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Japan's coming of age in the Asian LNG market

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If demand forecasts hold true, China will unseat Japan this year as the world’s largest importer of liquified natural gas. That shouldn’t divert attention from the fact that Japan will play a significant, if altered, role in the region’s LNG markets over the years to come.

One aspect of this role will be to provide stability. The country’s dependence on imported energy means that it can be counted on as a continuing source of demand for the foreseeable future. As a mature economy with an affluent population, this demand base is also much less likely to be adversely affected by price rises than demand from the emerging markets in Asia.

The restart of Japan’s nuclear fleet has been exerting downward pressure on Japan’s LNG import volumes, which peaked 2014. But the pace of the restarts has been gradual so far, and there are good reasons to think that it will continue to be so.

Another thing to bear in mind is that the liberalisation of the country’s gas market should help to make it a more flexible buyer. Market liberalisation was initiated in 2017, following on from a liberalisation initiative in the electricity sector. The removal of destination clauses from future supply agreements will also provide Japan with the latitude to import more LNG without fear of domestic oversupply.

Finally, Japan is becoming more outward looking in its ambitions for the LNG market. Liberalisation will help, promoting liquidity and developing the country’s role as a potential trading hub. So will investment by Japanese utilities in upstream projects in Australia, and supply agreements struck with a more diverse range of players, including the US and Mozambique.

Each of these factors will influence the demand profile of the Asian LNG market over the years to come.

Energy security

The central issue for Japan’s energy strategy, particularly in the wake of the Fukushima disaster, is one of security of supply. “[It] is a fundamental topic for Japan,” Ken Koyama, Managing Director and Chief Economist at the Institute of Energy Economics Japan, told KNect365 Energy. “We are more than 90% dependent on energy imports, mainly from the Middle East.”

Japan’s energy security worries have proved a mixed blessing for the LNG industry. On the one hand, a lack of available alternatives is the reason that Japan has historically provided such a large import market for LNG. On the other hand, such worries have in the past hampered the progress Japan needed to become a more flexible buyer. “Sometimes market reform, energy security and environmental protection have a kind of trade off relationship,” says Koyama.

Japan’s difficulty in meeting its energy needs is unfortunately reflected in the country’s inability to wean itself off coal, much to the chagrin of local environmental groups. While European economies like the UK are already marking months’ long records without coal-fired power generation, Japan will still generate 26% of its power from coal by the year 2030 – and that is if it can stay in line with its targets. There are presently 30 new coal-fired power states in planning or construction phases in Japan.

If Japan takes its commitment to reduce emissions seriously, raising natural gas’s share in the power generation mix would provide the swiftest pathway. But that can only happen if the LNG industry can solve the problem of high prices – a major challenge for a global market expected to tighten within the next half decade.

The success of the next round of liquefaction projects will be instrumental in deciding the pace of coal-to-gas switching in Japan, as in the rest of Asia. These projects will need to receive approval, gain financing, and be delivered on time and on budget to prevent the price spread between LNG and coal widening in the early to mid-2020’s.

Japan’s base level demand is, on the other hand, much better protected against rising prices than is the demand from the emerging Asian markets. “If the LNG price is going to top say $10 per mmbtu, I think that clearly the pace of demand growth for [emerging Asian economies] will slow down,” says Koyama. “Compared to this situation, with Japanese consumers the capacity to pay is higher… we will be able to buy LNG at the price of $10, $11 or $12 per mmbtu.”

One beneficiary of Japan’s energy security conundrum is set to be the United States. The need to maintain a diverse portfolio of suppliers will likely make Japan an increasingly significant export market for US LNG in the years to come.

Japanese buyers such as Tokyo Gas, JERA and Mitsui & Co have signed supply agreements with several US LNG projects under construction or vying for FID this year, including Freeport LNG, Cameron LNG, and Jordan Cove LNG. The Cove Point LNG project shipped its first cargo to Japan in April 2018 as part of a 20-year SPA with Tokyo Gas and the Sumitomo Corporation.

At present, the US’s largest export market for LNG is still Latin America, but more US LNG will make its way to Japan as new projects come online. Should trade tensions between the US and China persist, the US will also have to rely more on its other Asian buyers to make up the deficit. During H2 2018, the US shipped only six LNG cargoes to Chinese buyers, compared to twenty-five cargoes for H2 2017.

Nuclear restarts

The restart of Japan’s nuclear fleet has been much slower than most market observers anticipated. As of late last year, 9 out of a total fleet of 34 operable reactors had received approval from the Nuclear Regulation Authority (NRA), several of which have already come on-line. 20 of the 54 reactors generating electricity in Japan prior to 2011 have been permanently retired.

The government has “set an energy mix target for the year 2030 where nuclear is expected to account for 20 – 22% of total power generation in Japan that year,” says Koyama, adding that approximately 30 reactors would need to come on-line to meet that target. That target is still lower than the approximately 30% share of total power generation contributed by nuclear prior to 2011.

The slower than expected pace of retirements can be attributed to the NRA. Created after the Fukushima disaster to prevent a recurrence, the NRA implemented a much tougher safety standard on its formation.

“Based on the new safety standard the NRA are conducting very stringent safety reviews,” says Koyama. “Furthermore, even after the NRA gives the go ahead, the affected utility company needs to talk with local authorities, prefecture governments and city governments over the agreement of the restart.”

The result of this two-stage process is that there has been a degree of uncertainty about how soon new reactors will become operational. “No one knows at what pace, at what timing the next reactor will be restarted.” Koyama says. “Gradually the number of restarted reactors will increase, but I think that the pace will be very steady and will take some time.”

