Chairman’s Message

Nearly six months have passed since the attack on Iran started. While the outlook for the Iran crisis is still unclear, I would like to share with readers an update on the impact of the crisis on Japan and the responses by Japan to enhance its energy security.

<Main Points>

Japan has managed the crisis relatively well thanks to its energy security measures.

But several vulnerabilities have been exposed, which must be addressed.

Naphtha has been the greatest concern, which certainly requires action.

Diversification of crude oil imports is necessary but needs policy measures.

Bypass routes of Middle East energy must be strengthened.

Reserve system has worked well but can be improved.

LNG has not been a problem, but we must be prepared for future contingencies.

Vulnerabilities of Asia have been exposed, which call for region-wide efforts.

1. Energy security policy has helped Japan manage the Iran Crisis relatively well.

In spite of Japan’s heavy dependence on Middle East energy, the impact from the Iran crisis has been relatively well managed so far. Energy security measures which have been put into place over decades since the First Oil Crisis in 1973 have helped Japan in a significant manner.
　The 254 days’ worth of oil reserve at the time of the attack has bought time for Japan. The successful diversification of LNG and LPG imports from Middle East has limited the impact from the closure of the Strait of Hormuz. The maintenance of domestic refining capacity has ensured sufficient supply of oil products including gasoline and diesel fuel.

2. Several vulnerabilities have been exposed, which must be addressed.

In spite of the achievements of the energy security policies, several vulnerabilities have surfaced. PM Sanae Takaichi has directed the Japanese Government to prepare a package of policies to enhance the resilience of Japan’s energy system to deal with the vulnerabilities by the end of August. The full contents of the upcoming package are not yet clear, but I would like to share with you the measures that I expect to be part of the package. I would also touch upon several issues that should be addressed but may not be part of the package yet.

3. Naphtha has been the greatest concern, which certainly requires action.

Naphtha, which is a bridge between crude oil and chemical products, was not known to the general public outside of a small group of industry people before the Iran crisis. But, by now, naphtha has become part of the vocabulary of the general public. The concern about the stability of naphtha supply has disrupted the supply chain of many manufactured products. Japan’s dependence on naphtha from the Middle East was 40% of its total consumption without a reserve system in place at the start of the crisis.
　The leading supplier of bath systems in Japan temporarily suspended receiving orders, citing the shortage of chemical products derived from naphtha. This suspension impacted the construction of many houses. Numerous manufacturers and contractors were complaining about the shortage of thinners, which are essential for painting various products and buildings. The most reported development was the changing of the package of Japan’s top-selling potato chips from a colorful design to black & white, citing the concern about the shortage of paints.
　The disruption has been mitigated through the intensive efforts by the Japanese Government and the industry to import naphtha and its downstream chemical products. But the recognition of the vulnerability of naphtha is so strong that the measures for naphtha are bound to be part of the policy package.
　There was a reserve system for naphtha until 1993. It was abolished under pressure from the chemical industry, which argued that it was a burden on international competitiveness. Naphtha was taken outside of energy security then. It must be put back into the scope of energy security again. A reserve system for naphtha will most likely be reintroduced.

4. Diversification of crude oil imports is necessary but needs policy measures.

Japan’s 94% dependence on Middle East crude oil was absolutely too high. It was somewhat lower in the past, but Russia’s invasion of Ukraine pushed up Japan’s dependence on Middle East crude oil.
　After the Iran crisis broke out, the Japanese Government and the industry have been scrambling to procure non-Middle East oil mainly from the US. They have been relatively successful in the procurement, but a constraint has become apparent. Japanese refineries have been optimized to refine Middle East crude oil. They have been able to refine the procured non-Middle East crude oil by mixing it with Middle East crude oil. But there are limits to the degree of mixing.
　This recognition is guiding the policy discussions to retrofit the refineries to make them more flexible and capable of refining non-Middle East crude oil. As the refiners have little incentive to make this investment on their own, subsidies are expected to be introduced.
　There is also discussion about expanding the actual procurement of non-Middle East crude oil in normal times. If the refining capacity is made more flexible through the above-mentioned measures, procurement of non-Middle East crude oil becomes physically possible. But there are reasons why Japanese refiners have been almost exclusively favoring Middle East crude oil. Switching to non-Middle East crude oil will result in additional cost. Without policy interventions, oil companies will not buy non-Middle East crude oil, as this would be against their commercial interests. The Japanese Government is aware of this challenge and has implied that it would provide policy support to cover the cost differences of the freight. The industry is arguing that the cost increase is not limited to the freight cost. This is certainly an issue that must be resolved.

