Japan's importance as a purchaser of liquefied natural gas (LNG) production is second to none. LNG imports into Japan totalled about 50 million tonnes in 2000, and 54.8 million in 2001, equal to about half of total global demand. However, estimates for the growth in demand for LNG in Japan over the next decade vary considerably. Where one banking source will describe the market as ?rather saturated? another talks of, ?significant medium-term growth.?

In the next 10 years, one report prepared for a bank forecasts that LNG imports to Japan will increase by only 10 million tonnes, or 20%, at a time when global demand is projected to double. More bullish analysis forecasts stronger demand for LNG in Japan, estimating imports will grow to 70 million by 2010.

The assumptions underpinning the first forecast (the source of the report and the detailed contents are confidential) did not include key influencing factors which have emerged since its publication: continued economic weakness in Japan, and the impact of the nuclear industry's difficulties. ?To some extent the two factors cancel each other out, but the nuclear industry's woes may turn out to be the more important dynamic, certainly in the short run,? says Noburu Kato, head of SMBC's Project Finance Group. ?Even over a ten-year timeframe the impact is likely to propel demand growth and people now think 60 million tonnes is conservative.?

A series of nuclear accidents in Japan and the subsequent public outcry have forced the shutdown of much of Japan's nuclear power generating capacity. As a result, Japanese utilities have had to both resume operation of oil-fired and coal-fired plants and increase usage of LNG-fuelled power stations. The impact on one of the largest Japanese generating companies, Tokyo Electric Power Corporation (TEPCO), which gets roughly 30% of its electricity generating capacity from nuclear power, has been significant. According to one banker, TEPCO's LNG imports increased by one million last year to 16 million tonnes.

As JBIC will provide much of the financial support for future LNG projects, its perception of the problem is highly important. The governmental bank, which responded in writing to a Project Finance questionnaire on the Japanese LNG market, recognises both the view that the nuclear issue could affect market demand in the short term but also that long-term market demand largely depends upon the growth of Japanese economy and electricity supply plans of the power companies.

Other financiers believe the fate of the nuclear industry rests largely in the hands of Japanese public opinion. As one Japanese banker says: ?We understand that the Ministry of Economy, Trade and Industry would prefer to restart nuclear power facilities soon, not least of all because they forecast a shortage of power supply in certain areas this summer. But public opinion is against such a move.? No government department has come out with a public timetable for restarting nuclear power in the country, points out Atsushi Yamashita in SG's Tokyo based Export and Project Finance Department.

In response to demand for LNG in Japan and other Asian economies, two of the largest natural resource projects ever undertaken are vying for offtakers and financing. The Sakhalin 2 project in Russia, backed by a sponsor list which includes Royal Dutch Shell and for which CSFB is the adviser, and Indonesia's Tangguh project, valued at up to $5.5 billion. Bankers expect these two projects to come to market before the third mega-project currently under discussion, Sakhalin 1. ?Sakhalin 1 is more of an if,? comments a financier, ?partly because the development involves building a gas pipeline to Japan rather than the traditional method of shipping LNG.?

Bankers originally hoped to start talks about financing the $9 billion Sakhalin 2 project at the end of last year, but the project timetable has been put back. ?We are expecting a decision on whether the sponsors are going to proceed with the investment soon. They are already in discussions with JBIC and other export credit agencies,? a source in Tokyo says.

Meanwhile, the bidding process for the EPC contract for Tangguh is complete and a decision on the winning bid is expected to be announced in the next few weeks, says a banker close to the venture.

But it is not a foregone conclusion that the two projects will secure very extensive contracts with Japanese utilities. Securing long-term offtake commitments from Japanese power companies is becoming increasingly difficult, irrespective of the problems in the nuclear power sector. ?Japanese offtakers are more cautious about entering into the sort of long term, 20-25-year purchase agreements that they signed in the past. They want more flexibility in their agreements,? says Kato.

In addition, there is a perception amongst Japanese offtakers that they paid too much for their LNG supply in the past. ?Japanese utilities are shopping around much more actively in what is now a buyer's market,? another financier says.

The sheer volume of output from Sakhalin and Tangguh is likely to change the purchasing dynamic in Japan and elsewhere. ?Project finance bankers still need long-term forward sales purchase agreements, but LNG will become more of a commodity. Some amount will be consumed on the spot market and large scale forward sales purchase agreements will be less necessary,? says Yoji Morishita, Citibank's new Japan head of global project & structured trade finance.

Apart from the electricity utilities, the other major purchasers of LNG in Japan are the gas companies, accounting for about 30% of total market demand. Some sources believe that the gas companies will be critical to demand growth. ?Gas companies will account for much of the rise in demand for LNG as they are trying to diversify into LNG,? says Morishita. However industry data provides mixed signals. The largest four gas companies, which dominate 80% of gas supply in Japan, are already heavy users of LNG. One of the giants, Tokyo Gas, has already shifted from petroleum to LNG. As far back as 1997, over 90% of its supply came from LNG.

Financing LNG

If Japanese offtakers do sign up for LNG from the Tangguh, or Sakhalin 2 schemes, it is expected that JBIC will be a very major player in the financing. Indeed, while Nippon Export and Investment Insurance (NEXI) has only been involved in LNG project finance on a case-by-case basis, JBIC has been involved in all or almost all LNG projects where Japanese sponsors or offtakers have been involved.

