In the beginning….
2014 marks the 50th anniversary of the start of the first liquefied natural gas (LNG) export project. During the intervening years, Japanese companies have been central to establishing the LNG industry as a major source of global energy supply.
The Japanese companies were credit-worthy LNG buyers who gave both investors and banks the requisite comfort to invest in high-risk, capital-intensive LNG export projects. As the global LNG industry has developed, so too has the role of Japanese companies within that industry. Japan continues to perform its traditional role of LNG buyer consuming a third of the world's LNG in 26 regasification terminals. Japanese companies also now increasingly participate across the entire LNG supply chain.
The LNG Supply Chain
LNG projects are developed as an integrated chain of dedicated facilities and activities involving (i) natural gas production and liquefaction in the exporting country, (ii) marine transportation of LNG on LNG vessels, and (iii) regasification of LNG and distribution and consumption of regasified LNG in the importing country.
The following diagram illustrates the components of the LNG supply chain.
The fundamental justification for any LNG project is the economics. The LNG supply chain must be integrated economically through the addition of value at each component of the chain. An LNG export project will only be developed where there is a secure long term commitment to purchase the LNG, since the proceeds of the sale of LNG flow back up the supply chain to pay for the costs of production, liquefaction, shipping and regasification, and to give investors a return on their investment.
Each component of the LNG supply chain has many sub-components. By way of example, an LNG export project is comprised of a range of facilities including one or more LNG trains, storage tanks, jetties and tug boats, the construction of which involves a number of sub-contractors with different expertise. LNG ship building and LNG shipping are industries in their own right.
LNG projects are extremely complex involving a multitude of interested parties that include host governments, gas producers, export and import project sponsors, LNG sellers (including portfolio sellers), LNG buyers, commercial and other lenders, LNG ship builders, LNG vessel owners, charterers and contractors.
Whilst the components of the supply chain and the sequence in which they occur remains unchanged, the participants in the supply chain, their role and the allocation of responsibility with respect to the different components of the supply chain will vary on a project-to-project basis dependent on the unique characteristics and risk profile of each LNG project.
In the early 1960s air pollution in Japan led to enactment of environmental regulations, which stirred Japan's interest in importing LNG as a cleaner and more environmentally friendly fuel for power generation than coal and crude oil. Japanese power companies realized they could substantially reduce emissions by adopting LNG for power generation. However, many Japanese power companies, particularly in highly populated areas, were at that time only willing to switch to LNG if they received financial assistance from the Japanese government to cover the "high" capital costs. Non-power companies had expressed their interest in LNG as well.
On 6 March, 1967, the first Asian LNG sale and purchase agreement (LNG SPA) was signed for the sale of LNG produced by Phillips and Marathon Oil in Alaska to Tokyo Electric (75%) and Tokyo Gas (25%). The first delivery of Alaskan LNG to Tokyo Electric and Tokyo Gas occurred in November 1969. Although the sale price was set at $0.52 per MMBtu until 1984, the following additional price review clause was agreed:
"If in the future another Liquefied Natural Gas project is placed into operation to supply Japan with natural gas from foreign gas sources, such as Alaska, Canada, Australia, Brunei and the Middle East under similar conditions such as volume, distance, liquefaction and ocean transportation techniques, contract term and so forth, Sellers will hold a discussion with Buyers concerning the price as herein set forth, and shall endeavor to find a solution satisfactory to all parties concerned."
The LNG SPA contained other unusual provisions by today's standards, including that any disputes would be decided by arbitration in Tokyo with the arbitrators applying Japanese law.
In 1970, Tokyo Electric, Tokyo Gas and Osaka Gas signed LNG SPAs with Shell, Mitsubishi and the Brunei government to underpin the development of the Brunei LNG project, the first LNG project in which Japanese companies participated in both export (Mitsubishi has a 45% interest) and import.
Again, negotiation leverage on the side of the buyers resulted in the LNG SPA being governed by Japanese law, with arbitration under ICC arbitration rules to be held in either Tokyo or Osaka. The LNG SPA was set at volumes much larger than predecessor projects. From the outset, Brunei LNG dwarfed projects of the prior decade through the sale of 3.7 MTPA from four liquefaction trains, requiring six new ships of 75,000 cm cargo capacity each. The project's first cargo was delivered on time to Osaka Gas in December 1972.
Japanese buyers also provided a market for Indonesian gas in the early 1970s. The October 1973 oil crisis affecting Middle Eastern crude oil supplies (the Japanese economy was then still fueled largely by crude oil) generated keen interest in Indonesian LNG from five Japanese buyers and, most importantly, the Japanese Government.
