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Japan's Energy Vulnerability After the Nuclear Disaster

Kawasaki natural gas power station in Japan's Kanagawa prefecture - TOSHIFUMI KITAMURA/AFP/Getty Images

Energy demand in Japan is nearing that of before the country’s March 2011 nuclear disaster, but its power generation, largely dependent on nuclear energy, is still low. Liquefied natural gas may be Japan’s second-best option, but its adoption will be subject to severe limitations and will increase Tokyo’s energy security vulnerability.

Analysis

The aftermath of the March 2011 nuclear disaster in Japan caused a sharp decrease in the country’s energy demand. The damage to the country’s nuclear reactors, supply chains and energy infrastructure led energy consumption to drop by 10 percent year-on-year in November 2011. Nearly a year after the incident, Japan’s energy demand is nearing previous levels, but its output remains low, forcing it to look to other energy sources to meet domestic demand.

Japan appears to be looking to natural gas, specifically liquefied natural gas (LNG), to compensate, increasing LNG imports by 27 percent year-on-year in January 2012 and receiving imports from new sources such as Qatar and Russia. However, there remain serious limitations for natural gas-derived power to supplant Japan’s reliance on nuclear energy. Moreover, despite current debates on the viability and safety of its massive civil nuclear power industry, nuclear energy will remain a fundamental pillar of Tokyo’s energy independence and security strategy.

Importance of Nuclear Power

Before the disaster, nuclear energy was fundamental to Japan’s energy security. As a resource-poor island, the difficulty in importing energy adds to already high prices. Also, Japan’s supply chain of the requisite radioactive chemical element and isotope inputs for nuclear power was relatively secure, with allies such as the United States, France and the United Kingdom being major suppliers of the uranium necessary to fuel Japan’s civil nuclear power program. Japan was only meeting about 16 percent of its energy demand through domestic production before the disaster, and 30 percent of that production came from nuclear energy.

The nuclear disaster cut Japan’s total power-generating capacity, which includes nuclear, coal, petroleum and natural gas, by almost 25 percent. Only two of Japan’s 54 power-generating nuclear reactors are currently online, and aging nuclear plants are still up for review, with all of the country’s reactors set to go offline by April. Moreover, short- and long-term plans to increase Japan’s nuclear power generation, such as increasing nuclear power’s share of electricity generation to 50 percent by 2030, are likely to be pushed back amid strong public opposition to nuclear energy. Such opposition has led to talk of implementing a 40-year operational cap on older plants.

Thus, Tokyo is facing the need to diversify its energy import sources, but there are strong limitations and vulnerabilities to substantially increasing Japan’s use of natural gas, crude and thermal coal.

Benefits and Limitations of LNG

Japan’s imports of LNG have increased more than other energy sources since the nuclear crisis. It is likely that spot and most likely contract-based LNG supply will continue to be the main energy source to compensate for lost nuclear power generation, with good reason: Around 40 LNG import terminals remain online in Japan, and only one small regasification terminal shut down as a result of the disaster.

However, serious limitations remain in supplanting nuclear power with LNG power generation. Japan produces only 4 percent of its consumed natural gas, making it heavily reliant on suppliers such as Malaysia, Indonesia and Australia. Japan recently has bought Qatari and Russian natural gas on spot markets, but these prices remain relatively high, and settling supply on a contractual basis will likely be less favorable to Japan on pricing arrangements. Despite the natural gas glut, LNG use in Japan remains more expensive than nuclear energy and coal as an energy source. The government has projected that costs would still be higher for LNG as opposed to nuclear energy by 2030. This makes LNG less appealing at a time when increased energy imports at higher prices contributed to Japan’s first trade deficit since 1980.

Also, despite Japan’s being one of the world’s largest natural gas importers and its numerous import terminals, its domestic natural gas pipeline network is limited, hindering its ability to efficiently move natural gas to higher-demand regions. This is partly due to geographical constraints imposed by the country’s mountainous terrain, but it is also the result of previous regulations that limited investment in the sector.

Domestic politics also play a role in limiting the potential of LNG use. The powerful nuclear lobby, led by Tokyo Electric Power Co. (TEPCO), has engendered a strong nuclear dependence and limited natural gas networks. The lobby has been successful in making nuclear dependence a reality in Japan’s energy strategy, limiting Japan’s natural gas dispersal infrastructure.

Adding to the limitations are inefficiencies in Japan’s energy networks and infrastructure. The country has two power grids, one in the southwest and one in the northeast, which are incompatible with one another. Pipeline networks may have resolved the inefficiencies in the power grid, but Japan has few natural gas-fired power plants, so its capacity for natural gas power generation is limited to 6 million tons per month — a cap it is nearing.

Sustained LNG use for power generation is a viable option only if Tokyo addresses entrenched nuclear interests and invests in necessary infrastructure, and there are signs that this may be occurring. The nuclear lobby lost considerable clout after the disaster, and TEPCO may need to be bailed out by the Japanese government, which would see a subsequent government takeover, clearing one political obstacle for broader LNG use.

Meanwhile, Japan’s Ministry of Economy, Trade and Industry is studying the possibility of installing extensive natural gas pipelines linking major cities in Japan to address network weaknesses. However, under the current circumstances, in which the supply chain, infrastructure and costs of the nuclear power industry are significantly beneficial for Japan’s energy security and independence, it will be difficult for Tokyo to make such changes that could increase its energy vulnerabilities beyond its current problems.

