Japan’s decision of whether or not to impose additional new sanctions on Russia could have long-run implications for energy cooperation between Russia and Japan, especially in the gas sector.

Russian President Vladimir Putin, left, and Japanese Prime Minister Shinzo Abe meet in Sochi, Russia. Photo: RIA Novosti

Although Japan has delayed imposing new sanctions against Russia – sanctions that were supposed to be adopted this Friday – the country seems to be ready, even though still hesitant, to risk its relationship with Russia over the Kremlin’s controversial policy on Ukraine. In addition to their impact on economic and political ties, a new round of Japanese sanctions would likely affect future energy cooperation between the two countries.

With previous sanctions failing to dampen the economic ties between the two countries (the August round of sanctions included a list of 40 individuals and 2 companies based in Crimea), the upcoming sanctions might include measures affecting the energy and financial sectors.

So far, there has not been an embargo on energy supplies from Russia to Japan. In case such measures are implemented, Japan might encounter difficulties as 4 percent of its energy imports come from Russia. According to the Institute of Energy Economics (Japan), a crunch in economic relations could also lead to a contraction of Japan’s GDP by 0.2 percent, limit Japan’s exports to Russia and thus affect the transportation machinery industry and have a spillover effect on iron and steel, as well as non-ferrous metal production.

According to the Russian Federal Customs Service, Japan is one of the main trade partners of Russia and remained so in the first months of 2014, surpassing the U.S. The volume of Russian-Japanese trade in the first quarter, however, has decreased by 15 percent compared to the same period a year earlier.

The energy sector is where the two countries have large overlapping interests. Energy cooperation – the sphere that was holding Russian-European relations afloat until recently, has its impact on Russian-Japanese relations as well, albeit on a much smaller scale. This was indicated at a recent Russian-Japan summit “The points of common interest: business, investment, culture,” organized by Russia Beyond The Headlines (RBTH) last week in Moscow. A great deal of attention was paid to energy cooperation.  

What’s the scale of scope of Russian-Japanese energy cooperation?

From the Russian perspective, Japan is an important partner in Asia, although its potential is, of course, less overwhelming than China’s. According to the forecasts, Japan will decrease its primary energy demand from 509 million tons of oil equivalent (mtoe) in 2010 to 362 mtoe in 2040, not least due to a 17 percent decrease in energy intensity. Japan’s share in the world GDP based on purchasing power parity will decrease from 6 percent in 2010 to 3 percent in 2040.

There is a projected decrease in demand for crude oil and oil products (cumulatively, by more than 70 million tons in 2040 compared to 213 million tons 2010), Japan’s complete dependence on oil and oil product imports will persist. According to Japan’s Ministry of Finance, in 2013, Russia was the fifth largest crude oil supplier to Japan and the largest among non-Middle Eastern oil exporters.

Japan’s gas demand is also set to decrease in Japan after peaking in 2015 at 123 billion cubic meters (bcm) down to 69 bcm in 2040 – due to saving measures and in spite of policies of nuclear power use reduction. Despite the fact that Japan does not represent a large share in global gas consumption, it is one of the key players on the liquefied natural gas (LNG) market, accounting for 37 percent of all LNG imports, according to the International Gas Union.

Importantly (and this is often forgotten), Japan is also the key player in the Asian Pacific steam coal market – it is the second largest importer in the world, surpassed only by China, having purchased 184 million tons of coal on international markets in 2012, according to the International Energy Agency.

With extremely high levels of import dependency for all fossil fuels, even such modest outlook demands a well-thought-out energy security strategy, the basics of energy supply security are diversification and the ability to secure upstream assets.

This translates into a search for new partners and new suppliers, entering into joint projects and making strategic investments along the supply chains of various fuels (e.g. not exclusively natural gas). Naturally, Russia and Russian companies presented such prospective partnerships, as indicated from the speech of Sinji Fujino of Japan, Oil, Gas and Metals National Corporation (JOGMEC) who took the floor at the Russia-Japan Forum last week.