The real time horizon for Japanese LNG demand will be determined by the rise of renewables rather than the return of nuclear power, however. Although it is very early days for the industry in Japan, offshore wind alone has huge potential, with Linklaters estimating that the country’s 29,751km of coastline could provide as much as 1600 GW in wind energy. By comparison, the total capacity of the United States’ generation fleet in 2016 was 1074 GW. If Japan can tap this potential, it will finally be able to limit its dependence on imported energy sources.

Needless to say, growth of this kind is likely to be measured in decades rather than years. But there are questions to be asked about the role of LNG as renewables’ share in power generation increases. On the one hand, Koyama points out, gas-fired generation is “in some cases… a good match for the intermittent supply from renewables.”

On the other hand, the reduction in wholesale electricity prices that tends to result from the build-out of renewable power sources can “negatively affect the economics of gas fired generation,” says Koyama. “The way that renewable energy flows into the market will affect the appetite for natural gas in power generation.”

Market liberalisation

The nature of Japan’s role in the Asian LNG market of the 2020’s will to a significant extent depend upon the success of its liberalisation initiative. Energy market reform has been on the cards for Japan since the early 1990’s, but the kind of highly liquid, deregulated energy markets found in the US and Europe have been slower to emerge.

High oil prices in the first decade of the century kicked the energy security question up the agenda for Japanese policy makers. At least for the time being, market reform was pushed to the wayside. But the impact of the Fukushima disaster necessitated a rethink on how best to achieve a dependable energy supply at the lowest cost to consumers.

The first priority for the country’s policy makers was the electricity market. “Providing a stable electricity supply to the Japanese economy is a very important issue, and that’s why electricity became the centre of the debate,” says Koyama.

Accordingly, electricity market reform has gone ahead first, with liberalisation initiated in 2016, and unbundling of the power network expected to take place next year. The need to maintain balance between gas and electricity meant that the gas networks were not far behind. Liberalisation was initiated in 2017, with unbundling expected to take place in 2022.

Moving forward, market flexibility will be further assisted by a 2017 ruling from Japan’s anti-monopoly watchdog, intended to eliminate destination clauses in new supply agreements. Contrary to worries expressed by some suppliers at the time, the ruling did not force the renegotiation of existing SPAs. The shift to a more flexible model will instead come about slowly, as existing SPAs terminate.

These changes, assisted by the influx of US LNG, should in theory help to stimulate liquidity and bring down prices for Japanese consumers.

However, market reform will not be without its challenges. To a certain extent these will be a product of underlying physical fundamentals. Japan’s reliance on LNG means that gas still reaches consumers through several entirely unconnected networks, formed around individual receiving terminals rather than a single trunk line. This makes gas much more difficult to trade freely.

Liberalisation will actually make this particular problem more difficult to solve. “As we are now experiencing liberalisation of the gas and power networks, the market players need to survive through a very competitive environment.” Koyama says. “Under the circumstances the government cannot say that you should build a pipeline because everything should be based on the economics.” He predicts that further integration will come about through the natural expansion of the existing networks, rather than through an imposed integration initiative.

Looking outwards

As Japan takes a back seat on demand growth and moves through to the next decade, it will become an increasingly outward looking player. Diversifying its suppliers and investing in upstream projects overseas will be key if it is to maintain supply dependability in the face of growing competition from emerging markets.

Japanese utilities are altering their business models with respect to LNG, evolving from straightforward buyers into portfolio players with greater involvement along the supply chain. They are also learning how to monetise their experience in developing LNG and gas-fired power generation projects to provide engineering and advisory services overseas.

On January 14th, in a video address to GIIGNL members, Japan's Minister of Economy, Trade and Industry gave an indication of Japan's changing policy objectives. "The aim of LNG policy has been to secure LNG imports to Japan," he said. "But going forward, policy must also support development of LNG businesses by Japanese companies into rapidly growing third countries, and growth in the LNG market."

A prime example is Tokyo Gas. Late last year, Tokyo Gas signed a memorandum of understanding with RWE Supply & Trading, in which the two companies will aim to reduce costs in their respective LNG supply chains by cooperating to optimise their shipping usage. Tokyo Gas’s Engineering solutions division has taken a hand in LNG projects in Bangladesh, Thailand and Vietnam, to name just a few.

Another instance came in July last year, when JERA Co, also a Japanese utility, announced plans to form an “LNG optimisation and trading” joint venture with EDF’s trading division, EDF Trading Limited.

Partnering with European utilities and trading houses underscores a broader comparison between the two markets. Europe’s steady natural gas consumption and well-developed LNG terminal and storage infrastructure are analogous to Japan’s. This advantage, in addition to a liberalised market with flexible demand characteristics, has already allowed Europe to benefit from rising demand in the East by facilitating LNG reloads and acting as a price arbiter.

A proposed storage facility on the Japanese island of Kyushu, intended to allow the Russian LNG producer Novatek to cut the costs of shipping cargoes to consumers in China and South Korea, is the most recent example of how Japan could benefit from rising demand in the wider region.

Japan can follow Europe's example. First, however, it will need to ensure that doing so does not conflict with satisfying its base level demand, and that its energy market reform proves successful. These two imperatives will be the key challenges for the country’s gas industry in the years to come.

Ken Koyama will be speaking about Asian gas pricing trends at the Flame conference this May.

Can't afford to wait until May? Get the latest updates at LNGgc Asia next month.

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