I. Identification

1. The Issue

This case study considers the significance of the natural gas brought from the Sakhalin Project in Far East Russia for Japan's energy supply, and assess the environmental impact. The natural gas project will supply a huge amount of natural gas, which contain over 100 years' worth of Japan's natural gas consumption needs. This project will achieve a fervent wish of Japan to secure a stable energy supply. Recently, two measures, Pipeline Natural Gas (PNG) and Liquefied Natural Gas (LNG), to supply rich natural gas from Sakhalin to Japan have been considered among the Sakhalin Project consortium. Each measure has both good and bad points. However, sharp increases in imports of Sakhalin natural gas might have a significant impact not only on Japan's fragile energy structure of supply, but also may apply global warming issue.

2. Description

1) Project Background

The Sakhalin Project is developed offshore Sakhalin Island, which is approximately 450 kilometers north of Hokkaido Prefecture in Japan. The project involves eight mining areas, and the multinational consortiums including the Japanese companies make investments in developing each area. I will focus on two sub-projects, which are called the First and Second Sakhalin (Sakhalin-1 and -2) projects, which have already started working.

Originally, the Soviet government proposed the Sakhalin Project at the fifth Japan-Soviet Union Economic Joint Conference in 1972. The Soviet Union needed to develop the far east area and Japan needed to diversify energy resources shared a mutual interest. Therefore, the joint venture invested by Japanese companies and Soviet Union companies began exploration. Sakhalin-1 project covers three mining blocks, Odoptu, Chaivo, and Arkutun-Dagi, which is 25 kilometers east offshore of the Sakhalin Island. However, during initial phases of the exploration, the project made no business sense because of low crude oil prices and the chaos caused by the collapse of the former Soviet Union in1992. After the formation of the Russian government, the new joint venture organized by Sakhalinmorneftegaz (SMNG, Russia, 23 percent), Rosneft (Russia, 17 percent), Sakhalin Oil and Gas Development (SODECO, Japan, 30 percent), and Exxon (U.S., 30 percent) has resumed exploration. In 2000, Rosneft and SMNG had disposed of their half equity to Oil and Natural Gas Corporation (ONGC, India).

Sakhalin-2 project covers two mining blocks, Piltun-Astokhskoye and Lunskoye, whish is 15 kilometers northeast of the Sakhalin Island. In 1991, the Russian government put the right to develop these two areas for international competitive bidding, and Marathon (U.S.), McDermott (U.S.,) and Mitsui Corporation (Japan) bided off. Afterwards, these three companies with Royal-Dutch/Shell (Netherlands) and Mitsubishi Corporation (Japan) had made production sharing contract with the Russian government in 1994. In 1997, the first oil from Sakhalin-2 has already been exported to Korea. The project designs to double the rate of the production oil (180,000 barrel per day) by 2005 (See Table 1.)

Table 1. Over view of Sakhalin 1 and 2

Projects	Shareholders	Estimated Oil reserves (billion barrel)	Estimated Gas reserves (billion cubic feet)
Sakhalin-1	SODECO (30%), Exxon (30%), ONGC (20%), SMNG (11.5%), Rosneft (8.5%)	1.3	183
Sakhalin-2	Marathon (37.5%), Mitsui (25%), RD/Shell (25%), Mitsubishi (12.5%)	0.91	457

2) Significance for Japan's energy supply

Energy is essential for the human race to develop. Since recorded history, there have been armed conflicts among nations scrambling for energy resources. Ensuring a stable energy supply has been a first priority for nations. In fact, one of the reasons that Japan invaded China and the other Asian countries just six decades ago might be for securing plentiful energy resources. Even now, after over half a century, Japan has continued to have a fragile self-sufficiency in energy supplies. Furthermore, Japan depends on foreign countries for 97 percent of their primary energy consumption. For example, according to the report by the International Energy Agency (IEA), most of Japan's energy today comes from petroleum (52 percent), coal (17 percent), natural gas (12 percent), hydroelectric power (3 percent), and nuclear power (16 percent). This report indicates that Japan depends much more on petroleum for its energy consumption than the average of that in the world (See Table 2.)

Natural gas brought from the Sakhalin Project might open up great possibilities for securing Japan's stable energy supply with the object of diversification of energy resources. One of the worst energy vulnerabilities for Japan is the excessive dependency on petroleum from the Middle East.