Meanwhile, Russia’s activities have been shifting to the Asia-Pacific region in recent years. As was mentioned by Alexey Teksler of the Russian Ministry of Energy, most importantly, there are upstream projects in Sakhalin, the Sea of Okhotsk, and the Magadan shelf. Secondly, large pipeline projects such as ESPO and Sila Sibiri have regional potential and are targeted at Japan.

Thirdly, there is a potential for expansion of cooperation in the power industry. Developments of the last few years in Japan’s energy sector prepare a ground for massive expansion of relations between the two countries.

As noted by Taijo Takahashi of Japan’s Ministry of Natural Resources and Energy, 30 percent of Japanese nuclear power plants (NPP) were shut down after the accident at Fukushima, which caused a large shift in Japan’s power industry toward thermal power generation based primarily on natural gas.

Russia is the holder of the world’s largest resources of natural gas, and is one of the leading suppliers of fossil fuels (including coal) to the international markets. In the framework of geographic diversification of sources of fossil fuel imports, it remains to be seen if Japan will be ready to lose such a partner.

What Japan’s focus on gas means for Russia-Japan cooperation

100 percent of Japan’s gas imports are supplied in the form of LNG, and 65 percent of it is imported by power generating companies. When it comes to LNG, Japan might be interested in viewing Russia as a partner.

Russia’s role in the regional gas market is set to increase. Moreover, there are pipeline projects, and according to calculations, an undersea pipeline from Russia to Japan could be an economically viable solution, according to Shigeru Muraki of Tokyo Gas, one of the four largest gas supply companies in Japan.

Muraki considers the future of gas imports in close relation to the issue of gas trading hub formation in the Asia-Pacific region. Options for a hub include a Northeast Asian hub based on the Japanese and Korean gas markets, or a Southeast Asian hub based on the Singaporean node.

In his presentation at the Russia-Japan Forum, Muraki referred to the joint study conducted by the Energy Research Institute of the Russian Academy of Sciences and the Institute of Energy Economics (Japan). An important conclusion is that there is space for pipeline projects even in the Asian gas market, traditionally seen as purely LNG-oriented. Moreover, such projects are likely to have a significant on gas pricing patterns.

LNG trade – where, once again, Japan is the key player, providing for 37 percent of purchases – made up only 9 percent of total world gas consumption in 2013 (down from 9.5 percent in 2012). Gradual rise in competitive pricing for LNG from 13 percent in 2005 to 33 percent in 2012 was not sufficient to transform the international LNG markets into a competitive playing field – moreover, in 2013 the share of gas-on-gas competition for LNG imports decreased. The data thus suggests that oil indexation, the basis of Japan’s long-term contracts, is remaining the core of regional gas trade.

The future Russian gas supplies to Japan are also likely to be agreed under long-term contracts (because this is the basic form of cooperation in the gas markets, which are characterized by high upfront investment and committed costly infrastructure). However, the pricing debate is promising to be just as complicated as the debate with China. Noteworthy, in the latter case, the cooperation will be ongoing under a traditional long-term contract format.

Will energy security sustain Russia-Japan relations going forward?

Japan’s energy security is based on two-tier diversification. Firstly, diversification of the sources of energy within both the overall consumption of energy sources and the electricity sector in particular; secondly, geographic diversification of supplies of those sources that have to be imported.

Russia as a strategic supplier can help Japan with both aspects noted above. Firstly, with the increased role of gas in Japan’s energy consumption, Russia can potentially provide increased volumes for export, both in form of pipeline gas (and that would be an economically viable option) and LNG.

It is a new supplier and, therefore, can to an extent decrease the dependence of Japan on its traditional suppliers and/or provide for the increased demand. The format of cooperation is yet to be determined; however, it is clear that simple buying and selling is not the only format. Mutual investment, joint ventures, exchanges of assets and other forms of cooperation are set to play an important role in the energy links of the two countries.

All these should be significant enough to sustain the relations between Japan and Russia through a turbulent time in international politics.