assisted by arrangements that facilitate third party access to gas pipelines and prevent pipeline owners from engaging in discriminatory monopoly pricing and other practices that would undermine new markets for gas . . .”
The ANZMEC report identified a number of impediments to free and fair trade in natural gas that are directly relevant to this present matter:
• The use by some State Governments of exclusive franchises for the transmission and distribution of gas
• Control of gas pricing in some States, such as uniform and low tariffs to industrial gas consumers
• Direct government participation in the gas industry through the control of pipelines by government utilities in some States
• Limitations on further supply of gas from South Australia and restrictions on the production and marketing of South Australian ethane reserves
• Queensland Government conditions imposed on interstate gas sales
• The application of Resource Rent Tax on Bass Strait gas
However general assent to the report was qualified. The South Australian Minister withheld his approval because of its explicit mention of sections of the Natural Gas (Interim Supply) Act 1985 as restrictive on trade, including trade in ethane. The NSW Minister’s approval was subject to several reservations, notably the inclusion within the scope of the recommendations of pipelines for gas distribution as well as high‑pressure gas transmission. The Victorian Minister sought more forceful reference to price effects of the Commonwealth’s Petroleum Resource Rent Tax Assessment Act 1987 as a barrier to interstate trade. The Queensland Minister sought explicit mention of the reliance of States and Territories on long‑term contracts in covering their forward gas requirements.
On 25 August 1993, the report of the Committee of Inquiry into National Competition Policy (the “Hilmer Report”) was submitted to the Heads of Australian Governments. It recommended a national competition policy covering 6 elements:
• Limiting anti‑competitive conduct of firms
• Reforming regulation which unjustifiably restricts competition
• Reforming the structure of public monopolies to facilitate competition
• Providing third‑party access to certain facilities that are essential for competition
• Restraining monopoly pricing behaviour
• Fostering “competitive neutrality” between government and private enterprises when they compete
The COAG meeting in Hobart on 25 February 1994 agreed to the principles of the principle of the competition policy articulated in the Hilmer Report, and agreed to several consequent actions, including the merger of the Trade Practices Commission and the Prices Surveillance Authority to form the present Commission under an amended Act with wider application.
Specifically in regard to natural gas, the 1994 COAG meeting agreed the main features of a national framework characterised by free and fair trade in gas, and further agreed a number of explicit actions directed to that end, to be effected if possible by 1 July 1996. Relevant to this present matter, these planned actions included:
“1. removal of all remaining legislative and regulatory barriers to free trade in gas
2. complementary legislation so that a uniform national framework would apply for third‑party access to all gas transmission pipelines between and within jurisdictions
8. government gas utilities to be placed on a commercial footing
9. contracts between producers and consumers for the supply of gas entered into prior to the enactment of gas reform legislation not to be overturned by that legislation
10. publicly‑owned transmission and distribution activities, where vertically integrated, to be separated, and legislation introduced to ‘ring‑fence’ transmission and distribution activities in the private sector.”
These decisions closely followed the recommendations of a Report by a Working Group of Officials, set up by the 1993 COAG meeting. The report, entitled Progress towards a Pro‑competitive Framework for the Natural Gas Industry, within and between Jurisdictions and submitted to Heads of Government in February 1994, provides much useful background as to the arguments underlying the decisions at that latter meeting. In regard to the agreed action numbered 9 above in relation to existing contracts, the report included the following under the heading “Impediments to free and fair trade in natural gas,” and the sub‑heading “Restrictions caused by contractual arrangements”:
“39. Existing contracts between gas distributors, producers and transporters are relatively inflexible in their duration, quantities and take‑or‑pay provisions. Such contracts were essential to the development of the gas market, to enable the sharing the risks of the very large investments required of all three groups, much like the joint venture arrangements between explorers. As the market matures, however, the question arises as to whether contracts with similar terms and conditions are necessary to protect the interests of all parties or whether flexibility could be introduced into contract provisions.
40. Some of the features in existing contracts may make the transmission to new arrangements and market structures more difficult. In this case it does not mean that contracts can or should be unilaterally voided by government action. It would be open to government to signal, now, that certain features might be unacceptable in future arrangements, and for these signals to be recognised in negotiations for future contracts.”
This issue is discussed further in Section 16.1.2 of these reasons.
The COAG meeting in Canberra on 11 April 1995 did not discuss free and fair trade in gas, but focussed more broadly on national competition policy, and agreed on a legislative package to implement the policy. Heads of Government signed three inter‑governmental agreements which set out the agreed basis for doing so, including the passage of State and Territory legislation to apply the policy. The Council also expressed support for the legislation then before the Commonwealth Parliament that became the Competition Policy Reform Act 1995 .
10.2 Consequent action by Governments
In accordance with the above pattern of clear, sustained and shared intention, Commonwealth, State and Territory Governments have acted in several particular respects relevant to these reasons. For example, the Commonwealth sold the Moomba-Sydney Pipeline System to EAPL in 1994, with “ring‑fencing” instituted within EAPL to separate the functional elements of the business. Through its Competition Policy Reform Act 1995, the Commonwealth legislated inter alia to extend the reach of Part IV of the Trade Practices Act 1974 to bind the Crown in the States and Territories, and to add a new Part IIIA of the Act providing for negotiated access to services provided by means of facilities of national significance. The issue of South Australian restrictions on ethane sales was resolved, so that deliveries of ethane could commence in 1996 from Moomba to ICI Australia in Sydney. The Resources Rent Tax issue was resolved in late 1996, so that any future sales of Bass Strait gas into interstate markets will not be priced to include this tax. The Victorian Government has restructured its gas and energy authorities, and in March 1997 announced new market arrangements for the Victorian gas industry. In South Australia, the PASA pipeline was sold to Tenneco in June 1995. In April 1997, immediately subsequent to the completion of the hearing of this matter by the Tribunal, the South Australian Government announced an independent review of the Cooper Basin (Ratification) Act 1975 and of an associated agreement, to meet the State’s commitment under the COAG agreements.
10.3 Third-party access
The 1994 COAG meeting agreed, by 1 July 1996, to implement “complementary legislation so that a uniform national framework would apply for third‑party access to all gas transmission pipelines between and within jurisdictions”, again closely following the recommendation of the Report of the Working Party of Officials of February 1994. In respect to their recommendation, the Working Party report includes the following:
“48. Whether publicly or privately owned, many gas transmission networks are ‘natural monopolies’. In other words, it is not economic to duplicate such facilities. This gives the owners/operators considerable monopoly power which could be used ultimately to deny access to their facilities totally eliminating any competition. If the Australian economy is to benefit from free and fair trade in gas, it is essential that there exists a nationally consistent approach to give third parties fair and unrestricted access to transmission and distribution facilities”.
The Gas Reform Task Force, which became the Gas Reform Implementation Group (“GRIG”) in January 1997, was formed in 1995 as a focus and point of coordination for the numerous reform initiatives being undertaken by the various governments in regard to natural gas. In July 1997, GRIG and the National Competition Council jointly initiated a consultation process on a proposed national gas access regime. A Draft for Public Consultation of the National Third Party Access Code for Natural Gas Pipeline Systems, an Issues Paper in relation to the draft Code, and some associated explanatory papers, were issued in July 1997 as the basis for public consultation.
Introduction of third‑party access to the Moomba-Sydney pipeline system necessarily awaits completion of this process and the institution of a National Third Party Access Code for Natural Gas Pipeline Systems.
In NSW, the Gas Supply Act 1996 replaced earlier access provisions with a new framework consistent with National Competition Policy. The existing Independent Pricing and Regulatory Tribunal (IPART) was designated as the access regulator and arbitrator of access disputes. On 30 August 1996 the NSW Government introduced an Interim Third Party Access Code for Natural Gas Distribution Systems in NSW, modelled on the Draft National Code and intended to be replaced by the National Access Code when it is settled.
The Gas Supply Act 1996 also provides for the declaration of gas distribution systems, and that access undertakings must be established for declared distribution systems. It also sets out ring‑fencing obligations that require providers of access undertakings to maintain separate accounts for gas haulage services that are the subject of undertakings.
The AGL distribution network, through which gas from the Moomba-Sydney pipeline is reticulated to final users in Sydney, Newcastle, Wollongong, and several NSW country centres, was declared on 30 August 1996. In September 1996, AGL submitted a proposed access undertaking, and IPART issued a draft determination on which submissions were invited. On 22 July 1997, IPART issued a final determination approving AGL’s Access Undertaking, as varied to meet IPART requirements. Following gazettal of the access date on 1 August 1997, third‑party access to AGL’s distribution system is now available in accordance with the Undertaking, which sets out the terms, conditions, operating procedures and rights for third party access, and reference prices as a basis for price negotiation.
11. THE IMPENDING SHORTFALL IN SUPPLY OF GAS TO NSW FROM THE SOUTH AUSTRALIAN UNIT
Much of the voluminous evidence and lengthy argument in this matter was directed to establishing particulars of both the likely supply and demand for gas over the remaining nine years of the term of the Letter of Agreement, and for a few years beyond that date. The positions adopted by the Commission and the Applicants conflicted in some aspects of the detail and in the larger implications of the prospective supply and demand situation.
The supply obligations of the SA Unit to AGL are established by the terms of the Letter of Agreement. Delivery of any additional future supply requirements for NSW will need to be negotiated between buyers and sellers, whoever they may be, and from wherever the additional gas may be delivered.
Forward projections of demand, like any forecasts, rest on a body of assumptions as to future circumstances and events. It became plain to the Tribunal in the course of the hearing that the probability of particular relevant assumptions coming into effect is highly conjectural. In such circumstances, it is to be expected that the producers who might supply gas to meet future demand in NSW, whether from the SA Unit, or from the wider Cooper Basin, or from elsewhere, will be concerned to follow business strategies that pay balanced regard to both commercial opportunity and the practical control of business risk. Their perspective will differ from that of the Commission, with its concern to identify possibilities for anti‑competitive outcomes, and to deny them where that is reasonable.
Further, forecasts are revised as time passes, and evidence submitted amply demonstrated this reality. Changes in the perceived shape of future events correspondingly modify the assumptions adopted. For this reason, the Tribunal gave most weight to the most recent demand forecasts, and noted earlier forecasts as explaining why certain actions were taken at the time and as evidence of both changing perceptions as to the likely future and of the doubt that must be attached to any present prediction of future likelihood.
The Applicants contended that the supplies of SA Unit gas available for delivery to AGL are limited, and will barely be sufficient to satisfy the contracted quantities, as they reduce during the period from 2001 to 2006 in accordance with Schedule A to the Letter of Agreement. They submitted evidence that the depleted and diminishing gas reserves within the bounds of the SA Unit, supplemented by limited further gas discoveries within those bounds, are fully committed to this and other sales contracts, and indeed that there has been contention among the Producers as to whether the Unit might not be over‑committed. They noted that the annual contract quantities applying for the remaining years of the Letter of Agreement, expressed in petajoules, stand at 120 PJ until and including the year 2000, falling thereafter to 51 PJ in 2006. They also contended that, given a rising demand for gas in NSW that is already approaching the annual contract quantities and is testing the limits of the Unit’s capacity to supply peak demand, a shortfall in contracted gas supplies to NSW is likely in the near future - certainly between 2000 and 2005 - so that gas supplies from sources other than the SA Unit will be required in that time frame to meet demand within NSW. The argument of the Applicants, that inter‑basin competition is already emerging in NSW to meet the prospective supply shortfall, so that revocation of the AGL authorisation is not required to facilitate the conditions for free and fair trade in natural gas, rests in large part on the merits of these contentions.
The Commission argued, in effect, that the Applicants’ assertions of a prospective shortage of gas supplies from the Cooper Basin to meet NSW demand were over‑stated and subject to serious doubt. They submitted that on past experience significant further gas discoveries in the Cooper Basin were to be expected, that production from existing fields could be accelerated, and that in any event extra quantities of gas could be supplied from the adjacent gas‑fields of the south‑west Queensland sector of the Cooper Basin, where gas reserves are substantial. In this last regard, the Commission pointed to the substantial commonality of ownership between the SA Unit and the South West Queensland Unit. Counsel for the Commission also suggested that, with forecasts of NSW gas demand having fallen in recent months in response to lower prices for electricity, it should not be assumed that major power generation projects using gas as fuel will begin operation for some years. The Commission in effect argued that these circumstances point to the likelihood - despite the decline in ACQs after 2000, and termination of the letter of Agreement in 2006 - that Cooper Basin gas would in practice supply or substantially supply NSW for many years to come, creating a commercial context in which revocation of the AGL authorisation is justified and desirable.
