Japan’s Energy Supplies at Risk

Japan is well-known for being a resource-poor country, particularly when it comes to the acquisition of energy resources—such as oil and natural gas—that are needed to run its high-powered economy. Japan imports all of its energy supplies, the majority of which come from what most observers call “the volatile Middle East.” More precisely, the area of volatility they describe lies largely in countries around the Persian Gulf whose exports of crude oil and natural gas must pass through the Strait of Hormuz, described by the U.S. Energy Information Administration (EIA) as a key “chokepoint” in global energy shipping. The Japanese government considers political instability and terrorism in the Middle East the two biggest threats to its energy supplies. Given the vulnerability of the energy supply chain, as well as the most recent statistics concerning its import of crude oil, Japan’s energy security is clearly at risk—both from terrorist attacks or any undermining of the general political situation in the Persian Gulf.

Oil imports from countries along the Persian Gulf accounted for 90.3% of Japan’s total for the month of September (Kyodo News Service, October 31). Saudi Arabia was Japan’s largest oil supplier in September, with exports of 36.23 million barrels (bbl); the United Arab Emirates came second with shipments to Japan totaling 34.03 million bbl; Iran was third with 14.53 million bbl; Qatar was fourth with 11.51 million bbl; and Kuwait ranked fifth with exports to Japan at 7.11 million bbl. Since all of that crude oil must pass through the Strait of Hormuz, any sustained disruption of supplies—whether from terrorist attack or from conventional warfare—would have clear, catastrophic results for Japan.

Terrorism and Political Instability

Terrorism is one element in the mix of items that concerns the Japanese. Indeed, second only to the political situation in the Middle East, terrorism is recognized by Japanese authorities as one of the most significant threats to the country’s energy security [1]. In its Interim Report, published in June, Japan’s Energy Security Group identified sea lanes in general and the Strait of Malacca in particular as areas most vulnerable to a terrorist attack that would disrupt Japan’s energy supplies from Middle Eastern sources. Yet, authorities are no less aware that terrorists can strike other areas too: the fields from which oil is extracted; the gathering systems, pipelines and trucks used to transport oil to Middle Eastern export terminals; the Middle Eastern export terminals themselves; the ships that carry the oil to Japan; the Japanese import terminals; the pipelines or trucks that carry the oil to users; and refineries.

Iran’s current impasse with the international community has fostered speculation concerning the effect that any conflict might have on the supply or pricing of crude oil to world markets via the Strait of Hormuz. The answer to that, according to one analyst, is that a U.S.-led conflict with Iran could spur a shutdown in Persian Gulf oil traffic, throwing the world’s energy markets “into turmoil” [2]. The analyst quoted one U.S. insurance industry executive, who declined to be named due to the sensitivity of the subject, as saying: “If you shut down the Persian Gulf, oil would be well in excess of $100 a barrel.” Even assuming warfare with Iran did not completely stop oil traffic from the Gulf, it would send insurance rates soaring. The area would be declared a “Special Risk Zone” and oil tanker companies would be forced to purchase high-cost policies to cover the massively increased risks that go with operating in a war zone. Such increased costs, of course, would be passed down to consumers.

Any disruption of supply or increase in cost due to insurance rates—something that terrorists are acutely aware of—could have immediate consequences for the Japanese economy. The al-Qaeda attack on the tanker Limburg off the Yemeni coast in October 2002, for example, amply demonstrated the ability of terrorists to manipulate rising maritime insurance rates to adversely affect a country’s economy. Insurance rates more than tripled in the wake of that attack, making shipping into Yemen too expensive for most firms. The Aden Container Terminal was hit especially hard by the reduced traffic into Yemen. That, in turn, saw the withdrawal of financial support from the Aden Container Terminal by its erstwhile backers in Singapore.

Reducing Exposure to Risk

The sensitivity of the Japanese economy to the cost of supplies from the Middle East is evident from recent news reports. In early November, shipping group Kawasaki Kisen Kaisha Ltd (K-Line) said its net profit for 1H 2006 was 41% lower than in 1H 2005, largely due to the higher cost of fuel. K-Line noted in particular that the average price of bunker fuel for its ships rose by some 29.11% to $337 per metric ton in 1H 2006 from $261 per metric ton in 1H 2005 (AFX Asia, November 9). Very clearly, an oil price rise of that magnitude in a shipping firm will also have a significant impact on the Japanese economy as a whole. That point was confirmed in late October, when 10 Japanese power companies and four major gas firms announced that rates charged to consumers would rise in January-March 2007 due to the soaring prices of imported crude oil and Liquefied Natural Gas (LNG). Their explanation was simple: “Rates for the upcoming quarter are being adjusted based on import prices from July through September, a time during which the futures market topped $70 a barrel for crude oil due to instability in the Middle East” (Asia Pulse, October 31).