This excessive dependency might contain two serious hazardous natures for Japan. One is blockade. The other is ballooning oil prices. After World War II, Japan has increasingly expanded energy consumption, especially oil, with the traditional growth of its economy. At present, over 86 percent of petroleum, the main energy resource, comes from the Middle East countries. Oil from the Middle East to Japan, runs risks of blockade. Most oil tankers from the Middle East come through the narrow Strait of Malacca between Malay Peninsula and Sumatra Island of Indonesia. This geopolitical weakness might imply that not only pirates, but a government could easily blockade and cut off the oil supply to Japan. In the Energy Security Working Group report (2001) by the Agency of Natural Resources and Energy, the Japanese government is concerned that if blockades force these tankers to sail an indirect course, such as through the Strait of Lombok of Indonesia, the arrival price of oil will dramatically increase and cause panic not only for the Japanese economy, but also for the Asian countries which have not stock piled enough oil. Furthermore, the volatility of crude oil prices can exert a serious influence on Japan's account balance, because oil imports are a large share of Japan's total imports. Can the commercial oil markets in the world provide the world enough oil at anytime? Unfortunately, oil is still a strategic product, not a commercial product like a car. In fact, oil producing countries manipulate the oil prices according to their wishes by cutting production volumes. For example, the crude oil price of the West Texas Intermediate (WTI), which is one of the main benchmarks in the United States, skyrocketed from $10 at the end of 1998 to $37 a barrel over a period of just one year and a half. Two energy crises have already occurred in the 1970's. Nobody can prevent the possibility of another one occurring.

3) LNG versus PNG

The shipping system of natural gas is classified into two ways, a liquefied natural gas (LNG) and a pipeline natural gas (PNG). Japan imports natural gas by the way of LNG for 97 percent. The construction of LNG plant allegedly needs enormous investment at the stage of development, liquefaction, and transportation. Therefore the contract term is spread over the long term; LNG prices often result in a higher price than that of oil. Furthermore, the cost of transportation allegedly makes up 20 percent to 40 percent of the arrival price of LNG. For this reason, generally, in the case of short distance transportation less than 3,000 kilometers, PNG can minimize costs of transportation less than LNG can. The Sakhalin Island is about 2,200 kilometers from Kanto, which is the main consuming region of the energy in Japan.

- Speculation of the Sakhalin-1 consortium (PNG) -

The Sakhalin-1 consortium intends to deliver natural gas via pipeline. The consortium established the company to research the feasibility of the pipeline from the Sakhalin Island to markets in Japan in 1999. According to the news release by ExxonMobil (August 26, 2002), "The feasibility study began in April. It addressed issues related to route selection and design standards, as well as environmental and regulatory considerations. The results of the study indicate that a 26 to 28 inch natural gas pipeline, with capacity to deliver about 800 million cubic feet a day, is both technically and commercially feasible." However, some analysts show that the price of the Sakhalin PNG toward Japan will be slightly higher than that of LNG. Amy M. Jaffe, the senior energy advisor of the James A. Baker III Institute for Public Policy of Rice University reported at the Advisory Committee for Natural Resources and Energy of the the Agency of Natural Resources and Energy in 2000 that the PNG price from Sakhalin toward Japan will be $2.00 to $2.80 and PNG price $1.90/MMBTU. One of the reasons of rise in PNG price might be expensive construction cost of pipeline. The labor cost and the unit land value in Japan is so expensive that single pipeline builder might not be able to raise funds.

- Speculation of the Sakhalin-2 consortium (LNG) -

On the other hand, the Sakhalin-2 consortium considers the way of LNG. Supplying by the way of LNG will make it possible to deliver the Sakhalin gas not only to Japan, but also to China, Korea, Taiwan, and the North America. Furthermore, the way of LNG might have the advantages to cause price competition for selling LNG to Japan, and urge the other LNG suppliers to discount prices.

Whatever the case may be, Japan will benefit by securing a stable energy supply and diversify the sources of energy. In fact, the report of the Natural Gas subcommittee of the Ministry of Economy, Trade and Industry (METI) of the government of Japan (2001) propose strengthening the strategic relationship between Russia in energy cooperation, and official support for constructing a domestic pipeline for promoting consumption of natural gas in Japan. Rise in demand of natural gas in Japan will encourage the realization of a gas export from the Sakhalin Project.

