Heatwave fails to fire up Japan's LNG prices
Extensive use of term contracts has protected utilities from the cost of extreme weather but looming nuclear shutdowns could leave them exposed
LNG sellers expecting the second consecutive summer heatwave in Japan to again drive up spot prices have been left disappointed. Abundant global LNG supply and the widespread use of term contracts have contained prices, while drawing on domestic inventories and reopened nuclear plants has cooled the need for imports.
But nuclear safety measures—which could force the closure of reopened plants and prevent others being returned to service—point to a potential surge in gas demand next year.
A spike in temperature during July and early August—which left more than 57 dead and 18,000 hospitalised—increased the demand for electricity to power air conditioning units. It was severe enough for Tohoku Electric Power to source two supplementary cargoes in the spot market, for delivery in late August and September.
But the sweltering conditions are not enough to reverse falling LNG prices. Last summer's even deadlier regional heatwave, which cost the lives of 138 in Japan alone, contributed to the benchmark JKM price spiking to $11.75/mn Btu. Since then, increasing supply of LNG onto world markets, especially from new Australian and US projects, has weighed heavily on spot and futures prices.
While Japanese LNG demand remains elevated by historical standards, due to the under-utilisation of the country's nuclear capacity, it had been well below last year's level before the heatwave started; for the first six months of the year the Ministry of Finance reported an 8.2pc year-on-year decline in LNG imports to 38,587mn t, in a statement on 1 August. On 14 August, the cumulative Ice Japan/Korean Marker (JKM) average futures contract for September was $4.321/mn Btu.
The spike in electricity demand last year took utilities by surprise and motivated them to protect themselves even further with term contracts—contracts which already covered the vast majority of LNG supply. "Japan is overcommitted with LNG term volumes and is well-positioned to meet incremental demand from existing term cargoes," says Siddharth Kaul, a gas analyst with FGE. "It will not likely need to source substantial additional volumes on the spot market."
The period of low LNG spot prices are frustrating for Japanese power companies that tied themselves into long-term contracts, the vast majority likely still indexed to oil prices, leading them to explore alternative terms for existing and new sale and purchase agreements (SPAs).
"Japan's gas importers face great uncertainty in their future fuel needs," says James Taverner, energy and natural resources analyst at information provider IHS Markit. "The combination of uncertain nuclear restarts, rapidly-growing renewables and increased competition for domestic customers following retail market opening [which will be completed in 2022] means Japan's importers face challenges in assessing their LNG needs even a few months ahead, let alone the long-term horizons needed for planning supply contracts."
“Japan is overcommitted with LNG term volumes and is well-positioned to meet incremental demand from existing term cargo” Kaul, FGE
Utilities are coming up with innovative solutions. Jera, a joint venture between utilities Tepco and Chubu Electric, and Mozambique LNG agreed to use a European gas price index as part of a contract price formula in an SPA. Similarly, earlier this year Tokyo Gas negotiated a deal with Shell to use a pricing formula based on coal indexation. Power companies could also respond by building up marketing operations and flexible portfolios to sell excess supply to other markets, says Taverner, but this would require a "significant shift" in mindset. "To achieve this, Japanese LNG buyers need to rapidly enhance their marketing and trading functions."
The role of nuclear power in the future energy mix remains the greatest unknown. The government wants nuclear power to supply 20-22pc of Japan's electricity by 2030 to reduce the country's dependence on imports—which analysts estimate would entail increasing the number of operational reactors increasing from nine to 30—but has left the decision to restart each reactor to a combination of regulators, courts and local politicians.
The nuclear plan faces strong public opposition and legal challenges. In late April the Nuclear Regulation Authority (NRA) reconfirmed its position that, if the plants did not complete the construction of emergency facilities within five years of their plans being approved, reactors would be shut down until the work was complete. Ten reactors are expected to be prevented from operating (including one yet to start) as the owners have admitted they will not be able to meet the requirements for specific incidents, including anti-terrorist defences, by the deadlines, which will start to come due from March 2020.
Kaul says that, for the utilities overcommitted to long-term LNG supply, including Kansai Electric and Kyushu Electric, a key factor is whether the other nuclear facilities that are scheduled to restart in 2021 or 2022 will also be halted due to falling foul of the NRA's demands. "These have a total capacity of 4.4GW and, [if they are not restarted], might result in a sizable increase to overall Japanese LNG demand," he adds.