11.1 New South Wales demand for gas
In 1996, AGL purchased 105 PJ of gas from the Cooper Basin Producers to supply to its customers, with the likely figure for purchases projected by AGL to reach 116 PJ in 1997 and 118 PJ in 1998. In oral evidence, Mr McArdle of Santos estimated current annual demand to lie in the range 115 PJ to 120PJ. Demand at this level approaches the ACQ under the Letter of Agreement, which stands at 120 PJ until and including 2000.
Beyond this common ground, there is considerable disagreement among the parties as to likely levels of forward demand for natural gas in NSW, although it is generally agreed that demand will continue to grow. Differences between the several demand forecasts that were submitted in evidence arose largely from a single cause, viz. differing assumptions as to the likelihood of certain large projects proceeding, which each would consume significant annual quantities of natural gas.
The Tribunal notes a further consideration bearing on forecasts of gas demand, not provided for in the demand forecasts put in evidence, but apparent from the wider picture of future gas supplies to NSW. Up to the present, the total use of reticulated natural gas in NSW, and the quantity of gas sold by the Cooper Basin Producers to AGL, have been effectively identical. Demand for gas has been confined to those areas of NSW that are readily accessible from the Moomba‑Sydney pipeline, viz. the “Sydney region” that encompasses Sydney, Newcastle and Wollongong, where AGL at present holds a natural monopoly over gas distribution, and Canberra and certain NSW country cities close to the pipeline, where AGL also typically conducts local gas distribution. The forecasts of demand submitted in evidence all assume that NSW gas demand is confined to these areas.
However as the term of the Letter of Agreement approaches its end in 2006, and because the contract quantities will run down after 2000 in anticipation of substantial depletion of the gas‑fields operated by the SA Unit, AGL is necessarily pursuing additional forward supplies, both via the Moomba pipeline from the producers and ventures in the Cooper Basin, and from alternative suppliers via pipelines that are yet to be built.
At its simplest, it is evident that forecasts of total NSW gas demand, and of demand for gas from the SA Unit and from the wider Cooper Basin, must prospectively diverge. Also, when new gas transmission pipelines eventually reach into NSW from other gas production basins, which will be sooner or later according to the differing views of the parties, new points of gas demand will doubtless be tapped en route, and in some instances these could be of significant size. Submissions from the parties and others as to “the forecast demand” have therefore required that the Tribunal be conscious as to their attendant meaning.
All these considerations have required that Tribunal examine the factors that could introduce relevant variation in future demand for natural gas in NSW.
11.1.1 The impact of the third‑party access regime With the introduction of an approved third‑party access regime in NSW, numerous possibilities open as to circumstances in which natural gas will be traded over the next several years. The likely appearance of new aggregators who would offer gas to retail customers in the Sydney region, employing AGL’s distribution network, was mentioned several times in argument. Companies other than Cooper Basin and Gippsland Basin producers were named in witness statements as having explored supply possibilities with major industrial gas users. The wide variation in AGL’s pricing to industrial customers was described during the hearing as inviting market entry by new aggregators, with likely consequent reductions in gas prices to industrial and commercial users in NSW.
We accept that significant downward shifts in gas prices in the Sydney region are likely to result in some corresponding increase in gas demand, but the quantum of any such increase cannot be usefully estimated, for two reasons: the future competitive structure that might occasion price movements is as yet unknowable, and no evidence was tendered as to the actual sensitivity of demand to price.
Third-party access to the Moomba-Sydney pipeline system, given attractive haulage prices, could also introduce open competition to AGL from the Producers comprising the SA Unit for direct gas sales to major customers, either severally through Santos as their joint marketer, or by one or other of the Producers as a separate seller. Other production ventures in the Cooper Basin, for example in south‑west Queensland or in the Non‑Subject Blocks, insofar as they have non‑contracted supplies available for sale, might also offer gas to AGL via the Moomba-Sydney pipeline.
The Commission in cross-examination and argument presented this scenario of intra‑basin competition as a desirable outcome, while at the same time pointing to potential difficulties arising for AGL from consequent application of the take‑or‑pay clause in the Letter of Agreement. Difficulties for AGL could also arise from the application of clause 12 of the Letter of Agreement, with gives the Producers first right of refusal to supply additional gas to AGL. Witness statements and oral evidence from industrial customers for gas in NSW referred to recent sales inquiries from both Santos and Boral, and Mr McArdle of Santos in oral evidence discussed the possibilities for direct sales by the SA Unit Producers to industrial customers. He stated that for the time being, because of the constraints of the Letter of Agreement, Santos in defending the interests of the Producers prefers to discuss options with major customers jointly with AGL, rather than have take-or-pay problems arise.
11.1.2 Substitution between sources of energy, and the effects of electricity industry reform The market for natural gas in NSW has developed over twenty years because of growing demand for energy, particularly by industry, and by the progressive substitution of natural gas for other fuels. In recent years, demand has tended to stabilise into a pattern of steady growth in a context of reasonably settled technologies for fuel use, and reasonably settled price relativities in the energy market.
The general use of natural gas as an industrial fuel in preference to alternative fuels, particularly fuel oil and coal, has been encouraged by government concerns, in NSW as in other states, for the minimisation of the environmental impacts from industrial fuel use. The absence of objectionable and particulate emissions and of solid wastes when natural gas is used has been an especially significant factor in the choice of fuel by industry. Statements from several industrial users as to the logic of their continuing choice among alternative fuels, and from environmental authorities as to their attitudes and practices in the regulation of industrial emissions and wastes, satisfy the Tribunal that (unless the supply of natural gas somehow becomes unreliable or the costs of gas use relative to alternative fuels become highly disadvantageous) natural gas will be increasingly entrenched in the market as the industrial fuel of choice in NSW. This factor confirms the likelihood of, at worst, further steady increase in demand for gas over coming years.
However, growth rates in demand, and price relativities, have lately become less predictable.
Large increments in NSW gas demand could result from substitution of natural gas for black steaming coal used in power generation in NSW. In South Australia, where suitable steaming coal supplies are limited, natural gas has been used for many years at the Torrens Island power station of ETSA, the government electricity authority, so that in 1994‑95, 54% of the natural gas consumed in South Australia was used for public power generation. In Victoria, base‑load power generation uses brown coal fuel, with gas‑fired generation employed to meet peak loads.
In NSW, on the other hand, the availability of very large reserves of open‑cut steaming coal has encouraged power generation authorities towards a predominant dependence on coal‑fired plants for base‑load power generation, supplemented by peak hydro‑electric power from the Snowy Mountain Scheme. The balance between the use of gas and coal for power generation patently depends on relative costs, despite the environmental advantage that natural gas possesses. In the general case in NSW, coal‑firing remains for the time being the typical mode of power generation.
The new technology known as co‑generation has recently shifted the economic balance towards the use of natural gas fuel for power generation in particular industrial situations. The typical co‑generation facility is sited immediately adjacent to a group of industrial operations that together consume large quantities of electricity and process steam. The waste heat from power generation is used to generate the steam, so that both products can be sold to customers near‑by. Higher energy efficiencies are achieved than are possible for even the most efficient conventional power generation plant, because of both the co‑generation of steam and the avoidance of the significant transmission losses associated with an extended electricity distribution grid.
One co-generation plant began operating this year at Smithfield in the Sydney region, owned and operated by Sithe Energies Group, a US corporation with US and Japanese ownership. The Smithfield plant has a capacity of 160MW, and supplies both power and steam to the adjacent paper recycling plant of Visy Paper Pty Ltd. It uses approximately 10 PJ of gas annually, and thus has added about 9% to NSW natural gas demand. Sithe Energies is also looking into development of a second gas‑fired co‑generation plant in NSW, to supply the Caltex oil refinery and other adjacent industrial operations at Kurnell.
A joint venture known as the ALISE project was negotiating in 1996 for 24 PJ of long‑term gas supplies for a co‑generation plant to supply electric power and steam to industrial customers at Botany. The ABARE 1997 published demand forecasts refer to a proposal for a 350MW gas‑fired power station to be built at Tallawarra by Pacific Power, the NSW electricity generation authority. The commissioning of such facilities would add considerably to demand for natural gas in NSW, and would require significant supplementary gas supplies for NSW, beyond the quantities that AGL has contracted from the SA Cooper Basin Unit under the Letter of Agreement.
However the Tribunal heard consistent evidence that electricity prices available to major energy users in NSW have fallen sharply in recent months, so that the balance of energy cost is less encouraging to the use of natural gas for electricity generation, either in co‑generation facilities or power stations. This fall in electricity prices has resulted from the existence of unused capacity for electricity generation in both NSW and Victoria, coupled with the reform of the Australian electricity industry, in accordance with National Competition Policy, that has been proceeding in parallel with natural gas industry reform. The electricity reforms have included: action to develop a National Electricity Grid, so that the state power generation and transmission systems can physically supply electricity users in other states; the introduction of access regimes; the separation of ownership of power generation from ownership of electricity transmission; and the removal of government‑imposed impediments to open competition.
Two relevant consequences were described in evidence.
With the connection of the Victorian and South Australian electricity grids in 1990, the purchase of Victorian electricity became an option for ETSA, as an alternative to generation of electricity using natural gas as fuel. This circumstance:
• introduced a form of price competition between Cooper Basin Unit gas and Victorian electricity (originally generated from Victorian brown coal)
• reduced the dependence of SA electricity supplies on Cooper Basin gas supplies, and
• potentially released tranches of gas contracted by the Producers to ETSA, for sale to an alternative buyer. In the event ETSA has contracted to re‑sell a significant quantity of gas to supply a co‑generation plant in South Australia.
The connection of the NSW and Victorian electricity grids has also introduced the possibility of competition between NSW and Victorian power companies for the custom of large electricity users. Oral evidence referred to spot electricity prices as low as $25 per megawatt‑hour in NSW at present, compared with the prices of over $40 that had been usual in the past. However several witnesses agreed in their oral evidence that these electricity prices, occasioned by fierce initial competition between electricity companies, are not economically sustainable, and that electricity prices available to large industrial customers in NSW are likely to recover and stabilise in coming years at a level that will permit development of major new facilities that use natural gas to generate electricity. The probable timing for such future price recovery is not apparent to the Tribunal from the evidence.
In response to lower electricity prices, the plans of the ALISE co‑generation consortium were modified in March 1997, with the initial scale of the planned project halved, and with one of the venturers (a NSW electricity company) withdrawing from the consortium, so that it is now a 50‑50 joint venture of Air Liquide and ITOCHU Corporation. Negotiations that were close to completion for a long‑term gas contract to supply to ALISE 24 PJ annually of Cooper Basin gas (20% of the present ACQ), were not concluded, and modified plans now contemplate consumption of 12 PJ of gas annually. The prospects for immediate progress with other gas‑fired power generation projects also appear to have been affected. In the upshot, no investment decisions have been taken to date for the construction of plants in NSW for the generation of power from natural gas, beyond the Sithe Energies plant already in operation at Smithfield.
The uncertain prospects for gas‑fired electricity generation projects in NSW clearly introduce great uncertainty into projections of forward demand for natural gas in NSW, and must encourage both the Producers and AGL to develop flexible strategies that properly will allow a due response to a wide variety of possible future scenarios.
11.1.3 Projections of NSW demand Several forecasts of forward demand for gas in NSW were submitted in evidence.
The most recent published projections of ABARE, dated February 1997, show large and continuing consumption increases in NSW, commencing in 1996‑97, so that present gas demand would approximately double by 2010. These large increases in demand would result from the use of gas in power generation. However it seems that the ABARE forecasts were assembled from data that has been superseded by events; the first two forecast years are already demonstrably optimistic, in that they state that gas demand for power generation in NSW should already be growing strongly, when in the event the investment that would be required for that purpose has not been made.
The Producers exhibited confidential Santos demand forecasts with a significant range of possible variation, contingent particularly on the emergence and growth of demand for co‑generation. The Santos base case, prepared in June 1996, assumed that the original ALISE project would proceed promptly, with other co‑generation projects following in due course. AGL forecasts prepared in January 1997 similarly display alternative possibilities, depending in particular on whether the ALISE project proceeded.
The most recent evidence, dated May 1997 and received in evidence subsequent to the hearing, is in the Gas Supply and Demand Study 1997, a publication of the Australian Gas Association (“the AGA study”). The study is described in its secondary title as a “report to the participants [in the study] on the findings of a study into Australia’s natural gas supply and demand to the year 2030”. The listed participants appear to comprise all the significant natural gas production and transmission companies operating in Australia, and some gas distribution companies (but not AGL). The assumptions underlying alternative demand forecasts, which are usefully explicit in the AGA Study, demonstrate how substantially the timing of planned new co‑generation plants in NSW will affect natural gas demand in NSW. The Tribunal is satisfied that the demand forecasts in the AGA Study are generally consistent with the forecasts of NSW demand submitted in evidence by the Applicants and by AGL.
