Recent articles have asserted that Japan is over-contracting Australian LNG to profit from on-selling the volumes in other countries. As is often the case, this narrow analysis ignores a broader context. Neil Theobald dig deeper into Japan’s energy strategy as it relates to LNG, in the latest installment of The Energy Diary.
Japan, Korea and Taiwan. All economic miracles of the late 20th century. All are islands or quasi-islands in the case of South Korea. All are advanced industrial economies with few indigenous natural resources. This makes them vulnerable to disruption of their energy supplies.
This vulnerability became brutally apparent to Japan during the oil crises of the early 70s, when the bulk of oil imports were sourced from the Middle East. Since then, the priority of the Japanese government in energy matters is on security, which can only be achieved by diversification of supply. Japan accelerated the development of the emerging LNG industry, with supplies from Alaska, Brunei, Malaysia and Indonesia being secured in the 1970s to displace oil in power generation and improve air quality. Since then, LNG has been a critical part of the fuel mix in Japan, Korea and Taiwan and the industry has developed globally to connect natural gas markets where pipelines do not exist. This allows LNG to be diverted quickly to markets that suffer supply shocks, such as Europe during the Ukraine crisis.
Energy security was again front and centre in Japanese policymaking after the East Japan earthquake in 2011 and subsequent Fukushima nuclear incident, which led to the shutdown of all nuclear generation. A major uncertainty was the pace and extent of the return of nuclear power and the only realistic substitute was LNG. Reliance on LNG increased and a policy agenda was adopted to develop international LNG supply chains, especially in the Asian region, with the objective of facilitating a deeper and more liquid LNG market which would be more resilient to supply shocks and give more options to users in times of crisis.
At that time, economic development in Southeast Asia and the decline of local natural gas supplies meant that the region was poised to become a major importer of energy. The Japanese government supported Japanese companies developing LNG demand and all aspects of the energy supply chain as part of this overall energy security strategy. It expanded the role of the Japan Oil, Gas and Metals National Corporation (JOGMEC) to facilitate these developments and invest where necessary, making this a national effort.
To do this, Japanese importers needed to commit to long-term LNG contracts, even though their own projections of demand were uncertain and there was the potential for periods of decline. To help balance this, efforts were made to make contract terms more flexible around issues such as destination, allowing for a more agile response to changes in demand.
The commitments made by Japanese importers are critical to LNG suppliers as they underpin investments of tens of billions of dollars in production facilities and without them projects would not move forward. The projects often make domestic sales viable, contributing to Australia’s energy security. LNG contracts for the projects can last more than 20 years and contain “take or pay” provisions which require the buyer to take a certain volume each year, regardless of their own demand, or pay for the energy anyway.
This structure transfers risk from the project developer in Australia to the buyer in Japan and it is only prudent that those buyers seek to offset this risk by having other outlets for the volumes if their demand is not high enough at a particular point in time.
From the Australian perspective, these large projects – which sustain jobs and significant community investment and government revenue – now have guaranteed offtake at agreed pricing terms. The LNG market is unique in having a number of different pricing mechanisms for long-term and spot cargoes and at any time one will be higher than the other. Sometimes the spot market is higher, and it is possible that buyers could make a profit on volumes they on-sell. Rather than this being profiteering on Australian LNG, it is a natural outcome of the buyers taking on the price risk – when the spot market is lower, they could be exposed to a corresponding loss for on-sales.
This on-selling of LNG is also not restricted to the Japanese companies, with many producers and pure traders now operating on this portfolio basis and sending cargoes to the most efficient locations. This mirrors how other energy markets such as oil developed, reducing overall cost to the consumer.
Japanese energy strategy has always focused on security first. The development of deeper and more flexible LNG supply chains in Asia is a critical part of that strategy and will also support regional decarbonisation.
As other countries in Asia seek gas to displace coal and back up intermittent renewable generation, it will be important to have LNG supply available that is flexible to demand fluctuations.
Japan’s on-selling provides this, helping ensure Australian LNG contributes to reducing emissions around the region.
Neil Theobald has more than 40 years’ experience in the oil and gas industry, including 17 years at Chevron, where he was Vice President, Global LNG, Gas Supply & Trading. He has been a Senior Advisor to the Asia Natural Gas & Energy Association [ANGEA] since 2021.
ANGEA works with works governments, industries and communities in Asia, providing affordable solutions that promote energy security, economic growth and decarbonisation.
