Japan: Energy Security Ripple Effect

What happened: Japan is working to ease supply constraints brought about by the Iran war

Why it matters: As the region's energy market maker, Japan's efforts to realign supply will ripple through Asia-Pacific.

What happens next: Both government and industry will develop and implement plans to shore up energy security and hedge against political risk in the Middle East.

Assuming the most recent cessation of US hostilities with Iran actually holds, a relevant question to think through is how different countries adjust to the emerging reality. Every country will be different, but let’s take the case of Japan to refine our thinking and understand the emerging trends that may impact investments there.

Japan’s primary takeaway from the conflict is that it is uncomfortably exposed to supply disruptions from the Strait of Hormuz and must take measures to mitigate them in the future. This was less an issue for LNG imports (which mostly come from Australia) than for oil and petrochemical products (with naphtha being the most severe).

Japanese companies, at considerable cost, have rushed to secure alternative supplies and begin diversifying away from Middle Eastern hydrocarbons. But since the rising cost of living has become a high-sensitivity pain point for Prime Minister Sanae Takaichi and her government, this situation cannot endure forever. Japan's oil and petrochemical imports are mostly back to pre-February levels, but it will take time for the situation to normalize.

In the short term, Japanese companies and the government will be limited by access to the supplies and infrastructure that currently exist; in the medium to long term, they will be strongly motivated to develop or otherwise invest in production and infrastructure that give Japan long-term, reliable access to must-have economic inputs. This is already underway following a recent announcement by Malaysian Prime Minister Anwar Ibrahim, who promised to increase exports of LNG, naphtha, and other inputs during a recent visit to Tokyo.

In our view, however, Southeast Asia is a welcome source of diversification, but Japan’s long-term objectives can only be truly satisfied through the US West Coast.

A West Coast export option is not a new goal. Japanese companies have invested in several failed ventures over the years, most recently the Jordan Cove Energy Project, which would have developed LNG export capacity of 7.8mn tons per year near Coos Bay, Oregon.

Both JERA and Itochu were signed on as off-takers, but the project was canceled in 2021 after the Oregon Department of Land Conservation and Development refused to issue a slate of environmental permits. These decisions were widely seen as reflecting environmentalist and activist opposition rather than anything to do with the project's fundamentals. Since then, Japanese companies have expressed skepticism about a West Coast option, though few would deny its high desirability.

Fortunately, the tide is slowly turning for Japan as US West Coast states contend with a mounting affordability crisis and an eroding tax base. In Washington, for example, Gov. Bob Ferguson (see Featured Personality) faces a shrinking budget and a population increasingly fed up with the state’s high cost of living. Lacking the zealotry of his predecessor, Jay Inslee, Ferguson may be more pragmatic regarding energy development. Not that any of this will be easy, but difficult is preferable to impossible.

Will any of this impact Japan’s commitment to environmental targets or the country’s decarbonization agenda? The short answer is no, and the long answer is that it’s complicated but probably not.

Any realignment of energy or industrial policy must balance the competing interests of Japan’s primary trading blocks, namely the EU and the United States. The Trump administration doesn’t care much about climate or decarbonization, but the EU does and is plowing ahead with additional mitigation measures like ETS adjustments or CBAM. Japan has no interest in either weakening or strengthening its policy commitments, and neither trading bloc is interested in nudging Japan in either direction.

Savvy investors can and should take steps to encourage Japanese companies to pursue ideal win-win agreements. Especially in West Coast development, Japan has a reputational premium that allows it to do things other countries generally cannot.