Australian Institute of Petroleum executive director Jim Starkey said the tax deal required Australian refineries to meet tougher European fuel standards.

Under new rules expected to pass Parliament this month, diesel sulphur content would be cut to 50 parts per million by 2006 from a current industry average of about 1,300 ppm.

Petrol sulphur content levels were expected to fall to 150 ppm from current levels around 200-250 ppm.

"It is not going to be easy for the companies. If all eight refineries were to invest to be able to produce Euro 4 fuels, then the investment requirement would be of the order of A$1 billion," Starkey said.

"What's very likely is that we will see over the next little while some further attempts to rationalise the refining business. That may resultin some closures. It may produce mergers."

The conservative coalition government agreed to tougher fuel standards to win support for a tax reform package from the left-leaning minority Australian Democrats who hold the key to the legislation passing the upper house Senate.

Caltex Australia Ltd government affairs manager Frank Topham said the industry had already been working on cleaner fuel standards.

"The government's agreement with the Democrats on cleaner fuels has radically accelerated the agenda and the big issue is can the refining industry afford it," he said.

He said that the industry would need to restructure to be able to meet the additional investment costs.

"You would not invest in these fuel quality levels in all of Australia's refineries. The government has to look very closely at ways in which it can facilitate the restructuring."

The move to hasten investment in cleaner fuel comes as the Australian industry is already under pressure from low margins and competition from the Asianrefineries.

A proposed refining merger between Mobil Oil Australia Ltd, a unit of Mobil Corp, and the local unit of the Royal Dutch/Shell Group was proposed last year.

But the plan was ditched amid concerns that the Australian Competition and Consumer Commission would block the deal.

BP Australia Ltd, a unit of BP Amoco Plc, and Caltex Australia later also dropped plans for a merger.

Starkey said it was possible the oil companies would again seek government and regulatory approval for mergers.

"Given these policy pronouncements, it is in the national interest that refining companies be in a position to produce the Euro 4 diesel," he said. "In that sense a different view of the merger proposals might be worthwhile."

Australia's eight refineries produce around 8,00,000 BPD, with diesel fuel representing about 25 to 30 per cent of the output.

Analysts noted the ability of Australian refineries to rapidly meet the stricter standards varied widely.

BP Australia, which is already upgrading its80,000 BPD Bulwer Island refinery to produce diesel with a sulphur contest of 50 ppm by the end of next year, welcomed the new targets.

"BP Amoco has committed to manufacture cleaner fuels at its two Australian refineries in a relatively short time frame," regional director Greg Bourne said.

"I am delighted that our initiatives have been recognised and there are now moves to accelerate this process across the whole industry."