In sum, the demand forecasts examined by the Tribunal appear sufficiently consistent to be capable of summary as follows:
• the base demand for gas (i.e. excluding demand for power generation) in NSW will rise over the next ten years at an annual rate of 2% to perhaps 3%,
• substantial additional demand may well eventuate for the generation of electricity, but the quantum and timing of this extra demand cannot be known with any confidence, being critically dependent on future price competition between gas and electricity, and (self‑evidently) being subject to the time required to construct the necessary facilities after investment decisions are made.
11.2 When will demand exceed contracted quantities under the Letter of Agreement?
The steadily rising base demand for gas in NSW, very possibly supplemented by large additional tranches of demand for power generation, needs to be considered against contracted supply, which hitherto has been derived solely from the SA Unit in the Cooper Basin under the terms of the Letter of Agreement. Demand will surely exceed these contracted quantities within a few years, whichever demand scenario obtains, so that additional supplies, possibly large, will need to be found if NSW demand is to be satisfied.
The timing of the crossover in demand and contracted supply is an issue of considerable significance to this matter, as it defines the time when gas supplies from sources other than additional the SA Unit must be in place if NSW is not to go short of natural gas, and hence the time when competition in the NSW market from such new suppliers must have commenced.
The base projections separately put in evidence by the Producers and by AGL broadly agree, with demand (absent new power generation projects) first exceeding ACQ in calendar year 2000 (according to the Producers) and in June year 2000‑01 (according to AGL). However in this first year of deficiency, minor adjustments by one or other of the parties could presumably overcome the immediate difficulty if it were of short duration. While it might be noted also that the Letter of Agreement provides (in clause 25) that AGL may increase ACQ in any year by 5% with the consent of the Producers, on the same contract terms, the same forecast demand estimates project that demand will exceed ACQ by 5% or more within a further two years, and in all succeeding years.
In oral evidence, Mr McArdle of Santos, in response to an explicit question from the Tribunal, said:
“My view is that in terms of an inability of the South Australian Cooper Basin [to meet] contracted supply, including exploration results over the period to February 1999, the Cooper Basin could continue to satisfy all of South Australia’s and all of New South Wales’s demand until the early part of 2000. I don’t think we could go far into 2000 without some shortfall. The shortfall will be small, starting at a few petajoules, and will grow at 20 or 30 PJ a year”
and in further explanation, as to whether the timing of the shortfall might be as far ahead as 2003 or 2004, he said:
“If the demand [in the next three years] were actually lower than those forecast by the customers, then if they don’t take 10 PJ in 1999, theoretically that 10 PJ is available for future delivery. It is not available for just adding on to a subsequent year, but it can be spread out, and I would suggest that if demand is at the lower end of any reasonable range of forecasts, we might be able to squeeze through to, say, 2005. So the range [of possibilities] is about 5 years beyond 2000 in my view.”
Mr McArdle expanded this answer further in response to later questions from counsel as to what would be required for the Producers to meet NSW demand until 2005:
“It would need one or more - and I suggest more than one - of several possibilities. The first is ‘lower demand’ It would need some Queensland gas to come into the system. It would need exceptionally good and surprising unexpected exploration results from the program in the remainder of ‘97 and ‘98, and it would need the contracts we have entered into with SAGASCO and ETSA to have their offtakes deferred in time and not taken at the time the customers have indicated they would like.”
“I don’t believe the events [that] I foreshadowed would be required will occur. I don’t believe the demand will be below those numbers. I have no reason to think that the exploration results will be better than our technical people tell us. I believe we have a ‘reasonable endeavours’ obligation to provide the South Australian customers with the gas when they want it. And except perhaps for some small peaking volumes, I don’t expect any gas from south‑west Queensland going to New South Wales in the near future.”
The Tribunal found Mr McArdle’s exposition on this question convincing and, like much of his other evidence, useful in illuminating the facts and the issues. Identification of the probable year when contracted gas quantities will fall short depends solely on parallel projections of two quantities, the ACQ and the demand, subject to any difficulties in the SA Unit supplying the contracted quantities (which appear to be confined to brief and manageable problems in meeting peak demand). The Tribunal is satisfied that the shortfall of ACQ below NSW demand will appear in 2000 or shortly thereafter, and will in any event exist promptly on commissioning of any significant new facility to generate electric power from gas.
A related issue that the Commission pursued at length in cross-examination, and that emerges also in Mr McArdle’s oral evidence above, is not to be confused with the question of the timing of the ACQ shortfall. This other issue may be stated as follows, and is addressed in the next section of these reasons: Will the necessary additional gas supplies that will be needed to meet demand beyond ACQ in the period from 2000 to 2006, when the AGL contract terminates, also originate in the Cooper Basin, or will they more probably be derived elsewhere?
12. THE EMERGENCE OF MULTIPLE SUPPLIERS
12.1 The vulnerability of the initial business system
We have already described the form of business system that applied when natural gas supplies to major Australian cities began, and which has since largely persisted. The supply arrangements applying to each major state capital city and its surrounding region have been distinct, typically with a single source of supply, a single transmission pipeline from point of production to the major market, and a single reticulator supplying end‑users. The relevant governments were customarily involved, often owning elements of the industry, and exercising a degree of control which went beyond the allocation of licences for exploration and production. The governments typically stipulated the industry structure, sought to ensure reliable supplies within their jusrisdiction, and exercised some oversight over prices. This initial form of the business system, with its characteristic of state‑supported monopoly, provided the umbrella within which the use of natural gas developed and has become a conventional fuel option for domestic, commercial and industrial customers in Australia, over approximately the last 25 years.
However, any such business system is intrinsically vulnerable, in that it relies on its commercial isolation. Its continuance in any instance is underpinned by circumstances that can change, including:
• active encouragement and supportive intervention by the relevant state government
• control by the producing company of commercially recoverable gas reserves that are adequate to supply the market
• the absence in practice of alternative suppliers who might deliver gas through the same pipeline
• the absence of pipeline interconnections to other gas supply systems.
The last ten years has, as the evidence has shown, seen the substantial or potential breakdown of these underpinnings, in relation to more than one of the separate gas supply systems. Australian governments, working together through COAG, are also now co‑operating to foster free and fair trade across an inter‑connected national gas market. The deliverable gas reserves that originally supplied major cities have in some instances become so depleted that they need to be supplemented from other sources, or will do in the near future. Also, alternative suppliers have been encouraged both by the prospect of short supply in a regional market and by the changed public policy context, so that numerous projects to connect regional pipeline systems with each other are in active development.
In the upshot, a revised business system for the supply of natural gas is emerging in Australia, in which gas customers in practice have, or shortly will have, increasing choice among alternative suppliers. Evidence to the Tribunal shows that gas producers, pipeline companies, gas reticulators and potential new entrants to all sectors of the industry are already pursuing business strategies to establish or to defend their commercial position within this new business system as it takes shape.
The development of the gas industry in three states suffices to illustrate the above tendencies:
Queensland: The original supply of gas to Brisbane in 1969 was drawn from the Surat Basin, which contained gas reserves that were not large in comparison with other Australian gas provinces, but were sufficient until recently to satisfy demand in the population centres of south‑eastern Queensland. These fields have now been significantly depleted, with only 40 PJ of proven and probable reserves remaining in 1995, so that gas supplies to Brisbane need to be supplemented. Gas in the Denison Trough, immediately to the north of the Surat Basin, is predominantly committed to supply Queensland Alumina Ltd (QAL) at Gladstone, and in any event it is said that the reserves will be unable fully to meet QAL demand after 2002. The Adavale Basin supplies gas to a small gas‑fired power station at Barcaldine, but its reserves are considered too limited and too remote for economic connection to the Queensland pipeline grid.
Gas reserves in the south-west Queensland sector of the Cooper Basin therefore remain at this juncture as the only substantial source of gas within the state that is available for the longer term .
These reserves were held back by the Queensland Government in 1976 from incorporation in the SA Unit that is contracted to supply gas to both South Australia and AGL. The Gas Act 1965‑1988 (Queensland) requires that any significant sale of gas produced in Queensland has the approval of the Governor in Council. Following new discoveries in recent years, approval has been given for gas from the south‑west Queensland Cooper Basin to be committed for sale in three presently distinct markets, as follows:
• Following an Enabling Agreement with the Queensland Government that imposed several other confidential obligations on the producers in the Queensland sector of the Cooper Basin, 30 PJ per annum of gas was contracted by the Producers to PASA for the South Australian market in 1991. This gas has been transported since January 1994 via a raw gas pipeline to Moomba, where the raw gas is processed prior to transmission to Adelaide.
• With a new gas processing facility under construction at Ballera on the south‑west Queensland gas fields, gas is now supplied to Brisbane via a new pipeline to Wallumbilla, where it joins the Surat Basin pipeline to Brisbane. Contracts were entered in 1995 to supply the two gas utilities, Allgas Energy Ltd, which reticulates gas south of the Brisbane River, and Gas Corporation of Queensland, which reticulates gas north of the Brisbane River. A supply contract was also signed with Incitec Ltd, which operates a fertiliser plant on Gibson Island that consumes a substantial part of the gas supplied to south‑east Queensland.
• A further contract was signed in July 1996 to supply gas to Mt Isa, and AGL has been licensed to construct a pipeline from Ballera to Mt Isa.
The recent proposal for construction of a gas pipeline to transport gas from Papua New Guinea to Townsville and Gladstone, in the first instance, has introduced the possibility of large additional gas supplies to Queensland, with interconnection to the existing network of pipelines and the corresponding potential for renewed choice among gas suppliers. Prospects are discussed in a comprehensive report prepared by the Queensland Gas Industry Gas Force, a body comprised of major corporations with interests in the production, haulage, distribution and use of natural gas. They concluded that, given ample supplies from multiple sources and competitive pricing, demand for natural gas in Queensland could double within ten years.
Western Australia: Depletion of the original Dongara field and adjacent fields in the Perth Basin, and growing gas demand, led in 1984 to the construction of a new pipeline to the Perth region from Dampier, allowing supply from the very large gas reserves of the off‑shore Carnarvon Basin, on the North West Shelf.
South Australia: As earlier noted in these reasons, the South Australian Government has intervened frequently in the development of the gas fields of the South Australian sector of the Cooper Basin, because of continuing concerns that deliverable reserves from those fields could be inadequate to meet forward requirements within the state. The government has also been unwilling to accept subordination of reliable long‑term gas supply to Adelaide to the prior contractual rights of AGL in NSW, as in effect required by the Letter of Agreement. In the course of extended negotiations that involved legislative, regulatory and administrative initiatives directed to the resolution of these difficulties, the government seriously explored several supply alternatives, including supply from Bass Strait, from south west Queensland and from the Amadeus Basin in the Northern Territory. They rejected an arrangement other proposed by Santos under which the Unit would on‑sell additional supplies procured from other Cooper Basin ventures holding deliverable gas reserves, and for which Santos was also the Operator. Eventually PASA entered separate long‑term supply contracts in 1989 with three distinct Cooper Basin gas production ventures in South Australia - the SA Unit, and ventures covering the Patchewarra South West and Murta Blocks, which are Non‑Subject Areas within South Australia, and with the South West Queensland Unit, which was formed by the relevant producers to effect this first significant sales contract from that area, again with Santos as Unit Operator.
The Tribunal does not consider that these parallel contracts amount to intra‑basin competition for the South Australian market, because of commonality in the venture ownerships, and the dominant position of Santos in all four ventures both as Operator and as holder of the largest interest. Rather the contracts represent an outcome imposed by a strong buyer on a number of contiguous and commercially related ventures. In reaching this conclusion, the Tribunal notes that Santos is organised internally so as to separate South Australian and Queensland Business Units, and that Mr McArdle of Santos asserted in oral evidence that responses to “external competitive threats” are neither centrally co‑ordinated nor jointly managed as between the South Australian Producers and the south‑west Queensland producers.
In each of the three States as described above, the modification of the original single‑supplier business model followed inevitable depletion of the original gas reserves on which consumption of natural gas had been developed in the state, and the consequent actual or potential inability of the original supplier to satisfy growing demand.
12.2 Future suppliers to NSW
When the contracted quantities of gas from the SA Unit fall short of total NSW demand within a very few years, the physical supply of additional gas to meet demand in NSW will necessarily come from one or more sources that each satisfy certain criteria:
• gas reserves will be sufficient to assure adequate supply to additional markets
• production quantities will be available that are uncommitted to established buyers elsewhere
• the source gas‑fields will be connected to the NSW gas distribution structures through an existing or new transmission pipeline system.
