Why Japan’s utility firms want to pull the plug on destination restrictions for LNG supply

• Japan set a 2030 limit of 100 mtpa target for importers, well above the 79 mtpa currently contracted, IEEFA noted
• Policy signals Japanese companies will likely continue to play a major role in LNG markets and transactions
• Any effort to ban the use of the destination clause would likely unsettle sellers, legal expert says

A hardened feature of long-term LNG contracts, the destination clause, is coming under renewed scrutiny as the quest for flexibility gathers momentum. 

The ability to have wiggle room around contracts is being touted by buyers in burgeoning Asian markets as being crucial for energy security amid the flux of narratives around long-term supply and demand.   

Quite simply, utility companies in Japan, who have no indigenous gas source to rely on, have called on the country’s government to intervene in their LNG supply contract negotiations for better “destination clause-free" terms according to Tokyo Gas chairman Takashi Uchida, who also heads the Japan Gas Association, whose members include Osaka Gas, Hokkaido Gas and Fukushima Gas.  

Within the Asian market which consumes 65% of global LNG, Japan itself relies on LNG imports for the 21% gas component in its energy mix. Most recently, it dropped to second position in the ranking of largest global importers, with 66 mt – mostly from Australia, the US and Qatar – behind China’s 71 mt of LNG, according to GIIGNL’s 2024 annual report. 

Citing demand uncertainty in the region, due to factors such as seasonality, the trend towards decarbonisation and the impact of nuclear power plant operations, Tokyo Gas told Gas Matters Today: “In this situation, we believe that flexible contracts that take into account not only destination clauses but also quantities are important.”  

Tokyo Gas added that to achieve a stable supply while responding to the uncertainty of future supply and demand, “we believe that flexible contracts without destination clauses or restrictions are important”. 

Market commentators, though, argue that if buyers want LNG destination flexibility, this is typically offered by the US, but this comes at a higher price tag. 

“What I found the most interesting was how some Japanese [buyers] were reacting to the US LNG pause and were deeply affected by the fact that the source of flexible LNG may come to an end, while actually there is a lot of uncontracted LNG available,” Anne-Sophie Corbeau, Columbia University global research scholar at the Center on Global Energy Policy, told Gas Matters Today.  

I think you'll be hard pressed to find the long-term established sellers agreeing to buyers' requests to send cargoes on to wherever the buyer wants [outside their agreed contracts]

QatarEnergy’s North Field LNG expansion program includes NFE and the North Field South and North Field West projects. Taken together they aim to raise the Qatar’s LNG production capacity from 77 mtpa to 142 mtpa by the end of the decade.    

“This is not the flexible stuff that people may want... Qatar has plenty of LNG to sell. Strictly speaking there is a lot of uncontracted LNG out there,” Corbeau said.

The move by Japanese firms was surmised by one senior LNG commentator as “a battle for flexibility” with the buy-side now looking for it in order to lock in supply contracts (and their suppliers) for security of supply – “but not being themselves locked in because of the absence of certainty on future own-demand". 

Amid a changed landscape with more FOB volumes from the US, as well as other projects, a positioning for a negotiation with the Qataris may be driving the latest call to pull the plug on destination clauses, market observers suggest.  

Impact of spot market trading 

The LNG market little resembles the simplicity of point A to point B contracts that couched sales since LNG was first shipped 60 years ago.  

The emergence of liberalised or spot markets, underpinned by regasification and liquefaction technological developments, now make for a far more dynamic trading landscape swirling with variables from price volatility and lucrative arbitrage opportunities to geopolitics and extreme weather depressing, or boosting, LNG prices. 

Of total LNG trade in 2023, spot and short-term activity made up 40% of the market, up from 5% in 2000, according to GIIGNL, which attributes the trend to a “a growing need for market flexibility”. 

The initial iteration of the destination clause was part of the organic fabric of shipping and trading with less technological standardisation.

Now, sellers' ambitions are tightly bound to market development – this means control of the molecules to leverage higher economic value by taking LNG to different parts of the world. 

“The supply follows price and the capacity to access that price – not just price alone. This is why portfolio players hold import capacity into liquid markets,” a senior LNG market observer said. 

And despite a history since 1996 of holding LNG supply contracts with suppliers like QatarEnergy and its predecessors Qatargas and RasGas – whose arrangements characteristically feature destination restrictions – Japan's utilities have made a public show of now wanting out.  

