Japan's struggle to bring down LNG prices

November 11, 2013 | 00:00

More competition and liquidity should do the trick

Japan’s struggle to bring down LNG prices

Japan, still the world’s biggest LNG importing country, is on the hunt for lower LNG prices. Finally, you may say. Along with some other Asian nations, Japan pays a hefty premium for its supplies. LNG procurement costs on the spot market can be five times the Henry Hub price for natural gas and with a ticket of around $16/mBtu, Japan and other Asian countries are also paying far more for LNG than Europe.

Chinese want Shanghai as gas hub for domestic supplies (c) Nicholas Poon
In September, the second LNG Producer-Consumer Conference in the Shinagawa business district along Tokyo Bay attracted a record number of one thousand experts from all over the world. In front of this audience, the Japanese minister of Economy, Trade and Industry issued a heartfelt complaint about the current situation. “Avoiding high LNG costs and securing a stable supply of more reasonably priced LNG are a priority to us”, HE Toshimitsu Motegi declared.

As a result of a record LNG import volume, Japan registered a serious trade deficit in 2012 for the first time in 31 years. It started to buy up to twenty percent of its LNG consumption on the expensive spot market, after the shameful meltdown of its nuclear energy sector in 2011. Japanese utilities and gas companies still secure the bulk of their supplies through long- term contracts with big foreign oil companies and powerful Japanese and other trading houses. These long-term contracts are financially depressing as well. The prices are oil-linked. Because of rising domestic energy bills, the competitive force of companies in Japan is suffering.

Some say that Japan only has itself to blame. It lacks competition and pipelines. Partly as a result of laborious relations with neighbouring countries, partly as a consequence of the conservative business model of its energy sector. Japan has an uncompetitive energy market, dominated by an oligopoly of local monopolies who until recently were allowed to pass higher gas prices to final consumers and thus lacked incentives to look for lower procurement costs.

In this regard, Jonathan Stern, Chairman of the Natural Gas Research Program at the Oxford Institute of Energy Studies, did not withhold harsh criticism of the Japanese during his latest mission to Japan in March this year. “I’ve been visiting Japan for thirty years to exchange opinions and so on. During this period, Japan’s electric and gas utilities have been strongly resistant to the idea of a gas grid. It would have been possible to import pipeline gas from Russia, but nobody wanted to do it. This lack of pipelines is not some kind of natural phenomenon: it is the result of a choice made by Japan.”

So what will the Japanese do about it? Teaming up with and learning from the European Union that has done a lot to increase competition among its suppliers and has gas coming through tankers and pipelines is one strategy. At this point, some Japanese stakeholders in Tokyo smartly drew EER’s attention to the fact that European companies are currently re-exporting redundant LNG supplies to Asia and thus benefit from the Asian premium on LNG as well. But these stakeholders should bear in mind that the Europeans can do this thanks to a liberalized and far more flexible energy market that the Japanese have in part denied themselves.

Things are, however, changing rapidly. Japan’s government seems to embrace the notion that more competition is the best way to bring Japan’s excessive LNG prices down. Since the Great East Earthquake and the painful nuclear disaster at Fukushima, the government is opening up the domestic power market. Utilities are no longer allowed to pass higher procurement costs and market inefficiencies on to the consumer without a hitch. The hefty losses utilities are suffering are undeniable proof, with the biggest local monopoly TEPCO almost bankrupt and under state control.

Japan is manoeuvring towards a position where it can try to benefit from the wave of LNG that is expected to roll into Asia when the US starts to export its shale gas and a large number of new projects will be completed in Canada, Australia and East Africa. New players are allowed on the domestic energy markets. Together with Japanese utilities, these new faces are diversifying supply, trying to get on the US shale gas train and seeking ways to separate Japanese LNG prices from crude oil market prices.

In September last year, Kansai Electric marked a major milestone when it signed a deal with BP Singapore for the yearly import of LNG from South America at Henry Hub linked prices, thirty percent cheaper than oil-linked LNG from the Middle East. In January this year, Japanese utility Chubu Electric announced it struck a deal with ENI to procure LNG from East Africa and elsewhere against ‘competitive prices’. Chubu and other Japanese companies such as trading houses Mitsui and Mitsubishi have also secured deals in North America that are linked to Henry Hub prices. The volumes involved are still low as a percentage of total imports, but it looks like Japan has reached a turning point.

A novel way to do the job would be the introduction of an LNG futures contract on the Tokyo Commodities Exchange and possibly elsewhere in Asia. This idea is being fuelled by the growing global demand and supply of LNG that will probably add liquidity to the LNG spot market. According to the Institute of Energy Economics Japan (IEEJ), “the supply-demand balance of (global) LNG is likely to ease considerably towards 2020, even if demand grows.”

A big chunk of additional demand will fall in Asia. According to the latest Energy Outlook of the Asian Development Bank,

“In the near future there is no possibility for prices to come down. The LNG spot market will be relatively tight in the next five years. And there is no interest in the market.”
Japan, China, Korea, Singapore and Thailand will increasingly depend on LNG imports in order to cover the 3.9 percent annual growth of gas demand in the region. China is building LNG import terminals fast and is expected to surpass Japan as the biggest LNG importer in 2020. The Chinese are aiming to launch Shanghai as a future gas hub for domestic supplies. Simultaneously, Singapore is securing its place as a regional LNG hub. The city-state is taking advantage of its strategic geographic location and a growing LNG demand in South East Asia. The region is expected to import 40 mtpa by 2025, from virtually nothing three years ago.

In Japan, the idea for an LNG futures contract started to flow last year. It was prominently pushed back into the spotlights during the LNG conference last September. The new contract should be listed by March 2015, would allow parties to hedge against price swings, increase transparency in price formation and challenge the LNG-link to oil. The idea provoked sceptical reactions. The industry has warned on several occasions not to bank on lower LNG prices in any case because they may lead to the delay of new LNG projects that are facing a considerable cost increase.

And it is not sure whether a futures contract will bring prices down at all. “I think that it will take at least ten years to have any effect” one gas analyst said. “In the near future there is no possibility for prices to come down. In the first place because the LNG spot market will be relatively tight in the next five years. And secondly because there is no interest in the market. Most sellers are oil companies who are not interested in efforts of the Japanese government to bring prices down. And big Japanese buyers are not interested in a futures market either. The Tokyo commodities exchange has listed an oil futures contract for more than ten years without any effect on prices.”

Hiroshi Mashimoto, senior gas analyst at the Institute of Energy Economics (IEEJ) in Tokyo is cautiously optimistic. “We do not know whether it will have a downward effect on prices. The establishment of an LNG futures exchange is a positive development. But that is only part of the solution. The main issue is to bring down prices in long-term contracts.” And that will remain the bottleneck. According to the Asian Development Bank in its latest Energy Outlook, “LNG will continue to be traded under long-term contracts. That makes it hard for LNG buyers and will involve arduous contract negotiations to bring the current premium Asia is paying for LNG deliveries down.”

New players are allowed on the Japanese energy markets, although access is still very tricky. “Japan remains a difficult market”, one stakeholder told EER. Gas trader Tokyo Gas is expanding by means of vertical integration and is becoming a competitor on the electricity market. KPMG and PWC have increased the number of consultants in Tokyo that sell services to new market entrants.


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