The evidence is consistent in suggesting that any such further supplies to NSW during the next 10 years will be derived from either the Cooper Basin or the Gippsland Basin, these being the only two basins with substantial gas reserves that lie within a practicable distance, and the only two basins that have, or are likely to have, pipeline connections to the NSW market within the relevant timescale.
12.2.1 Additional supplies from the Cooper Basin The gas‑producing ventures in the Cooper Basin are each in a favourable position to supply gas to NSW as the SA Unit’s present contract with AGL runs down after 2000 and terminates in 2006. For them, the Moomba-Sydney pipeline is in place, with ample transmission capacity available. Also Santos, the Operator for all four relevant Cooper Basin joint ventures, has close knowledge of the NSW market from past experience. However the ability of the various Cooper Basin ventures to supply the Sydney region with useful additional quantities of gas over, say, the period from 2000 to 2010 depends on the existence of adequate deliverable reserves that have not already been committed elsewhere.
The magnitude of the Cooper Basin gas reserves was the subject of much evidence and argument before the Tribunal. The Commission adduced from a considerable body of evidence that large gas reserves remain to be drawn on from the Cooper Basin, which will be increased in the future by further discoveries and by the proving of deposits that are presently classified only as “possible” reserves. Their contentions in this regard are supported by the recently published AGA Study. The Commission went on to contend that the Tribunal could reasonably conclude that gas supplies to the Sydney region would be derived from the Cooper Basin, in particular from the south‑west Queensland sector of the Basin, for several years subsequent to the termination of the AGL contract.
On the other hand the Applicants contended that supplies to Sydney from the SA Unit are already barely adequate to meet the Unit’s contractual obligations to AGL, given the Unit’s other contractual obligations, and that any supplementary supplies would be limited to so much of the residue of the “tail” of gas produced from the depleted Unit fields as is not already committed to South Australia. In support of this contention, the Applicants exhibited in confidence detailed information presented by Santos to a meeting of the participating Producers on 24 October 1996. The meeting was called to discuss present and proposed contractual commitments of the SA Unit Producers, and the practical feasibility of meeting these commitments on various assumptions as to feasible production rates and future discoveries. The meeting was held in response to concerns among some Producers that the Unit could be overcommitted, and that entry into proposed further commitments might be imprudent.
The Tribunal is satisfied that the difference, as described above, between the contentions of the Commission and the Applicants arises from their use of different frames of reference.
The Applicants were concerned to demonstrate that the reserves of the SA Unit are approaching serious depletion, and that further discoveries within the Unit area in the remaining period before Santos’ exploration permit expires in February 1999 are predictable and limited as to likely quantity. In this context, the immediate strategic issue for the Producers participating in the Unit venture is to derive maximum commercial advantage from the depleted gas reservoirs of the venture, from which total production will decline seriously after 2000, and for which there is competing demand.
The Commission did not appear to dispute the impending inability of the SA Unit to do much more than meet its contractual obligations over the next several years, but (as already noted) contended rather that the substantial reserves remaining in the Cooper Basin, and in particular in its south‑west Queensland sector of, might be reasonably considered as potential sources of gas for NSW for many years to come.
However, it is not the responsibility of the SA Unit Producers to find and supply gas to satisfy NSW demand beyond their contractual obligations, as their capacity to meet total demand diminishes. As Mr McArdle said in response to a question in this connection from counsel for the Commission:
“The Cooper Basin Producers wouldn’t decide [what alternatives exist for the next century] at all. The Cooper Basin Producers are a joint venture to undertake activities in South Australia. The Unit Producers are there to produce gas that the producers in individual joint venture discover. There will obviously be some time when the life of those Producers completely is extinguished. I would imagine that will be way beyond anybody in this courtroom’s time. But they will start to reduce in the scope of their activity as we get closer and closer into the next century or the next decade.”
While accepting the existence of substantial reserves of gas in the Cooper Basin, the Tribunal has found it helpful to distinguish the capacity of each of the four Cooper Basin production ventures to supply NSW, taking all relevant factors into account.
The SA Unit, in the Tribunal’s view, is not to be considered as other than a possible marginal supplier of gas to NSW prior to 2006, beyond its ACQ commitments. This cannot be a surprise. The Unit was set up as an organisational instrument for the performance of contracts to supply gas to two customers, PASA and AGL, from a number of adjacent gas‑fields in Blocks held by various joint ventures. The scope of the Unit was defined to match the gas quantities required to meet these two contracts with licensed areas that could be expected to deliver those quantities. The contract schedule of deliveries to AGL assumed depletion such that delivered quantities must fall sharply in the final years of the contract. For a time after formation of the Unit, the Unit Producers struggled to discover and prove the contracted reserves.
The Tribunal finds the evidence of the Producers’ meeting on 26 October 1996 to be convincing, and concludes that available Unit supplies will be close to fully committed until 2006. After 2000, the Unit’s capacity to produce gas will diminish , and concluded contracts with NGASA, ETSA and SAGASCO in South Australia, and with AGL, will absorb production. There could be circumstances when contracted quantities and projected commitments are not taken up - for example if ETSA should elect to purchase its electricity in large part from Victoria, rather than itself generate electricity from gas, or if a major co‑generation project should not proceed as forecast. However, such possibilities are conjectural, and cannot be assumed to be so likely at this juncture that NSW customers for gas could rely on them. After 2006, the “tail” of production from the depleted Unit gas‑fields could allow the SA Unit to supply perhaps 15% to 20% of NSW demand for several years, assuming that prices offered for gas in NSW justify such sales in comparison with prices available in other markets.
Non‑Subject Blocks in South Australia, viz the Murta Block and the Patchewarra South West Block, produce limited quantities of gas, which are contractually committed to NGASA for the South Australian market. Any surplus gas could in theory be sold to NSW, these being separate ventures with access to the Moomba Pipeline via the Moomba processing plant. However neither presently is considered by the Tribunal as a credible supplier to Sydney, because of their small reserves, limited prospects for further discoveries, and their existing contractual obligations to supply South Australia.
The South West Queensland Cooper Basin Raw gas from the SWQ Unit equivalent to 30 PJ of sales gas annually presently flows to Moomba for processing and delivery to NGASA. The SWQ Unit also is contracted for the substantial supply of demand for gas to the Brisbane region as Surat Basin supplies are exhausted; and will additionally supply Mt Isa. As at the end of 1996, total contracted quantities to be delivered from the SWQ Unit amount to about 200 PJ to South Australia up to 2003, and 375 PJ to Brisbane and 225 PJ to Mt Isa with contract terms of 10 and 15 years. Evidence to the hearing was that 400 PJ of deliverable reserves remains uncommitted. Santos estimated for the Queensland Gas Industry Task Force that a further 1,000 PJ in proven and probable reserves could be discovered in south west Queensland over the next 5 to 7 years. The AGA Study relied on information from producers to derive an assumption underlying its projections that annual gas production from all Cooper Basin fields will be limited to 300 PJ until general depletion obliges a progressive reduction, commencing after perhaps 2006 or 2007.
Mr McArdle in oral evidence stated that the south‑west Queensland producers would have difficulty supplying Queensland demand, and that the Queensland Government had been informed of this. Mr McArdle repeated more than once his doubts that gas from south‑west Queensland would be available to provide gas supplies to NSW, although he conceded that some sales could be made if NSW customers proved willing to pay a higher price for gas than Queensland customers.
The report of the Queensland Gas Industry Task Force postulates one eventuality that could cause significant quantities of gas from the Queensland sector of the Cooper Basin to be sold outside the state via Moomba - the emergence of a surplus of gas supply over demand within Queensland following construction of the proposed natural gas pipeline from Papua New Guinea.
In sum, the Tribunal accepts that useful quantities of gas from the Cooper Basin, either from South Australia or from Queensland, could be offered in the NSW market after the AGL contract no longer meets NSW demand, depending on competing sales opportunities. However the Tribunal concludes that the available quantities of gas originating from any part of the Cooper Basin, while not open to confident prediction, are unlikely to satisfy the whole NSW market gas for any significant number of years after 2000.
12.2.2 Supplies from the Gippsland Basin The off‑shore Gippsland Basin contains considerable reserves of natural gas, and the capacity of the basin to supply NSW demand for gas for many years was not questioned before the Tribunal. Mr Dixon of Esso Australia stated in evidence that about 3,400 PJ of Gippsland Basin gas remains uncommitted. Both Mr Dixon and Mr Biggs for BHP Petroleum referred to the supply of gas to NSW with particular regard to how and when this might be done and the commercial sense in doing so, but apparently with no large qualification as to available gas reserves or their deliverability. They rather pointed to the prerequisite of new pipelines being built, to connect and allow access to existing NSW gas transmission and distribution systems. Additional production capacity on the Gippsland Basin gas‑fields would also be required, estimated by Mr Dixon of Esso as costing $750m over fifteen years.
The AGA Study projections assume that production from Gippsland Basin fields is limited at present to supplying 350 PJ annually to all buyers, but that this production limit will be increased to 450PJ annually. On this latter basis, and assuming further gas discoveries, the AGA Study forecasts that the Gippsland Basin will be the major source of supply of gas to eastern Australia until after 2015.
Two planned pipelines to link the NSW and Victorian gas pipeline systems were described in evidence. In both cases, project planning is well advanced, although final investment decisions had not been taken at the time of the Tribunal hearings. The two proposals are:
The “Interconnect” This project is for a pipeline some 146 km long connecting the Victorian gas transmission system near Wodonga with the Moomba‑Sydney pipeline, via a side‑branch that already extends from Young to Wagga Wagga. The joint venturers considering the Wodonga-Wagga Wagga link are both pipeline operators - Gas Transmission Corporation (GTC), the operator of the Victorian high‑pressure gas transmission network, and EAPL, the owner and operator of the Moomba‑Sydney pipeline.
The pipeline is designed to permit transport of gas in either direction, with an initial annual capacity of 20 PJ, although removal of some bottlenecks in the Victorian gas transmission network will be required for this capacity to be fully utilised. The venturers have concluded that the transmission route can, as required, be progressively and economically upgraded to carry 90 PJ annually.
Mr Semenas of East Australian Pipeline Marketing Ltd, the ring‑fenced marketing agent of EAPL, stated in evidence that haulage tariffs have been published, firm to July 2005, made up of a capacity charge and a commodity charge, at various price levels according to whether the service is to be firm or interruptible or for spot sales. Numerous requests for transportation services have been received since publication of the tariffs, amounting at the time of the hearing to 65 PJ for gas to move south and 140 PJ to move north, the latter comprised of 50 PJ delivered to Wilton for Sydney and 90PJ for off‑take at other points on the Moomba‑Sydney pipeline, which has capacity to handle a further 90 PJ annually above its present use. The predominant gas flow is expected to be northwards, and contracts for simultaneous haulage southwards (“backhaul”) would be accommodated by exchange arrangements, at discounted rates. Generation Victoria (GV), which operates two gas‑fired power stations in Victoria using about 30 PJ of gas annually, has put itself forward as a potential customer for backhaul gas from the Moomba pipeline via the “Interconnect”.
The Eastern Gas Pipeline The joint venturers for Eastern Gas Pipeline Pty Ltd (EGP) are subsidiaries of BHP Petroleum Pty Ltd (BHPP) and Westcoast Energy Pipelines Pty Ltd. A new and separate pipeline of 747 km is planned, to run from Longford, the on-shore delivery point in Victoria for Gippsland Basin gas, by a fairly direct route to the neighbourhood of Sydney, probably to Wilton, the entry point to the AGL gas reticulation network. On the way it would pass close to Bairnsdale, Orbost, Bombala, Cooma, Nowra and Port Kembla. Negotiation with AGL is envisaged, directed to using the existing AGL line between Wilton and Port Kembla, as an alternative to EGL duplicating it. A project cost of about $383m is estimated. Pipeline permits have been issued by the Victorian and NSW Governments. Issues of environmental impact and native title claims were being addressed and remained to be completed as at the date of the hearing. BHP Petroleum stated in evidence that any decision to proceed with construction of the pipeline necessarily awaited the IPART determination on the access regime for the AGL distribution system, which had not be made at that time. In the event of the terms able to be negotiated for third-party access not proving acceptable, EGP would examine the alternative of by‑passing the AGL system by building pipelines direct to major industrial customers in the Sydney region.
