Japan in a Quandary as Iran Tensions Expose Energy Vulnerability

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"Japan faces a dilemma. It has to balance its changed energy needs in the aftermath of the Fukushima disaster with the more urgent matter of cutting its imports of Iranian crude oil to avoid being shut out of the U.S. financial system."

Japan faces a dilemma. It has to balance its changed energy needs in the aftermath of the Fukushima disaster with the more urgent matter of cutting its imports of Iranian crude oil to avoid being shut out of the U.S. financial system.

Whatever the outcome of discussions with Washington on the extent of the reduction in imports from Iran, Japan faces longer term energy security issues because of its heavy reliance on Middle Eastern crude, a vulnerability that has been exposed further with recent threats by Iran to block the Strait of Hormuz.

Indeed, the whole issue arising from the sanctions against Iran may force Tokyo to develop alternative supplies beyond the medium-term shift in its import sources as it seeks to make up for the inevitable loss of Iranian barrels, the percentage of which has yet to be agreed with the United States.

Reports so far about the talks underway in Washington suggest that Tokyo may agree to cut its oil imports from Iran by 10-20% from a 2011 level of 310,000 barrels per day (b/d) to ensure that Japanese banks are not excluded from the U.S. financial system. Iran was the fourth largest supplier of crude to Japan last year.

Rising tension over the security of oil and LNG traffic through the Strait of Hormuz, gateway for 20% of total tradable oil heading out of the Persian Gulf to world markets, is another worry for Japan. Close to 90% of Japan's oil imports and more than 20% of its LNG are shipped through the strait.

As a maritime importer, the country's options are, however, limited.

Japan, the world's third largest oil consuming nation after the U.S. and China, is particularly aware of the dangers posed by any security threat to the Strait of Hormuz after one of its tankers was hit by a mysterious explosion in August 2010.

And, since the Fukushima nuclear disaster in March last year, Japan has had to import more crude oil and products to make up for the loss of power generation capacity from all but two of its 54 nuclear reactors.

The anticipated loss of Iranian crude oil, therefore, comes at a particularly awkward time for Japanese decision makers.

On the one hand, Tokyo has to satisfy the U.S. administration that it is prepared to lessen its reliance on Iranian crude oil while struggling to meet higher demand in a rising oil price environment as the tensions over Iran have contributed to the recently premium that pushed oil prices to their highest level in eight months.

The U.S. has launched a diplomatic effort to convince major Asian buyers of Iranian crude oil as part of a wider effort to put pressure on Tehran to quit its controversial nuclear program. Unilateral U.S. sanctions that came into effect on Jan. 1 threaten to exclude any company or country dealing with Iran's central bank from the U.S. banking system. A cut in Iranian imports would provide an exemption.

But even if Japan were to cuts its Iranian imports by 10-20% a year, it will still be importing more than 200,000 b/d of crude oil from Iran. This means that Japan may have to seek spot cargoes if supplies are disrupted due to other complications that have arisen.

Japanese ship owners can expect to see their insurance coverage for voyages to Iran drop dramatically when European Union (EU) sanctions come into effect on July 1.

Current international arrangements mean that Japanese ship owners can obtain insurance coverage of up to $1 billion for an incident such as an oil spill, said an official at the Japan Ship Owners' Mutual Protection & Indemnity Association.

But this coverage will drop to $8 million, the maximum the Japan Protection and Indemnity (P&I) Club will be able to guarantee, when the EU ban takes effect, the official said.

The EU sanctions extend beyond just an embargo on the import and transportation of Iranian oil but also ban insurance cover for vessels. Because of pooling arrangements for reinsurance between the various P&I clubs around the world, the sanctions will have an impact on non-EU shipping.

The crisis over Iran has therefore served as a wake-up call for Japan to revise its energy policy not just in the months ahead but for the years ahead.

Takeo Kumagai, Platts

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