Fallout of Fukushima: an energy giant awakens

Fallout of Fukushima: an energy giant awakens

By Rudolf ten Hoedt

The disaster in Fukushima will probably not lead to the end of nuclear power in Japan after all. With the victory of Shinzo Abe's Liberal-Democratic Party in the elections on 16 December, the prospect of a German-type Energiewende have faded. Nevertheless, Fukushima will prove to be a turning point in Japan's energy history: old monopolistic structures are being broken up, new players are entering the market, the renewable energy market is growing, Japanese companies are increasingly active in gas production around the world and Japan may even become a gas trading hub for East-Asia. EER correspondent Rudolf ten Hoedt reports from Tokyo.

Shinzo Abe, leader of the Liberal-Democratic Party (c) Tibet Sun

Almost two years after the dramatic meltdown of three nuclear reactors at Fukushima, and nine months after the decision to temporarily shut down all 50 commercial nuclear reactors in Japan, the future of Japanese energy supply is still very much up in the air. For a major country like Japan, a remarkable situation – to put it mildly.

Market watchers agree that Japanese energy policy is in a state of confusion. Bureaucrats and utilities have lost their formerly tight grip on the market. "There is chaos in energy policy both at the institutional and at the political level", says energy policy professor Andrew DeWit of the Rikkyo University in Tokyo. "After Fukushima we got a proliferation of institutions that are responsible for all kinds of regulations. Energy policymaking, which used to be a very technocratic process, is now much more open."

Strictly speaking, there still is a (pre-Fukushima) plan in place to lift Japan's nuclear capability from 30% to 50% of the nation's power output by 2030. But nobody in Japan believes this will happen. The question is, what is the alternative? The government has set up a national Advisory Committee for Natural Resources and Energy which is in charge of redrawing Japan's energy map, but it is deeply divided. It is looking at three scenarios with a nuclear share of 25%, 15% and 0%. After months of sometimes emotional deliberations, it has not been able to come up with a unanimous advice yet.

A few months ago, in September, some sense of direction seemed to emerge, as then Prime Minister Yoshihiko Noda announced the intention of making the country nuclear-free by 2040. It was a gesture meant to placate the shocked Japanese population and the many opponents of nuclear power. But in the end it went nowhere. Industry and the big energy companies called the policy irresponsible. And in the general elections of 16 December Noda and his Democratic Party of Japan suffered a huge defeat.

The incoming Liberal-Democratic Party (LDP), led by Shinzo Abe, is much closer to the big utilities and the nuclear industry than their predecessors. Abe places much higher priority on security of energy supply. As Japan cannot link up with power grids outside its borders and produces very little energy of its own (it is 93% import-dependent), nuclear energy inevitably comes back into the picture. The prospect of a German-style, nuclear-free, renewables-based Energiewende, which a few months ago seemed to be on the horizon, has quickly faded again.

Big concern

The LDP has proposed a three-year transition period during which it will test the safety of each of the 48 idled reactors (2 have already been restarted) and decide which ones can be put into operation again. But this plan will require some careful managing. The previous cabinet put responsibility for the nuclear power sector in the hands of a new regulator, the Nuclear Regulatory Agency (NRA), which operates at much more distance from the nuclear lobby than the previous one. At this moment it is investigating whether the existing nuclear power plants are located over active fault lines. For one, it is considering closing down the Tsuruga II reactor in the western part of the country. This would probably lead to the bankruptcy of Japan Atomic Power Company, one of the smaller power producers in Japan, with three plants and annual sales of €1.75 billion. It is 85% owned by six of Japan's ten major utilities.

The incumbent utilities have been put heavily on the defensive by the nuclear crisis. They each have a regional monopoly and are highly dependent on nuclear power.

"There is chaos in energy policy both at the institutional and at the political level"

Tepco, the largest utility and owner of Fukushima, has been nationalised and is kept alive by the government and Japanese banks. Most utilities are operating at a loss. Their costs have risen but they cannot raise their tariffs. At the same time, observers point out that they do have plenty of scope to cut back costs. The management is paid high salaries and the employees have lucrative pay packages.

The utilities claim that Japan cannot do without nuclear power, and they may have a point. "Without nuclear energy our country will face serious problems", says Ken Koyama, managing director and senior economist of the Institute for Energy Economics Japan (IEEJ) in Tokyo. IEEJ, a member of the Advisory Committee for Natural Resources and Energy, is in favour of a nuclear share of 25% in 2030. Koyama: "After Fukushima we have managed to avoid blackouts through a sharp increase in the imports of fossil fuels. This is costing the Japanese economy dearly and the financial situation of the utilities has deteriorated very significantly in the past two years. Without a restart of nuclear power plants in fiscal 2012, they will reach a very critical situation. That would create a big concern for the overall energy security in Japan."