The pipeline is designed to carry gas northward, to deliver Gippsland Basin sales gas to the Sydney region and to markets at intermediate points. The indicated capacity of the pipeline is 90 PJ annually, with a volume for planning purposes of 70 PJ to be achieved in stages over three to four years. The capacity would be readily capable of further increase to 105 PJ should demand justify it.
EGP describes itself as a transmission company, willing to transport gas for any party if capacity is available, but clearly the pipeline proposal is predicated on its carrying gas to the NSW market on behalf of the Gippsland Basin joint venturers, as an element in their business strategies. Ms Cutler, who gave evidence for EGP as NSW Project Manager, is the BHP Petroleum representative on the EGP management committee, and pointed in her evidence to the BHP strategy of creating an interstate natural gas grid. EGP is well advanced in negotiating tariffs and terms of sale with BHP Petroleum and Esso, consistent with the BHP Petroleum strategy of pricing its gas on a “city‑gate Sydney” basis, rather than ex‑field with the purchaser contracting for transmission, as is the case with Cooper Basin gas sold to AGL and to South Australia. AGL would prefer to buy gas ex‑field (i.e. at Longford) and to arrange its own haulage.
In oral evidence, Ms Cutler indicated awareness of the status of the “Interconnect” pipeline proposal, and said that she understood that pipes had been ordered for it. She deduced that a decision to proceed with the “Interconnect” had effectively been made, as pipe is one of the major cost items. She said that, from the outset, planning for the EGP had proceeded on the assumption that the “Interconnect” would go ahead.
The Tribunal notes that, should both pipeline connections proceed (as seems very possible from the evidence), purchasers of Gippsland Basin gas in NSW will potentially have a choice as to the transmission pipeline used in its delivery.
12.2.3 Other supply options
All gas supply scenarios explored by the AGA Study demonstrate that the total supply of gas to markets in eastern Australia (i.e. NSW, Victoria, South Australia and Queensland) will be necessarily derived from multiple suppliers, because “assuming that the presently separate pipeline systems are interconnected in the near future” neither the Cooper Basin nor the Gippsland Basin offers the reserves and production capacity to supply the total market in the four states concerned.
The Tribunal concludes, having regard to a clear consensus among knowledgeable witnesses on the point, that the progressive interconnection of the Australia’s separate gas supply systems will continue over the coming years and decades. The interconnection will be driven by the reality that the gas‑fields at present supplying eastern Australia, while substantial, are finite and are being depleted. Perceptions of commercial opportunity will also encourage interconnection, as will the initiatives of governments to implement National Competition Policy. An extensive gas pipeline grid will in due course take shape, connecting the centres of gas demand in the south‑east of the country with each other and with very large but remote gas reserves.
Indeed, even the most optimistic of the AGA Study projections points to a shortfall in gas supply to eastern Australia (taken as a whole) from sources within eastern Australia, after 2008. Granted that the AGA Study projections rely on mathematical modelling and on certain perhaps arbitrary assumptions, and granted also that substantial further gas reserves may well be discovered and developed close at hand, in (say) Bass Strait, the conclusion seems inescapable that the construction of pipelines to haul natural gas from newly developed, remote gas-fields is likely on a time-scale of ten to fifteen years from now.
The AGA study canvasses this prospect, and points to three likely new sources of gas supply to eastern Australia, substantially supplementing supplies from the Gippsland and Cooper Basins and from other smaller nearby sources of gas production. These sources, with estimated recoverable reserves as at the date shown, are:
Carnarvon Basin (North‑West Shelf): 46,000 PJ (1995)
Bonaparte Basin/Timor Sea (offshore from
Northern Territory/Kimberleys) 30,000 PJ (1995)
Papua New Guinea 9,000+ PJ (1997)
The AGA Study compares total proved and probable gas reserves in eastern Australia as at end 1995 with total projected demand in eastern Australia between 1997 and 2030, and finds a deficit in gas supply exceeding 15,000 PJ. The Study goes on to conclude that this deficit could be amply supplied from uncommitted reserves in the western off‑shore fields, without regard to the further Papua New Guinea option.
The interconnection of gas supply systems opens a further possibility - a secondary trade in gas and in gas contracts. Secondary trade in gas is well developed in the USA, where the use of long‑term sales contracts between gas producers and gas aggregators or major industrial users, which in Australia constitute the dominant commercial device in gas trade, has there been substantially supplemented by trading in gas in spot markets, by devices such as swaps, and by trade in contracts for physical gas and for pipeline haulage capacity. This diversity in the commercial forms and instruments available to the gas buyer has resulted from the number and diversity of primary gas producers in the large and developed US gas market, and from the dense US network of interconnected pipelines, which together allow a reasonably uniform product to be traded freely.
Such alternative trading procedures have not significantly emerged in Australia at this stage in the development of the Australian gas industry, and such emergence must presumably await a sufficient diversity of gas sources and pipelines, and a sufficient extent to their interconnection. However the possibility was illustrated in evidence on the sale of Cooper Basin gas, where a single basin supplies the two distinct markets of Sydney and Adelaide. In 1986, there were inconclusive discussions between AGL and the South Australian Gas Company (now a part of SAGASCO) for the possible sale of some gas that was contracted to AGL but had not been taken, at a price that could suit the interests of both parties but did not accord with Unit contract prices at that time. Also secondary trade in gas has recently appeared in Adelaide, where ETSA, consequent on its option of purchasing cheap power from the Victorian electricity grid, has been able to re‑sell gas that is contracted to ETSA but is surplus to its immediate requirements, to another gas‑user in the Adelaide region. ETSA has also explored the possibility of sales to end‑users in NSW.
12.3 Strategies of the Gippsland Basin partners
Connection of the Victorian and NSW gas transmission and distribution systems, when it occurs, and the consequent capability to supply Gippsland Basin gas to NSW, will introduce several new parties into the business system, insofar as it affects supply of gas in NSW. Evidence to the Tribunal from representatives of the two pipelines and of the two Gippsland venture partners, and from the Producers, AGL and gas‑users in NSW, exhibited diverse strategic perspectives as to the commercial opportunities and consequences that will arise. However, several underlying assumptions were plainly held in common, as the basis for the strategies that the parties have variously adopted. These assumptions are shared by the Tribunal, as being amply supported by evidence:
• that the supply contract between the Producers and AGL will not fully satisfy NSW demand for gas after some date in the near future, probably 2000 or 2001
• that the market for gas in NSW, beyond the AGL contract quantities that apply up to 2006, will be contestable
• that some continuing and additional supplies will be available from joint ventures in the Cooper Basin, but will be inadequate to meet total demand
• that the supply of Gippsland Basin gas to the NSW market is thus inevitable and necessary
• that facilities to transport gas between Victoria and NSW, through one or both of two proposed pipelines, are likely to be commissioned around 2000, and perhaps prior to that
• that effective regimes for third‑party access to relevant gas transmission pipelines and reticulation systems will be in place before 2000
• that it is timely for participants in gas industry to develop strategies suited to these circumstances, and for aggregators and users to explore advantageous gas purchases.
Within this expected framework of circumstance, the strategic intentions of the Gipplsland Basin producers, BHP Petroleum and Esso Australia, are of particular relevance to this matter. When AGL was exploring options for gas supply to NSW in the negotiations that culminated in their Letter of Agreement with the Cooper Basin Producers in 1971, the Gippsland joint venture was the other eager competitor for the business, and they have not since supplied gas to any significant Australian market beyond Victoria.The Gippsland Basin producers supplied 226PJ of gas to its customers in 1995, of which 80% was purchased by GASCOR, the Victorian reticulator, and (excluding some consumption by affiliates of the joint venture partners) the rest was purchased by Generation Victoria for its two gas‑fired power generation plants.
The evidence of Mr Biggs of BHP Petroleum and Mr Dixon of Esso together provided a sufficient picture of the strategic intentions and expectations of the two companies. Their statements describe how, following their unsuccessful bid in the late 1960s to win the contract to supply AGL, the Gippsland producers made no substantial move to supply NSW during the 1970s and 1980s. They did not then consider themselves in a position to compete with the SA Unit Producers for reasons that included the following:
• the SA Unit Producers had necessary pipeline infrastructure in place, while the Gippsland Basin producers did not
• the AGL Letter of Agreement covered foreseeable demand up to about 2000
• the Gippsland Basin producers, because they operate off‑shore, were subject to Petroleum Resource Rent Tax (PRRT), while the on‑shore Producers were not.
However, the shared strategic perspective changed in the early 1990s with growing awareness of likely gas supply shortages in NSW around 2000, government initiatives towards free and fair trade in gas, and the prospect of third‑party access regimes being put in place for gas infrastructure. More recently the PRRT problem seems to have been sufficiently resolved.
After examining current production capabilities and the economic deliverability of reserves, Esso has concluded that a significant tranche of gas could be made available for sale in NSW in 2000. The Eastern Gas Pipeline project was initiated around 1994 with BHP Petroleum as a venture partner. BHP Petroleum has since been exploring the NSW gas market, talking to AGL and to large industrial users of gas. The proposed route of the pipeline passes close to Port Kembla, where BHP steel operations currently supplement internal sources of recycled energy with large quantities of natural gas presently purchased from AGL. This gas would presumably be supplied from the Gippsland Basin when the pipeline is built, as the Tribunal presumes it will be. BHP Petroleum also entered a contract to supply 10 PJ of gas annually to the Sithe Energies cogeneration plant at Smithfield for up to 20 years, commencing in late 1996. With the EGP not yet built, BHP has entered a contract, said to be for four years, for AGL to supply BHP with gas for on‑sale to Sithe.
The Tribunal sees the above pattern as reflecting the behaviour of a gas supply venture that is actively pursuing entry to the NSW gas market around 2000.
13 THE TRIBUNAL’S METHODOLOGY
Before we turn to the assessment of the Letter of Agreement in accordance with s 91(4) of the Act, it is appropriate that we recapitulate here the Tribunal’s methodology in determining a review of a revocation of a previous authorization. As already stated, there are three questions that the Tribunal must address in turn:
(1) Has there been a material change of circumstances since the authorization was granted?
(2) If so, should the authorization be revoked?
(3) If so, should there be granted a further authorization in substitution for the authorization so revoked?
In answering the first question, there are two tests that may be applied, as discussed in Media Council (No 4) at 42,261:
· Is the current conduct that is undertaken by the parties the conduct that was originally authorized; or is the original authorization a dead letter?
· Has there been such a change of circumstances since the date of the original authorization as will likely have significant impact upon the balance of public benefit and detriment?
As already discussed, the current conduct in this matter is substantially the same conduct as that authorized in 1986, even though the Letter of Agreement has been amended from time to time. Hence the first question reduces in this instance to our consideration of the issue of material change of circumstances.
To answer the second question, the Tribunal asks: what difference would revocation make to future benefit and detriment to the public interest - the “future-with-and-without test”.
To answer the third question, we employ the Tribunal’s standard authorization methodology, which also requires the application of the “future-with-and-without test” to establish the likely balance of benefit and detriment that would arise from the substitute conduct that it is proposed to authorize.
All three questions that have relevance to the present application therefore require us to identify likely benefit and detriment to the public. This will normally demand that we inquire into the functioning of relevant markets with and without the conduct under examination. (See, in particular, Media Council (No 4) at 42,261-42,262 and the references cited therein.) Hence, the first step in assessing benefits and detriments to the public is to identify the relevant market or markets.
14. MARKET DEFINITION
The conduct that is the subject of this determination is the giving effect to the provisions of the Letter of Agreement, a long-term gas supply contract that was signed in 1971, authorized in 1986, and expressed to run initially for thirty years from the commencement of supply. The contract does not terminate at least until 2006. Thus a long time period is intrinsic.
Professor Teece (the economist called by the Applicants) wrote in his Statement:
“For industries such as natural gas, which are characterised by long-lived assets, long-term contracts and long-term planning horizons, the correct temporal perspective for defining markets must necessarily be longer than in other industries. In the present case, anti-competitive problems associated with this contract, to the extent there are any, will expire with the contract in less than ten years.
Thus, the appropriate temporal perspective in this case is at least several years. Viewing the market in the short term to determine competitive impacts would be inappropriate. With such long-lived assets and contracts in this industry, adaptation to new market circumstances should appropriately focus on a medium term perspective.”
The Closing Submissions of the Applicants state that the “temporal dimension is much greater than five years”:
“The long lead times in exploration, proving up reserves, developing reserves for production, constructing processing facility, constructing pipelines and the long term supply needs of major industrial gas users and the long term planning of gas producers (eg, ESSO has planned to sell Gippsland gas into New South Wales at the turn of the century since 1971).... make a temporal dimension of only 5 years entirely inappropriate.”
