Japan mulls greater LNG supply diversification as Australian policy shifts

Reforms to Australia's Safeguard Mechanism that took effect July 1 will have a significant impact on LNG business and import costs for Japan and are accelerating the import-dependent country's efforts to diversify supply sources, with a renewed focus on Middle East prospects.

The reforms, the latest in a series of Australian policy changes that could have impact on LNG supply, have shaken Japan's confidence in Australia's role as a stable long-term LNG supplier, sources and analysts told S&P Global Commodity Insights.

The unexpected turnaround in Australia's policy direction has raised concerns in Japan, where the government and companies see impacts on cost scenarios for investments as well as a likely increase in LNG import prices in the long run.

Japan currently sources more than 40% of its LNG from Australia, and has more than 24 million mt/year of long-term Australian LNG supply contracts due to expire by 2039, with more than 8 million mt/year set to expire by 2029 unless they are extended, according to S&P Global's LNG database.

"The Australian government's sudden change in its policy affecting existing [LNG] projects to be applied retroactively will not only increase its country risk but also undermine its credibility for stability in its policy," said Takayuki Nogami, chief economist at Japan Organization for Metals and Energy Security, or JOGMEC.

"The move could also deteriorate the country's environment for natural gas investments, which could deter companies from making investments in Australian LNG supply projects," said Nogami, adding that rising environmental costs from the Safeguard Mechanism reforms would likely be reflected in LNG supply prices in the mid-to-long term.

The Safeguard Mechanism applies to industrial facilities, including oil and gas production and mining operations, that emit more than 100,000 mt/year of CO2 equivalent, and requires offsetting of CO2 emissions through steps such as purchasing carbon credits or carbon capture and storage.

The mechanism requires affected facilities to cut net emissions by 4.9% annually though 2030, while new facilities, including gas fields, are expected to have a baseline of net-zero emissions from the start of operations.

Questions remain as to whether there will be sufficient policy support for CCS and whether sufficient carbon credits will be available, said Hiroshi Hashimoto, senior fellow at the Institute of Energy Economics, Japan.

"Such elements need to be explained sufficiently to Australia's domestic investors, Japanese and other international investors in its gas and LNG projects, as well as to Japanese LNG offtakers," Hashimoto said.

Barossa exemption

Among the areas of concern, Japan's Minister of Economy, Trade and Industry Yasutoshi Nishimura noted in comments June 16 that the requirement under the Safeguard Mechanism reforms for projects that had already taken final investment decisions to be net-zero from day one would create unexpected costs, and raised concerns over protecting investors.

It emerged June 29 that the Japanese government has called on the Australian government to give an "immediate and sincere" response to a list of inquiries regarding the enforcement of Safeguard Mechanism reforms, including a request to exempt a new gas development project.

A Japanese government source told S&P Global Commodity Insights that, in a three-page long questionnaire sent to the Australian government in early June, Tokyo had sought clarity over the availability of Australian Carbon Credit Units (ACCUs) and Australia's readiness for a CCS project over two jurisdictions.

Tokyo is also seeking an exemption for the Barossa gas project operated by Santos, in which Japan's JERA has a 12.5% stake.

The project, which has already taken a FID, plans to capture CO2 emissions and ship them to the Bayu-Undan oil and gas field in the Timor Sea for storage, requiring the governments of Australia and East Timor to adjust legal frameworks under the London Protocol on transboundary CO2 transfers.

Amid a lack of clarity over the legal frameworks, the Barrosa gas project would likely see delays in starting up its CCS project, meaning the project partners would end up having to purchase ACCUs, the source said.

Located off Australia's Northern Territory, the Barossa project will link to the Darwin LNG terminal by pipeline and is expected to start production around 2025, with CCS starting up from around 2027 and reaching fully-fledged CCS around 2030, the source said.

Middle East

Given the uncertainty over Australia as a stable LNG supplier, Japan is finding an increased need to diversify its LNG import portfolio and is exploring LNG supplies in Qatar and the UAE, a source with direct knowledge of the matter told S&P Global.

The answers Tokyo gets to its questions about the Safeguard Mechanism reform will be among the factors Japanese companies weigh when considering renewals of long-term contracts with Australian suppliers, according to the source.

Australia's share of Japanese LNG imports rose to 42.7% in 2022 from 35.8% the previous year, due in part to the expiry of Japanese companies' long-term LNG contracts with the Qatargas 1 project in 2021. Qatar's share of Japanese LNG imports conversely shrank to 4.0% in 2022 from 12.1% the previous year.

A couple of Japanese companies are in negotiations with Qatar for LNG supply contracts as well as participation in Qatar's North Field expansion project, the source said.

The negotiations come to light as Japanese Prime Minister Fumio Kishida is visiting Qatar, along with the UAE and Saudi Arabia, as part of a whirlwind tour in July.