4) Environmental impact

Increase of natural gas brought from the Sakhalin Project has a significant environmental impact for Japan. Compared to the other fossil fuels, natural gas has environmentally some attractive features. The report by the Agency of Natural Resources and Energy of the Japanese government shows that LNG power generation plant emits less carbon-dioxide (564 g-CO2/kWh) than coal (945 g-CO2/kWh) and oil (742 g-CO2/kWh) fired power plants (See Figure 1.) In fact, the International Energy Outlook 2002 estimatess that natural gas consumption by electricity generators show more rapid growth than consumption by any other fuel. Natural gas consumption for electricity generation will increase by 4.0 percent per year in the industrialized countries, compared with -0.1 percent for oil and 0.9 percent for coal. Energy conversion from oil and coal to natural gas in Japan will help to achieve this commitment. According to the Kyoto Protocol on measures to prevent global warming adopted in 1997, Japan has to cut emissions of carbon-dioxide in 6 percent compared to that in 1990 by the year 2010. To achieve this goal, the Japanese government promotes the development of the Sakhalin project as a national policy and to import its natural gas. In fact, the report of the Natural Gas subcommittee of the Ministry of Economy, Trade and Industry of the Japanese government (2001) proposed strengthening the strategic relationship between Russia in energy cooperation, and official support for constructing a gas pipeline from Sakhalin to Japan for promoting consumption of natural gas in Japan (See Figure 1.)

3. Related Cases

1) Oil cases

2) Gas cases

3) Nuclear cases

4. Author and Date: Tomoyoshi Hisamori, November 2002

II. Legal Clusters

5. Discourse and Status: Agreement and In Process

There are some problems transfering natural gas from Sakhalin to Japan via pipeline. One is the expensiveness of the construction cost of pipeline. The labor cost of pipeline and the unit land value in Japan is so expensive that single pipeline builder can not raise funds. Furthermore, many regulations in Japan such as the ground use and pipeline specification drive up construction costs.

It is true that across-the-board liberalization of the energy service sector is difficult, since the structure of energy supply is different country by country. However, securing effective energy supply is essential in consideration of the great importance of energy for economic development. For Japan, the liberalization of the energy service sector, espesially of the "core" energy services, might enhance the competitiveness in the domestic energy sector, the spoon-fed industry, and promote the separation of the supply stage, such as gas development, refining, distribution, marketing, and product management. Hence, discussions in WTO might effect on measures of feeding the Sakhalin gas to the Japanese consumer market, in the respect that the liberalization of the energy service sector in Japan might attract foreign competitive energy providers.

6. Forum and Scope: WTO, GATS: General Agreement on Trade in Services

7. Decision Breadth: The 144 WTO member governments

8. Legal Standing: Treaty

III. Geographic Clusters

9. Geographic Locations

a. Geographic Domain: Asia

b. Geographic Site: East Asia

c. Geographic Impact: Russia and Japan

10. Sub-National Factors: Yes

11. Type of Habitat: Cold

IV. Trade Clusters

12. Type of Measure: Liberalization

Currently, Japan has no imports of natural gas from the Russian Federation despite being the nearest country. All of Japan's natural gas today comes from eight countries (See Table 3.) Furthermore, Figure 3. shows that Japan is the greatest LNG importers and world trade trend of natural gas is by PNG. Because of geographical restrictions, Japan could not have connected the Eurasia continent nether via natural gas nor oil pipeline, and the isolated situation has forced Japan to think about LNG supplies. Since the first LNG from Alaska in 1969, the consumption of LNG in Japan has steadily increased, and Japan has became the top buyer of LNG in the world, out of the regret that Japan has extremely depended on Mideast oil. According to Jonathan P. Stern, the reason why Japan came late to natural gas trade is classified into two developments, one domestic and one international. From the domestic standpoint, the country required clean sources of energy which could meet the increasingly stringent pollution standards being introduced in the major sities. Internationally, the first oil crisis highlighted the vulnerability to interruption in the supply and price of oil, virtually all of which is imported. Diversification away from Middle East oil allegedly became a priority of considerable proportions and natural gas was admirably placed to perform this function.

Table 3. JAPAN - Natural Gas Import Movements 2001 - by LNG*

	From
	USA	Oman	Qatar	UAE	Australia	Brunei	Indonesia	Malaysia	Total
To Japan	1.79	0.83	8.30	6.89	10.1	8.20	22.7	15.3	74.1 Bcm**

* LNG (Liquefied Natural Gas)
** Billion cubic meters
Note: Flows are on a contractual basis and may not correspond to physical gas flows in all cases.

