Japan’s LNG dilemma and energy supply challenges

Japan's LNG imports 2012-2013
Japan's LNG imports 2012-2013

Energy supply security has always been a major concern for Japanese governments. The decision to close all its nuclear power plants following the 2011 Fukushima nuclear accident has imposed huge costs on Japan's economy. Now the government plans to restart its nuclear generation, using more coal-fired power plants, creating a gas-to-gas and a spot-LNG market, as well as expanding renewables, in an attempt to reduce its import-dependency on LNG.

Japan was the world’s largest LNG importer even before the Fukushima nuclear catastrophe in 2011. Its nuclear phase-out after Fukushima resulted in increasing costly-LNG imports. This increased its unstable energy import dependencies and related supply insecurities. Japan’s government approved its new, but unpopular, energy policy in April 2014 by reinstating its nuclear power capacity as an ‘important base-load power source’ as core national policy. It has tried to reassure the public that the overall direction towards less reliance on nuclear power generation has not changed, but prospects are mixed. The government is looking to establish a gas-to-gas market, more flexible long-term gas contracts and reduce an over-dependence on costly LNG imports.

JAPAN’S government approved its new, but unpopular, energy policy in April 2014 by reinstating nuclear power as an ‘important base-load power source’. It is a core national policy.

But it has tried to reassure the public that the overall direction towards less reliance on nuclear power generation has not changed. It is unclear how many of the existing 48 idle nuclear reactors will really be able to restart operations given the high costs of further upgrades to meet new safety guidelines, local opposition and seismic risks.

The share of nuclear power fell from 30 per cent of Japan’s power supply before the Fukushima nuclear catastrophe in 2011 to just three per cent of electricity generation by 2012. Japan had an annual import capacity of around 250 bcm to a natural gas demand of 123 bcm even before the Fukushima disaster.

From the perspective of most of Japanese energy experts in governments, ministries, industries, and academia, the importance of nuclear power in Japan’s energy mix has never been really questioned

Japan was the world’s largest importer of LNG with about 33 per cent of the global market before 2011. It has limited and declining proven natural gas reserves of 738 billion cubic feet (bcf) as of January 2012. Natural gas comprised 27 per cent of its total power supply while coal accounts for 43 per cent.

Energy triangle

Energy supply security has always been a major security concern for Japanese governments before and after the Second World War. Historic concerns about securing access to raw materials, including oil, drove Japan into the war.

Japan was the third-largest economy in the world, its fourth largest energy consumer, the third largest oil consumer and importer, the second largest coal importer and the world’s largest LNG importer before the Fukushima nuclear catastrophe. Its poor availability of domestic energy resources determined Japan’s domestic energy policies and drove its foreign energy policies.

The expansion of nuclear power since the 1973 -1974 oil crisis was the result of Japan’s heavy oil and LNG dependence on the Middle East, which took up to 90 per cent of its imports.

From the perspective of most of Japanese energy experts in governments, ministries, industries, and academia, the importance of nuclear power in Japan’s energy mix has never been really questioned. This is because it serves all three objectives of the energy triangle - energy supply security (reduction of unstable energy imports), environmental/climate targets (like the one of the Kyoto protocol) and the economic competitiveness of its entire industry.

Japan can never, in their view, realistically hope to come close to the Kyoto agreement targets and decrease its high dependence on politically unstable fossil fuel imports without nuclear power.

Risk levels

Japan, with its limited fossil fuel resources, was only 16 per cent energy self-sufficient at the beginning of 2011. It had one of the highest energy security risk indexes of developed countries, before the Fukushima nuclear catastrophe, despite one of, or even the best, energy efficiency standards in the world.

Its average risk score in 2010 was about a third higher than the OECD average over the last 30 years, according to an International Index of Energy Security Risk analysis of 2013 which is conducted annually by the Institute for 21st Century Energy and the US Chamber of Commerce. It even had the second highest average risk score between 1980 – 2010 with no available significant domestic fossil fuel resources at all.

But thanks to its nuclear power programme and its efforts to enhance energy efficiency, its risk level in 2010 was lower compared with 1980.

