The administration of Prime Minister Fumio Kishida has been at pains over recent weeks to emphasize its commitment to the Sakhalin-1 and Sakhalin-2 energy projects with Russia. Both multinational ventures invest in oil and gas imports produced in Russia’s Far East, with Japanese imports from Sakhalin-1 weighted more toward oil and Sakhalin-2 toward liquefied natural gas (LNG).
However, as other Group of Seven countries and private enterprises step up efforts to oppose Russia’s ongoing war in Ukraine, Japan’s involvement in the Sakhalin-1 project is now under particular scrutiny.
Following a virtual meeting of G7 leaders in early May, Kishida told reporters that Japan would join other nations in gradually phasing out Russian oil. The government would conduct the move “in a manner that minimizes adverse effects on people’s lives and business activities,” he said, “but we plan to keep our interests (in the two Sakhalin projects) unchanged.”
Both Sakhalin energy agreements are highly advantageous for Japan. As long term contracts, they are unaffected by fluctuations in the market prices for oil and gas, which amid the present geopolitical climate and heightened competition for limited resources are highly inflated. Until Russia’s invasion of Ukraine on Feb. 24, the agreements were also considered extremely reliable — the government’s long-term answer to the instability of Middle Eastern oil supplies, which has been a recurring issue since the first oil shock of the early 1970s.
Big Oil acted swiftly and decisively in response to the Ukraine invasion: BP, Shell and Exxon Mobil all walked away from huge Russian energy contracts worth billions of dollars. Given that the reputational risk of association with Russia is extremely high both geopolitically and for Japanese businesses, the government must now decide if the obvious cost benefits of remaining in the Sakhalin energy projects outweigh international pressure to sever ties with Russia.
Essential source
Japan imports roughly 8% of its LNG supply from Russia’s Sakhalin-2 project. Compared with the EU, where Russian supply accounts for 40% of total LNG imports, the relatively low percentage makes Japan far less vulnerable to the severe energy poverty that a variety of European countries would face if they lost access to Russian gas.
However, Japan boasts no outside electricity providers, meaning that LNG is not only processed for heating, but for over a third of the country’s electricity supply. Japan also possesses a limited LNG storage capability of only two to three weeks' worth of reserves, meaning that the electricity grid is stretched thin during periods of high use, and is therefore vulnerable to outages.
With summer just around the corner and a spike in usage inevitable as the nation turns to air conditioning to escape the heat, a sudden loss of Russian LNG could lead to considerable energy disruption.
Exiting the Sakhalin-2 contract would result in a major revenue hit to suppliers as Japan enters into competition with energy-strapped European countries, driving up the global market price of LNG even further. Facing the prospect of being pushed into the red, suppliers would likely pass costs onto the consumer.
With the Upper House election looming in the summer, the precipitous rise in energy prices is already a potential banana peel for Kishida as he attempts to build on an impressive start as premier with a convincing win for the ruling Liberal Democratic Party. And given that there are very few non-Russian LNG suppliers possessing the requisite combination of both capacity and willingness to share, resource-poor Japan appears to have few viable alternatives.
“This makes Sakhalin-2, with its focus on gas, a red line that the government is very unlikely to cross without dire circumstances,” said Yuriy Humber, CEO of research company Yuri Group. “It is not just the gas that Japan would be losing, but the decades that went into securing contracts for what was thought to be a secure supply, the tech and innovation costs, the years of financial planning and investment.”
The government would also be handing over a considerable cost advantage to other regional players, namely China and India, with both countries likely happy to fill the space vacated by Japanese investment. This is something that, from a global security and competition standpoint, Humber contends, Japan would be “extremely loath to do.”
Growing uncertainty
While experts believe that there is currently little chance Japan will walk away from the gas-focused Sakhalin-2, Japan’s continued involvement in Sakhalin-1 is increasingly up for debate. This is mainly due to the fact that the Sakhalin-1 project focuses on the extraction and supply of crude oil.
Russian supply accounts for just 4% of Japan’s total oil imports. And while Japanese firms are reluctant to offset any Russian deficit by increasing their reliance on Middle Eastern oil — which currently accounts for 90% of supply — the country’s largest refiner, Eneos Holdings, has said that it intends to “get alternatives from existing trading partners” before eventually diversifying its supply chain.
Comprising multiple international business interests, the Sakhalin-1 project will lose the backing of its principal development partner Exxon, as confirmed by the U.S. oil and gas corporation in early March. On May 6, the Japanese trading house Marubeni — which owns a 12.3% stake in government-led consortium SODECO, itself a 30% owner of the Sakhalin-1 project — announced that it would freeze all further transactions with Russia in order to limit its exposure to the country.
It remains to be seen whether Marubeni’s stance will open the door for other Japanese companies wishing to walk away from their Sakhalin-1 contracts, particularly while the government line remains fixed on maintaining that particular aspect of Japan's relationship with Russia.
However, with the exit of project operator Exxon, alongside the reputational risk of association with Russia for carriers, Japanese companies could experience difficulty sourcing the tankers and ice vessels necessary to import supplies from Sakhalin-1, which may then prompt some to follow suit.
Ultimately, the decision will likely come down to what the government feels comfortable giving up, and how it decides to balance the nation’s own energy interests against a need to match G7 partners in boycotting Russian supplies.
“If the war in Ukraine continues, we could see a situation where the Sakhalin-1 project is sacrificed in order to save Sakhalin-2,” said James Brown, a political scientist at Temple University, Japan. “It would be more of a possibility given that a loss of Russian oil is not the risk to overall energy supplies we would see with the loss of Russian LNG.”
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