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Japan trades on new LNG role fuelled by stronger yen

Japanese trading houses are reinventing their role in the gas game fuelled by a stronger yen, healthy balance sheets and a new political vigor

A visit to Tokyo reveals a new sparkle in the eyes of the trading house officials. Although the previous governments were largely uninterested in their overseas resource investment efforts, it is clear the new prime minister, Yoshihiko Noda, is fully behind their activities in the energy arena, specifically after the Fukushima nuclear disaster.

The sogo shosha or general trading houses as they are known in Japan, trade everything from ramen noodles to missiles, but their involvement in energy spans decades. The top five houses – Mitsubishi, Mitsui, Sumitomo, Itochu and Marubeni – are significantly exposed both as producers and traders to the natural resources sector, including the liquefied natural gas (LNG) business.

The top two houses, Mitsui and Mitsubishi, are active in the LNG game, from the Middle East to Asia and Australia, as well as in the Sakhalin LNG development in Far East Russia, alongside Gazprom and Shell. The pair are the biggest of Japan’s trading companies, with an estimated ¥694 billion ($8.6bn) of combined net income from their energy and minerals divisions in the year to March.

But, while the traditional mantra for the shosha has been to buy small stakes and leave the operations up to their partners, times are changing. The larger houses are keen to take on controlling stakes and bigger operational roles in projects.

Early last year, when Mitsubishi took the final decision to invest in the Donggi Senoro LNG project in Indonesia, it was a moment to savour for the firm.

The $2.9bn development, which by 2014 should be shipping 2 million tonnes per year (t/y) of LNG to Japan and South Korea, is the first energy project to be controlled by the trading house. It marks an important step in the group’s evolution from passive investor in assets to an active operator of them.

Historically, energy majors such as ExxonMobil saw the trading houses as useful support acts, inexperienced at running projects, but flush with cash and brimming with contacts. Backing from a shosha, which have long-term supply deals with utilities all over the world, was a good way to reassure project financiers that the end-product could be sold.

But now that global resources companies can borrow very cheaply and have plenty of cash of their own, the competitive advantage of the shosha has dimmed. Meanwhile, Japan’s utilities, led by Tokyo Electric Power and Tokyo Gas, have taken direct stakes in projects overseas, bypassing the trading houses, which usually act as intermediaries.

Junichi Iseda, chief operating officer of Mitsubishi’s natural gas division B, which focuses on new projects, recently told The Financial Times that his company was literally skipped in favour of the utilities.

Elsewhere, the Chinese national oil companies (NOCs) have upped the ante, taking bigger stakes in projects. In 2010, PetroChina grabbed a 50% share in the proposed Australian Arrow Energy LNG development, while compatriot Sinopec recently raised its stake to 25% in the Australia Pacific LNG (APLNG) scheme being built in Australia.

Traditionally, Japanese trading houses have been bit players, taking small, conservative stakes in projects, generally under 5%. The exception is the Sakhalin project with Mitsubishi holding 10% and Mitsui on 12.5%. As a consequence, the shosha need to adapt to compete with the increasingly ambitious Chinese, as well as the rising threat from firms in energy-hungry India.

Meanwhile, the Fukushima nuclear crisis reignited concerns over energy supplies to the world’s third-largest consumer of oil, and largest importer of LNG. The shutdown of all but one of Japan’s 54 commercial nuclear reactors after the earthquake and tsunami in March 2011, means the country has had no choice but to boost imports of LNG. According to Japanese customs data, LNG imports increased by more than 11% in 2011 over 2010 figures. The future of Japan’s nuclear energy sector is also uncertain, and although politicians and big business are pushing for reactor restarts, the public is very much against it

The increase in imports has pushed Japan’s trade balance into the red. In April, the nation reported its biggest fiscal year trade deficit ever, a contrast from decades of surpluses on booming exports. The finance ministry's preliminary trade data puts Japan's trade deficit for the 2011 fiscal year at ¥4.41 trillion as the nation imported oil and gas to make up for an electricity shortfall following the tsunami in March last year. In 2010, Japan recorded a trade surplus of ¥6.77 trillion for the year. The Japanese government is worried about the effect high energy costs will have on the competitiveness of the nation’s manufacturers, particularly at a time when US industry is enjoying the benefits of cheap gas.

Japanese firms are now ramping up their efforts to secure cheaper gas. As a result, Mitsubishi is one of several big Japanese importers applying pressure on producers to change the way long-term supply deals are drawn up, seeking to weaken the traditional pricing link to oil.

