Proposal to adopt “Japanese model” of LNG investment unlikely to be approved given reselling challenges and climate commitments.

WHAT: The EU’s Action Plan for Affordable Energy has recommended examining if the “Japanese model” of direct investment in overseas LNG projects with joint purchasing contracts could be feasible for Europe.

WHY: With the EU grappling with high energy prices, electricity consumption expected to rise by 60% by 2030 and ageing power grids struggling to handle increased demand and more renewables, investing in foreign LNG projects is being touted as a potential solution.

WHAT NEXT: Adoption of the Japanese model appears unlikely given the EU’s lack of experience in gas reselling, its sustainability commitments, the long lead time of projects and volatile trade relations with the US.

The European Union is in the midst of assessing whether to adopt a “Japanese model” of direct investment in LNG projects as the bloc grapples with high energy prices and low gas storage levels.

In late February the European Commission unveiled its Clean Industrial Deal detailing a roadmap to lowering energy costs, mitigating future shocks and stabilising markets.

A key part of the strategy is its “Action Plan for Affordable Energy”, which proposes assessing whether a Japanese model of direct foreign investment in LNG projects with joint purchasing contracts would work in the European context.

While the Japanese model has indeed served the northeast Asian country well, a number of elements within its structure appear to be at odds with Europe’s predicament.

An analysis by the Institute for Energy Economics and Financial Analysis highlights some of the roadblocks Europe would face if it were to attempt to adopt the Japanese model. For instance, Japan’s approach involves investment and support for the entire LNG value chain.

This includes the resale market, where Japanese utilities have been active in reselling excess LNG cargoes to the country’s energy-hungry neighbours in South and Southeast Asia.

Japanese utilities have been busy building the midstream and downstream gas infrastructure in these countries, such as regasification terminals and new LNG-fired power plants, enabling the resale of excess cargoes.

Moreover, a number of Japanese utilities have set up trading desks in neighbouring countries. They also frequently charter LNG carriers, directly enabling them to take advantage of arbitrage opportunities.

Indeed, this expertise in reselling, marketing, shipping and the downstream aspects of the LNG value chain is not held by European companies to the same extent as Japan, which has mastered the art.

And attempting to develop these capabilities could be too costly, risky and too slow for it to make sense financially for European firms.

Building an LNG plant typically takes between 3 to 5 years after a final investment decision (FID) is taken. Long-term purchasing contracts, as lengthy as 20 years, have been used by Japanese firms to protect themselves from volatility in the spot market and squeeze as much value out of their investment as possible.

Clearly, this approach would not work for the EU as the bloc has set a legally binding target of achieving net-zero by 2050.

While European companies could invest in overseas LNG facilities in Africa or the Middle East, the ideal location would be the US.

However, there are concerns on whether US LNG would meet Europe’ss environmental requirements. In his final month before leaving office, President Joe Biden pressed the EU for alignment on methane standards to ensure US shipments of the super-chilled fuel would match Europe’s standards.

Biden left office without achieving alignment and there are concerns that President Donald Trump could roll back pollution standards and environmental regulations.

If that is the case, we could see a repeat of the situation in 2020, where French utility Engie abandoned talks with US-based NextDecade over a proposed LNG supply deal involving gas from the planned Rio Grande LNG terminal in Texas after pressure from Paris to seek cleaner supplies.

Relations between Washington and Brussels are on tenterhooks and the EU is surely sceptical about locking long-term investment into a volatile and unpredictable trade partner that appears determined to redefine trade relations and impose tariffs.

Assuming trade relations between Washington and Brussels thaw, directly investing in foreign LNG projects also poses considerable risks given the glut of supply slated to hit the market in the next few years. Goldman Sachs predicts that the global capacity of LNG to be added by the end of the decade will be almost equal to half of the global supply of 2023.

With an oversupply of LNG expected prices for the super-chilled fuel appear destined to fall. As such, sales margins will slip and even have the potential to turn negative.

The EU finds itself in a difficult conundrum. Energy prices remain high and demand for LNG on the spot market in Europe saw cargoes originally destined for Asia rerouted to Europe for higher prices.

By February 28, gas storage levels had plummeted below 40% in Europe and officials remain aware that more LNG cargoes on the spot market will need to be yanked away from Asia as new LNG projects slowly trickle online.

The European Commission expects electricity consumption to rise by 60% by 2030 and aging power grids are likely to pose challenges with this increased demand. And while the bloc is keen to inject more renewables into the energy mix, unless major advancements are made in battery storage, the intermittent nature of solar and wind power will likely require LNG to be used as baseload power.

Europe now finds itself between a rock and a hard place. The Japanese model for foreign direct investment (FDI) in LNG projects is not a one-size-fits-all solution that would be tenable for European energy companies.

However, sitting on their hands is also not an option given the current high energy prices, low gas storage levels and projected increased energy demand. With Europe’s target of achieving net-zero by 2050 legally binding under European Climate Law, the bloc would be best suited to invest further in electrification and decentralised renewables given that 40% of its grids are over 40 years old.