Iran has become the biggest source country. Asylum seekers from Iran last year accounted for one in seven arrivals. This year, they make up one in three.
Indonesia announced Thursday it will stop issuing visas on arrival to Iranians in a bid to stem the flow to Australia.
Rudd said his government would negotiate with other neighbors in a bid to restrict visa access from other source countries. Afghanistan, Sri Lanka, Pakistan, Vietnam, Iraq, Bangladesh and Myanmar are the next largest sources of asylum seekers arriving on Australian shores.
O'Neill set no limit on how many asylum seekers his country was prepared to accept.
"It is not going to be easy, but of course Papua New Guinea is blessed with a large land mass and a very small population so there is enough assistance that we can give to the Australian government," O'Neill said.
Australia is PNG's former colonial master and is now its largest source of foreign aid. In return for accepting the refugees, Rudd said Australia will redevelop a hospital in PNG's second largest city and reform the country's university sector.
The new policy echoes that of a previous Australian government that in 2001 also pledged that asylum seekers who arrived by boat would never be accepted by Australia. That policy all but stopped the asylum seeker traffic.
Some refugees spent years in an Australian-run detention camp on the tiny Pacific atoll of Nauru before Australia eventually resettled them because no other country would.
A protest by 150 asylum seekers on Nauru turned violent Friday with several demonstrators and their guards injured, Australia's Immigration Department said in a statement.
The department said the unrest was unrelated to the new policy, which was announced later.
Associated Press writer Niniek Karmini in Jakarta contributed to this report.