IEEJ: September 2012 All Right Reserved

Special Bulletin
A Japanese Perspective on the International Energy Landscape (98)

August 10, 2012

A New Development for Japan’s Procurement of U.S. LNG
Ken Koyama, PhD
Chief Economist, Managing Director
The Institute of Energy Economics, Japan
In late July, a new development came for Japanese companies’ procurement of liquefied
natural gas from the United States. In their press release on July 31, Osaka Gas Co. and Chubu
Electric Power Co. stated that they had executed binding liquefaction tolling agreements with asubsidiary of Freeport LNG Development, L.P.
Under the agreements, Osaka Gas and Chubu Electric will each acquire an annual LNG
production capacity of 2.2 million tonnes at a train of a new natural gas liquefaction facility to bebuilt in Freeport, Texas. The facility is projected to have a total of three trains, each with an annual
capacity of 4.4 million tonnes. The facility will be constructed at the Freeport LNG terminal thatFreeport LNG Development now owns and operates. The terminal, which has been built forimporting LNG, now includes an LNG receiving berth, an LNG tank and an LNG regasification
system. Given the sharp change in U.S. gas supply and demand conditions after the “shale gasrevolution”, however, Freeport LNG Development has been planning to build a gas liquefaction
facility for LNG exports. In a manner to join the plan, Osaka Gas and Chubu Electric reached theagreements.
Under the plan, Freeport LNG Development will proceed with the construction of thenatural gas liquefaction facility and work to obtain approval by the U.S. government (including theDepartment of Energy) on LNG exports to Japan and other countries that have no free tradeagreements with the United States. The two Japanese firms plan to start LNG procurement in 2017.
If the project is successful, Osaka Gas and Chubu Electric will procure some 30% and 20% of theirrespective FY2010 LNG imports from a new source under a new LNG pricing system based on U.S.
Henry Hub prices.
I here would like to discuss the significance of the new development for LNG procurementfrom the United States to the two Japanese firms and the whole of Japan.
First, the deal to import U.S. LNG from a new source will contribute to securing a newLNG supply source and diversifying LNG import sources for stable LNGprocurement. As notedabove, securing the new supply source and diversifying supply sources are clearly important for the1IEEJ: September 2012 All Right Reserved
two companies. For the whole of Japan, successful LNG imports from the United States under thedeal will be coupled with other Japanese companies’ North American LNG procurement projects todiversify LNG supply sources. Of Japan’s LNG imports (totaling 83.18 million tons) in FY2011,
Malaysia accounted for the largest share of 18%, Qatar for 17%, Australia for 16%, Indonesia for10%, Russia for 9%, Brunei for 7%, the United Arab Emirates for 7% and Oman for 5%. The eightlargest LNG exporters to Japan covered about 90% of Japan’s total LNG imports. LNG procurement
under Freeport and other U.S. LNG projects involving Japanese companies will cause a majorchange in Japan’s LNG import mix. For the entire world, U.S. LNG projects are significant for theexpansion of LNG supply capacity to meet a rise in LNG demand.
Second, the deal is significant in that it will introduce a new pricing system for Japan’sLNG procurement. As mentioned above, the deal adopts the U.S. hub-linked pricing system insteadof the traditional Japanese LNG import pricing system linked to Japan’s crude oil import prices.
Given Henry Hub gas prices and Japanese LNG import prices at present, LNG imports under thedeal could cost 20-30% less than those under the existing contracts in average. The latest deal may
thus contribute to improving Japan’s price competitiveness in LNG procurement. Since market
prices fluctuate always, however, the price advantage under the deal cannot be guaranteed. Despite
the price advantage, the deal may not necessarily substantially reduce overall LNG procurement
costs for the two companies as far as most of their LNG imports are based on the existing contracts.
But the introduction of the new competitive pricing system at present may contribute to lowering
LNG procurement prices under other deals and may be significant for discussions on the pricing
system for the existing deals. For the buyers, the additional LNG procurement and the new pricing
system under the new deal will be significant for improving their bargaining power and hedging
risks through the diversification of their LNG portfolios.
Third, it is characteristic and significant that the Japanese electric and gas utilities havecooperated in clinching the deal for direct LNG procurement. The deal thus meets the promotion ofresources users’ involvement in upstream resources development phases as one of the five principles
under the resources security strategy that was released by the government in June. It can also beinterpreted as representing joint procurement that has been considered as one of Japan’s measures toenhance stable LNG procurement. Although electric and gas utilities had formed consortia fortraditional LNG procurement, they have recently tended to individually procure LNG under theelectricity and gas market deregulation. Under such situation, the possible joint procurement hasbecome subject to consideration as one measure to enhance procurement capabilities. In this sense,
we can interpret the deal as indicating that the two LNG user companies, which can pursue commoninterests, have joined hands to participate in the specific project and contributed to clinching the deal
as foundation buyers. They have made actual joint LNG procurement efforts. We can also take thedeal as representing a new successful approach for enhancing Japanese companies’ LNG
procurement capabilities.
We have thus seen a new development that is very significant. The deal still has some2

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challenges including the construction of the gas liquefaction facility and the pending acquisition ofthe U.S. government’s approval on LNG exports to countries having no FTAs with the United States.
If the project is implemented successfully with the challenges solved, the deal will bear significant
fruit. As the deal is very significant for securing stable energy supply in Japan, we may have toclosely watch future developments of Freeport and other projects for Japan’s LNG procurement fromthe United States.

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