Japan was the third largest consumer and importer of oil after the US and China even before the Fukushima disaster. It consumed 4.5 million barrels per day (b/d) and imported 4.3 b/d. Eighty-seven per cent of Japanese crude oil imports are supplied by the politically unstable Middle East, with Saudi Arabia being the largest source of imports.

Japan stored 589 million barrels against supply disruptions at the end of 2011 and has decreased its oil dependence by almost 20 per cent since 2000.

Renewable sources

The government’s objective, as part of its 2006 energy security strategy, was to further decrease oil consumption and import 40 per cent of Japan’s total crude oil imports from Japanese-owned concessions belonging to the state-run Japan Oil, Gas and Metals National Corporation (JOGMEC) by 2030 compared with 19 per cent in 2012.

Japan was forced to import 30,000 b/d in 2011 and another estimated 80,000 b/d in 2012 because of the impact of Fukushima and the need to compensate for the loss of almost all nuclear power. The cost of imported fossil fuels rose from one per cent of Japan’s GDP in 1998 to almost five per cent just months after Fukushima.

Renewable energy sources are still seen as a mid and long-term solution. The Japanese government has encouraged its energy companies to increase their involvement in oil and gas projects from 20 per cent to 40 per cent over the next 20 years.

The loss of the capabilities of Japan’s nuclear reactors has to be replaced primarily by much higher unstable fossil fuel imports in the forthcoming years, as long as renewables cannot guarantee a base-load supply and offer a viable alternative to nuclear energy.

Japan’s oil supply situation became even more challenging when Japan was forced to decrease imports from Iran because of Teheran’s unwillingness to cooperate with the International Atomic Energy Agency (IAEA) regarding its perceived nuclear weapons ambitions and US-led international sanctions. This complicated further its decades-long attempt to diversify its crude oil imports.

The loss of the capabilities of Japan’s nuclear reactors has to be replaced primarily by much higher unstable fossil fuel imports in the forthcoming years, as long as renewables cannot guarantee a base-load supply and offer a viable alternative to nuclear energy

Record deficit

Coal was not used initially as the primary substitute for the loss of the nuclear power supply and even experienced a decline in consumption in 2011. Japan’s LNG imports rose by 12 per cent in 2012 to 3.8 trillion cubic feet (tcf) or 87 mt (in comparison with 78.5 mt in 2011 and 70 mt in 2010), with a much better diversification than in its oil import portfolio. From 2010 to 2012, its LNG imports grew by 24 per cent and in 2013, Japan’s LNG imports continued to grow, but at a slower pace.

LNG import prices rose by 38 per cent in 2011 compared with 2010 and between 2010 and 2012, the total value of Japan’s LNG costs surged from 3.5 trillion yen (US$42 billion) to 6.5 trillion yen (US$78 billion). Japanese Trade Minister Yukio Edano warned in 2012 that Japan was experiencing an ‘outflow of national wealth’. If most of Japan’s nuclear reactors were not restarted, Japan’s LNG consumption could double by 2030.

Malaysia (19 per cent), Australia (18 per cent) and Qatar (15 per cent) have been the biggest exporters of LNG to Japan. In 2012, 34 per cent of all Japanese LNG imports were shipped through the unstable Strait of Hormuz.

Japan has coped with the dual challenge of a 30 per cent rise in LNG imports and gas import dependency along with increasing LNG prices. This has been against a background of huge public debt of approximately 200 per cent of its GDP and rising electricity prices undermining economic competitiveness. Increased imports of LNG resulted in a record trade deficit of US$72 billion in 2012.

Funding investment

The LNG-import demand was expected to rise further until the end of 2013, to almost 90 mt. But if nuclear reactors were restarted in 2014, the LNG import demand could be reduced by 5 mt per year in a best-case scenario as it would be a costly import option and a comparatively expensive source of fuel for power generation.

In addition to its more proactive foreign energy policies to secure and diversify its oil and LNG imports, Japan has also become more interested in the US shale gas revolution and the option of importing stable and less expensive LNG supplies from America. It was the only country importing US LNG since 2010, when it received about 30 bncf via the Kenai terminal on the Alaskan coast.

