Understanding Australia’s minimum stockholding obligation and its role in addressing the nation’s fuel security challenge

What is the minimum stockholding obligation (MSO)?

The MSO was introduced under the Fuel Security Act 2021 (Cth) (the FS Act) and the Fuel Security (Minimum Stockholding Obligation) Rules 2022 (Cth) (the MSO Rules), which commenced operation on 1 July 2023. In short, the MSO requires importers and refiners¹ of liquid transport fuels to “hold” a designated quantity of fuels in storage in Australia.

The MSO seeks to address the national and economic security risks of Australia’s heavy dependence on imported fuels. With Australian oil and condensate reserves depleting and the successive closures of most Australian refineries over the past 20 years (only two refineries now remain in operation), approximately 90% of Australia’s refined fuel demand is now met by imports of refined products and crude oil/other refinery feedstocks. Significant interruptions to fuel supplies due to external factors for an extended period would have serious economic and societal impacts. The MSO is intended to bolster Australia’s resilience against such risks.

The MSO applies in relation to each major liquid fuel type used for road or air transport purposes: petrol (across all grades in aggregate), diesel and jet fuel. The required volume is calculated as the average daily volume of the particular fuel type imported by an entity during a prior 12-month reporting period multiplied by a “target number of days” which has been prescribed by ministerial declaration² for each fuel type.

For each fuel type, the target number of days has been initially set at the 2018 and 2019 calendar year (pre-Covid) average level of “consumption cover days” (i.e. the number of days that stocks would last at average levels of demand if no further supplies were made). In the case of diesel, the target number of days will increase to 140% of that number of consumption cover days from 1 July 2024. The more onerous stockholding requirement for diesel reflects:

• The importance of diesel to the Australian economy given its critical role in sectors such as mining, agriculture and transport and in delivering essential services such as electricity generation in remote areas. Diesel use in Australia is projected to grow over the coming years. In contrast, use of petrol is expected to shrink as the take up of electric vehicles increases, and
• That the overall level of consumption cover days has been lower for diesel than for other MSO fuels.

• Importers must report their holdings to the Commonwealth Department of Climate Change, Energy, the Environment and Water (the DCCEEW) on each “obligation day” (currently, every second Tuesday). The reporting regime under the Petroleum and Other Fuels Reporting Act 2017 (Cth) (the POFR Act) has been extended to require reporting against the MSO
• There are detailed provisions about what counts as being “stored in Australia”. Most notably, fuel in transit on road or rail tankers or stored at retail fuel stations is excluded. However, fuel stored on ships in an Australian port, moored waiting to enter an Australian port or travelling directly between Australian ports, in addition to fuel stored at terminals or inland storage depots, can be counted
• An importer is treated as the “holder” of stocks stored in Australia (and therefore entitled to count them towards meeting its MSO) if, broadly:
  • It owns the stocks and they are not the subject of any arrangement described below which results in another person being the holder of the stocks (s22 of the FS Act), or
  • Another entity owns the stocks and a legally enforceable written arrangement is in effect between the owner and the importer under which:
    • the importer has a right to take possession of the stocks (s23 of the FS Act and s11 of the MSO Rules), or
    • the stocks are held, reserved or quarantined (however described) by the owner for the importer for a specified period (s24 of the FS Act and s12 of the MSO Rules) and the importer reports those stocks under the POFR Act.

What have been the key impacts of the MSO so far?

Although the MSO is helping to reduce Australia’s vulnerability to fuel supply disruptions, it is also imposing a new and substantial financial burden on the liquid fuels sector. A number of companies have implemented capital works programs to increase their land-based storage capacity. This is counter to concerted efforts of the fuel majors in recent years to optimise their product distribution by selling off their networks of inland fuel depots and moving to a near “just in time” model where fuel orders are picked-up (or delivered) directly from import terminals and refineries to retail fuel outlets and commercial customer sites.

Increasing diesel storage has been a particular focus since the introduction of the MSO due to the higher MSO target number of days requirement and relatively low levels of existing storage. In recognition of this, the Commonwealth government’s Boosting Australia’s Diesel Storage Program provided matching grants totalling $227 million for eight additional storage capacity projects completed by 30 June 2024. However, this still leaves the industry needing to fund substantial storage infrastructure development.

The financial impacts are not restricted to building new storage facilities. The MSO has also meant that importers are carrying additional fuel inventories on their balance sheets – a significant increase to their working capital burden.

From the perspective of wholesalers, distributors, independent retailers and end-users, there are concerns that amid an inflationary environment, the MSO is:

• creating further upwards pricing pressure as compliance costs are passed on by fuel suppliers to their customers, and
• producing uneven and distortive pricing effects, depending on the costs to particular suppliers of complying with the MSO and the location of supply. Industry feedback provided to government on the draft MSO Rules prior to their implementation indicated that the impact of the MSO would vary significantly between the fuel majors, and this appears to have been borne out by experience.

What are the further changes to the MSO coming into effect on 1 July 2024 and beyond?

