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Energy

Japan fears China-Russia LNG alliance after Shell exits Sakhalin-2

Tokyo could see its import quotas reduced under new ownership

A Japanese-made liquefied natural gas carrier anchored near an LNG plant on the Russian island of Sakhalin.   © Reuters

BEIJING/TOKYO -- Energy giant Shell's reported talks with Chinese companies over its stake in the Sakhalin-2 project raise energy security concerns for Japan as possible Moscow-Beijing dominance in the project could end up reducing Japan's liquefied natural gas access.

Sakhalin-2, Russia's first LNG project, is operated by Russian gas giant Gazprom, which holds a roughly 50% stake. Shell, the No. 2 shareholder with a 27.5% stake, is reportedly holding joint talks with China National Offshore Oil Corp., China National Petroleum Corp. and China Petrochemical Corp. to sell its entire interest, according to U.S. and British media.

The London-listed company said in February that it would exit from the project, after Russia's invasion of Ukraine triggered international sanctions.

Japanese trading houses Mitsui & Co. and Mitsubishi Corp. also hold 12.5% and 10%, respectively, making Sakhalin-2 a crucial project for energy-starved Japan.

Sakhalin-2's export quotas do not correspond to the sizes of the investments. Of the 10 million tons it produces annually, roughly 60% is bound for Japan. The project accounts for almost all of Japan's LNG imports from Russia and about 10% of Japan's overall LNG imports.

About 20% of Sakhalin-2's LNG is purchased by South Korean energy companies under long-term contracts. Chinese companies also purchase a portion on the spot market.

The talks with CNOOC, CNPC and Sinopec -- as the three Chinese state-owned enterprises are known -- are in early stages and could fall through. Representatives from Shell and CNPC declined to comment on the reports of the negotiations.

Shell has not told the other Sakhalin-2 shareholders when and how it plans to withdraw from the project. Apart from Chinese enterprises, multiple energy companies have shown interest in Shell's stake.

Shell would need approval from Moscow before it can sell its stake in Sakhalin-2.

Now that much of the international community has turned against Russia, "the only likely buyers will be Chinese or Russian companies," a source at a major Japanese power company said.

Even if China and Russia end up owning a majority of Sakhalin-2, "the long-term contracts will be honored," a source at a Japanese trading company said. "The business impact on Japan will be limited for the time being."

Japanese energy importer JERA, a 50-50 joint venture between Tokyo Electric Power Co. Holdings and Chubu Electric Power, procures more than 1.5 million tons of Sakhalin-2 LNG annually under a 20-year contract starting from 2009.

A change in ownership would normally be unlikely to affect JERA's contract. But with Russia currently at war with Ukraine, uncertainty remains.

The expiration of current contracts heightens the risk of Japan losing energy access. A number of long-term contracts struck by Japanese companies will expire in or around 2030.

Even assuming that Mitsui and Mitsubishi hold on to their Sakhalin-2 stakes, Chinese and Russian companies may have a bigger say over new long-term supply contracts. This may lead to a reduction of Japan's share in LNG supplies.

That companies in authoritarian countries are involved in Japan's LNG procurement also raises energy security concerns.

Procuring LNG from Sakhalin-2 is far cheaper than purchasing it on the spot market. Without Sakhalin-2, the Japanese public may face additional energy costs to the tune of trillions of yen (1 trillion yen equals $7.79 billion) a year. Electricity and gas bills could be pushed up further.

At this stage, Mitsui and Mitsubishi have shown no indication of leaving Sakhalin-2.

"We're concerned that if Japan exits the project and if interests are acquired by Russia or a third country, that would benefit Russia and would not amount to effective sanctions," Koichi Hagiuda, the Japanese minister of economy, trade and industry, told reporters Friday.

A Japanese company involved in energy will find itself in a difficult position to exit a project independently if such a decision will affect national policy. At the same time, Japan paid about 370 billion yen for Russian gas in 2021. A company that maintains substantial business operations in Russia risks undermining the effectiveness of the sanctions.

For Japan to beef up energy security, policymakers will be tasked with exploring other options, such as diversifying energy supplies, expanding renewable energy sources and restarting idled nuclear plants. The Ministry of Economy, Trade and Industry has formed a new organization to study approaches to ensure stable supplies of energy and rare metals.

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