We are reminded of the oft-quoted passage in Re Queensland Co-operative Milling Assocation Ltd, Defiance Holdings Ltd (1976) ATPR 40-012:
“A market is the field of actual and potential transactions between buyers and sellers amongst whom there can be strong substitution, at least in the long run, if given a sufficient price incentive.” (at 17,247, emphasis added).
Yet we recall that the phrase “the long run” is to be read in a special technical sense as referring not to a span of years but to “operational time” as explained in Telecom Corporation of NZ Ltd v Commerce Commission (1991) 3NZBLC99-239 at 102,363:
“We include within the market those sources of supply that come about from redeploying existing production and distribution capacity but stop short of including supplies arising from entirely new entry. Thus ‘the long run’ in market definition does not refer to any particular length of calendar time but to the operational time required for organising and implementing a redeployment of existing capacity in response to profit incentives.”
The ACCC submitted that the time dimension of the market should be approximately one year, emphasising the limitations to substitution posed by the commitments of users to fixed equipment utilized in burning gas. However, this traditional approach does not do justice to the dynamic quality of the market setting and the emerging processes of competition. Dr Carpenter, an economist called by the ACCC, has much experience of the deregulation of the gas industries of the United States, Canada and Britain. Throughout his evidence he emphasized “gas markets undergoing a transition to increased competition”.
We have concluded, as canvassed with counsel in the course of the hearing, that the appropriate approach in this matter is to think in terms of a market expanding over time -i.e. an expanding market definition. Such an approach is consistent both with commercial reality and the traditional methodology of market definition, and is apt to expose the issues in this matter.
In considering this expanding market, we specify three dated markets of interest: the market in 1986, the market today, and the market in “the future” - perhaps ten or fifteen years hence. Quite obviously the geographic market is expanding over this time period, and the product market is also expanding, as we explain below.
As a further preliminary comment we note a tendency for the parties when addressing the product market to confine their attention to natural gas. As one expressed it, the subject-matter of the contract was the supply of natural gas. But the relevant markets need not be confined to the activities that are co-extensive with the conduct at issue. While the conduct at issue must necessarily be the starting point for analysis, the product market may embrace wider substitution possibilities than this. Also there may be more than one product market if we are to understand the competitive (or monopoly) forces at work so that a mapping of interconnected markets may be required.
We find that there are three product markets of relevance for this application. The first is natural gas, extending at the margin to encompass, at times, alternative and complementary energy sources, principally electricity. When we refer to the “natural gas market”, it should be understood in this extended sense. Then there are two further product markets, the services of transmission and reticulation.
For the natural gas market, there are a number of functional dimensions to be considered: exploration and development (ie proving reserves); production and processing; and distribution.
The geographic dimension of the natural gas market has been expanding from NSW in 1986 to south east Australia (NSW, Victoria, South Australia and Southern Queensland) today. In the “future market” it will be Australia-wide, including off-shore sources of gas in West Australia and the Northern Territory, and also possibly Papua New Guinea.
In 1986 the Producers, the venturers in the SA Unit, were supplying almost all the requirements of NSW, in accordance with the Letter of Agreement. Although they were also supplying all the requirements of South Australia, these two geographic markets were effectively partitioned with no possibility of substitution between them. The Bass Strait gas supplied all the requirements of Victoria; and once the contract to supply AGL was lost in 1971, there was no room for the Bass Strait producers to trade into NSW apart from the border trade at Albury.
In today’s natural gas market there are pipeline connections between NSW, South Australia and Queensland, although not much free gas (over and above contracted gas) to move between them. The State Governments have largely lifted their restrictions on interstate trade. The electricity connections between NSW, South Australia and Queensland mean that to some extent gas trading (as embodied in electricity) can occur via these interconnections. Although neither of the mooted pipeline connections between Victoria and NSW is yet in place, the evidence is that NSW enterprises are already reacting to the prospective entry. BHP has negotiated for gas sales with at least two NSW industrial customers and has entered into a 20-year contract to supply the Sithe co-generation plant at Smithfield, NSW (although the gas must currently be procured from AGL).
The content of the product markets has also been expanding. So far as the natural gas market is concerned, the main factor is the relationship with electricity which has become much more important. In today’s market, gas and electricity may be substitute fuels in industrial, commercial and domestic uses, and they are also complements in co-generation; either way, there may be pressure upon the price of gas. The COAG reforms in the electricity industry are already advanced. They envisage a National Grid, in conformity with which there are already links between States and Territories in south east Australia.
The content of the gas transmission market is also expanding. Gas may be transferred from one delivery point to another not just through a pipeline but also through more sophisticated mechanisms - the use of swaps, futures contracts, the development of a “secondary market”. At the present time these more sophisticated transfers of gas are just starting to be developed as the demand for gas increases and as the National Competition Policy encourages more contestants to enter the gas industry; there is an increasing “depth” in the gas market.
We conclude by indicating the relationship between the markets just defined and the market structures they contain. Just as markets are expanding so market structures are evolving. We observe a transition from monopoly to at least “contestability” in present-day markets and possibly to full workable or effective competition in the markets of the future. We make this distinction between “contestability” and competition, since current Australian usage requires for “contestability” no more than that a second competitor enters the market-place; and, as we have seen in a number of Australian industries, the presence of two competitors does not necessarily give rise to effective competition.
In 1986 it was appropriate for the Commission to state in its authorization determination that the relevant market was for natural gas in NSW. An uncomplicated supply chain existed, with a monopoly producer supplying a monopoly distributor by way of a monopoly pipeline. The commercial transactions were controlled by a long term contract that was sufficiently comprehensive to create a state of quasi-vertical integration, or as Santos once labelled it in a submission to the Commission, a “joint venture”. Within NSW there was no free gas.
In 1997 the natural gas market has expanded to incorporate a degree of substitutability with electricity. There is a marked expansion in the geographic scope of that market to encompass south east Australia. The numbers of contestants has increased. Access to transmission and reticulation services becomes a relevant consideration.
In the present-day market, we observe the play of conflicting forces. On the one hand there are the dramatic changes associated with the implementation of the National Competition Policy: the corporatization and privatization of gas utilities; the removal of State government imposed barriers to interstate trade; the vertical separation of production, transmission and distribution, met in part by ring-fencing arrangements; the implementation of third party access rules to transmission pipelines and to distribution and reticulation networks; and the unquestioned application of the Trade Practices Act to the conduct of all business entities within the gas industry.
As against this, there are forces that may limit the prospects for effective competition. There is much common ownership of leases for exploration and production in the gas fields. Ordinary commercial sense indicates that ring-fencing arrangements are quite compatible with an awareness of common interests. There are large economies of scale in the development of reserves and the building of pipelines that will restrict the numbers of viable enterprises. While new players can play a useful role in developing financial instruments and participating in secondary markets, the final outcome for consumers of gas will depend to a considerable extent on the extent to which competition develops between producers of gas, for it is they who control the initial supply, though competition downstream would certainly squeeze subsequent costs and margins.
It is against this background that we are required to assess the role of a particular long-term gas supply contract, the Letter of Agreement.
15. THE FIRST QUESTION:
HAS THERE BEEN A MATERIAL CHANGE OF CIRCUMSTANCES?
“Material change of circumstances” refers to circumstances that have an impact or likely impact upon public benefit and/or detriment. Hence we ask whether there has been such a change in the facts since 1986 as will likely impact on the benefit and detriment to the public resulting from the implementation of the Letter of Agreement.
In the present hearing the Tribunal has been supplied with very voluminous evidence relating to the circumstances both in 1986 and currently, as well as predictions as to the future. We have also been assisted by detailed evidence from three economists and by careful and detailed submissions by the ACCC, the Applicants and AGL.
We begin by setting out the relevant contentions of the ACCC, the Applicants and AGL. It is common ground among the parties that in 1986, and at the time when the original contract was entered into, substantial benefits flowed from the contract. All accept that the character of the investment required to develop the natural gas industry in NSW was such as to require a long-term contract that would bind the Producers and AGL.
The closing submission of the Applicants described the situation as it existed before 1976:
“Introduction of gas into New South Wales would only become possible:
· if the capital to build the pipeline was underwritten by a long-term gas supply contract;
· long-term gas supply could not be assured in the absence of large capital expenditure on exploration and development of the gas fields and on processing facilities which would not be undertaken in the absence of a long-term supply contract;
· field development and conversion to enable distribution in New South Wales would not be undertaken in the absence of assured long-term supply.”
The investments required by both the Producers and AGL were thus characterized by scale, longevity and specificity. In other words, the parties to the contract would have to commit to investments that would create large, long-lived, sunk assets (i.e. assets that are specialized with little alternative use). And this would be for a market that was yet to be created and where gas reserves and supply were uncertain. Thus the contract performed two functions:
· it created a mechanism for sharing and apportioning risks;
· it protected each side from opportunistic behaviour by the other.
As Dr King expressed the point in his written statement:
“In a major commercial venture, such as the development, transportation and sale of gas from a new gas field, each party to the transaction must undertake substantial sunk investments. These ... include the development expenses for the gas producer and the infrastructure and marketing costs for the gas wholesaler. A major role of a long term contract is to link the mutual interest of the producer and the wholesaler and avoid opportunism.....
Another role of the contract is to share the project risk between the contracting parties. An economically efficient contract will share the project risk between the contracting parties so that each party bears the risk that it is best able to influence and minimise.”
Hence the main benefit to the public in 1986 was to make possible the development of a natural gas industry in NSW that would contribute to the efficient functioning of the Australian economy. There was also, all agree, a benefit from cost savings associated with conducting arbitrations in Sydney rather than in South Australia.
The Tribunal accepts these two benefits to the public.
However, the parties differed as to:
· whether all the clauses of the contract were justified;
· whether there had been a change in the benefit since 1986;
· whether detriment was present in 1986 or the present time; or if there has been detriment, whether that detriment has increased or alternatively been “softened” by changing circumstances.
There was general agreement in the features of the contract that might cause concern - although the Applicants would say unnecessary concern. These features are:
· the length of the contract;
· clause 12: right of first refusal;
· clause 18: take or pay;
· clause 20: exclusive dealing.
To the extent that detriment is present the question would arise as to whether a less restrictive contract would deliver the same or sufficient benefit.
The Tribunal accepts that there are anti-competitive detriments associated with the contract. We defer detailed analysis to the following Section.
The closing submission of the ACCC affirmed the three material changes of circumstances identified in the 1996 determination revoking the authorization:
· “The deletion of clause 24 of the Letter of Agreement and substitution of a new provision
· AGL is no longer the sole actual and potential source of natural gas to both domestic and industrial consumers in New South Wales
· Since 1986 it has become less difficult for Gippsland Basin producers to compete in the supply of natural gas to distributors and industrial customers in New South Wales.”
It added eleven additional matters as constituting changes of circumstances. As noted earlier, we have already rejected the first of these points.
Counsel for the Applicants criticized the Commission’s approach, saying that it was a “miscellaneous catalogue approach” lacking any argument that would connect the matters listed to the creation of benefit or detriment. For our part we are content, in addressing this first question, simply to satisfy ourselves that there has been some material change of circumstances - sufficient to warrant our moving on to the second question regarding revocation which necessarily requires us to assess benefit and detriment in detail. We find no need to undertake detailed analysis of the Commission’s list.
The Applicants’ case was expressed in the alternative. It was first said that there had been no material change in circumstances. A key argument was put that has considerable force. This went to the essential character of a long-term contract such as this, that it embodies a continuation of benefit over the life of the contract. The benefit today, on this view, is the same as at the beginning. Further to this, if the contract had not come into existence, there would have been no supply of gas, and no creation of the natural gas industry in NSW in the first place.
The alternative position of the Applicants conceded that there may have been anti-competitive detriments created by the contract but that these had been ameliorated by two main developments: the large increase in the size of the market in which the contract is embedded, and the COAG reforms.
The position of AGL has changed. Counsel submitted that there has been a material change of circumstances since 1986, describing the change as “opening up the gas market to competition by the action of governments and the commercial responses to that process”. AGL’s final submission criticised three elements of the contract: its length, clause 12 and clause 20. That AGL should adopt a submission in these terms is itself indicative of a material change of circumstances.
This shift in AGL’s stance might be set down as follows. In the beginning, at least, there was the necessity for a long term contract that might be characterized as “integration by contract”. There was formed a vertical partnership between buyer and seller that contained, it must have been hoped, balanced terms directed to the maintenance of a long-term profitable relationship with division of the proceeds in an “equitable” manner. But now the common interest in the maintenance of the partnership on the original terms is breaking down (at least somewhat) as the parties seek to position themselves for changing market circumstances.
