Energy wars: Russia threatens to cut off Japan’s gas lifeline

Japan is peculiarly vulnerable to the threat of being cut off from Sakhalin-2’s gas, which currently supplies about 4 per cent of its overall gas requirements. Resource-poor Japan imports about 90 per cent of its gas needs.

It is currently in the grip of a particularly acute energy crisis. Soaring oil and gas prices since the Russian invasion of Ukraine have been compounded in Japan’s case by the divergence of its monetary policies – negative policy rates and a zero per cent cap on long-term bond yields – from the rising interest rates and quantitative tightening occurring in the US.

The value of the yen relative to the US dollar has plummeted to its lowest levels in nearly quarter of a century. As oil and gas are priced in US dollars, that has significantly exacerbated the surge in its energy costs.

Japan buys Sakhalin-2 gas under long-term contracts at relatively low prices because of its proximity to the project, which is in Russia’s far east. That explains why Japan’s government has said it has no plans to leave the project, which it describes as extremely important to its energy security.

Japan has, however, joined the West in imposing sanctions on Russia and Russian individuals and is supportive of the recent G7 plan to impose a price cap on Russia’s oil exports (and possibly its gas and coal) at about half the international market price.

The decree appears to be retaliation for that support, which drew a threat this week from former Russian president, Dmitry Medvedev, that Japan would be kicked out of the project and be cut off from supplies of Russian oil and gas if a price cap were imposed, which suggests that the Putin decree is designed to exert leverage on Japan to coerce it to shift its stance and fracture the G7 unanimity.

With the Europeans competing fiercely for the limited supplies of spot market LNG that would otherwise have been sold into Asia the problem for Japan if its access to Sakhalin-2 gas is cut off is that there isn’t enough gas available in the global market to replace the gas it buys from Russia.

Whatever the course and outcome of the war in Ukraine, global energy markets will be permanently transformed by it – and Russia’s key pre-invasion role in them significantly diminished.

Tearing up the contracts with Japan wouldn’t, however, be costless for Russia, given that Japan accounts for nearly half the exports from Sakhalin and the sanctions and the logistics of redirecting the gas would complicate efforts to find alternate buyers.

An alternative would be to force Japan, as it has done to some European buyers, to pay for the gas in roubles, supporting its currency, circumventing financial sanctions and helping to fund the war.

It was always a possibility that Russia would expropriate the Russian assets of foreign companies whose governments have backed the sanctions or those, like most of the oil majors, that have shut down or announced plans to exit their Russian businesses in response to the invasion.

Indeed, legislation has been proposed, but not yet enacted, that would give the Russian government the legal authority to nationalise foreign-owned assets without compensation. At some point in future, that could lead to messy and protracted litigation if the foreign companies try to gain compensation.

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Within the Putin decree, the proceeds from any sale of the foreign interests in Sakhalin-2 would be deposited in special Russian bank accounts, not available to the exited shareholder, and used to repay the “damage” to the project caused by the foreign investors. Under the decree, any disputes relating to the new corporate entity would be decided by Russian courts.

The threat of being cut off from Sakhalin-2’s gas, a threat latent since the start of the war, is accelerating Japan’s efforts to encourage renewable energy supply while also generating pressure on the government to restart nuclear reactors that were mothballed after the 2011 Fukushima disaster.
Whatever the course and outcome of the war in Ukraine, global energy markets will be permanently transformed by it – and Russia’s key pre-invasion role in them significantly diminished.

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