Japan weighs Sakhalin 2 LNG supply risks after Russian ownership decree

Japan's Ministry of Economy, Trade and Industry expects no immediate disruption to imports from Russia's strategically important Sakhalin 2 LNG project following a decree transferring ownership of the operator -- hitherto led by Shell and Gazprom -- to a new entity, METI minister Koichi Hagiuda said July 1, adding that contingency planning was underway.

Russian President Vladimir Putin issued a decree June 30 transferring all rights and obligations held by Sakhalin Energy, the operator of the Sakhalin 2 project, to a new Russian company citing unspecified "actions by the US and linked foreign countries and organizations that are unfriendly and incompatible with international law."

It comes after Shell, Gazprom's main partner in the project with a stake of 27.5% minus one share, announced its withdrawal from Russia on March 8 in light of the invasion of Ukraine.

"We are currently in the midst of scrutinizing the impact on Japanese companies' stake holdings in the Sakhalin 2 project as well as on Japanese companies' LNG imports from the project based on this presidential decree," Hagiuda told reporters.

"We believe we are not in a situation where Sakhalin 2 LNG cannot be imported immediately," Hagiuda said. "To be prepared for various contingency situations, we will need to take carefully thought-out measures."

Japan had already warned in June of a rising risk of disruption to Russian LNG supplies, vital for power generation in the country, amid rising tension and global competition for LNG as Europe tries to reduce its dependence on Russia.

The two-train Sakhalin 2 LNG facility -- which was launched in 2009 -- produced and shipped a record volume of LNG in 2020, reaching 11.6 million mt. It had an original design capacity of 9.6 million mt/year, but upgrades have seen output consistently exceed capacity. The operator also produced over 100,000 b/d of Sakhalin Blend crude in 2020.

Shell has had a rocky history at Sakhalin, where it was originally the majority stakeholder before being obliged to surrender part of its stake in 2006. Analyst George Voloshin of Paris-based Aperio Intelligence said the decree came after inconclusive efforts by Shell to sell its stake, reportedly involving Chinese counterparties.

Operational 'paralysis'

Voloshin described the decree as a "clear and unambiguous expropriation," but went on to say it was also intended to "normalize the production situation" amid a state of "paralysis" following Shell's decision to exit.

The decree stipulates existing stakeholders, also including Japan's Mitsui and Mitsubishi, with 12.5% and 10% stakes respectively, have a month to submit their approval for the transfer of stakes to the newly created company, after which the government will rule on the admissibility of the submissions.

It was unclear on what grounds the government would or would not allow the existing shareholders to hold proportional stakes in the new company. In the event of refusal or the deadline being missed, the corresponding stakes are to be sold, with the proceeds transferred on behalf of the shareholders to government-designated Russian bank accounts, from which any expenses incurred to date can be deducted.

A Shell spokesperson said: "As a shareholder, Shell has always acted in the best interests of Sakhalin 2 and in accordance with all applicable legal requirements. We are aware of the decree and are assessing its implications."

However, Voloshin questioned the likelihood of the foreign stakeholders assenting to the transfer on the terms set out and suggested the eventual buyers would most likely be from China or India, potentially at steeply discounted prices and leading to an "inevitable" switch of LNG exports away from Japan.

"Shell's plans to withdraw from Sakhalin 2 have resulted in a paralysis at the operating company. Its inability/unwillingness to sell its stake quickly enough [reflecting] the geopolitical and economic context… and the prospect of steep losses suggests the paralysis will last for as long as Shell is a shareholder," Voloshin said, adding Shell had been the "driving force" behind operations.

Japan's Hagiuda, however, was more moderate. "We recognize that this presidential decree is not about a seizure. It is questioning existing stakeholders' consent to move to a new entity after having transferred all of the rights and obligations from Sakhalin Energy to the newly establishing entity," Hagiuda said.

"Either way we will give rigorous consideration from a standpoint of ensuring stable supply for Japan's power and gas," he said, adding the country currently has two to three weeks' worth of LNG inventory held by power and gas companies.

Japan exposure

Russia accounted for 9% of Japan's total LNG imports of 74.32 million mt in 2021, its fifth-largest supplier, according to data from Japan's Ministry of Finance. Almost all of Japan's Russian LNG imports come from Sakhalin 2.

Officials from Mitsui and Mitsubishi said they would consider their response following discussions with other stakeholders and Japan's government. A Mitsubishi spokesperson added that Sakhalin 2 was producing as normal.

Tokyo Gas does not currently see any impact on its Sakhalin 2 LNG procurement, a company spokesperson said.