Figure 3. Major Trade Movements of Natural Gas (Bcm)

LNG plants including pipelines to condense a gas to a liquid need huge initial investment. Therefore the trade contract results in the long term and LNG prices have to be relatively expensive in order to recoup the initial investment. Furthermore, the LNG price is decided not based on LNG market price but on the contract between the buyer and seller. Generally, the LNG price into Japan is linked to the average CIF (cost, insurance, freight) price of petroleum which is relatively expensive because of the Asian Premium-inclusive prices. In fact, as compared with the average LNG import prices into Europe and the United State from 1993 to 2000 and the pipeline gas prices, the price into Japan is slightly expensive than the others (See Table 4. and Figure 2.)

Table 4. LNG import prices into Japan, the United States, and European Union Member States

			US dollars per million Btu*
Year	Japan	The United States	EU Member States
1993	3.56	2.15	2.55
1994	3.21	2.23	2.40
1995	3.48	2.25	2.35
1996	3.67	2.74	2.64
1997	3.91	2.67	2.84
1998	3.08	2.67	2.40
1999	3.18	2.47	2.00
2000	4.73	3.39	3.10
Average	3.60	2.57	2.54

* British thermal unit (Btu)=0.252 kcal=1.055 kJ

On the other hand, Table 6. shows that Russia is the greatest natural gas producer and exporter in the world. Especially, for Western Europe, the Russian gas has an important role to meet its gas demands. Currently, all of the Russian gas toward Western Europe is carried through the gas pipelines, which were constructed all over the Western Europe markets in the 1960s. However, according to the report by The Royal Institute of International Affairs (1998), Gazprom, the key Russian energy company has announced plans to focus its strategy on penetrating the Asian market. The economic growth in Asia might have changed the Russian energy strategy. This manifestation may encourage the construction of the trans-boundary pipelines which connect China, North and South Korea, and Japan to the Siberian natural gas resources (See Table 5.)

Table 5. Russian Fed. - Natural Gas Export Movements 2001 - by pipeline

Table 6. Producers, Exporters, and Importers* of Natural Gas (2001 data)

13. Direct v. Indirect Impacts: Direct

14. Relation of Trade Measure to Environmental Impact

a. Directly Related to Product: Yes, Energy

b. Indirectly Related to Product: No

c. Not Related to Product: No

d. Related to Process: Yes, Climate Change

15. Trade Product Identification: Natural gas

16. Economic Data:

17. Impact of Trade Restriction: BAN

18. Industry Sector: Energy

19. Exporters and Importers: Russia and Japan

V. Environment Clusters

1) General information on the project

The Sakhalin project has increased investments and created new jobs in the Island. According to Hokkaido government of Japan, the Sakhalin project has attracted $1.5 billion of investments, mainly from the U.S. and Japan from 1995 to 2000 and created over 6000 jobs for the related projects. Furthermore, the project has increased 0.3 billion ruble of the annual revenue of the Sakhalin government, and Russian companies has received $490 million orders from the Sakhalin-2 consortium. The data shows that further development of the Sakhalin project will create over 20 thousand new jobs and 3 billion ruble revenue for the Sakhalin state. Correspondingly, the Overseas Private Investment Corporation (OPIC) estimates that $270 million in U.S. goods and services and nearly 1,000 American jobs will result from the project to develop an offshore oil field near Sakhalin Island. In fact, the royalty from the Sakhalin project has contributed to resolving pending issues such as the infrastructure building. These advantages might be far outweighs the disadvantages of a possibility of environmental effect.

2) Impact on the environment of the Sakhalin Islander

On the other hand, the development of the project might have damage ecosystems of the Island. One of the key industries in the Sakhalin Island is the fishery and the marine product processing industry. The Sea of Okhotsk is well known as the three major fishing banks of the world and is full of marine resources. Furthermore, the mammals such as earless seals, hair seals, and sea cows make their habitat near the Sakhalin project. An oil spill accident might cause heavy damage to the earnings of these people.

20. Environmental Problem Type: Global warming

21. Name, Type, and Diversity of Species

Name: 1) Earless seal, Hair seal, and Sea cow, 2) Salmon, Trout, and Herring

Type:

Diversity: 1) Mammals, 2) Fishes