U.S.-Japan Cooperation under the “Free and Open Indo-Pacific” & Japan’s Energy Security

By Yohei Katakawa —

An LNG Carrier entering Ishikari Bay, in Hokkaido, Japan. Source: Wikimedia user とまりん♪, used under a creative commons license.

The “Free and Open Indo-Pacific (FOIP)” is the diplomatic vision of the Abe administration aiming for regional stability and prosperity through promoting a rules-based order, improving connectivity, and strengthening economic partnerships. The United States and Japan have shared the goal of advancing this vision and confirmed cooperation on energy sector development as one of the main pillars in September and November 2018. Also, both countries recently confirmed the importance of working closely in the liquefied natural gas (LNG) sector during February 2019. Such cooperation will develop further opportunities to expand U.S. energy exports principally involving liquefied natural gas (LNG) and may appear more advantageous for the Trump administration aiming for “American energy dominance,” but it also would make contributions to Japan as a keystone of its energy security and as a bargaining chip in the opening stages of trade deal negotiations.

Shifting Japan’s Energy Strategy

Japan still depends heavily on offshore fossil fuels and the dependence on a primary energy supply basis was 89 percent in FY2016 and will be about 75 percent even by FY2030. Japan deregulated its electricity retail market in 2016 and its gas retail market in 2017, and therefore primary energy procurement at an affordable cost is not only needed for international industrial competitiveness but is also becoming more essential to facilitate competition in the domestic energy market. Regarding LNG, although Japan is the largest importer, its bargaining power is not sufficiently demonstrated and the import price it pays is relatively higher than international standards. Japan depends on LNG imports mainly from the Middle East, Australia and Malaysia, whose pricing mechanism is often conventionally linked to volatile crude oil pricing with no relation to LNG supply and demand. Moreover, these LNG imports contain destination clauses that mandate where cargos can be delivered and limit buyers like Japan from reselling the excess gas.

In comparison, the U.S. natural gas price (Henry Hub) is often lower than other market prices and competitive even after adding liquefaction and shipping costs. Also, U.S. gas is not restricted by a destination clause. For Japanese buyers, adding Henry Hub pricing to their portfolios can make it easier to optimize and to hedge prices through arbitrage and swap. In the future, a larger amount of LNG will be exported from the United States to Europe, the Middle East, China, and other Asian countries. Under such a circumstance, the Asian region will be not just the shipping destination but also play a role as an LNG trading hub. That is why Japan is seeking to establish a more flexible and transparent international LNG market and serve as one of the hubs by the early 2020s under the “Strategy for LNG Market Development” announced before the start of the Trump administration. In this strategy, government support such as public financing and capacity building were additionally included as an important measure for LNG demand generation in Asia — and that is consistent with U.S.-Japan cooperation under FOIP.

Mitigating Trade Conflict & Advancing the FOIP

The Japanese government is trying to avoid substantial concessions in the trade talks with the Trump administration by promising to import more U.S. products such as defense equipment and LNG and to open its agricultural market to the degree permitted in the Trans-Pacific Partnership (TPP) negotiation. President Trump’s Economic Report of the President states that “China and Japan are the world’s two largest importers of LNG and are likely to be attractive future markets,” which suggests that increasing LNG imports from the United States could be a powerful bargaining tool.

On the one hand, China and the European Union (EU) are also likely to expand LNG imports from the United States due to U.S. pressure in trade negotiations. However, their demand situations are quite different from Japan’s. China has high gas demand as the largest gas market and it is expected to continue rapidly growing. China must manage to fill its strong gas demand via LNG imports. The EU’s gas demand is expected to decrease, but domestic gas production is also rapidly declining. EU member states also need to increase gas imports and diversify import sources to improve security of supply as described in the European Commission’s fact sheet EU-U.S. LNG TRADE. On the other hand, Japan’s gas demand equal to its LNG demand has been already declining as nuclear reactors were gradually restarted. According to the IEEJ Outlook 2019 by the Institute of Energy Economics Japan (IEEJ), the demand is expected to actually continue to decrease in the long-term. If so, Japan would have the concern of excess supply of LNG which could not be consumed in the domestic market and would need to be put forward for resale.

Therefore, along with the expansion of the LNG trade with the United States, Japan will cut back on overvalued contract imports from other states and develop the resale market. As noted above, Japan will also contribute to developing potential growth in demand for U.S. LNG in Asia and other regions beyond merely expanding its own direct imports. From this point of view, Japan’s decision to expand the import of U.S. LNG and its strategy to promote reselling and become an LNG trade hub would be carried out to strengthen its energy security ties and diplomatic relationship with the United States as its closest ally. With U.S.-Japan trade talks in a nascent stage, the trade balance should not be the only consideration and Japan’s efforts to work closely with United States toward shared bilateral interests on energy security should be recognized. Furthermore, U.S.-Japan energy cooperation will lead to strengthening energy security in the Indo-Pacific region as a key pillar of advancing their shared vision of the FOIP.

Mr. Yohei Katakawa is a Visiting Fellow with the Japan Chair at CSIS, seconded from Marubeni Research Institute of Marubeni Corporation. The views expressed are the author’s alone and do not represent any affiliated organizations.

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