Chairman’s Message

Tatsuya Terazawa

Tatsuya Terazawa
Chairman and CEO
The Institute of Energy Economics, Japan

Chairman’s Message
- De-Russianization -

Message for May 2022

The crisis in Ukraine will lead to a fundamental transformation of our energy system, as it is clear that we must drasticallyreduce our dependence on Russian energy. The “De-Russianization” of our energy system is essential, especially for natural gas and LNG which are most vulnerable to potential Russian supply disruptions.

But do we have consensus on the strategies to realize “De-Russianization”? Are the strategies sufficient in magnitude and can they beintroduced quickly? Do we have policies fully aligned to back up the strategies? These are questions that need to be addressed.

There is consensus that we must continue pursuing the decarbonization of our energy systems through energy efficiency and renewable energies. There is growing recognition, but not yet consensus, that nuclear power could play a very important role in decarbonizing and“De-Russianizing” our energy system, particularly in East Europe.

As decarbonization would certainly lead to “De-Russianization” in the long run, some might argue that the acceleration of carbon neutrality will be the answer to the risk exposed by the Ukraine Crisis. But the decarbonization process cannot be completed in the short noreven in the medium term. Betting solely on decarbonization will leave us exposed to the Russian risk for the many years of the transition.

Fossil fuel will continue to play a vital role, at least during the transition period. Consequently, we need non-Russian alternative sources of fossil fuel in the transition. This is particularly true for natural gas and LNG markets which are faced with serious shortage of supply capacity if we are to exclude Russian gas. This is the vulnerability which has been exploited by President Putin. We need to invest in non-Russian sources of natural gas and LNG to substantially expand capacity. There was an argument last year which claimed that there would be no necessity for future investment in new oil and gas upstream projects, but that was before the crisis in Ukraine. It should be clear by now that we need to fundamentally shift the direction towards investment for more non-Russian sources of natural gas and LNG.

But many policies have been put into place recently to accelerate the shift away from fossil fuel which would certainly impede the investment related to natural gas and LNG. Serious discussions have not been made on this point, but it is urgent to start changing these policies to shorten the period of our dependence on Russian energy. Let me go through some of these policies that need to be changed.

Finance is essential for investment thus many measures have been put into place to discourage the financing of fossil fuel related projects. Multilateral financial organizations, faced with pressures from their major members, have issued policy guidelines to that effect. There are also initiatives to prohibit financing for fossil fuel related projects by national public financial organizations, including “theStatement on International Public Support for the Clean Energy Transition” issued at COP26. Banking regulators are scrutinizing the portfolio of financial institutions to raise yellow flags when they find fossil fuel related assets, claiming that the long-term risk associated with global warming is not addressed. But what about the shorter-term financial risk associated with the dependence on Russian energy? Investments to reduce such risk should be valued in the assessment. Private sector financial institutions have also launched initiatives, including GFANZ, to refrain from lending, investing and insuring activities inconsistent with their pledges to achieve net zero carbon portfolio by 2050. These policies and initiatives need to be changed to accommodate financing for investment to develop alternative sources of energy to the Russian natural gas and LNG which are essential for a smooth transition.

Rules for disclosure, while not restricting any particular investment, do affect financing decisions. TCFD and the related national disclosure rules including the US SEC disclosure rules should be implemented in a manner which could encourage, not discourage, investment to develop non-Russian sources of energy. Categorization of investment activities, while not restricting any particular investment either, also has great effect. The typical example is the EU taxonomy categorizing sustainable investment. Investment to develop non-Russian gas fields, LNG export and receiving facilities do not appear to be categorized as being “sustainable”. It should be helpfulif “De-Russianization” related projects could be categorized in a favorable manner.

It is not just financing that need to be revisited. Regulations also play a great role. For example, the process to authorizeconstruction of pipelines and terminals should be accelerated. The recent decision by the US FERC to add more elements in the review process to construct pipelines makes pipeline construction more time consuming. Across the board review of the regulation and authorization process need to be conductedto facilitate the projects which could help us reduce our dependence on Russian energy.

But a big question emerges. Will these investments to expand non-Russian natural gas and LNG be consistent with the long-term goal of decarbonization? Companies may well hesitate to invest in these projects without the assurance that they will not become “stranded assets”. Strong messages from the governments at the highest level should be sent out to make it clear that these investments are necessary, legitimate and welcome not just for today but for the future as well. Relevant regulations, disclosure rules should be changed to be in line with these messages. Private sector financing should also accommodate these investments.