The Tribunal concludes that there has been a material change of circumstances. No detailed analysis is required to establish the point. At bottom, the Letter of Agreement now operates in a changed competitive environment. Earlier, we spoke in terms of an expanding market, an evolving market structure, and a transition to increased competition. The changed competitive environment stems largely from the COAG reforms, a very important and decisive change in Government policy for the whole federation. In addition there are the very substantial increases in demand that form the basis for current strategic decision-making. There is now, finally, greater knowledge of gas reserves and prospects for alternative supply and marketing. There can be no doubt that the gas markets have been “opened up”. As market opportunity and market vulnerability shift, so there must be an impact not only upon private benefit and detriment but also upon benefit and detriment to the public.
16. THE SECOND QUESTION:
SHOULD THE AUTHORIZATION BE REVOKED?
16.1 Preliminary considerations
16.1.1 The relevance of the South Australian Ratification Act
As part of its commitment to “free and fair trade in gas”, South Australia has brought forward and is currently undertaking a public review of the Ratification Act which involves consideration of the legislation in light of South Australia’s commitments under the COAG gas agreement. If the Act is repealed, any replacement exemption would have to be in accordance with the Competition Policy Reform Act 1995.
So long as the Ratification Act stands, the parties can continue to give effect to the Letter of Agreement. If the Tribunal were to revoke the authorization the parties would however need to have their arbitrations in South Australia. But the Ratification Act might be revoked or amended.
How then should we proceed? We consider it to be best, as a procedural device, to consider the case for not revoking the Letter of Agreement on the assumption that the Ratification Act is repealed. We thus consider the case for the maintenance of the authorization on the assumption that, from the parties’ viewpoint, it may be needed.
16.1.2 The status of the COAG gas agreement
We refer particularly to the COAG stance on prior gas contracts recorded in the 1994 agreement (see point number 9 which we previously noted) and to the underlying Report by a Working Group of Officials set up by the 1993 COAG meeting. Relevant passages are set out in Section 10.1 above.
The communique that emanated from the 1994 COAG meeting included the following:
“The Council noted that the contracts entered into prior to the enactment of any complementary gas industry legislation would, for the duration of those contracts, not be subject to that legislation.”
What are the implications for the Tribunal’s work? The communique and Report do not say that existing contracts are to be preserved - either as an expression of opinion or intention. What is said is that it would be inappropriate for governments unilaterally to void existing gas contracts, in other words for legislative revocation without examination. We take this to be consistent with this Tribunal considering whether authorization of the Letter of Agreement should be revoked, in light (amongst other considerations) of the COAG reforms.
Indeed the Tribunal’s concepts of benefit and detriment to the public on which it bases its decisions are apt to contain the appropriate analysis. Public benefit refers to (QCMA at 17,242):
“anything of value to the community generally, any contribution to the aims pursued by the society including as one of its principal elements (in the context of trade practices legislation) the achievement of the economic goals of efficiency and progress.”
The concept of public detriment has been given a similar wide ambit, viz:
“any impairment to the community generally, any harm or damage to the aims pursued by the society including as one of its principal elements the achievement of the goal of economic efficiency” (Re 7-Eleven Stores (1994) ATPR 41-357, at 42,683).
16.2 Assessment of benefit to the public
The assessment of future benefit (and detriment) to the public deriving from the relevant conduct was much debated in the hearing, both between counsel and between the expert economists. The debate arose notably because the revocation test, as enunciated by the Tribunal, requires assessment of the likely future, while the Letter of Agreement was designed to sustain investments in the past.
Counsel for the Applicants maintained that nevertheless there is a continuation of benefit over the life of the contract, and that the benefit today is the same as in the beginning.
The ACCC, on the other hand, wrote that “at all material times, the benefits have been “sunk” benefits. That is to say, it cannot be seriously suggested that gas will not continue to be supplied to New South Wales in the absence of continued authorization.” Dr King’s opinion supported this viewpoint. While affirming the utility of a long term contract in establishing the investment required for the gas industry, he wrote in his statement that “clause 18 of the Letter of Agreement has already ‘done its job’.” He said:
“when we’re analysing this contract we are meant to be forward looking, not backward looking. To say, ‘Ah, there’s a benefit in the future because of investments which are irreversible which were made in the past’ seems to me to be getting the argument somewhat wrong-headed. The argument should be: is there any benefit in the future from continuing this clause? The investments have already been made. I don’t think anybody is suggesting that if this authorisation is revoked we are going to see some people out there digging up gas mains around Sydney.”
As against this, the Applicants upheld the utility of certainty in contracts, particularly in the context of the development of resources. Professor Teece pointed to the “chilling effect” of revocation on investment, and said that the incentives for future development should form part of the “future with-and-without analysis”. He wrote in his statement that:
“(a) One of the essential principles of the economic literature on long-term contracting, paralleling a long-standing legal tradition, is that the provisions of the contract must be assessed ex ante, from the point at which the parties were contemplating entering into the contract.
(b) For this reason, when a contract extends over a substantial period, it is not consistent with sound economic principles to examine the contract anew at each point in time, demanding a ‘competitive’ justification for each provision at every instant. As in the previous example, the seller may accede to provision X to be performed now only because the buyer has acceded to provision Y which will be performed later. In such circumstances it should be sufficient to determine whether or not the contract was anti-competitive when the parties agreed to it.”
Counsel for AGL submitted that the certainty of contract may be subject to some limitations (as, indeed, was indicated by Professor Teece above). Counsel argued that “business cannot expect to be insulated from risk at the expense of consumer welfare when legislation has been introduced to secure that objective after the risk has been assessed”. Further, he pointed out, the Letter of Agreement has already been amended on several occasions, inviting the reflection that for a contract with such a long term it cannot be unexpected that circumstances will change, including government policy itself.
Also highly relevant is Dr Carpenter’s view that this is a decisive moment in the hoped for transition of the Australian gas industry. But “what the contract does is it continues to Balkanise the States”. Both Dr Carpenter and Dr King urged that the Tribunal should examine realistically the likely consequences of revocation or variation of the contract.
The Tribunal concludes:
1. A distinction can be drawn between those long term contracts that are necessary to sustain substantial, long-lived, sunk investments, as in this matter, and those long term contracts that create no such social utility but are, rather, an instrument of foreclosure.
Examples of the latter were the contracts that created the brewery “ties” in Tooth and Co Ltd; Application by Tooheys Ltd (1979) ATPR 40-113. Many of those contracts could certainly be characterized as “long term”: a significant number were for a period of over 50 years, yet no benefit to the public was found by the Tribunal.
In that matter, the contracts were the instrument of foreclosure and hence of anti-competitive detriment. However, in the present matter the contract is the instrument of benefit, at least to a significant extent, and its long-term character is intrinsic to the creation of benefit to the public.
2. We have no doubt that, speaking generally, there is social value in the preservation of contractual commitments, and that society proceeds on the basis that, in the broad, contractual commitments will be met. The institution of contract goes hand in hand with the institution of property rights which, in turn, gives rise to appropriate incentives for behaviour that will be both efficient and fair. It is part of the web of interconnectedness that characterizes society as a whole. Accordingly we reject the ACCC view that, on the future with-and-without approach, contractual commitments are “sunk” and can be disregarded.
3. We affirm, nevertheless, the appropriateness of the future with-and-without test. Choices today with respect to the use of resources relate to today and tomorrow, not yesterday. Our treatment of contractual commitments will affect the investment decisions of the future and the reliance that may be placed upon long-term commitments.
4. It was a long-term contract, the Letter of Agreement, that in the beginning made possible a project that has given rise to benefit to the public. This does not mean that all the detailed terms were necessary; or that there is not the possibility of some anti-competitive terms having been introduced. Hence, we have to examine whether a less restrictive contract would, in Dr King’s phrase, have “done the job”. If a less restrictive contract would suffice, both in respect of past obligations and future obligations, the consequent detriment must be subtracted from the benefit created. See Hatrick Chemicals Pty Ltd (1977) ATPR 40-044 and Broken Hill Pty Co Ltd v Koppers Pty Ltd (1981) ATPR 40-203.
5. It is consistent with our methodology to revisit the past and ask the rationale for the various provisions included at that time. A clause that now seems anti-competitive might in earlier times have contributed to the viability of the project. On the other hand, the rationale for a clause may have been anti-competitive at the beginning.
6. We do not rule out the possibility that circumstances may have changed so as to diminish the importance of certain contractual protections to the viability of the investments. There is evidence of less need, with current and future developments in the gas and transmission markets, for contractual protection against opportunism and risk. As regards opportunism, commercial alternatives have emerged for both the buyer and the seller, were either side not to fill its side of the bargain. As regards risk, there are the beginnings of developments in trade in financial instruments and future commitments that can offer some protection.
In summary
We conclude that substantial benefit to the public is continuing from this long term contract. In our view there is some evidence that the benefit has been lessened by the change in circumstances. We leave open, until we have considered the assessment of detriment to the public, the possibility that a less restrictive contract would have sufficed.
16.3 Assessment of detriment to the public
16.3.1 General Considerations
The preceding observations of the Tribunal regarding the function of long term contracts apply similarly to detriment, but need not be repeated.
The Applicants submitted that there is a “short and obvious answer” to all the claims regarding anti-competitive detriment. In Professor Teece’s words:
“The AGL contract with the Cooper Basin producers has just 10 years remaining. The combination of anticipated increases in demand and the near-term decline in deliveries under the AGL contract means that there is a large shortfall when current contractual commitments are compared with demand forecasts. Thus, a substantial marketing opportunity looms for producers and marketers.”
There is no doubt as to the factual underpinnings of the Applicants’ contention. The review of the evidence set out in Section 11 confirms a steadily rising base demand for gas in NSW, probably supplemented by large additional tranches of demand for power generation in due course. There is the same likelihood of a substantial increase in demand within the south east Australian natural gas market.
After considering the evidence regarding the timing of the cross-over in demand and contracted supply, the Tribunal is satisfied that the shortfall of ACQ below NSW demand will appear in the year 2000 or shortly thereafter.
On this basis, the Applicants concluded that, within this expanding market, there will be ample room for new sources of supply to enter, even with the Letter of Agreement being preserved in all its terms.
The ACCC contested this conclusion, relying upon the opinions of its two economists. In the Commission’s submission, the expansion in the gas market and its changing structure mean that clauses which, hitherto had only the theoretical potential to create barriers to entry, now become relevant as practical impediments. In 1986 and before, the Letter of Agreement was, in the Commission’s phrase, a “market filling contract”. But now there is the possibility for the emergence of multiple suppliers.
Dr King made the point:
“It is important to realise that with regard to this contract, there’s been a change in the structure of the market. There’s been a change in the ability for competition to grow, which now makes any potential anticompetitive effects of the clauses within the Letter of Agreement much more important, not less important. If there is no potential for entry and you have a clause in a contract that provides a barrier to entry, then the clause in the contract isn’t going to have any anticompetitive effect because competition cannot occur anyway. If you go through a COAG process that says we want to support competition in gas, then you have removed one barrier, possibly a legislative barrier or political barrier to entry. The contractual barrier to entry then assumes new importance. It now is a barrier to entry and now becomes anticompetitive compared to its previous status.”
Dr Carpenter, likewise, stressed the “need to create headroom” for new contestants so as to promote a process of transition that will be both timely and efficient. The institutional barriers to competition have been removed, he said, but rigid long-term contracts of the kind that are at issue in this case are a barrier to a transformation to a more liberalised gas market.
Both Dr Carpenter and Dr King envisage that if the contract were revoked, a less restrictive contract between the Producers and AGL would eventuate.
There is a further general consideration. Professor Teece said that the Letter of Agreement is “fundamentally a vertical contract. Vertical contracts are innocent of anticompetitive effects in almost all circumstances”. In the Tribunal’s view such a generalization may be defensible for wide and open markets, as they occur in the U.S., but cannot be applied generally in Australian conditions. For small markets, containing very few contestants (as in the present matter), and with large capital investments in relation to the size of the markets concerned, vertical agreements can have a market foreclosing effect.
16.3.2 Clause 18 : Take or pay
This clause is seen to be the core provision that underpinned the development of the project. The Tribunal accepts the necessity for a long-term contractual commitment by AGL to purchase gas, sufficient to generate future cash flows that would cover both financial commitments and a sufficient return to justify the initial investment.
As noted under the consideration of benefit, the evidence before us was to the effect that, with the expansion in the gas market and its changing structure, exposure both to risk and opportunism is somewhat diminished. This consideration has particular applicability to the take-or pay provision. Nevertheless some protection to future cash flows is required, though not necessarily in the form of a take-or-pay contract and, moreover, one with a relatively high take-or-pay requirement.