Shaken up

Nevertheless, even though Fukushima may not lead to the end of nuclear power in Japan, it is still likely to prove a turning point in Japanese energy history. The temporary shutdown of all nuclear generating capacity has created a great momentum for change. With the meltdown of the three reactors at Fukushima, the frozen Japanese energy market has melted as well. The reputation of the sheltered incumbents has been damaged heavily. The old boys network, in wich utilities, producers and suppliers were able to thrive, while keeping (foreign) competitors at bay, is being broken down.

Thus, the Japanese government is using the nationalisation of Tepco to rationalise the operations of this power house. In a joint document, Tepco and the Nuclear Damage Liability Facilitation Fund set up by the Japanese State, declare: "A drastic reform of procurement procedure such as international procurement or having advice outside the company will be performed, not by the closed custom of procurement from the affiliated companies, so called 'family companies', nor companies having continuous contract, to reduce cost even more and improve transparency in business."

But the consequences of Fukushima are not limited to Tepco. The entire energy Japanese industry is being shaken up. The old monopolies are under attack. The utilities do not have the wherewithal anymore to keep out new entrants. Tokyo Gas, the one but largest LNG importer of Japan at 12 million tons annually, has started to compete with Tepco in the production of gas-fired power. New legislation supporting competition has also prompted Tokyo Gas to become active in gas-fired co-generation for large buildings and industries. Cement and steel manufacturers are stepping up their on-site power production, which is already good for 15% of total power production in Japan. Paper manufacturer Oji Paper is now the largest in-house generator of renewable energy in the world.

"The Japanese power market is shrinking and the governing power utilities will do everything they can to protect their income streams"

Renewable energy is for the first time being taken seriously in Japan. In July feed-in tariffs for renewable energy sources were announced that offer investors in solar and wind parks long-term guarantees. In the past few months one after the other megaproject in renewable energy was announced, mostly by new and foreign players who so far have never had a chance on the Japanese energy market.

The utilities have also announced that they will roll out 70 million smart meters to better manage demand. They have little choice as they are faced with acute capacity shortages, says Toru Hattori, senior research economist of the Central Research Institute of the Electric Power Industry (CRIEPE).

DeWit, however, warns against too much too optimism. "Watch out, it is all about the grid that remains in the hands of the old powers. Utilities still have the legal mechanisms to make it difficult for new suppliers to enter the market with their generation capacity. Even in the ostensibly deregulated market for big users, the utilities have been able to create powerful disincentives to prevent the rise of new players. Actually, only 2% of the Japanese power market is deregulated. And this is not a growing market like China or India. The Japanese power market is shrinking and the governing power utilities will do everything they can to protect their income streams."

Steep prices

Fukushima is also having a major impact on the LNG market. The Japanese utilities have replaced the 26% loss of their generating capacity for about 80% by turning to the unused capacity of their gas-fired power stations. Before March 2011 the utilization rate of the gas-fired power stations was about 50%. Now they are all operating at full capacity. At this moment some 45% of Japanese electricity supply is based on gas, which is supplied to Japan in the form of LNG. According to a July 2012 report from the Japanese Institute of Energy Economics (IEEJ), the import of LNG grew from 70 mta (million tonnes per annum) in 2010 to 83 mta (113 billion cubic meters or bcm) in 2011. (To compare: natural gas consumption in the UK, the highest in Europe, was 80 bcm in 2011.)

Most of the growth in LNG imports was supplied by Qatar, which was able to compensate in this way for the expected demand from the US which did not materialise. Nigeria was the second largest supplier to Japan. West Africa in general is growing in importance as LNG source for Asia, especially now that demand in Southern Europe has declined as a result of the economic crisis. News agency Nikkei reports that Japan in the first nine months of 2012 imported 7.6 million tons (more than 10 bcm) of LNG from African nations like Nigeria and Equatorial Guinee, 140% more than the year before.

June 2012: Qatargas 1 signs long-term agreement with Tokyo Electric Power Company (c) Qatargas

"Most of the additional LNG was bought at steep prices on the spot market", says Akira Ishii, gas adviser of the Japan Oil, Gas and Metals Corporation (JOGMEC). The price Japan is currently paying for LNG is the highest in the world. It is the result of the expensive combination of the urgency of Japanese demand and the connection to a basket of crude grades, the Japan crude cocktail or JCC. The average price for Japan this year is $18 per mmbtu (million British thermal units) compared to $10-12 for other Asian countries and Europe, and more than 5 times as high as the Henry Hub spot market price of $3.50 in the US. In 2011 prices in Japan averaged $14.73 and in 2010 $10.91, according to the BP Statistical Review of World Energy.

The high prices Japanese utility and gas companies are faced with, have had another consequence as well: they have started on a search for direct upstream access to gas and LNG sources. "They are trying to skip Shell and the Japanese trading houses", says Akira Ishii.

