Japan's green transformation policy to alter LNG contract strategies

Japan's Green Transformation (GX) policy to map out its decarbonization pathways will not take the country's focus off energy security but will likely accelerate companies' pursuit of more flexible and shorter LNG contracts.

The GX basic principle and a set of related bills approved by the Japanese cabinet Feb. 10 laid out the country's decarbonization policy, with steps to be taken including utilization of nuclear power, boosting renewables and introducing a carbon-pricing mechanism, while ensuring immediate energy supply.

Analysts and industry sources said that among the policy measures, the country's revived nuclear power policy will likely affect the country's LNG demand and contracting strategy the most as it will be a key source of baseload electricity generation.

The GX basic principle stipulates that Japan will consider replacing nuclear reactors that have been decided to be decommissioned with "innovative next-generation reactors" at the same power plant, marking a turnaround in its nuclear power policy since the 2011 Great East Japan Earthquake and the subsequent nuclear crisis in Fukushima in the northeast.

The basic principle also allows for an extension of the life of reactors beyond the total 60-year operational limit by excluding shutdown periods for external reasons beyond the operator's control, upon a safety assurance from the Nuclear Regulation Authority.

LNG impact

"The GX policy, specifically the possibility of allowing lifetime extension beyond the current 60-year limit will have the most immediate impact on the near-to-mid-term LNG contracting activities," said Kaori Tachibana, associate director of gas, power & climate solutions at S&P Global Commodity Insights.

It allows Japan to "secure more baseload power for longer, diminishing the need to secure as much LNG volume as in the past," Tachibana said.

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The latest push for nuclear power utilization comes at a time when Japan's long-term LNG supply contracts are expiring, with volumes set to fall from around 99 million mt/year in 2020 to just 65 million mt/year by 2030, according to S&P Global's LNG database.

With Japan's policy push expected to progress after 2030 towards carbon neutrality in 2050, the country would actively explore using carbon capture and storage (CCS) for power generation, said Takayuki Nogami, chief economist at Japan Organization for Metals and Energy Security.

"Without a significant reduction in CCS operational costs, we cannot rule out the possibility of LNG demand turning marginal in Japan in 2050," Nogami said.

Given the uncertainty over Japan's LNG demand towards 2050, "without a strong initiative by the government, Japanese end-users would increase their reliance on short-term or spot contracts for LNG procurements in exchange for curbing their share of long-term contractual procurements to minimize business uncertainty."

The nuclear utilization policy under the GX basic principle could eventually lead to Japan having a maximum of 37 GW in operable nuclear power generation capacity over 36 reactors in 2050 on proceeding with restarting safety-assured nuclear power plants, Nogami added.

Term supply

Japanese industry sources said there would still be a need for LNG term supply contracts with the flexibility to allow utilities to balance fluctuations in renewable energy output amid a relatively low utilization of nuclear power in the country currently.

"The policy is leaning towards nuclear power, but it is unclear if the output from nuclear power plants will actually increase," said a source with a Japanese power utility.

"As we have experienced supply shortage of fuels, we are not in a situation where we can reduce LNG procurement," the source said.

A source with another Japanese power utility also said that the company does not currently expect any change in its LNG procurement strategy following the cabinet approval of the GX policy.

However, another market source said that some Japanese power utilities might opt to shift their term LNG supply focus to shorter-term supply contracts of about five-to-10 years with the option of replacing expiring long-term contracts around 2030 to respond to any changes in demand.

The spot share in Japanese power utilities' LNG procurements stood at 31.7% in fiscal year 2021-22 (April-March), over double 15.8% in FY 2017-18, according to the Ministry of Economy, Trade and Industry.

Carbon pricing

The bills related to GX include the gradual introduction of an EU-like "auction" for CO2 emission allowances for large power generation companies from FY 2033-34, eventually making fossil-fuel fired power generation more costly.

"Without decreasing CCS costs, Japanese end-users would shun using fossil fuel including LNG [for power generation] because of an expected increase in operational costs for using LNG and other fossil fuels upon introduction of the auction," Nogami said.

"This could lead to a reduction in investments for LNG and other [fossil-fuel] thermal power generation facilities, which could increase the frequency of glitches at the facilities and occasionally undermine supply stability," he added.

As part of the GX bills, Japan plans to launch a fully-fledged emissions trading system in FY 2026-27 following the launch of the first phase of ETS, involving voluntary participation from companies for three years until the end of March 2026.

The launch of the ETS would not only effectively help drive corporate behavior towards 2050 carbon neutrality in the world's fifth largest CO2 emitter but also monetize local companies' push to reduce carbon emissions.

The country also plans to introduce a carbon surcharge for fossil fuel importers from FY 2028-29 as part of a series of GX policy actions.