Japan Strives to Balance Energy Needs with World Politics

As much of the world grapples with higher oil prices, no industrial country is as vulnerable to rising energy costs as Japan. Almost entirely dependent on foreign oil, Japan has focused on conservation and alternative fuels, but recently has begun to push hard to get new access to overseas oil.

Wharton faculty and energy analysts say Japan’s new posture has led to tensions with other countries, including the United States, forcing Japan to maintain a delicate balance between geopolitics and its energy needs. “It seems that Japan has become more aggressive in the past year when it comes to seeking new sources of oil,” says Wharton finance professor Ayako Yasuda.

Energy demand in Japan is not expected to increase dramatically due to an aging population and changing patterns of industrial production. However, rising competition for global resources from China and other emerging economies has put new pressure on Japan and other industrialized countries to lock up energy resources.

Japan’s new focus on developing overseas oil supplies is part of an ambitious national energy policy, unveiled this spring, that sets specific targets to reduce dependence on foreign oil while increasing nuclear power generation and energy conservation.

The policy sets a specific target to reduce the amount of oil as a share of overall energy consumption from 50% now to 40% by 2030. The government also wants to reduce the percentage of oil used in the transportation sector from nearly 100% today to 80%. In addition, the policy aims to increase the amount of oil developed and imported by Japanese companies from 15% to 40% by 2030.

Seeking Deals Abroad

Yasuda points to the creation earlier this year of a national energy exploration firm, Inpex, as a clear sign that Japan is weary of depending so much on foreign oil producers. The government owns a 30% stake in the company, which was formed from a government-sponsored merger of two energy firms. Inpex has engaged in high-profile negotiations with Iran and Russia in attempts to secure long-term energy supplies, although problems with both those deals have surfaced.

In early 2004, one of Inpex’s predecessor firms agreed to be a partner in a $2 billion development of Iran’s Azadegan oilfield. This year, however, Japan came under intense pressure from the U.S. following a United Nations resolution condemning Iran’s nuclear weapons program. Japan backed down from the project this fall, reducing its stake from 75% to 10%. “I think Japan is cautious about offending the U.S. at this point. Inpex just reduced its stake in the Iranian field sharply, having seen the political cost of clinging to its rise recently,” says Yasuda.

Jennifer Amyx, a political science professor at the University of Pennsylvania and a member of The Graduate Group in International Studies at Wharton’s Lauder Institute, says Japan is not only heavily dependent on foreign oil, but is especially tied to the Middle East, which accounts for 85% of Japan’s oil supplies. Iran is Japan’s third-largest supplier after Saudi Arabia and the United Arab Emirates.

“One big tension is dealing with Iran. The Japanese government has been more hesitant than the U.S. government to take a hard-line stance because Japan relies on Iran for 14% of its oil,” says Amyx. “This does constrain the Japanese more than the U.S.” because the U.S. at least has some oil of its own.

According to Tomoko Hosoe, an analyst at FACTS Inc., a Honolulu-based energy advisory firm, the breakdown of the Japanese deal in Iran will cost both countries. “The loss of supplies from Azadegan could be conceived as a big blow to the Japanese, but in reality we believe the loss is greater to the Iranians, as the Japanese side would have offered Iran a better option…. Iranian companies will not be able to do the job on their own and on time, given their past record,” Hosoe writes in a November report titled, “Japan’s Key Energy Issues and Supply Security Concerns.”

Another setback to Japan’s new push to secure energy abroad came in Russia. After lengthy negotiations, the Russian government this fall revoked environmental permits on a $20 billion natural gas project known as Sakhalin-2. Japanese energy companies have a 45% stake in the project. Officially, the Russians said environmental inspections were taking longer than expected, but Hosoe points out Russia’s public spending and revenue agency, the Audit Chamber, has indicated expected increases in spending targets are not justified.

Hosoe says the collapse of the Russia deal may create more problems for Japan than the failed negotiations in Iran because it will delay Japan’s efforts to diversify the origin of its energy supplies away from the Middle East.

Despite these problems, Yasuda notes, Japan is pursuing many other energy options. “Japanese government officials are keen on securing independent energy sources and continue to be creative in pursuing various projects and aiding private sector companies in winning concession rights, whether in Libya, Russia, or elsewhere,” she says. 

