High LNG Imports To Remain Even If Nuclear Returns

BMI View: In wake of the changing dynamics of the Japanese power sector, we have concluded that crude oil imports to Japan will continue to reduce while LNG imports will remain at the elevated levels seen throughout 2012 and 2013. BMI's Power analysts are anticipating nuclear restarts from 2014 with a gradual increase over our forecast period, however this is unlikely to affect the strong gas demand due to the amount of nuclear capacity expected to be permanently kept offline.

In light of the recent developments in the Japanese power market and following the complete shutdown of the country's nuclear power, we have taken a closer look at the impact of oil and liquefied natural gas (LNG) imports into the country. Over the last two years Japan has struggled with importing sufficient fuel to replace around 44GW of nuclear capacity that has come offline since the 2011 Fukushima disaster. The vast majority of the fuel imported to cover the nuclear shortfall has been oil and LNG, though more recently BMI's Power analysts are noting an increased use of coal for power generation. The surge in oil and LNG imports in 2011 and 2012 has had a significant impact on the country's balance of trade due to the high costs of additional energy imports. Due to this development Japan is experiencing its longest running trade deficit in over 30 years, which is being further undermined by a weak Yen.

From 2010 to 2011, LNG imports rose 12.2%, then soared again by another 11.2% as imports reached an all time high of 118.75bn cubic metres (bcm) in 2012. More recently imports have stabilised and slightly lower LNG purchases in so far in 2013 over 2012. Oil imports and its use in power generation also grew substantially in 2011 and sustained at a high level through 2012.

Oil & LNG Spike Soothed By Coal
LNG, Coal And Crude Oil Consumed By Japanese Power Utilities 2007-2013, MT

BMI View: In wake of the changing dynamics of the Japanese power sector, we have concluded that crude oil imports to Japan will continue to reduce while LNG imports will remain at the elevated levels seen throughout 2012 and 2013. BMI's Power analysts are anticipating nuclear restarts from 2014 with a gradual increase over our forecast period, however this is unlikely to affect the strong gas demand due to the amount of nuclear capacity expected to be permanently kept offline.

In light of the recent developments in the Japanese power market and following the complete shutdown of the country's nuclear power, we have taken a closer look at the impact of oil and liquefied natural gas (LNG) imports into the country. Over the last two years Japan has struggled with importing sufficient fuel to replace around 44GW of nuclear capacity that has come offline since the 2011 Fukushima disaster. The vast majority of the fuel imported to cover the nuclear shortfall has been oil and LNG, though more recently BMI's Power analysts are noting an increased use of coal for power generation. The surge in oil and LNG imports in 2011 and 2012 has had a significant impact on the country's balance of trade due to the high costs of additional energy imports. Due to this development Japan is experiencing its longest running trade deficit in over 30 years, which is being further undermined by a weak Yen.

From 2010 to 2011, LNG imports rose 12.2%, then soared again by another 11.2% as imports reached an all time high of 118.75bn cubic metres (bcm) in 2012. More recently imports have stabilised and slightly lower LNG purchases in so far in 2013 over 2012. Oil imports and its use in power generation also grew substantially in 2011 and sustained at a high level through 2012.

Oil & LNG Spike Soothed By Coal
LNG, Coal And Crude Oil Consumed By Japanese Power Utilities 2007-2013, MT

However, our view is that Japan's oil imports peaked in 2012 due to both the unsustainable nature of burning high cost fuel oil and also the sharp decline in the country's refining capacity as the downstream streamlines its operations. This will lead to falling oil consumption in Japan, particularly as fuel efficiency improves and negative demographics reduce demand over the longer term. Also with our expectation that nuclear power will gradually begin to restart from 2014, we anticipate the oil fired power facilities to be among the first to be axed as spare power generation capacity grows. This will further reduce the demand for crude oil over the medium to long term, hence the spike then reduction in the consumption of fuel oils seen in our fuels forecast.

