Gas to remain critical as Japan tweaks energy mix

The Japanese government is working to reduce the country’s natural gas consumption over the coming years. This is in large part because of the energy transition – Japan is trying to raise the share of renewables and nuclear power in its energy mix, while scaling back consumption of hydrocarbons. Under its sixth strategic energy plan, approved in late 2021, the government set a target of having renewables account for 36-38% of power generation by 2030, which is roughly double the share generated in 2019.

On top of this, in the absence of significant domestic hydrocarbon reserves, Japan is very heavily dependent on imports to meet its energy needs and is seeking to reduce its exposure to volatility in international gas markets. Indeed, the outbreak of war in Ukraine in early 2022 and its impact on natural gas prices and trends may have served to make many countries, including Japan, wary of how much exposure they have to international markets.

On the other hand, Japanese energy targets for 2030 could prove difficult to achieve. Indeed, a February report from Fitch Solutions described the target to reduce gas for power generation from 38% in 2022 to 20% by 2030 as “extremely ambitious”. Fitch’s power team noted the high costs of offshore wind technologies, intermittency challenges with renewables and long-standing opposition to nuclear generation in the country in the wake of the 2011 Fukushima disaster.

Given these challenges, Fitch said natural gas remained “pivotal” to Japan’s energy mix. Given the country’s dependence on energy from overseas, this translates into ongoing imports of LNG, which also represent a cleaner alternative to coal and oil – Japan’s other options for offsetting shortfalls in renewables and nuclear power.

Energy picture

Japan was not among the countries most affected by the gas market shake-up in the wake of the war in Ukraine thanks to its long-term LNG import contracts.

“There are two critical factors we take into consideration when we look at the Japanese gas market: the long-term LNG contracts and nuclear generation,” an Energy Aspects analyst, Min Na, tells Global Voice of Gas. “Japan has been over-contracted, so the weighted average cost of LNG imports are more linked to the oilindexed long-term contracts and Japan’s exposure to spot JKM prices is relatively small,” Na says.

“The average landed cost of Japan’s imported LNG in 2022 is $17 per mmBtu, half of the JKM prices averaging around $34 per mmBtu,” Na continued. “So, it’s relatively easier for Japan to cope with high natural gas if we are just looking at gas. But for Japan, another issue is energy security as the country almost fully relies on imports across different fuels, including gas, coal and oil.”

Indeed, under these circumstances, Japan found itself turning more to oil and coal last year to help offset shortfalls in nuclear generation when it found LNG spot prices to be unfavourably high.

“Given nuclear availability averaged 0.9 GW lower year on year in 2022, Japan increased coal generation as well as oil generation to meet power demand and reduce spot LNG purchases at the same time,” Na said. “Generating with spot LNG last year was even more expensive than oil generation, which is typically the most expensive generation source in Japan.”

This situation resulted in oil and coal use for power generation going up, while LNG imports were down.

“Oil generation was up by 36% year on year and coal generation up by 3% in 2022, which helped to keep the price of import LNG in check,” Na said. “Japanese LNG imports were down by 2.3 MT year on year in 2022.”

A further complication for Japan related to the fact that Japanese companies had interests in – and contracts with –oil and gas projects in Russia, including Sakhalin-2 and the under-construction Arctic LNG 2. In the wake of the war in Ukraine, and international sanctions imposed on Russia, these Japanese companies came under pressure to exit their operations in Russia, as supermajors were doing. However, under the recently approved green transformation (GX) plan, the government granted official approval for Japanese investors to maintain their interests in Russia, citing the projects’ importance for energy security.

There is no guarantee, though, that Russia will not alter its terms for the participation of foreign players in projects such as Sakhalin-2. Already, Moscow has transferred ownership of the Sakhalin-1 and Sakhalin-2 projects to newly established Russian operators in response to the withdrawal of super-majors. Japanese participation in the projects has been approved by the Russian government, but concern has been expressed that new, unfavourable terms for their continued participation could be introduced in the future, forcing them to rethink.

Looking ahead

An increase in oil and coal use at the expense of natural gas such as the one seen last year has been seen as counterproductive to Japanese energy transition goals. As the country looks ahead it will likely be keen to avoid having this situation repeat. At the same time, the uncertainty over the future of Japan’s participation in Russian energy projects is also likely to drive a push to bolster the country’s energy security.

Indeed, in December 2022 it emerged that Japan was planning to build up a strategic reserve of LNG in a bid to shield the country from gas market volatility. Details of how it will secure supplies have yet to be finalised, but under a proposal from the Japanese Ministry of Economy, Trade and Industry (METI), in the event of an emergency, the government could direct LNG supplies to utilities with the greatest need. The state-owned Japan Organization for Metals and Energy Security (JOGMEC) would cover any losses incurred by the company or companies directed to import the additional LNG volumes required under this plan.

What is expected to change in the wake of recent developments is the nature of LNG supply contracts that Japanese buyers sign. Shorter-term, more flexible contracts could grow in popularity.

“We think Japan would want some flexibility in these contracts, compared with legacy contracts they had, given their long-term energy strategy to reduce thermal generation and the extreme volatility in gas markets,” said Na.

However, given Japan’s push to increase the share of nuclear and renewables in its energy mix, the country’s GX plan includes a levy on LNG and other fossil fuel imports from 2028 based on their carbon content.

At the same time, additional nuclear capacity is due to start up in the coming years, displacing some demand for LNG.

“We expect Japan to restart a few nuclear reactors in the next few years, which will reduce calls on thermal (both gas and coal) in general, so we expect Japanese LNG imports to drop,” said Na. “However, term LNG will be declining at a faster pace than LNG imports, indicating Japan will have a bigger exposure to the spot market and JKM than before. We will not be surprised if Japanese companies sign new term contracts or renew existing contracts and we recently saw a few new deals signed by Japan.”

There is some scepticism over Japan’s ability to meet its new nuclear generation targets. Fitch Solutions anticipates that nuclear power will account for only 9% of the country’s generation by 2030, despite the government aiming for 20-22%. This means that other sources of energy will be required to make up the shortfall, and natural gas stands to maintain a significant role, especially if Japan wants to avoid falling back on oil and coal again.