In December 1973 Indonesia's Pertamina signed an LNG SPA for 8.18 MTPA with Chubu Electric, Kansai Electric, Osaka Gas, Kyushu Electric and Nippon Steel. The ex-ship sales price was divided into an "LNG Element" based on crude oil export prices and a "Transportation Element," with the LNG Element being a minimum LNG price of $0.99 per MMBtu, escalating at an agreed rate, and the Transportation Element being $0.30 per MMBtu, escalating based on changes in seller's actual cost of transportation payable to its transporter.
The fixed prices achieved by LNG buyers during the 1960s were gone. The Japanese buyers were instead more focused on guaranteeing a steady, safe supply and were less concerned about price volatility. Furthermore, unlike the Alaskan LNG SPA signed only six years prior, this LNG SPA did not contain a commitment to Japanese arbitration and governing law. The Indonesia LNG SPA reflected the negotiating leverage of the sellers; the governing law of the LNG SPA was New York law and any arbitration was to be held under the ICC arbitration rules in Paris. The first Indonesian cargo was delivered from the Bontang plant to Osaka on 19 August, 1977.
The complex financing of Indonesia's Arun and Bontang projects totaled $1.638 billion and involved considerable Japanese government support, including by a new Japanese entity, JILCO. The Japanese government made loans from the Overseas Economic Cooperation Fund to the Indonesian government and Pertamina. The Japanese government's Ex-Im Bank (JEXIM) and a group of associated commercial banks loaned the bulk of the project financing funds to JILCO, with 60% of these guaranteed by JNOC, a Japanese state-owned oil and gas company, and 40% guaranteed by the consortium of five major buyers, which had support from the Ministry of International Trade and Industry (MITI) in the form of overseas investment insurance. JILCO then loaned money for project development to Pertamina. Payments for LNG from the five buyers were sent to a trustee in New York for disbursement.
Demand for LNG in Japan grew from around 17 MTPA in 1980 to more than 45 MTPA in 1990, largely due to a sharp increase in gas-powered electric generation. This demand was instrumental in facilitating the development of export projects in Malaysia and Australia.
In the early 1980s, Japanese buyers supported the development of the MLNG Satu export project, Malaysia's first LNG export project. JEXIM provided loans to Petronas and Mitsubishi, who were two of the project's four sponsors.
In May 1985, five Japanese power companies and three Japanese gas companies signed LNG SPAs for the Northwest Shelf project, the first Western Australia export project. Japan Australia LNG (MIMI) Pty Ltd, a joint venture between Mitsubishi and Mitsui, was one of the six project sponsors. Unusually, the venture was established as an unincorporated joint venture, and, as a result, gas competition issues influenced the structuring approach to the final LNG SPAs. For instance, for the first time, multiple participants in one joint venture chose to execute separate, parallel LNG SPAs with each buyer.
A total of 48 separate contracts were negotiated between the parties but they were almost identical and in practice they functioned as one. Each of the multiple LNG SPAs deemed a portion of each commingled cargo to be from the respective seller. The contracts also had an atypical LNG price clause that evolved into a series of rolling five-year pricing agreements. Shipping was provided by the sellers but included a "complicated arrangement… [whereby] Japanese ship owners chartered two ships into the NWS project and they became the sellers' ships, and both the ships were built in Japan." The project's first shipment to Japan occurred in July of 1989.
In addition to these innovative structuring approaches, an important safety and liability development arose when the initial Japanese FOB buyers from Indonesia insisted that a liability regime for LNG accidents at the loading port be incorporated into the LNG SPA. In the 1981 Indonesian SPA, Pertamina and the Japanese buyers agreed to detailed principles for determining the liability of the "shoreside interests" and the "LNG vessel interests" in the event of an LNG "incident."
These LNG SPA principles obligated the parties to agree to separate "Omnibus and Waiver Agreements," governed by English law and subject to the jurisdiction of the High Court of Justice in London, overriding the existing Conditions of Use that the Master of the LNG vessel was required to sign upon entry of the vessel into the Indonesian port. Under these port liability principles, the parties set the liability limit of the LNG vessel owner at $150 million, an amount much higher than would otherwise apply under law. A similar contractual approach to establishing port liability has thereafter been implemented in numerous ports globally.
A number of Japanese companies were instrumental in bringing Qatar's Ras Laffan LNG project to life. The project sponsors were QGPC (70%) and Mobil (30%). Mobil had established a close relationship with the Japanese trading house Nissho Iwai in relation to the marketing of LNG from Indonesia's Arun plant and Mobil quickly elected to bring in Nissho Iwai and other Japanese trading companies to assist in marketing of RasGas LNG. A separate class of shares was established for Nissho Iwai and Itochu, and Nissho Iwai and Itochu together provided QGPC with $864 million in loan commitments and other financial assistance in order to enable the state-owned company to meet its share of the RasGas project costs.
