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Japan to recalibrate LNG demand by summer

Japan will have a clearer idea of its demand for fossil fuels later this summer when it decides how much nuclear capacity will be idled, the Ministry of Economy Trade and Industry (METI) said in an interview with Petroleum Economist

The results of its new long-term energy plan will determine future needs for LNG, oil and coal, Hirohide Hirai, director of METI’s petroleum and natural gas division, told Petroleum Economist in Calgary.

The Japanese government is revisiting its long-term energy needs in the aftermath of the devastating Tohoku earthquake on 11 March, 2011, and expects to complete a final review by the end of the summer. Much depends on the final status of the country’s nuclear reactors, but the government is looking to reduce its nuclear dependence by at least 30%-50% – if not more – which will necessitate a restructuring of the country’s entire energy complex.

“I think it (the earthquake) will have a longer impact for energy configuration not only this year or next year, but at least mid-term or even longer term”, he said. “Realistically, the replacement (for nuclear) is coming from gas-fired power, so we need more LNG, that much is clear.”

On 3 May, Japan shut the last of its 50 reactors for maintenance, leaving the country without nuclear-derived energy for the first time since 1970. Plans to restart some units to meet peak summer demand have been met with protests. Although pressure is on the government to retire its entire fleet of nuclear reactors, it’s unlikely given the country’s dependence on nuclear energy to meet demand.

Before the earthquake, nuclear power accounted for about a third of Japanese electricity production. Demand for fossil fuels to make up the shortfall has jumped significantly in past year since the Fukishima disaster.

According to the US government’s Energy Information Administration (EIA), Japanese thermal coal-fired power generation has risen 40% year-over-year. LNG demand is up 34% in the same period. According to the EIA, Japan's LNG consumption set a record in January 2012, nearing 9 billion cubic feet per day (cf/d), or 2bn cf/d greater than 2011.

Hirai said it’s still unclear if those numbers will be sustained, but the demand picture will be clearer later this year. “We haven’t decided how far we will reduce nuclear power. After summer we’ll have more of a hint about the replacement for Japan and the long-term energy plan.”

Before the earthquake, Japan was already the world’s largest LNG buyer, at around 79m t/y in 2011. In the aftermath, cargoes have fetched record prices of $17-18 per million British thermal units (Btu).

With North American natural gas futures at $2.35/m Btu as of 31 May, it’s no surprise that producers are lining up to export gas to Asia and, specifically, Japan, where they hope to more than double their money.

But there is confusion as to what pricing formula will be used once that gas hits the waters of Tokyo Bay. Presently, cargoes are based on the Japan Customs-cleared Crude (JCC) price linked to oil. Hirai said there is a clear preference to shift that bias to Henry Hub, but suggested buyers are likely to settle for a portfolio of fixed price, spot and oil-linked contracts.

That many Japanese buyers, such as Mitsubishi and Inpex, are also investing in North American upstream production is an example of a diversified approach to mitigating price risks. Indeed, the main purpose of Hirai’s two-day visit to Canada was to meet with producers and government officials to discuss upstream projects, including Shell’s proposed 12m t/y Kitimat project, which will be supplied from Canada’s shale-gas basins, including Montney, Groundbirch and Horn River.

“As a customer, the lower the better”, Hirai said of Japan’s ideal price threshold. “The slope could be $14.85 (per million-Btu) to single digits, which is a big reduction. They (importers) definitely want to see some part of that Henry Hub.”

Whether it materialises is another question. Shell’s chief executive, Peter Voser, said it was unlikely that any Canadian gas would be sold without long-term contracts under alternative mechanisms to Henry Hub. Speaking in Calgary, he said one of the reasons for bringing in state-controlled firms like PetroChina, Kogas and Mitsubishi was to secure committed “customer-producers” for the Kitimat volumes.

Even US producers such as Cheniere Energy that are offering long-term contracts based on Henry Hub have structured the deals with “fixed” components, belying notions of a true spot market. In January, it signed a 20-year contract with the South Korean state gas company Kogas, linked to Henry Hub with an undisclosed fixed price component.

It’s all part of a growing recognition that future LNG markets will increasingly be focused on Asia. And despite the prospect of cheaper Henry Hub-linked futures, Hirai says Japan prefers to work with countries such as Canada, rather than the US, which he said is a little too free-market oriented for its liking.

The US “hasn’t decided” what its future export policies are going to look like, he said, whereas Canada has expressed willingness to open new markets to Asia. Canada has expressed a willingness to work with the Japanese government at a high level – Prime Minister Stephen Harper visited the country in March to talk about energy policy – and Japan’s state-sponsored producers feel more comfortable under Canada’s regulatory regime, although Hirai admits Japan would prefer some changes.

Canada has vowed to streamline approvals for large projects such as Shell’s proposed Kitimat terminal, which would speed its notoriously slow regulatory process. Hirai is careful not to comment on the country’s internal politics but says this is a step in the right direction.

The trade-off is that it’s unlikely any Canadian gas will ever be sold under spot prices, and only long-term committed volumes will ever leave its shores. But for Japan, still reeling from the impacts of last year’s earthquake, the assurances of steady supplies from a trusted, like-minded trading partner will seemingly suffice, for now.

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