There are more economically efficient ways to assure cash flows, in particular the use of a two-part tariff, that is to say, a contract with a “standing”, “reservation” or “capacity” clause coupled with a per unit price for the quantity of gas purchased, to reflect the marginal cost of supply. This type of contract is beginning to be used in Australia for gas, electricity and transmission facilities. For example, the proposed tariff for the transmission of gas by the Interconnect, already published, uses such a two-part tariff.
Further, there was evidence that in the new regime there will be the possibility of trading in gas and transportation contract entitlements, including divisible segments thereof, provided the structure of the contract is such as to permit tradeability. For this to be the case, there would be a need, however, for the number of participants in the relevant markets to increase and for alternative transmission routes (in the extended sense) to be developed. The Letter of Agreement lacks a structure that will generate tradeable entitlements, a defect, however, that is not especially relevant in the present stage of development.
16.3.3 Clause 20 : Exclusive dealing
This provision relates to quantities between the take-or-pay levels and the ACQ, i.e. the last 20% of the ACQ in a particular year. The Applicants emphasize that there is here a mutual obligation. If AGL wishes more gas up to this level, it must purchase from the Producers. But the Producers, in turn , must be ready to supply, including any peak demands as specified by the provisions of the Letter of Agreement.
Counsel for AGL submitted that this clause is anti-competitive in the new regime that is evolving:
“The provision has the greatest potential to affect competition in the remaining years of the agreement, particularly the last five years, when ACQs could fall below AGL’s requirements. Its effect in those circumstances is not only to foreclose to a competitor the opportunity to meet any shortfall in AGL’s requirements, but also to diminish the prospect of a competing supplier finding it attractive to bid for AGL’s requirements after 2006, or for a period commencing before but extending beyond that year, because, while clause 20 stands, there can be no transitional period for such an alternative supplier building up to the quantity it might be prepared to supply after that date, so long as the Applicants are able to supply AGL’s requirements.”
The evidence from Mr Biggs of BHPP was that clauses 12 and 20 “are a major issue for BHPP in selling gas to AGL”. Mr Dixon of ESSO said that clauses 12 and 20:
“are not material to (Esso’s) plans to market natural gas in New South Wales overall, but may have an impact on its plans to supply natural gas to AGL .... (w)hile Esso does not consider the ... clauses to be a ‘deal breaker’, they are an impediment which needs to be addressed and overcome before Esso is able to supply natural gas to AGL.”
This was later qualified in cross-examination when it became apparent that he did not regard clause 12 as a significant impediment “at this time”.
It is apparent that the exclusive dealing clause is interdependent with the take-or-pay clause. If a two-part tariff had been used to protect cash flows, instead of the take-or-pay mechanism, the exclusive dealing clause would have no justification.
16.3.4 Clause 12: First right of refusal
This clause requires AGL to give the producers first right of refusal for any gas purchase requirement beyond those governed by clauses 18 and 20.
Earlier the Tribunal commented that the provision does not seem to be directly consequent on any overall commercial purpose of the Letter of Agreement. We have just quoted the view of Mr Biggs.
The clause has three obvious anti-competitive effects. First, it would compel AGL to disclose to the producers the details of offers from alternative suppliers. In the Australian context, this is a plain inhibition on alternative suppliers disclosing their hand.
Second, the clause will become relevant when the ACQs under the contract commence to decline. It was AGL’s submission that:
“AGL faces the need to supplement its purchases during the period from the end of 2001 when the contract quantities under the Letter of Agreement commence to decline, and to find an alternative source of supply from 2007. Even allowing for some reduction in AGL’s market share, the quantities involved are very substantial and it will be apparent to the Tribunal that the sort of lead times required to negotiate arrangements of this kind are also substantial. The clause has the effect of preventing AGL purchasing any gas for delivery before the end of 2006 from another source without offering the Applicants the chance to match it. ... Yet AGL needs to be in a position to provide security of supply to its customers for periods extending beyond 2006, as for example the Sithe Energies contract.”
Third, the evidence was that AGL will be required increasingly to seek alternative supplies from other sources, as the Producers’ capacity to supply declines. By possible design and current likelihood, the clause comes into play when the Producers are unable to supply. It follows that the Producers would gain information of use to them in their other gas and oil activities. Professor Teece maintained that such a clause improves market intelligence, especially price information, within the market as a whole and is thus pro-competitive. Perhaps this would be so in a wide and open market with a considerable number of participants. But this is not the case in our market today and is unlikely to be so even up to the end-date of the contract.
16.3.5 The term of the contract
In principle we would wish the length of the contract to be sufficient to cover both the amortization of fixed assets and the generation of protected revenues that would give some security for the highly risky business of developing gas reserves. The latter consideration is akin to the customarily accepted case for patent protection for risky inventive activity.
Yet the longer the term the more likely that external circumstances will change, so that it becomes increasingly attractive to cover risks through such devices as hedging and futures contracts, or perhaps not at all.
It was argued that a thirty year contract is over-long. There was some confidential evidence that may point in that direction, namely, the term of some of the new Queensland contracts. However, there must be a trade-off with other elements of such a contract, especially other provisions governing take-or-pay or capacity reservation. It may be that fifteen to twenty years could be ample, but the evidence was not sufficient to allow a conclusion.
16.3.6 Conclusion regarding detriment
We deferred drawing any conclusions regarding detriment when considering the specific terms of the Agreement, because the clauses are largely interdependent and need, moreover, to be related to the benefit which, it is claimed, they make possible. The Letter of Agreement needs to be read as a whole.
Approaching the assessment of detriment in this way, the Tribunal concludes:
1. A long-term contract between the parties was essential for the project to proceed and to generate the benefit we have identified. It is not possible to judge, on the evidence, whether the initial term of thirty years is excessive.
2. Clause 12 (first right of refusal) is quite independent of the other clauses. It generates no benefit and carries with it significant detriment.
3. Clauses 18 and 20 are interdependent. If clause 18 (take-or-pay) is used, clause 20 (exclusive dealing) is required to protect the revenues that justify the project. There are nowadays more economically efficient ways to cover the necessary future cash flows, in particular the use of a two-part tariff, yet we are conscious that take-or-pay clauses were conventional at the time of formation of the contract.
4. It is plain that, all things considered, a less restrictive contract would have sufficed, and would suffice today, to yield the benefit to the public.
5. The revocation question requires us to adopt a forward-looking approach - to consider the future with and without the contract. While it is proper to regard this contract as continuing from the past into the future, it is also proper to recognize that in today’s world, and the world of the future, the detriment that results from the contract has increased, for two reasons. First, the current and future need for protection against opportunism and risk has diminished. Second, the restrictions embedded in the contract now have greater practical significance as impediments to the transition to a more competitive marketplace.
6. Yet the contract has less than ten years to run and supplementary supplies to NSW will be needed probably inside three years. This consideration has considerable weight in light of the transaction costs that would arise were this contract to be revoked and a less restrictive contract to be negotiated in substitution.
7. In sum, the Tribunal finds that significant detriment to the public would result from a continuation of the Letter of Agreement to the end of its thirty year term.
16.4 The balance of benefit and detriment to the public
The Tribunal finds substantial benefit to the public from not revoking the Letter of Agreement. As against this, the Tribunal finds significant detriment.
Overall the Tribunal concludes that the future benefit to the public from not revoking the Letter of Agreement outweighs the future detriment.
17. CONCLUSION
The Tribunal has concluded that there has been a material change of circumstances since Authorization No A90424 was granted by the Commission in 1986, so that the Tribunal has been required to consider whether the authorization should be revoked.
In this second respect, the Tribunal has concluded that the determination of the Commission on 27 March 1996, revoking the Authorization and granting a further authorization in substitution, should be set aside. It follows that authorization No 90424 remains in effect.
The Tribunal having reached this last conclusion, the third question to be addressed in respect of the sequence required by the Act, the possible grant of a further authorization in substitution, does not arise.
The assessment by the Tribunal of the balance of benefit and detriment to the public likely to arise in the future, from revoking the authorization as against not revoking, underlies the Tribunal’s decision. Two aspects of our assessment warrant explicit mention.
First, the balance of benefit and detriment turns significantly on the public benefit, deriving from the original negotiation and implementation of the Letter of Agreement in its present form. This allowed certain natural gasfields in the Cooper Basin to be developed, and natural gas to be introduced and supplied to New South Wales for more than twenty years. The Tribunal has rejected the contention of the Commission that this benefit is in effect spent, or is “sunk” as the Commission has stated the point, so that it need no longer carry significant weight in the present balance of benefit and detriment. Rather, the Tribunal has concluded that the relevant benefit obtains for the life of the contract, although its weight has diminished in the changed environment of the present day and the prospective future.
Secondly, although the Tribunal accepts that certain provisions of the Letter of Agreement are anti-competitive in their effect, we have concluded that in some instances these provisions were so essential in their effect to the original conclusion and implementation of the Letter of Agreement, as to be intrinsic also to the achievement of the benefit that arises from its existence and implementation. This consideration warns against assessment of particular clauses in isolation from each other. It is important that benefit or detriment is determined by considering the Letter of Agreement as a whole. It is the sum of its parts, some of which in their effect are anti-competitive; but others have positive benefit.
Nevertheless, the Tribunal has found certain clauses in the Letter of Agreement to be troubling. In reaching our decision, we have been influenced by specific characteristics of the Letter of Agreement, the past and present circumstances of its operation, and the immediate and prospective competitive situation in the markets in which it will continue to have force, all of which are particular to this matter. However, in that long-term contractual arrangements covering production, sale and distribution are characteristic of many Australian industries, the Tribunal sees value in supplementing its specific decision in this matter with a few more general observations.
The first of these pertains to the terms for which a long-term contract may operate, without excessive detriment to the public interest arising. In respect of a major new development requiring the funding of significant capital expenditure, so that borrowings must be secured against the cash flow of the venture, the term of a contract that provides the necessary cash flow is properly related to the period within which borrowings are to be amortized. There may also be other commercial circumstances where the assurance of a lengthy contract term is required if the public benefit to be derived from a major development is to be realized. In such circumstances, as it appears to the Tribunal, a lengthy contract term does not necessarily represent a detriment, but rather may contribute to the achievement of a benefit.
However, in this matter, the Tribunal has noted provisions of the Letter of Agreement that could have extended its effect beyond the explicit date of termination. Provisions relating to the supply of “banked” gas in clause 18, could have effectively extended the term of the Agreement, although in the event they will not do so. In other circumstances, these provisions could have proved anti-competitive. Further, clause 12 of the Letter of Agreement, which gives first right of refusal to the Producers in the supply of gas to AGL additional to the annual contract quantities, has been a dead letter hitherto because demand did not exceed the annual contract quantities, but could (if it were applied rigorously) inhibit competition between alternative suppliers of gas to AGL for deliveries of gas subsequent to the term of the Letter of Agreement. In other circumstances, a provision of this character in a contract could well be adjudged highly anti-competitive.
The take-or-pay clause 18 of the Letter of Agreement, and the associated exclusive dealing clause 20, which precludes opportunistic behaviour by AGL, are together accepted by the Tribunal as sufficiently warranted, in that they have served to secure the cash flow required for the original financing of the relevant investments, and hence the benefit that flows from those investments. At the time that the Letter of Agreement was entered into, the use of the simple “take-or-pay” formula for the securing of cash flow was conventional and unexceptionable. However, in today’s more sophisticated financial environment, where preferable contractual devices that serve the same end are available and in common use, provisions such as are typified by clauses 18 and 20 in the Letter of Agreement might well be considered unacceptable.
The Tribunal determines that the Determination of the Australian Competition and Consumer Commission revoking Authorization No A90424 and granting a new authorization in substitution for the revoked authorization be set aside. It follows that the 1986 Authorization of the Commission remains in force.
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I certify that this and the preceding one hundred and fifteen (115) pages are a true copy of the Reasons for Decision herein of the Australian Competition Tribunal |
Associate:
Dated: 14 October 1997
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Counsel for the Applicants: |
Mr B C Oslington QC Mr S J Rushton |
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Solicitors for the Applicants: |
Freehill Hollingdale & Page |
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Counsel for the Australian Competition and Consumer Commission: |
Mr F M Douglas QC Mr C P Comans |
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Solicitor for the Australian Competition and Consumer Commission: |
Australian Goverment Solicitor |
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Counsel for AGL: |
Mr A I Tonking |
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Solicitors for AGL: |
Minter Ellison |
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Date of Hearing: |
17-21, 24-27 March, 2-4, 7, 8, 14, 15 April 1997 |
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Date of Decision: |
14 October 1997 |