This article is provided courtesy of Stratfor

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How would oil prices be affected if a conflict with Iran were to break out ?

The price of a barrel of Brent could spike from current levels of around $114 to anywhere between $135 and $210 in the unlikely event of a military strike on Iran’s nuclear facilities by the US or Israel. However, this threat is itself a very powerful reason for the West to hold off. Instead, by far the more eminent risk is that near term oil prices will collapse due to an escalation of the financial crisis in the euro-zone.

Oil prices are still some way below the peaks seen during the Arab Spring. (See Chart 1 below) But they have recently been propped up by three factors:

  • renewed optimism that the crisis in the euro-zone can be contained;
  • reduced fears about the US and Chinese economies, due in part to fresh hopes of monetary easing;
  • and persistent speculation that Israel or the US is about to launch a military strike on Iran.

It is hard to quantify the relative importance of these, and other, pressures on the oil price. However, based on the price movements observed after recent news on Iran, worries about a potential conflict with the West are probably already adding between $2 and $5 to the cost of a barrel of crude.

Tensions between Iran and the US, as well as both Israel and Saudi Arabia, are unusually high and have been raised further by the latest International Atomic Energy Agency (IAEA) report on the alleged militarisation of Iran’s nuclear programme and the resulting rebuff by Iran’s envoy to the International Atomic Energy Agency (IAEA) Ali Asghar Soltaniyeh. As a global investment house, geopolitical research – provided by the likes of Stratfor is an essential ingredient of our macro-economic research in a world that is ever more connected.

Nonetheless, any military action against Iran does still appear to be a long way off. The US is struggling to disengage from Iraq and Afghanistan, was reluctant to take the lead in Libya, and has plenty to worry about in Syria and Egypt. Officials have stressed that a strike on Iran’s nuclear facilities, whether by the US or Israel, would have limited benefits but many potential costs, not least the impact on oil prices, and is therefore very much a last resort. Instead, the US is focusing on encouraging other countries to tighten economic sanctions on Iran.

However, as investors regularly ask, it is worth considering what might happen to oil prices if we are wrong. Iran produces approx 3.5m barrels per day (bpd), or 4% of global supply, second only to Saudi Arabia within OPEC. (See Chart 2.) It is unlikely that any military strike would target Iran’s oil facilities, but global sanctions or the withdrawal of supplies by Iran itself could have a similar effect. One useful rule of thumb is that the percentage increase in the oil price required to balance the market following a shock should be roughly five times the percentage reduction in supply. Correspondingly, a temporary halt to Iranian supply might add 20% (4%*5) to the price of Brent, taking it above $135 per barrel.

The impact could be much greater if Iran followed through on past threats to disrupt oil supplies through the Strait of Hormuz, the only waterway available to ship oil from the Persian Gulf. This could reduce global supply by 10-15m bpd, at least temporarily, which might lift the price of Brent to between $180 and $210 per barrel. However, the impact would be offset in part by the release of emergency stocks and there are serious doubts that Iran has the military resources to block the Strait for long.

In all this, though, it important to reiterate that we do not think that a military strike on Iran is imminent. Instead, for the next several years the more likely seismic shock is the break-up of the euro, which could see significant temporary oil price collapsing despite the long term fundamentals and unprecedented demand from the developing world. Some of our energy traders predict a $150 trading range within the next 12 months irrespective of the Iran threat, purely based on demand from the developing world and the fact that the 2008 – 2010 credit crisis virtually evaporated refining and exploration investments in the crucial supply regions. Either way, energy markets will continue to dominate global investment themes for the future.

About Global Fund Exchange

The Global Fund Exchange Group is an investment management group offering sensible diversified portfolio solutions to institutional investors since 2005. These are often customized to the particular requirements of clients, optimizing returns and controlling risk. Our focus is on the real and evident global macro trends that will shape our planet in future years.

Global Fund Exchange has constructed tailor made multi-manager portfolios exceeding US$2 billion for some of the world’s most sophisticated pension funds, sovereign wealth funds and other institutions in global tactical asset allocation, alternative investments, energy, commodity and multi-strategies.

The Earth Wind & Fire Fund is an actively managed global macro, multi-strategy, multi-manager fund focused on the future of energy and the future of our planet. The fund aims to provide our institutional investors with the ability to participate in these mega macro opportunities whilst significantly reducing volatility. Through strategic mandates with highly experienced specialists all across the world, we specifically focus on opportunities in:

  • Clean Energy
  • Agriculture
  • Carbon & Emissions Trading
  • Systematic Trading
  • Water
  • Traditional Energy
  • Natural Resources

The AquaTerra Fund is a focused carve out of the existing Agriculture, Water and Natural Resources portfolios originated from the  the multi strategy Earth Wind & Fire Fund. This more concentrated portfolio invests in agriculture, water and other scarce natural resources across equities, commodities and futures throughout the world. It is managed by the same multi-manager team at Global Fund Exchange, headed by Lauralouise Duffy and Anric Blatt.

The Earth Wind & Fire Fund is an actively managed global macro, multi-strategy, multi-manager fund focused on the future of energy and the future of our planet.

The fund aims to provide our institutional investors with the ability to participate in these mega macro opportunities whilst significantly reducing volatility.

Through strategic mandates with highly experienced specialists all across the world, we specifically focus on opportunities in:

Clean Energy Agriculture Carbon & Emissions Trading Systematic Trading
Water Traditional Energy Natural Resources Hedge Strategies
 

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