A JBIC official says that the agency is able to extend loans to: Japanese firms for their equity participation in the upstream gas development; Japanese firms for their equity participation in or shareholders' loans to an LNG joint venture company; the LNG joint venture company for its debt financing; and Japanese importers for their advance payments for long-term LNG purchase. JBIC can also provide its direct loans for terms over 10 years.

These capabilities are provided under JBIC's general Overseas Investment Loan (OIL) scheme. In addition, according to a banker, a more specific natural resources development financing scheme, allows more generous terms and conditions regarding the volume of finance provided and interest rate than would be permitted for most other types of project.

As Sakhalin 2 will prove to be one of the largest ever natural resource projects, it could also be the subject of JBIC's largest ever direct loan. ?It is very likely to be a loan worth several billion dollars,? says a banker.

Such a large direct loan would be unprecedented, even for JBIC, and the organization would not comment on possible support for Sakhalin 2. Yet, demand for JBIC's LNG financing is enormous. JBIC provides critical support to Japan's national energy policy which (in JBIC's own words): ?puts an emphasis on the promotion of natural gas utilisation to ensure diversification of energy supply sources and the protection of natural environment.?

JBIC's natural gas-related loans may have fallen 22% between 2000 and 2001, the last years for when figures were available (see table above), but outstanding JBIC loans in the natural resources sectors total $12 billion (as of the end of March 2002). According to the JBIC official, in the last LNG project the bank was involved in (Malaysia LNG Tiga), ?we provided around $1.4 billion of financing?. Malaysia LNG Tiga features both Japanese investors (Nippon Oil Corporation and Mitsubishi Corporation) and offtakers, including a gas consortium (Tokyo Gas, Toho Gas and Osaka Gas), Tohoku Electric Power Company and Japan Petroleum Exploration.

But JBIC is a budgetary institution and heavy involvement in the Sakhalin and Tangguh ventures may require a substantial increase in JBIC funds. ?Annual approval for JBIC's budget is needed from the Diet, from the Ministry of Finance and so on,? says one banker. ?It is not easy to get this approval, especially given Japan's current budget constraints,? says one financier.

In recent years, says Yasuo Sato, Head of oil, gas & natural resources at Mizuho Corporate Bank, JBIC has been expanding the coverage and availability of its financing instruments. Notably, JBIC has extended its guaranteed loan scheme under which commercial banks provide finance backed by a JBIC guarantee. But such guarantee facilities are less common than direct JBIC loans. There is no indication that JBIC will utilise its guarantee scheme for either the Sakhalin 2 or Tangguh ventures.

Even if JBIC is able to extend a record-breaking direct loan to the two projects, commercial banks may be called on to provide a substantial amount of finance with little or no ECA support. Project Finance has not found that the issues raise much concern amongst Japanese banks, despite the substantial exposure the banks have built up to the LNG market. ?Our LNG portfolio has turned out to be a very good asset,? says Kato at SMBC. ?If you look at Indonesia since the Asian crisis many project deals, for example those financing power stations, have gone badly wrong. But all the LNG financings in the country have performed very well ? because of their offshore income stream ? meeting their repayments on schedule, or in some cases, even prepaying,? Kato adds.

The key cause for concern for bankers, and not just the Japanese, is a potential change in the pricing structure of LNG supply contracts. In the past LNG prices have been linked to oil prices (to the obvious benefit of LNG suppliers over the last few years because of the high crude prices). But recent deals struck with offtakers in Europe have included LNG being linked to the power price. ?We haven't really seen this in the Japanese market yet,? says a banker, ?but the trend could well catch on amongst Japanese offtakers.?

If analysts are correct about the increasingly commoditised nature of LNG, Japanese bankers will also have to adapt to projects where Japanese sponsors are no longer willing to take the major portion of a project's LNG capacity on long-term contract. ?Banks, both Japanese and foreign, will have to rely more heavily on credit derivatives, hedges and other instruments to take account of the changed characteristics of these projects,? Morishita comments.

In Japan itself project finance bankers are not expecting substantial limited recourse financings as a result of the expansion of domestic LNG power facilities. ?Utilities here traditionally finance on balance sheet. They are only going to consider non-recourse financing if their credit ratings come under strong pressure,? says a financier.

Morishita agrees: ?on-shore Japanese LNG developments will probably only tap limited- or non-recourse funds if non-Japanese companies are involved in a big way.?

However, one company that has invested in LNG ventures before, and is actively looking to invest in further opportunities both onshore and offshore, is Orix. ?They are keen to look at non-traditional financing structures and that could mean more opportunities for non-recourse financing in the Japanese LNG market,? says one banker.

JBIC Natural Resource Loans by Item (billions of Yen, %)

FY2000 FY2001

Percentage

Number Total Share Number Total Share Change

Energy Resources 22 615.3 99 21 278.1 67 ?55

  Petroleum (14) (500.1) (81) (6) (178.4) (42) (?65)

  Natural Gas (7) (114.8) (18) (5) (89.3) (22) (?22)

  Uranium (1) (0.4) (0) (10) (14.0) (3) (3,173)

Other Resources 27 5.5 1 29 135.3 33 2,372

  Iron Ore (?) (?) (?) (3) (19.8) (5) Aggregate

Increase

  Copper Ore and Concentrate (3) (4.3) (1) (5) (59.9) (14) (1,308)

  Aluminium and Bauxite (?) (?) (?) (2) (19.0) (5) Aggregate

Increase

  Wood, Wood Chips and Pulp (24) (1.2) (0) (19) (36.6) (9) (2,901)

Total 49 620.8 100 50 413.4 100 ?33