With diplomacy and outright investments, Japan has been reaching out to energy producers around the world. Former Prime Minister Junichiro Koizumi visited resource-rich Kazakhstan and Uzbekistan this summer, despite U.S. reservations. Japan is also focusing on Iraq as a potential new source of energy, even though it withdrew its troops from Iraq this summer. Japan is now the largest donor of aid to Iraq after the U.S., with $5 billion pledged — $1.5 billion in outright grants and the remaining $3.5 billion in soft loans. The loans are expected to go toward development of Iraq’s battered energy sector.

Oilfields in Libya

Meanwhile, Inpex plans to invest $6 billion to develop a natural gas field off the coast of northwestern Australia to generate liquefied natural gas (LNG). The company is also working on projects in Indonesia, Brazil, and the Caspian Sea. In Libya, five Japanese enterprises have acquired rights to develop six oilfields.

Yasuda points to Libya as an example of how Japan is ready to approach countries with governments that might have been considered unsavory in the past. “Libya is now on better terms in the international community, so the political cost of pursuing interests there has declined, and Japanese companies seem to be aggressively pursuing interests there,” she says.

Japan’s lack of energy resources has, for decades, led to an emphasis on nuclear power generation. The nation’s new energy policy calls for the share of nuclear power to rise from 30% to at least 40% of total power by 2030. Nuclear power is also a key to achieving Japan’s clear-air obligations under the Kyoto accords. “Japan does not have the same sources of fossil fuels as most other developed nations by virtue of its geography, and has long had to go to alternative sources of energy,” says Wharton professor of business and public policy Matthew White. “Nuclear power is just one of them, although it has been controversial there as it has in the United States and Europe.”

Hosoe notes, however, that constraints on nuclear power may be developing. In September, for the first time since 1978, government regulators have revised earthquake guidelines for nuclear power plants. The guidelines apply to new and existing plants, which may require more investment to comply with the new standards.

In addition to nuclear power, Japan relies heavily on imports of LNG. Japanese demand for LNG is expected to grow at an average annual rate of 1.6% through 2015. However, critical supplies from Indonesia, Australia, Russia and elsewhere may not keep pace with Japan’s needs, as China and other countries vie for the same resources.

Japan is now the world’s largest LNG importer, taking in 40% of total global imports, although China is expected to catch up by 2020. China began to import LNG for the first time in May with a shipment from Australia. Meanwhile, Japan and China are engaged in a territorial dispute over gas resources in the East China Sea.

“The change in the global landscape and the dramatic shifts in LNG supply availability pose a serious challenge to Japan’s energy security,” Hosoe writes. “This has emboldened the government to become more aggressive, but there are limits to what Japan can do in the face of fierce competition from emerging markets in the region. To go forward and to defend Japan’s stake, even more interventionist policies may well be needed, far beyond what the current Japanese system is willing to consider.”

Wind and Solar Power; Hybrid Cars

Japan is also experimenting with new forms of renewable energy. In August, the Tokyo Metropolitan Government issued its own strategy to increase the use of renewable energy in the city from the current 2.7% to 20% by 2020. The government has sponsored several pilot projects including wind generators in Tokyo’s waterfront and a water treatment plant run on solar power.

Wharton management professor John Paul MacDuffie says that long term, Japan’s oil shortage has prompted it to become a world leader in energy-saving technologies. Most recently, hybrid automotive technology has given Japanese automakers a boost following the increase in global oil prices.

The Japanese government has provided incentives for companies to focus on fuel economy and environmentally friendly technology because of the nation’s vulnerability to world oil shocks, MacDuffie says. However, in the case of hybrid technology, it was Japanese automakers themselves who pushed the idea. “Toyota threw down a challenge to its engineers to double fuel economy.” The company’s founding Toyoda family has long valued innovation and has been motivated by idealism and a desire to make a difference in improving society, he adds. “There is a feeling that’s the way to win global acceptance.”

Finally, conservation remains an important energy goal in Japan and is a hallmark of the new energy policy. The government has set the goal of improving energy efficiency by 30% in energy consumption per unit of GDP by 2030. “Japan has a long-standing history of scarce energy resources and has been very active in finding efficient ways to produce energy and use what it has more wisely,” says White.

The government ran a major campaign last summer to encourage the Japanese to turn down their air conditioners, Amyx notes. “There have been a number of movements like this underway in Japan, and they seem to be more effective than a U.S. campaign to get people to stop driving SUVs would ever be.”

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