Some may be concerned that these investments, considered necessary for the “De-Russianization” in the mid-term, could hurt the decarbonization in the long-term. This is indeed a legitimate concern, but there is a bridge to overcome this apparent inconsistency.

The bridge is the “decarbonization offossil fuels”. The natural gas and LNG from the expanded non-Russian sources can be used to generate power and heat while deploying CCUS technologies to capture the CO2 generated in the process as the technologies become more readily accessible and economically feasible in the future. Later, the newly developed natural gas can be turned to produce “blue hydrogen” or “blue ammonia” which uses CCS technologies to capture the CO2 produced in the process. With a credible strategy to introduce and deploy blue hydrogen, blue ammonia and CCUS, we can bridge the “De-Russianization” necessary for the mid-term with the decarbonization necessary for the long-term. Assurances by the governments to recognize these technologies are also essential to induce companies to invest in these technologies as well as in non-Russian sources of energies without the fear that such investment might turn into stranded assets in the future.There is another problem. The essential investment to expand non-Russian sources of natural gas and LNG will require several years, possibly four to five years, before supplying natural gas and LNG. How can we reduce our risk during this “window of vulnerability”?

For oil, we do have spare capacity to increase production in a short space of time. Given some time, we can expect the oil production to increase, including the shale oil from North America. But the largest spare capacity exists in Saudi Arabia and the UAE together with other Middle East producers. It is vitally important to have these two countries agree to produce much more crude oil as soon as possible to alleviate the tension in the oil market. The US has a great role in persuading these two countries to cooperate by exerting its maximum diplomatic efforts which will require addressing the legitimate security concerns of these two countries.

Unfortunately, as the world lacks meaningful spare capacity for natural gas and LNG there is not much that can be done to increase the supply side during this period. We therefore must rely on measures which could reduce demand for natural gas and LNG during this period. Acceleration of renewable energies and energy efficiency would be helpful but not sufficient in magnitude to fill the gap. Using more coalcan help reduce the dependence on Russian gas and LNG but certainly not desirable from the environment point of view. The decision to impose sanctions against Russian coal will make the expanded use of coal more difficult.

Nuclear power can be helpful to both reduce our dependence on Russian energyand reduce carbon emission. We can postpone the retirement of several nuclear units to achieve these objectives. But this only helps avoiding the reduction in the use of nuclear. Whilenuclear power will be very helpful in the long-term, we cannot expand the use of nuclear power in just several years.

However, there is one exception to this. Japan happens to have a large fleet of nuclear units that can be put into operation in a relatively short time frame. After the Fukushima nuclear accident, 21 nuclear units have been retired, but 33 units still remain operable without counting the 3 units under construction. Out of them, only 7 units are actually generating power today and, theoretically, an additional 26 units can be put into service without constructing new units, which would require years. Roughly speaking, one nuclear unit operating for a full year can reduce consumption of LNG by one million tons. If the existing 26 idle units were all put into operation, 26 million tons of LNG canbe released to reduce the global dependence on Russian gas. This would have a much larger effect than any other measures that can be put into place during this limited timeframe. Of course, this is just a calculation on paper as we still need consent from the local governments, and we cannot sacrifice safety. Not all 26 can be ready for operation in several years, but 6 units have already received approval from the regulatorand 12 are now going through the safety review process. The restart of nuclear units can help absorbsome of the energy price increases, help improve Japan’s trade balance, help alleviate the drop in the value of the Yen which is adding to the increase in the cost of energy and help reduce carbon emissions. The reduction in LNG demand by Japan would be especially vital during the “window of vulnerability”. These results would not only help Japan but would greatly contribute to reducing the global dependence on Russian gas. I cannot overemphasize the utmost importance of safety, but these points should notbe overlooked.

The war in Ukraine was unthinkable for many. The atrocities in Ukraine are beyond our imagination. The reality in Ukraine is forcing the world to redesign the international system and the energy/environment sector cannot be the exception. We need to redesign many of our energy/environment policies. We need to move out from the boxes in which we might have been comfortable.

I believe that in light of the crisis in Ukraine, we need to look into what we need to do, move beyond what we have been doing and implement what is deemed necessary.