The recent supply deals, whereby Mitsui and Mitsubishi will each take 4m t/y of LNG from a new US export facility to be built in Louisiana owned by Cameron LNG, an offshoot of Sempra Energy, highlights the nation’s predicament. The Tokyo-based firms will get a third of the 12m t/y export capacity in exchange for helping develop and finance the project.

With Sempra, the duo are likely to negotiate more flexible long-term supply deals. Analysts predict they will fix the contracts against Henry Hub prices, similar to deals signed by Cheniere for its Sabine Pass LNG export project in Louisiana. 

The current US gas supply glut has caused the benchmark Henry Hub gas price to fall over 80% from a peak in 2008 to below $2 per million British thermal units (Btu) at the start of this year – one ninth of the average rate paid for LNG imports into Japan in February. The Japanese will pay a liquefaction fee on top of that, but nonetheless at current Henry Hub prices the deal would be cheaper than oil-linked contracts. 

Also, Henry Hub forward gas prices for 2016 – when first production is planned – are trading higher, but between $4 and $5/m Btu, so Japanese importers could lock prices in now. Sumitomo and Tokyo Gas have also signed a deal in late April with Dominion’s Cove Point LNG export project for the very same rationale – cheap, hub-linked LNG.

For all these reasons Mitsubishi, Japan’s largest shosha, is looking to move up the value chain. The trading houses know their bargaining power has been diminished over time and the risk of doing nothing has gone up since the tsunami.

Spurred by the strong yen, the shosha are now using their abundant cash on hand to invest more aggressively.

Of course, Mitsubishi is a long way from supermajor status. Its 45% stake in Indonesia’s Donggi Senoro venture means its people are taking the lead in planning, purchasing and budgeting. However, the top job – chief executive – is an appointee from Indonesian state-run energy firm Pertamina, which is a junior partner in the project with a 29% share.

Nevertheless, operating is a long way from Mitsubishi’s core strength, which is investing. But, Donggi Senoro, a relatively small LNG project, could be a good way for Mitsubishi to cut its teeth. Mitsubishi''s Iseda says he is not looking to take the initiative in all projects, but he wants to use the experience from Donggi Senoro as leverage to gain access to more projects.

The strategy could be paying off. Mitsubishi has been busy mopping up natural gas assets in Canada and aims to accelerate its ongoing feasibility studies to develop Canadian LNG exports. It is in talks with Anglo-Dutch supermajor Shell, as well as Chinese NOC China National Petroleum Corporation and South Korea’s Kogas to produce LNG in Western Canada.

In early May, Mitsui and Mitsubishi announced a $2bn deal with Woodside Petroleum for a 14.7% stake in its Browse natural gas project off Western Australia. Japan Australia LNG, a joint venture between Japan’s two largest trading houses by market value, will also buy 1.5m t/y of LNG from the project. In addition, the shosha will work with Woodside to sell LNG to the Asian market and help the Perth-based outfit raise cash to finance the development, which could cost as much as $40bn to develop.

In February, Mitsubishi announced a tie-up in Papua New Guinea with independent Canadian explorer Talisman Energy. The Japanese firm farmed into Talisman’s nine exploration blocks and the pair agreed to work together to aggregate natural gas in PNG’s Western Province with a view to developing a potential 3m t/y LNG export scheme.

The trading house, which has held stakes in LNG operations since 1969 and is now involved in nine major LNG projects across the globe, sees PNG as a vast and under-explored country with huge potential to supply LNG to Asia-Pacific markets. Talisman welcomed the shosha’s extensive LNG development experience as well as its marketing clout.

Elsewhere, Mitsubishi was the first international firm to grab pole position in Western Australia’s potentially massive shale-gas play in the Canning basin. The basin holds a huge estimated recoverable resource – about 229 trillion cubic feet (cf) of gas. The shosha also hooked up with local outfit Buru Energy and the pair has mooted a potential LNG development as a result. Iseda acknowledges Mitsubishi cannot compete with the majors on resources and capability, but he wants to expand. And his peers are watching closely.

The state-owned Japan Bank for International Cooperation is also on hand to offer cheap financing for energy investments deemed in the national interest. Therefore, expect further bold moves from the shosha in the energy arena, especially at a time when financing from European banks shrinks in the commodities markets.

If Donngi Senoro does well, more shosha will follow suit, backed by the high yen and the government’s blessing. Watch this space.

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