The Japanese government offered the US project-financing and loan guarantees for its planned LNG-export terminals in February 2012, as well as credit guarantees to fund investment by Japanese companies in US shale gas projects.

Mitsui and Mitsubishi, for instance, are developing and building Sempra Energy’s US$6 billion Cameron LNG-liquefaction plant in Louisiana in order to diversify Japan’s LNG imports. Japan has also shown interest in importing LNG from Canada.

At the same time, Japanese utilities have become increasingly reluctant to commit themselves to any new oil-indexed LNG supplies. Japan has shown interest in the European gas market price developments by giving up the oil-indexed gas price, which has been a feature of the LNG industry for decades.

Strong competition

Japan has become the primary factor driving the spot-LNG market in Asia because of its LNG demand growth. But Japan needs to renegotiate the terms of its existing LNG contracts away from its oil-indexed JCC basis or it will be unable to change the price formation basis of its LNG imports.

Tokyo hopes to import 10 per cent of Japan’s total LNG imports on the basis of Henry Hub prices from the US from 2015. But it faces strong competition in the US and other gas markets from other Asian countries, as Asia’s LNG demand is expected to account for 61 per cent of global LNG-growth until 2030. Japan has even threatened to quit its costly LNG import contracts with Qatar.

Japan’s LNG supplies from the Middle East rose by 28.6 per cent between April 2012 and April 2013, despite the increased emphasis on energy supply security and a diversification of supply sources and imports. Currently, only 10 per cent of Japan’s LNG imports come from Africa, with Nigeria accounting for more than half of them.

Russia is another potential strategic supplier as Moscow seeks to diminish its dependence on the stagnating or even decreasing European gas market. Russia’s high gas prices and political uncertainty are hindering Japan in creating a comprehensive gas partnership with Russia, although it started to import LNG from Russia’s Sakhalin 2 plant from 2009.

At the same time, however, gas is facing tough competition from much cheaper coal as a base-load fuel for power generation. Whereas the average LNG import price in Japan was US$16.6 mmBtu, the average price for thermal coal was US$4.7 mmBtu. Japan’s coal demand has increased since 2012 and grew by up to 20 per cent by 2013 compared with a year earlier.

Unsustainable development

Japan will remain the world’s second largest importer of coal and used this as the primary base-load fuel in 2013 as it actively promoted the expansion of renewables in its national energy mix.

Japan’s largest utility, TEPCO, has now announced plans to build an alliance of Japanese LNG buyers to jointly source and buy 35-40 mt a year in order to reduce costs by up to US$6.2 billion a year.

This is another indicator that Japan’s rising LNG import dependence and the long-term oil-indexed LNG prices need addressing by the Japanese government and industry to establish a gas-to-gas and spot-LNG market with trading gas hubs, more flexible and long-term gas contracts and a reduced over-dependence on expensive LNG imports.

Japan’s growing dependence on increasing its expensive LNG imports and its heavily increased subsidies to expand renewable energy have complicated Prime Minister Shinzo Abe’s plans to revive its long-foundering economy. These problems can be seen in the Abe-government’s decision to close the environmental assessment process for new coal-fired power plants as its power sector struggles with surging energy bills because of rising oil prices, increased LNG imports and rising gas prices.

Japan’s growing dependence on increasing its expensive LNG imports and its heavily increased subsidies to expand renewable energy have complicated Prime Minister Shinzo Abe’s plans to revive its long-foundering economy

Japan’s energy sector recorded US$13 billion in annual pre-tax losses in 2012 because of rising imports and fossil fuel prices. Economically, such a development is unsustainable even in the short-term. This suggests restarting at least some of Japan’s undamaged nuclear reactors with the introduction of new safety standards which could make the mid and longer-term prospects for its nuclear sector still rather mixed.

But if a significant nuclear capacity was revived along with greater use of coal-fired power plants and an expansion in renewables, it could significantly reduce Japan’s LNG import dependency in the forthcoming years. This could have larger impacts on the global LNG market by creating some overcapacity before 2018 and may ultimately reduce worldwide LNG prices. Taking these assumptions into account, Japan’s LNG demand may have peaked in 2013 and could decline in the next few years.

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