Spike In Residual Fuel Oil consumption
Fuel Consumption Breakdown by Product, '000b/d

However, while price pressures and a falling liquids demand scenario are dictating a clear trend for oil imports, the outlook for LNG tells a different story. Demand has also shot up considerably, though there do not appear to be the same kind of signs to indicate a sizable retraction of imports. Currently, LNG imports appear to have reached an upper limit with operational gas fired power facilities running at close to full capacity, while domestic and industrial gas use remains limited. It therefore remains unlikely Japan will be able to reduce current consumption by a significant level.

BMI's Power analysts are expecting nuclear power to return in 2014 and gradually increase as inspections pass new facilities to restart. We anticipate oil power generation capacity to be the first to be scrapped, while additional coal power capacity is not expected until between 2020 and 2029, through which time 3.8GW is planned to come online. This means gas will remain the principal generation fuel and imports of LNG will need to remain high.

Furthermore, BMI's Power analysts expect that at least 40% of Japan's nuclear power capacity will remain offline indefinitely and gas power will be the main replacement for this loss of capacity. Over the 2013 to 2021 timeframe, 30 new gas fired facilities with a capacity of 16GW are due to come online. However, while new capacity will become available we don't expect a significant increase in LNG imports as a result. We are expecting a slight increase in demand for gas power though believe the new facilities will play a greater role in providing relief to the current fleet which is being over utilised. As a result Japan will have greater spare capacity and will be able to more efficiently manage its power demand.

While taking into consideration new contracts for LNG supply initiating over the coming years combined with those ending over the forecast, we have compiled a scenario that highlights Japan's considerable insufficiency of contracted LNG deliveries over the coming years. The following chart emphasises the impact of the Fukushima disaster, with Japan having to considerably dip into the more expensive spot market to cover the difference between contracted LNG supplies and that needed to meet demand.

LNG Gap To Remain Until 2017
Contracted LNG Imports And Actual/Forecasted LNG Imports, bcm
In A Spot Of Bother
Difference Between Contracted Volumes And Imports, bcm

However, while the extreme liquidity of oil trade allows for little divergence from the influence of the spot price, LNG trade has a far greater percentage of its deals locked up in long term contracts. The limited physical supply on the LNG spot market has meant the substantial increase in demand for LNG from Japan has also led to an increase of Asian LNG spot prices, further straining Japan's finances due to sustained high volume of imports.

Vicious Circle - Growing Demand Pushing Prices
Monthly LNG Imports (bcm) vs Monthly LNG Price ($/mnBTU)

Longer-term LNG supply contracts are set at a fixed price over a 20 to 25 year term, guaranteeing consumers a stable price and producers with a return on their investment. Pricing, although often not transparent, is at a discount to spot prices. As such, while Japan has had to find far more LNG than it currently has under contract, it has increasingly managed to negotiate to bring some of its contracted volumes forward, rather than dip too heavily into the spot market. This has given LNG the advantage over oil despite the price of gas being indexed to the crude.

Leaning On Qatar To Avoid A Tough Spot
Volumes Over Contracted Values Imported By Country, bcm Left = 2012 Right = 2013

The above chart indicates this trend and how Japan has managed to significantly reduce paying high spot prices in 2013 over 2012. Japan has long term supply contracts with Qatar, Oman, UAE and Russia, all of which delivered more LNG to the country in 2012 and 2013 than their contractual obligation. While it is unclear how much of this is due to bringing contracted deliveries forward and how much is purchased on the spot market, it is clear that Japan's activity in the spot market has significantly reduced in 2013. Far fewer countries delivered LNG to Japan in 2013 over 2012, while the long-term contyract partners that were leaned on in 2012 remained equally important in 2013. Also of note is the ramp up of Australian LNG deliveries to Japan. Australia under delivered in 2012 and over delivered in 2013, allowing for a reduction in expensive spot deliveries from further afield such as re-exports from Brazil and shipments from Norway.

We anticipate a continuation of this trend and for Japan to lean on its long-term contracts until at least 2016. From this point we are expecting the contracts Japanese companies have signed with the Australian mega-projects and US LNG export projects to come into play. The Wheatstone project is due to begin deliveries in 2016, while shipments from Cove Point, Cameron LNG and Ichthys are scheduled to begin in 2017. By this point Japan should have a more manageable gap between contracted deliveries and spot cargos with demand remaining stable.

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Sector: Oil & Gas
Geography: Japan
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