5. Bypass routes of Middle East energy must be strengthened.

The Japanese Government is explaining that Japan has succeeded by now in securing sufficient supply of oil to match the level before the crisis. In the early months after the beginning of the crisis, the release of the stockpiles has helped fill in the gap. The gradual increase in the procurement from non-Middle East sources, mainly the US, has helped supply more than a third of the lost supply through the Strait. The largest supply now is Middle East oil coming from bypass routes of the Strait. This flow comprised more than half of the supply in June.
　The contribution of bypass oil has demonstrated the strategic importance of bypass routes. However, their capacity is limited, and they are vulnerable to attacks by Iran or the Houthis. To strengthen them, it is important to expand the capacity and to develop more secure routes. I believe that Saudi Arabia and the UAE are determined to do so. Japan will also have a strong interest in realizing this strengthening, and I believe that Japan will be willing to participate. One form of participation can be equity investment in the bypass pipeline projects. The expansion of the role of JOGMEC, a Japanese Government-affiliated organization, is being discussed to enable investment into pipeline projects.

6. Reserve system has worked well but can be improved.

The very high level of oil reserve, amounting to 254 days’ worth at the end of February, has provided a vital cushion for Japan. The strategic stockpiling has been the greatest factor in minimizing the impact of the crisis for Japan. It has bought us precious time. But that does not mean that there is no room for improvement.
　Among the available reserve at the start of the crisis, there was six days’ worth of reserve which had been developed through collaboration between Japan and the Gulf Countries (Saudi Arabia, the UAE and Kuwait). The reserve has already been released to alleviate the tension in the supply/demand condition of oil in Japan. I believe that this joint reserve system can be further strengthened. Having more stockpiles should give more assurance to Japan. This reassurance can enhance the perceived security of Middle East oil. The strengthening of the joint stockpiling could be a win-win for both Japan and the Middle East oil producers.

7. LNG has not been a problem, but we must be prepared for future contingencies.

Japan’s dependence on LNG coming through the Strait was just 6% before the attack. This low dependence has spared Japan supply issues for LNG. It is a result of luck as well as successful diversification policy. The dependence was higher until 2021, when a large contract with Qatar expired. After Russia’s invasion of Ukraine, the Japanese Government and the industry took actions to restore some of the expired contracts. They succeeded in signing a three million tons per annum contract with Qatar, which will start delivery in 2028. 2026 came just in between, leading to a very low level of dependence at the start of the crisis.
　While the immediate impact has been avoided, Japan must be better prepared for future contingencies. Japan will have to continue diversification of its LNG supplies. Long-term supply contracts, which are now generally insulating Japan from the price hike in the spot market, must be kept at a reasonably high level. But with the future uncertainties, engaging in new long-term contracts may become more difficult for Japanese players. This challenge is recognized, but effective and cost-efficient policies are yet to be developed.
　LNG must be transported by vessels. Insurance is the precondition for shipment. But the insurance currently depends on the reinsurance provided by London insurers. The reinsurance may be disrupted depending on the security situation and the policy of host governments. To ensure continued shipment of LNG, the argument is gaining momentum to introduce reinsurance means which would be provided by the Japanese public sector in times of necessity.
　The level of inventory of LNG is generally limited to a few weeks due to the boil-off problem and the high cost for reserve. Compared with the high level of reserve for oil, this low level for LNG is gradually seen as a concern. While this issue is recognized, cost-effective means to raise the level of LNG inventory are still not clear.

8. Vulnerabilities of Asia have been exposed, which call for region-wide efforts.

As I wrote in my previous Message, Asia has been the hardest hit by the crisis. Asia was highly dependent on Middle East energy. Asia’s reserve was at a very low level. Asia has exposed its vulnerability. But this is not just a problem for Asia. It is a problem for Japan as well. Asia is Japan’s major market. Asia forms the core of its supply chain. The energy security of Asia is in Japan’s interest as well.
　This is the reason why PM Takaichi proposed the POWERR Asia Initiative backed by a pledge to provide 1.5 trillion yen, or about $10 billion, to finance Asia’s activities to enhance its energy security. The immediate targets will be helping the procurement of expensive energy and the building-up of reserve systems. The scope of the support can be expanded to include various measures to enhance Asia’s energy security including energy efficiency.
　The Initiative was announced at the AZEC Plus Summit Meeting. In addition to Japan, major ASEAN members and Australia, which form AZEC (Asia Zero Emission Community), India, the Republic of Korea, Bangladesh, Sri Lanka and East Timor joined the Summit Meeting. I hope the POWERR Asia Initiative can develop into a region-wide framework, building upon AZEC, to enhance energy security in Asia.

At this point, the prospect of the crisis is still unclear. But we should not just wait for the outcome. We must start taking actions to enhance our energy security.