The Japanese trading houses Mitsubishi, Mitsui and Sojitz have long been the main LNG importers. Indeed, they are giants in LNG trading. Japan has been importing LNG since the end of the 1960s and is the largest importer in the world. The trading houses or sogo sosha have for years worked closely together with Shell, which is the biggest LNG supplier to Japan, before Chevron and Total. Long before Fukushima, they became active in upstream gas production, often as minority partners of Shell, for example in Sakhalin and in Australia. But now, with the growing demand for LNG, they are putting much more effort into this type of vertical integration. For example, earlier this year Mitsubishi for the first time acquired a controlling interest in an upstream gas project, in Indonesia.

And for the first time the sogo sosha are seeing Japanese competitors entering the upstream game. Thus for example Chubo Electric Power, which supplies power to Japan's industrial heartland Nagoya, has invested heavily in Canadian shale gas in British Columbia. Tokyo Gas has also become active in Canadian shale gas. Tepco, the power supplier of Tokyo, has entered Australian gas production. And Japanese oil company Inpex recently acquired a 70% interest in Australian gas project Ichthys, the first ever gas production project with a Japanese operator. Ichthys will supply Japan with the equivalent of 7% of the country's LNG demand.

Discount

Market watchers European Energy Review talked to project LNG imports in 2013 to rise further and peak somewhere at around 88-90 mta. LNG's share in power generation may decrease from 45% now to 35% or even 30%, depending on how many nuclear plants will come back into operation. According to Akira Ishii, roughly half of this decrease will be compensated by the increasing use of LNG in co-generation of electricity for commercial buildings and housing complexes. He expects the volume of LNG imports in the near future to consolidate around 83 mta, i.e. at a 20% higher level than before Fukushima.

At the current prices, however, such import volumes are unsustainable, say market experts. When prices will decline and by how much is uncertain, says IEEJ's senior economist Ken Koyama, but what is certain is that they have to come down. "If not, security of supply in terms of volume and pricing would become critical."

The Japanese have recently urged Qatar to lower its prices, but to no avail.

"They are trying to skip Shell and the Japanese trading houses"

A representative of Chevron said in December in the Wall Street Journal that LNG prices cannot be linked to US Henry Hub prices, as this would make most LNG projects unprofitable. Still, there are signs that the market may turn. Japanese utility Kansai Electric recently announced a deal with BP Singapore for 500,000 tons per year for 15 years at Henry Hub-benchmarked prices, a discount of about $6 on current Japanese LNG prices.

Akira Ishii expects utilities to opt for cheaper coal in combination with renewables if LNG prices stay high for another three or four years. "Therefore, Japan needs a solid mid and long term LNG procurement strategy that results in lower prices", he says.

Snapped up

One place where Japan will no doubt look is the US. The US government is considering whether to allow LNG exports. It will probably allow limited exports to countries with which the US has a free-trade agreement. Japan, curiously enough, is not one of those, but the US government will probably make an exception for Japan, out of strategic considerations. If the US allows exports of 30 mta, which some experts say is likely, then this will probably all be snapped up by Japan. The Japanese can outbid all competitors and still save money compared to what they are paying now. But Koyama notes that new US supplies will affect the overall supply-demand balance on the Asian market, and will also have an effect on prices paid by other Asian countries.

Russia is another potential strategic supplier for Japan. President Putin has said that a major new gas export outlet from East Asia is top priority for Russia, to diminish its dependence on the stagnant European market. The Russians want to build an LNG train in Vladivostok to supply the Japanese with new gas from East Siberia. Gazprom is already supplying Japan with LNG from Sakhalin II, in which Shell, Mitsui and another Japanese company, Diamond Gas, have minority interests. At the same time, a consortium of Japanese companies, including Tokyo Gas, is investigating the commercial viability of a subsea pipeline from ExxonMobil's Sakhalin I to Japan.

A group of Japanese gas buyers, suppliers and the government are also looking into the possibility of establishing an LNG futures market in Japan. That would require a large, competitive and highly liquid market, which Japan might be able to offer. But there are competitors. Singapore would be a logical spot for an LNG futures market, in view of all the gas from the Middle East passing through the Strait of Malacca. Singapore also imports LNG from Indonesia and has constructed two tanks and importing facilities. It wants to expand these facilities for re-export. "So is makes sense for Singapore to add an LNG exchange in the near future to the already existing oil exchange", says Akira Ishii. Other possibilities are Thailand and Shanghai. China is one of the few countries in Asia that have diverse supplies of gas both from LNG facilities (in Shanghai) and from pipelines, including one from Turkmenistan. But China does not have an open and flexible market.

Japan's trump card is that it is the leading LNG consumer of the world. Akira Ishii: "If exports from Canada and the US to East Asia will reach a big volume and the plans for the development of Vladivostok as an East-Asian outlet for Russian gas would materialise, Japan would not be a bad location for an LNG futures market, with LNG cargos coming in from Sakhalin, from Alaska and the US, from East and South Australia and the Middle East. That could turn Japan into a centre in the international gas trade."