Japan's oil strategy hits snags

WORLD / Wall Street Journal Exclusive

Japan's oil strategy hits snags

By YUKA HAYASHI (WSJ)
Updated: 2006-10-25 13:49

http://online.wsj.com/public/article/SB116172232390902471-eDNwgc_py5x5KbSpU
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Tokyo -- Just five months after its unveiling, Japan's ambitious 25-year
plan to sharply increase oil and gas development is hitting snags,
suggesting Tokyo may find it even harder than expected to stabilize the
nation's future energy supply.

On Monday, Exxon Mobil Corp. said it reached a preliminary agreement to
sell natural gas from a giant project off Russia's Sakhalin Island to
China, instead of to Japan as originally planned. This came several weeks
after Russia ratcheted up regulatory pressure that could jeopardize
another Sakhalin gas project in which the bulk of the planned output of
nearly 10 million tons a year -- about a fifth of Japan's current
natural-gas imports -- was destined for Japan.

Earlier this month, Iran canceled the right held by Inpex Holdings Inc.,
Japan's largest oil-development company, to participate in a $2 billion
project in the Azadegan oil field. At its peak, the project was expected
to meet as much as 6% of Japan's oil demand.

The developments are a blow to Tokyo, which had counted on the deals as a
major component of its push to expand its access to energy. Japan, whose
economy is the world's second-largest, relies nearly entirely on imports
for its oil and gas, making it vulnerable to swings in global oil prices
or political tensions in energy-producing regions.

In May, Tokyo announced a long-term strategy that urges Japanese
companies, including developers such as Inpex and trading companies such
as Mitsubishi Corp., to boost energy exploration and development around
the world to help secure a stable flow of oil and gas. Its goal: to
import 40% of its oil needs from Japanese-owned concessions by 2030, up
from the current 15%.

The strategy, while flexible, was supposed to help Japan overcome its
vulnerable position. Unlike most developed nations, Japan doesn't have a
big state-run oil firm or powerful private oil companies with stakes in
the world's largest oil fields. That has forced Japan to cobble together
oil and gas supplies from small Japanese companies that could invest only
in small-scale projects, sometimes in politically risky areas such as
Libya or Iran. Japan is Iran's largest foreign oil customer, purchasing
581,000 barrels of crude a day last year, or 14% of Japan's total oil
imports.

Expanding Japan's activity overseas is proving increasingly difficult, as
energy-rich nations, empowered by rising fuel prices over the past
several years, flex their muscles to get better deals. What's more, other
fuel-hungry nations such as China are eager to one-up Japan, snatching
away deals Tokyo thought it had locked up and competing fiercely for new
projects.

"Both Azadegan and Sakhalin were to represent big chunks of Japan's
energy supply," says Koichi Iwama, a Wako University professor and a
governmental adviser on energy issues. "Without these projects, it would
simply be impossible to reach the target." Mr. Iwama says Japan should
rethink its long-term energy strategy, expanding the role of the
government or possibly setting up a state oil company.

The projects in Russia and Iran are a stark reminder of the challenges
Japan faces. In September, the Kremlin began meddling in a Sakhalin gas
project led by Royal Dutch Shell PLC that also involved two Japanese
trading companies, Mitsubishi Corp. and Mitsui & Co. The government has
accused Shell of violating environmental standards and threatened to pull
its permits.

But industry experts speculate Russia wants to renegotiate the pact to
give it a bigger share of the output. The initial contract was signed in
the 1990s, when oil prices were low and energy-producing nations had to
sweeten their offers to entice foreign oil companies to develop fields.

In Iran, Inpex had faced a series of obstacles since it signed a contract
in 2004 with the National Iranian Oil Co. that gave it a 75% stake in the
giant Azadegan field and the right to lead the development. Washington,
which had tightened sanctions on Iran in the 1990s in response to
Tehran's efforts to acquire nuclear expertise and reputed support for
terrorist groups, griped about Japan's involvement. Inpex went ahead with
negotiations anyway, but repeatedly asked Iran to postpone the deadline
for concluding a deal, hoping the political tensions would ease.

Instead, the situation got worse. What's more, Inpex's hopes of reaping a
profit from the project dwindled. The United Nations Security Council is
considering whether to impose further sanctions to pressure Iran to give
up its uranium-enrichment program, which the U.S. and others say is a
precursor to atomic-weapons production and the Iranians claim is for
civilian energy use. If sanctions are imposed, the Japanese government
would have to halt its plans to provide loans and low-cost trade
insurance. That would make it difficult for Inpex to raise enough money
to fund the project, let alone make it profitable.

Iran, for its part, grew increasingly impatient with Japan's slow
response. In August, Iranian officials threatened to give the Azadegan
project to China or Russia. In early October, Inpex lost its operator
status and its stake was cut to a token 10%. Inpex says discussions over
project details are continuing,but won't comment further.

Despite the recent difficulties, some experts say Japan should continue
seeking new projects to develop. Indeed, it has no choice, says Masahisa
Naito, chairman and chief executive of the Institute of Energy Economics
Japan, a government-affiliated research group. "It's such an important
element if we want to secure a stable energy supply," he says.

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