Qatargas was able, with the assistance of Mitsui, to secure an LNG SPA with Chubu Electric in May 1992 (governed by New York law and providing for arbitration under ICC arbitration rules in Geneva). Japanese financing supported the LNG plant; Japanese lender JEXIM supplied $1.6 billion via an intermediate financing company that was guaranteed by the two Japanese sponsors. While Japanese limitations on financing were satisfied since the borrower from JEXIM was a Japanese company, the funds were simultaneously lent on by the borrower to Qatargas. Although front-end engineering work had been completed in Houston by US construction contractor, MW Kellogg, the final EPC was awarded in May 1993 to Japanese contractor Chiyoda.
During the 1980s and early 1990s, Japan also dominated the LNG vessel building business. Between 1993 and 1994 Japanese companies constructed 10 of the 13 LNG vessels built during this period. Japan has since been overtaken by both Korean and Chinese ship yards. Some Japanese LNG buyers have acquired substantial LNG vessel fleets for their FOB LNG sales into Japan.
Over the course of time Japanese LNG buyers and electric power companies recognized that there were benefits to extending their participation beyond LNG purchase to participation in LNG export projects. In this capacity they are sometimes described as "strategic investors." The perceived benefits include influence over the destination of LNG sales and the administration of the LNG SPAs from a seller's perspective, and generally managing project risks.
A number of Japanese companies are involved in the Sakhalin 2 LNG project, which was developed from the mid-2000s. Nine of the 12 LNG buyers from Sakhalin 2 are Japanese. Chiyoda Corporation and Toyo Engineering Corporation were involved in the construction of the plant. Mitsui Sakhalin Holdings B.V. (a subsidiary of Mitsui) and Diamond Gas Sakhalin (a subsidiary of Mitsubishi) have a 12.5% and 10% interest, respectively, in the project company, Sakhalin Energy Invest Company.
In June 2008, Sakhalin Energy signed Russia's largest project finance deal, securing a loan of $5.3 billion from the Japan Bank for International Cooperation (JBIC) and a consortium of international banks. JBIC provided $3.7 billion of the funds. The first cargo of LNG was delivered from Sakhalin in March 2009.
2010s, Today and Beyond
On the buying side, Japanese demand for LNG rose sharply in the wake of the 2011 disaster at the Fukushima No.1 nuclear power plant (NPP), which resulted in LNG being highlighted as a key alternative for meeting Japan's energy needs. Since September 2013, all of Japan's 48 viable nuclear reactors have been offline.
Japan is looking to exports from the US in the hope of securing long term LNG supply at lower prices. One of the most significant factors driving Asian (including Japanese) demand for US LNG is price. Historically the price of LNG under Japanese LNG SPAs has been linked to the price of crude oil using the Japan Crude Cocktail (JCC) index. In contrast, in the US, LNG is priced according to the Henry Hub price index, which is determined by supply and demand for natural gas in the US. The price differential between JCC and Henry Hub is significant, although the export price increment is, in part, a product of the associated liquefaction, processing and pipeline transportation costs. Some commentators believe that even if the price of US LNG is linked to Henry Hub by the time high liquefaction and transportation costs are added the delivered price will be close to the conventional JCC delivered price of LNG.
Of the US LNG export projects that have been granted non-FTA export licences the following have signed agreements with Japanese buyers:
Freeport (Texas): Liquefaction tolling agreements with Osaka Gas and Chubu Electric (Train One) and Toshiba (Train 3);
Dominion Cove Point (Maryland): Terminal service agreement with Sumitomo. Sumitomo and Kansai Electric Power have entered into a Heads of Agreement for the sale of LNG from Cove Point by Sumitomo; and
Cameron LNG (Louisiana): Heads of Agreement with Tohoku Electric Power, and Toho Gas has signed a 20-year sale and purchase agreement with Mitsui for LNG produced at the Cameron LNG project. A Mitsubishi/Nippon Yusen Kabushiki Kaisha joint venture and Mitsui & Co are investors in Cameron LNG, each having a 16.6% interest, and have contracted for liquefaction capacity.
Long term LNG SPAs with Japanese buyers have also underpinned recent non-US LNG export projects including Indonesia's Donggi-Senoro (Chubu Electric 1.0 MTPA and Kyushu Electric 0.3 MTPA), and PNG LNG (TEPCO 1.8 MTPA and Osaka Gas 1.5 MTPA). In addition to long term LNG SPAs, Japanese companies are increasingly active in the growing global LNG spot market.
