Japan: The Review And Renegotiation Of Japanese LNG Import Contracts

Japan's Fair Trade Commission (JFTC) is currently conducting an investigation into alleged unfair restrictions on the resale of liquefied natural gas (LNG) imports into Japan from abroad. The investigation could lead to a radical shake-up of the Japanese LNG import market.

Developments in Japan

Japan imports more than one third of global LNG production volumes. LNG is used in Japan as a feedstock for power generation and as city gas, and is typically procured under long-term (10 to 20 year) contracts which often contain so-called "destination restriction" clauses. The aim of these clauses is to prevent LNG resales to third parties and so to protect the segregated market interests of LNG sellers. LNG sellers have generally been very successful in getting these clauses in place in LNG sales into Japan (and also into other North Asian LNG buyer countries).

The commercial landscape in Japan is fast changing however. Japanese LNG buyers are now facing surplus inventory risk, as LNG consumption falls below import projections and commitments (particularly in light of a combination of lifting the suspension of nuclear energy generation, greater reliance on renewable energy sources and the increasing liberalization of Japan's gas and electricity markets), and will need the flexibility to undertake LNG resales in the future.

An Energy White Paper published by the Ministry of Economy, Trade and Industry (METI) in May 2016 said that it was important for Japan to seek to increase LNG market liquidity through efforts such as (i) an investigation into destination restriction clauses from the competition law perspective (based on the experience of the relaxation or abolishment of destination restriction clauses in the European Union), and (ii) collaboration with other LNG importing countries, particularly in Asia. The need to relax destination restriction clauses was also affirmed at the G7 Energy Ministerial Meeting in the same month.

According to recent media reports the JFTC is currently working to clarify existing LNG import conditions and to understand relevant market structures and trading practices by collecting LNG supply contracts and surveying gas and electric companies and other parties related to LNG importing.

According to a document recently published by METI, it is estimated that destination restriction clauses are included in approximately 80% of long-term LNG procurement contracts made between suppliers and major users in Japan (and Korea). Some of these clauses are very likely to be subject to Japan's Act on Prohibition of Private Monopolization and Maintenance of Fair Trade (the Antimonopoly Act), which prohibits unfair restrictions on the business activities of trading partners. Examples of prohibited behaviours in the context of LNG import contracts, apart from direct resale restrictions, could include clauses that do not provide for the deduction of additional costs in the calculation of distributed profits with respect to resales, clauses that demand the disclosure of confidential information regarding resale buyers and resale prices and clauses that do not ensure the prompt calculation of distributed profits.

As the Antimonopoly Act applies also to business practices abroad, LNG sale and purchase arrangements will have to be revised if the JFTC decides that they are in violation. Although the JFTC has not issued any formal opinions to date, media reports suggest that the JFTC could make a statement on potential Antimonopoly Act infringements before the end of the year.

Lessons to be learned from Europe

The historical re-regulation of gas and LNG sales in Europe could provide invaluable insights for persons responsible for managing the renegotiation of previously agreed contractual provisions for the sale and supply of LNG into Japan.

A number of decisions of the European Commission (EC) were made in a series of cases between 2002 and 2007 involving several gas and LNG production and sales companies, which are together popularly often described as the Algeria case or simply as Sonatrach. The collective outcome of these decisions was a determination by the EC that destination diversion control, territorial demarcation and resale restriction clauses in sales where the buyer has assumed responsibility for transporting the commodity (production point sales for pipeline gas and free on board (FOB) sales for LNG) would be unenforceable and would have to be severed from the relevant contracts. Such clauses could, said the EC, perhaps be viewed more favourably in delivered ex ship (DES) sales contracts but only where there was a related profit sharing mechanism where the additional costs associated with the diversion were borne equally between the seller and the buyer before the profits were then divided between them (rather than one where the buyer alone had to bear those costs from its share of the profits).

For Japanese LNG buyers, most of whom have been buying LNG on a DES basis, there might therefore need to be a carefully managed transition away from absolute destination restriction controls to a new world of permissible diversions and mutually beneficial cost and profit sharing arrangements.

Japanese LNG buyers might also wish to reflect upon whether there is any useful precedent for forcing the commercial changes which they might need even without the insistence of a market regulator as the agent for change. Once again, although even further back in time, there is a useful European precedent to consider. Following the liberalisation of the United Kingdom gas market in the late 1980s the monopsony gas buyer British Gas embarked on an ambitious programme of renegotiating significant volumes of high priced and long term take or pay commitments with all of the gas producers from whom it bought all of its gas requirements. These renegotiations took place through the early 1990s. They were successful and they ensured the continuing survival of British Gas – and this all happened despite the absence of any statutory imperative or contractual right for such renegotiations to take place.

Conclusion

METI and the JFTC are very likely to be considering the historical regulation of gas and LNG sales in Europe as part of their thinking about what could be best for Japan, and the lessons learned from the re-regulation of the European market could be invaluable for all Japanese and other North Asian industry players. The future direction for Japanese LNG imports will certainly depend upon where the JFTC's deliberations come out but this is a future which has been experienced already in the European gas import markets.

Changes in Japan could also be reflected in Korean and other North Asian LNG import markets. If contractual resale restrictions are modified then LNG buyers could secure favourable revised conditions from sellers which could herald the introduction of a new Japan-centered LNG market with the ability to influence worldwide LNG supply and demand conditions.

However, care will also be needed in the transition to a new world of LNG contracting in Japan and North Asia (in existing contracts, impending renewals and new contracts), to ensure that the economic balance of the contract remains intact and that price reopener, hardship and force majeure provisions are not inadvertently triggered.

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