Japan has taken a number of steps in order to reduce its exposure to energy supplies that must run through the Strait of Hormuz. Apart from investing in new forms of technology and substitute fuels, changing its sources of supply is the most obvious step toward energy security undertaken by Japan and its energy firms. An early example of that took place in 2004, when Japan’s Mitsubishi Corp., Itochu Corp. and Osaka Gas Co. were set to sign a 20-year contract with a state-run Omani company to purchase LNG. The security aspect of the deal was well noted by Japan’s leading financial newspaper, the Nihon Keizai Shimbun, on June 30, 2004, which said that, “The embarkation port is outside the Strait of Hormuz and transport via the port is less vulnerable to conflicts in the Middle East.” Farther afield, in North Africa, Libya is now attracting the attention of Japanese oil exploration companies due to its potential reserves and because it is one of the few countries to allow foreign firms to bid for promising fields. As a result, three Japanese companies recently announced plans to start work on six concessions that they successfully bid for in 2005 (Nihon Keizai Shimbun, October 9).

The desire to locate alternative sources of supply is understandable, but it has risks of its own. Consider one project that had been central to Japan’s plans for energy supplies: Iran’s giant Azadegan oilfield development. According to the EIA, Azadegan was discovered in 1999 and represents Iran’s largest oil discovery in 30 years, with proven crude oil reserves of 26 billion bbl. In January 2001, the Iranian parliament approved development of Azadegan by foreign investors. In February 2004, a Japanese consortium led by Inpex signed an agreement on the $2 billion development project. Initial production of crude oil from Azadegan was due in 2009, rising up to 160,000 barrels per day (bpd) by 2012 and 250,000 bpd by 2014-15. At its peak, according to the EIA, production from the Azadegan field could account for as much as six percent of Japan’s oil imports. Yet in September 2005, Iran criticized Inpex for postponing development of Azadegan due to the firm’s concerns about Iran’s nuclear development plans. By October, the Iranians had grown tired of Inpex’s delays, and they drastically reduced the Japanese firm’s stake in the project. Iranian Oil Minister Kazem Vaziri-Hameneh said that Inpex’s share had been cut “from 75% to 10%” because it took no action to develop the field (AFX Europe, October 8).

Japan may be facing a similar reversal of fortune in regard to Russia’s Sakhalin-2 oil and gas development project being developed by Royal Dutch Shell, along with Japanese partners Mitsubishi Corp. and Mitsui & Co. Touted by the EIA as Russia’s first LNG facility, construction of the project’s two-train, 9.6-million-tons-per year facility began in early 2003, with Shell expecting initial LNG production beginning in 2007 and LNG exports commencing in 2008. In March 2004, Sakhalin-2 announced the sale of 300,000 metric tons of LNG per year to Japan’s Tokyo Gas and Tokyo Electric Power (TEPCO) starting in the summer of 2008. Yet all of that has now been cast into doubt after the Russian government suspended the project, citing reasons of environmental protection. Yorihiko Kojima, president of Mitsubishi Corp., with an eye on investors and customers, said on October 31 that negotiations with the Russian authorities over the resumption of the Sakhalin-2 project would likely be settled in early 2007. At the time, Kojima said that more than 80% of the construction had been completed by the end of September, and he expressed optimism that the shipment of LNG, slated to begin in September 2008, would not be delayed (Nihon Keizai Shimbun, November 6).

Japan has faced similar frustrations in its efforts to source oil and gas even closer to home, as indicated by a new belligerence from China regarding the East China Sea, as well as political uncertainties in Indonesia, another repository of Tokyo’s hopes for energy security (AFX Asia, November 9; Nihon Keizai Shimbun, October 18). That has had a predictable effect on public opinion. In October, following the Azadegan debacle, the Asahi Shimbun summarized Japanese frustrations. It said: “Japan needs to work out a new energy strategy. Azadegan was estimated to have an expected output of 260,000 bpd. It was to have supplied six percent of Japan’s oil imports. Now that Inpex has lost its majority stake, it is certain that Japan will not get that much. The government in May put together its new national energy strategy, announcing its intention to raise the ratio of independent development of oil resources to total oil imports from the current 15% to 40% by 2030. With the Azadegan situation, however, this strategy has already lost one of its driving engines” (Asahi Shimbun, October 9). After Sakhalin-2, Japanese calls for a new energy strategy have become more urgent.

Conclusion

In its search for energy security, Japan has been forced to recognize the need to diversify sources of supply. Whether from terrorist attack or simply a deterioration of political or economic stability in the oil-supplying countries of the Middle East, Japan’s economy is clearly at risk from a disruption in its energy supplies. Nevertheless, in a world of obviously growing demand and apparently decreasing supply, Japan—like many other countries—is already learning that any such diversity of supply and any hoped-for security based upon it may ultimately be viewed as unsustainable illusions. This is especially true in the post-9/11 world with the ever-present specter of terrorism hovering over supply chains that are increasingly long, fragile and closely scrutinized for their vulnerabilities.

Notes

1. See the June 2006 “Interim Security Report” prepared by Japan’s Energy Security Group: “Through our evaluations we identified the major energy risks as: (1) political conditions in the Middle East, (2) terrorism, natural disasters, and accidents (misconduct), (3) reduction of investments from supply nations, (4) trends of demand nations (China, India, etc.), (5) issues facing the energy industry.” This document is located at: https://www.enecho.meti.go.jp/english/report/060908c-1.pdf.

2. Seideman, Tony. “A no-brainer in Iran,” Marine Digest & Cargo Business News, October 2006.