On the LNG export project development side, an increasing number of Japanese companies are taking an equity stake in LNG projects. Today the following Japanese companies own interests in existing LNG export projects:
Inpex: Australia Darwin (11%), Indonesia Tangguh (7.8%);
Itochu: Oman Train 1 (0.9%) and Train 2 (3%), Qatar Ras Laffan (R) 1: T1 & T2 (4%);
JX Nippon: Indonesia Tangguh (13.5%);
Kansai Electric: Australia Pluto (5%);
LNG Japan: Qatar Ras Laffan (R) 1: T1 & T2 (3%), Indonesia Tangguh (7.4%);
Marubeni: Equatorial Guinea (6.5%), Qatar Ras Laffan (Q) 1: T1 & T2 (7.5%) T3 (7.5%), Peru (10%);
Mitsubishi: Oman Train 1 (2.8%) and Train 2 (3%), Australia Withnell Bay Trains 1-4 (8%) and Train 5 (8%), Brunei (25%), Indonesia Tangguh (9.9%), Indonesia Bintulu 1 (5%), 2 (15%) and 3 (5%), Sakhalin 2 (10%);
Mitsui: Equatorial Guinea (8.5%), Abu Dhabi (15%), Oman Train 1 (2.8%), Qatar Ras Laffan (Q) 1: T1 & T2 (7.5%) T3 (7.5%), Ras Laffan (Q) 3: Train 1 (1.5%), Australia Withnell Bay Trains 1-4 (8%) and Train 5 (8%), Indonesia Tangguh (2.3%), Sakhalin 2 (12.5%);
Osaka Gas: Oman (3%);
Tokyo Electric Power: Australia Darwin (6%); and
Tokyo Gas: Australia Darwin (3%), Australia Pluto (3%).
A number of Japanese companies have been instrumental in making many of the LNG export projects that are under construction a reality, particularly the new Australian projects. For example, on the West Coast of Australia Inpex is leading the Ichthys LNG project, which has entered the construction phase. The Australian subsidiaries of Tokyo Gas, Osaka Gas, Chubu Electric Power and Toho Gas are also project sponsors. Inpex's wholly owned subsidiary, INPEX Shipping Co, will own one LNG vessel via a joint venture with Kawasaki Kisen Kaisha, Ltd. JBIC is providing a loan of up to $5 billion to support the Ichthys project.
Also in Western Australia, the Gorgon project joint venture includes Osaka Gas (1.25%), Tokyo Gas (1%) and Chubu Electric Power (0.417%). On Australia's East Coast, Tokyo Gas is both a sponsor of the Queensland Curtis LNG project (2.5%) and an LNG buyer. In nearby Papua New Guinea, Nippon Oil has a 4.7% interest in PNG LNG.
The appetite of Japanese companies for investment in LNG projects does not appear to be waning. There is significant Japanese representation in many of the proposed export projects. Mitsui, for instance, has an interest in the proposed Mozambique project and JAPEX has a stake in Canada's proposed Pacific North West project.
Today you do not need to look far to see evidence of the far-reaching role of Japanese companies across the entire LNG supply chain. Japanese companies have used creative strategies to develop and adapt to the ever-changing and evolving global LNG industry. Recent examples include:
The alliance between four large Japanese shipbuilders, Mitsubishi Heavy Industries, Kawasaki Heavy Industries, Mitsui Engineering & Shipbuilding and Imbari Shipbuilding, to bid to win orders to transport shale gas-based LNG from the US, notably the Cameron project;
A joint venture between Japanese heavy machinery manufacturer IHI and a Chinese EPC contractor to supply LNG tanks for a floating storage and regasification unit;
The integration of the thermal power system operations of Mitsubishi Heavy Industries and Hitachi to service the LNG industry;
Japan Oil, Gas and Metals National Corporation (JOGMEC), an Independent Administrative Institution of the Japanese government, has provided equity capital to support the development of the Wheatstone, PNG, and Ichthys projects which are under construction, and the proposed Mozambique LNG project; and
Idemitsu Kosan and AltaGas formed a joint venture in 2013 to pursue LNG export opportunities from Canada to Japan.
There is some uncertainty about how LNG will contribute to Japan's future energy mix. This is partly because the impact on the LNG industry of nuclear restarts in Japan later in 2014 is as yet unknown. Further the Japanese government continues to develop policy on sources of energy supply to Japan going forward. Citibank, amongst others, has forecast a steady fall in Japanese LNG demand from 2015. Nonetheless, LNG will continue to be a major energy source for Japan and Japanese companies will continue to play a very important role in the global LNG industry.