The MSO has been implemented progressively in recognition of the time needed for the industry to ready for full compliance.

The key changes taking effect on 1 July 2024 are:

• the target number of days of average daily import volumes which must be held by importers will increase from 24 to 27 days for petrol and jet fuel, and from 20 to 32 days for diesel, and
• the frequency of reporting of fuel stock holdings (i.e. “obligation days”) will change from fortnightly to weekly.

For the 12 month periods ending 30 June 2024 and 30 June 2025, importers have been able to apply to the DCCEEW to reduce their MSO volume commitments by up to 25% if the DCCEEW is satisfied (among other things) that an importer has taken all reasonable steps since 1 July 2023 to prepare for meeting the MSO. This transitional arrangement is ending. For periods commencing on or after 1 July 2025, applications to reduce MSO volumes will only be considered by the DCCEEW on more limited grounds, such as:

• tank maintenance, repairs to infrastructure or significant shipping disruptions beyond an importer’s reasonable control, or
• loss of a contract with a major customer which reduces the amount of the relevant MSO fuel that an importer needs to import for the remainder of the period by 20% of its expected import volume (or 100 ML, if less).

What further industry developments are expected as a result of the MSO?

Although fuel importers will do what it takes to achieve compliance with the MSO, many will be reticent about committing significant capital to expanding their storage capacity, particularly in the face of uncertainties about the timing, extent and nature of impacts of the energy transition on demand for traditional carbon-based fuels.

On the one hand, the move to cleaner transport fuels (such as hydrogen-based fuels, sustainable aviation fuel and other biofuels) and increasing take up of electric vehicles will see demand for certain liquid fuels reduce over time.

On the other, there may be sporadic and unpredictable spikes in demand, particularly for diesel, depending on how smoothly the energy transition proceeds. For example, the Australian Energy Market Operator’s latest gas market outlook³ forecasts a structural gas supply gap in Australia’s southern states from 2028 due to depleting Bass Strait gas reserves that will require greater supply to resolve than is currently committed or anticipated, which may necessitate use of diesel as a back-up power generation source. This will potentially require significantly larger volumes of diesel imports until renewable electricity generation sources reach sufficient scale to satisfy market demand.

Although the FS Act and the MSO Rules embed flexibility for the DCCEEW to temporarily reduce or suspend MSO requirements to respond to market developments, there is no certainty about how those powers will be exercised in future periods of market disruption. The fuel security concern will remain a very real one for policymakers for the foreseeable future, so it can be expected that such powers will only be exercised reluctantly and in a manner that remains aligned to the MSO’s objective.

Bearing those considerations in mind, we expect that importers will increasingly look for more flexible means to meet their MSO commitments.

Here are some specific responses and market developments we anticipate seeing as a result of the MSO:

• Fuel companies reviewing their terms of supply to branded retailers and commercial customers to ensure that they can pass through costs of MSO compliance, and potentially including specific terms entitling them to pass through MSO-related supply costs on contract renewals and in new business contracts
• Fuel companies seeking to include terms in contracts with large customers whose businesses routinely hold substantial fuel volumes in tank storage enabling them to count those stocks towards their MSO using the contractual mechanism permitted under s24 of the FS Act
• Continued expansion of storage facilities by fuel importers who seek to achieve MSO compliance independently through holding their own storage capacity
• Increased prominence of specialist developers and operators of storage facilities at sites adjacent or proximate to import terminals which lease storage capacity to importers an attractive alternative for some importers to committing capital expenditure to build their own storage)
• Possible re-emergence of inland fuel storage networks at strategic locations near to large fuel owners and users (e.g. around key mining, transport and industrial centres)
• Potential involvement of infrastructure funds (whose role to date in development of Australian downstream fuels infrastructure has been limited) as a source of capital to fund the development of storage infrastructure facilities
• Optimisation of shipping delivery schedules to align with obligation days on which importers are required to report fuel volumes in order to manage import/stock levels, especially as the interval between obligation days reduces to one week (note that the FS Act permits importers to hold less than the required volume of stocks outside obligation days)
• Fuel companies moving lower margin spot customers to term contracts or terminating spot contracts due to the MSO cost implications of keeping stocks on hand
• Potential development of an intermediary market to support compliance with the MSO (relying on arrangements under s23 and s24 of the FS Act described above)
• Importers and refiners looking to take advantage of their capacity to absorb/minimise MSO-related cost increases as a competitive differentiator to increase sales and support network expansions
• Continued ACCC monitoring of fuel price boards to ensure that the MSO is not being used as a smokescreen for unjustified price increases, particularly given industry concerns about the uneven impact of the MSO across fuel suppliers and locations.

In addition, the MSO is likely to create greater impetus for the development of cleaner transport fuels from renewable and sustainable sources, which have the potential to become gamechangers over the longer term in meeting Australia’s fuel security challenge.

For further information regarding the MSO and its impact, please contact:

Julian Traill, Partner, Brisbane
julian.traill@nortonrosefulbright.com
+61 7 3414 2718