A $7 billion program to create an Australian military-grade satellite communications system has been cancelled, with the prime minister insisting the government is busy "prioritising" all defence purchases.

Eighteen months ago, US defence giant Lockheed Martin was selected to deliver a hardened network of three to five satellites to provide high-level protection against cyber and electronic warfare attacks in what would have been Australia's largest-ever defence space contract.

The project — known as JP9102 — was expected to include locally controlled and operated geostationary communications satellites, as well as multiple ground stations, but on Monday the Department of Defence confirmed it no longer met "strategic priorities".

"With the acceleration in space technologies and evolving threats in space since the project's commencement, defence has assessed that a single orbit GEO-based satellite communications system would not meet strategic priorities," the statement read.

"As such, defence has decided to cease its current procurement activity with Lockheed Martin Australia for a single orbit GEO-based satellite communications system."

Lockheed Martin Australia beat rival bids from Airbus, Northrop Grumman and Optus to be named as the preferred tenderer but contracts for the work have not been signed.

Ahead of the announcement, Prime Minister Anthony Albanese told ABC radio that Labor would "make decisions based upon advice and in the national interest".

"We're busy prioritising all of our purchases when it comes to defence assets, we've got a considerable increase in our defence budget and we'll make sure all of the decisions that we make are in our national interest," he said.

"We are not only seeing advances with the AUKUS arrangements being on track and on time and on budget, we're seeing our capabilities increased with increased asset purchases, we are also very much interested in this being part of our 'future made in Australia' agenda."

Shadow Defence Minister Andrew Hastie blasted the decision to scrap JP9102 as disgraceful, but some industry figures privately suggested that the government is right to explore other cheaper and more viable options.

"It appears that the program has been cancelled because Labor has not funded it in the defence budget," Mr Hastie said.

"This is a disgraceful decision by the Albanese government, made only 18 months after it was announced to proceed.

"The cancellation of this project devastates our capabilities in strategic overwatch and our ability to coordinate our future defence force," he added in a written statement.

A defence source with knowledge of the current deliberations told the ABC that as projects were being reviewed, the department had to make cuts totalling billions, rather than "salami slicing various projects already under contract".

Defence industry figures believe there are cheaper options available which would involve putting Australian space assets on existing satellites operated by United States companies.

But defence analyst Malcolm Davis, from the Australian Strategic Policy Institute, described cancelling JP9102 as a "staggeringly stupid" move that risked undermining the country's credibility.

"Without comms, you are not in the fight — Australia can't have a sovereign defence force without sovereign satellite communications," he said.

"And the defence industry can't invest in Australia if the government is a flaky customer."

In a statement, Lockheed Martin said it would continue to support the Commonwealth to meet its strategic needs and was proud to be partnering with the Australian Defence Force on many other programs.

"We are committed to preserving our sovereign workforce with impacted staff being redeployed across other existing and emerging programs where possible," the spokesperson said.

Last year Defence Minister Richard Marles declared the government was "confident about our ongoing presence in space" after the ABC revealed hundreds of Chinese satellites were deployed above Australia to monitor military exercises.

That same year, Labor also scrapped a Morrison government program to develop new Australian satellites to gather data on natural disasters, agriculture and marine surveillance as part of budget savings.