- The Writer holdsÌýan MSc in Eurasian Political Economy & EnergyÌýfrom King’s College London andÌýalso anÌýMA in European Studies from Sabancı University.
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Following the Great East Earthquake and Fukushima Nuclear Accident, Japan decided to shutdown of all of its nuclear power stations that once provided one fourth of Japan’s electricity. Currently forty-two operable nuclear reactors remain offline due to safety concerns. Consequently, natural gas has become one of the main energy supply sources in Japan’s energy mix, increasing from 28 percent to 39 percent in power generation between 2010 and 2015.
With an annual volume of 125 billion cubic meters of LNG consumption and with no cross border pipeline, Japan stands as the world’s largest LNG consumer. Japan’s import sources are well diversified and very well organized in the case of possible supply disruptions. However, its import dependency was 98 percent back in 2014. While 70 percent of natural gas was consumed to generate electricity, the residue of the gas was used by the industrial and residential sectors.
According to the IEA’s data, the Asian market is predicted to be the largest LNG market by 2035 with a quantity that will exceed the North American and European market. However, as there is no competitive market in the Asian natural gas market, there are speculative expectations about where the market will evolve in the near future. High demand for gas with a tight LNG market along with high oil prices between 2009 and 2014 pushed spot LNG prices in Asia to as much as $18 per million British thermal unit (MBtu), climbing from an average of $10/MBtu. Since then, both Japanese and other Asia Pacific LNG importers are seeking to find new ways to have more flexible pricing and procurement contracts.
Although hub pricing is efficient in the U.S. or EU spot gas market, this structure has not yet been an effective pricing mechanism in the Asia Pacific market. Long-term oil-indexed pricing is still a competent pricing method in the Asia-Pacific LNG market, meaning that short-term spot market contracts are not fully effective in this region. On the other hand, the International Energy Agency (IEA) stated that 50 percent of the total LNG contracts in the Asia-Pacific region will end in 2017, implying that there is an opportunity for LNG importers to demand a pricing mechanism that will provide more flexible conditions. However, most of the conventional LNG contracts contain destination clauses, which impedes the buyers reselling cargoes, and restricts the manufacture of a liquid, flexible and transparent gas market.
The destination clause has been used especially in the Asia-Pacific LNG market and has recently been perceived as a barrier to trade liberalization. The destination clause, initially defined as an obstacle to the sale of natural gas to another market, was originally aimed at preventing arbitrage and is being opposed citing reasons that the LNG supply chain will be made more ridid and with claims that a competitive LNG market will be prevented.
As of November 2016, a total of 80 percent of the LNG contracts signed by leaders in LNG consumption, Japan and South Korea, included the 'destination clause' in their contracts. Although the clause restricts re-selling cargo and only allows for direct consumption, there is a provision called the “Downward Quantity Tolerance�, which allows for flexibility for users in meeting demand variations of up to 10 percent once a year. In May 2016, the Japanese Ministry of Energy suggested opening up the market to more players to ensure competitive pricing in a more flexible market and to overcome critical problems in the LNG market.
In a study undertaken in 2016 by Credit Suisse, they suggest that Japan will be over contracted in 2017-2021 period, resulting in oversupply in the Japanese gas market. In addition, due to unclear demand forecasts, operational flexibility will be needed for better trading opportunities. However, leeway is needed to re-sell the over-supplied volumes, which are prevented with the destination restriction clauses. For this reason, the Japanese Fair Trade Commission (FTC) launched an investigation last year to look at whether the destination clause prevents fair competition, since the majority of buyers complained that such clauses have put unfair restrictions on trade and have hampered market expansion. Following the commission’s final report, the FTC would likely call for either the relaxing or abolishment of the destination clauses. In an interview with Bloomberg in 2016, an analyst at Wood Mackenzie Ltd, Nicholas Browne said that, “If destination clauses are removed, this would lead to a growth in trading and optimization of LNG cargoes. It would also likely lead to other companies and countries trying similar moves.�
In 2016, the Japanese Ministry of Economy Trade and Industry (METI) published the Strategy paper for LNG market development with the aim of creating a flexible market and developing an LNG Trading Hub in Japan. The paper stated that “easing and elimination of destination clauses is indispensable for achieving a flexible and liquid LNG market.� The strategy proposed to “play an initiator role in creating a global LNG market�. The removal of destination clauses would allow for easier operational planning and flexibility for Japanese LNG buyers as well as increase the spot market liquidity.
LNG will continue to play a leading role in Japan’s future energy mix. It seems possible that this unfair trading restriction in "destination clauses" will be history in future when large amounts of LNG exports come online as demand slows. Only though a flexible and liquid LNG market will Japanese LNG buyers be able to boost their supply security resilience and balance their short-term and long-term contracts by optimizing their portfolios. With the lifting of these clauses, LNG optimization will logistically be achieved to allow for growth in world LNG trade volumes. It seems possible in the near future that the price trade-off will be reduced when this trade obstacle is overcome and LNG traders will be directed towards markets where demand is high.
- Opinions expressed in this piece are the author’s own and do not necessarily reflect Anadolu Agency's editorial policy.Ìý