Queensland LNG royalty challenge upheld

Australia Pacific LNG Pty Ltd v The Treasurer [2019] QSC 124 

Whatever difficulties it has caused for domestic gas consumers, the Queensland LNG export boom has produced a significant new source of royalty revenue for the Queensland government.  The recent Australia Pacific decision resulted from a protracted and heavily contested dispute over the basis for calculation of those royalties: Australia Pacific LNG Pty Ltd v The Treasurer [2019] QSC 124..

Under the Queensland petroleum and gas legislation, a petroleum producer is liable to pay royalty at 10% of the wellhead value of petroleum.  The regulations empowered the Minister to “state a method or formula” to be used in working out particular components of the wellhead value.

Australia Pacific LNG (AP LNG) applied to the Minister to state a method to determine a component of the wellhead value of processed coal seam gas (CSG) at the first point of disposal:  at the exit of the CSG processing plant prior to liquefication.  The value to be worked out was the amount that the gas could reasonably be expected to realise if it were sold on a commercial basis:  this was a counterfactual assessment because, in reality, the first disposal was a non-arm’s length related-company transfer.

AP LNG’s application, which was supported by an expert report of Ernst & Young, argued for the use of a “residual price” method.  The Office of State Revenue (OSR) commissioned a responding report of Lonergan Edwards (Lonergan), before preparing its own draft report which supported the use of a “netback” method.  The OSR provided those reports to AP LNG.  AP LNG then commissioned a further six responding reports, which it submitted together with a detailed covering submission.  The OSR then obtained two further reports from Lonergan, which informed the OSR’s final report to the Minister.  The OSR did not give AP LNG an opportunity to make submissions in relation to the second and third Lonergan reports.

The Minister made a decision setting out a formula for a “netback” valuation of the feedstock gas.  AP LNG, being dissatisfied with the Minister’s decision, then commenced a judicial review proceeding in the Queensland Supreme Court.

Bond J upheld some, but not all, of AP LNG’s grounds of judicial review, and ordered that the decision be set aside and referred back for reconsideration by the Minister.  The finer details of the Court’s review will likely be consigned to historical interest only, given the Queensland government’s recently announced review of its LNG royalty regime.  However, the decision in AP LNG is instructive as to the circumstances in which other economic regulatory decisions – such as electricity and gas network revenue determinations or access determinations – may be susceptible to challenge by way of judicial review, after the demise of limited merits review.

Challenges to the substance of the determination

The grounds to challenge the substance of an administrative decision through judicial review are narrow:  available grounds include that the decision was based on an error of law, or that the decision was so unreasonable as to be outside the scope of the decision-maker’s jurisdiction.

In Australia Pacific, the Court rejected arguments that the Minister had misapplied the statutory test in deciding to apply a netback valuation method.  Bond J acknowledged that the regulations gave the Minister a wide latitude in deriving an appropriate method or formula:  so long as the decision was one that the Minister could reasonably make, arguments of economic theory in favour of one method or other would not suffice to make out an error of law.  Similarly, Bond J rejected arguments that the Minister’s determination was legally unreasonable:  particularly in the context of economic regulation, establishing legal unreasonableness requires more than emphatic disagreement between experts.

However, Bond J did uphold a challenge to the Minister’s decision on the ground of uncertainty.  The regulations implicitly required the Minister to specify the input variables in a manner that did not leave those inputs open to subjective or discretionary assessment by the Minister, because that would defeat the whole purpose of the royalty decision mechanism.  In particular, inputs as to the expected economic life of downstream assets, and as to the allocation of capex and opex between domestic and export LNG sales, were not specified with a sufficient degree of certainty.

One important consequence of the limited basis on which Bond J upheld the challenge to the Minister’s determination was that the Minister is not necessarily precluded from again determining that a “netback” method is the appropriate valuation methodology, provided that the reassessment is done in a procedurally fair manner and results in a sufficiently certain valuation formula.

Procedural challenges:  prohibited considerations and procedural fairness

Bond J upheld two grounds of judicial review that attacked the process by which the Minister reached his decision.

The more interesting of these grounds was an argument that, in formulating its recommendation to the Minister, the OSR took account of the better fiscal return to the State from applying the “netback” method – notwithstanding that, as the decision material revealed, the OSR was aware that this was an inappropriate consideration to take into account.  Bond J held that the OSR’s impermissible consideration of the revenue impact could be attributed to the Minister, and thus required that the determination be set aside.

In addition, Bond J held that AP LNG was denied procedural fairness in that the OSR did not give it an opportunity to make submissions in relation to the second and third Lonergan reports.  It is notable that, unlike the regime for the making of network revenue determinations by the Australian Energy Regulator, there was no detailed procedural framework prescribed for the making of the Queensland royalty determination.  In the absence of a clear procedural framework that is designed to afford procedural fairness to stakeholders, it becomes important for a decision-maker not to cut corners in a way that may expose its decision to review.

The relatively unstructured procedural and substantive framework for the making of Queensland royalty decisions may have made this decision fertile ground for challenge by way of judicial review.  The successful challenge in Australia Pacific might not be so readily transposed to other significant decisions in the economic regulation of electricity and gas.

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