It is not the first time the clause has been scrutinised. After investigation, the country’s competition regulator, the Japan Fair Trade Commission (JFTC), suggested in 2017 that LNG sellers should not include the restrictive clause in their contracts.  

The JFTC said then a significant proportion of all LNG contracts to Japan contained clauses which, if tested in court, would be ruled as imposing illegal restrictions, and would therefore not be enforceable.   

But no law to that effect was made, a senior LNG industry expert noted, adding that Japan has since not been very aggressive on matters relating to liberalisation or increasing competition. 

Could the Japanese government choose to now push the issue further? “The government isn't going to intervene in contracts, unless they're contrary to Japanese law. If there are destination clauses still there, you must assume that both the buyer and seller considered whether they're legal under Japanese law,” the expert added. 

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The clause was also investigated in 2005 by the European Commission which considered contracting practices of both Nigeria LNG and Sonatrach. It concluded that any sort of destination restriction in an free-on-board (FOB) contract was likely to be illegal if it impacted deliveries to EU countries, while destination provisions might be reasonable in some cases for delivery ex-ship (DES) contracts, as the seller still has title to the cargo until it is unloaded. 

Deals and gas aggregator ambitions? 

Another view emerging is that Japanese LNG buyers may themselves be after commercial upside.  

Japanese LNG imports peaked in 2014 and fell to their lowest level in a decade last year, according to the Institute for Energy Economics and Financial Analysis (IEEFA).  

But the internal demand decline does not mean it will necessarily pull back from gas: as a veteran buyer, having developed around 50 years of expertise in the services necessary for nearly all aspects of the LNG supply chain, the country holds the potential to benefit from being perfectly situated to becoming a key local player or aggregator. 

Japan’s Ministry of Economy, Trade and Industry established a strategy for LNG, and set a 2030 100 mtpa target for importers, well above the 79 mtpa currently contracted, IEEFA noted in a March 2024 report. 

“Despite declining domestic demand, the policy sends a clear signal that Japanese companies will likely continue to play a major role in LNG markets and transactions, either through long-term contracts, spot market trades, and/or investments in upstream and LNG export projects,” the report said. 

The country’s lawmakers are also effecting fiscal policy that would aid Japanese companies’ ability to make inroads as a local aggregator, including investing in midstream and downstream infrastructure such as regasification terminals and LNG-fired power plants, IEEFA notes. 

Japanese utilities are also offering consultancy work in the region around engineering to aid the development of energy and power roadmaps in the region, according to IEEFA’s tracking of their local activity in Bangladesh, Indonesia, Malaysia, Pakistan, Philippines, Singapore, Taiwan, Thailand and Vietnam.  

With domestic demand falling, these companies can continue to be relevant by pursuing infrastructure and trading opportunities abroad. Yielding LNG market share to other regional players could be seen as a threat to these business models.

Meanwhile, a survey in 2023 by the Japan Organization for Metals and Energy Security (JOGMEC) shows LNG sales by Japanese companies outside of the country and in the spot market went to more than 38 mt in FY2021 from 15 mt in FY 2018; this dropped to 31 mt in FY2022, in a year hit by soaring gas prices amid Russia’s war on Ukraine. 

“The plan is to become a portfolio player like BP and Total,” JERA’s chief buyer Hiroki Sato told the Financial Times at a Tokyo commodities conference in 2017.

Since then, in addition to acquiring a 19% interest in Bangladesh LNG importer and power generation firm, Summit Power, JERA has also developed a fleet of 17 LNG carriers and invested in LNG-fired power plants and regasification units in south-east Asia. 

Tokyo Gas launched an LNG trading unit in 2020 following earlier plans to bump LNG transaction volume to 20 mtpa by 2030, inclusive of 5 mtpa trading volume lift. 

Osaka Gas in 2022 clinched the front-end engineering and design award for an LNG project in Taiwan, while IEEFA notes that Kansai Electric has built out a presence in the region on the back of its overseas power generation business alongside engineering and maintenance services.

LNG exporters “are surely fine” with Japan’s integral role in unlocking new LNG supply “as the largest public financer” of the gas sector, IEEFA LNG expert for Asia, Christoper Doleman, told Gas Matters Today.  

“Through policy-driven organizations like JBIC, NEXI, and JOGMEC, Japan provides key financing services that can lower the cost of capital for upstream gas and LNG supply,” he said.   

Further, removal of destination restrictions would be key if Japan is to ensure the security of the business models that depend on its handling staying at current levels, Doleman adds. 

“With domestic demand falling, these companies can continue to be relevant by pursuing infrastructure and trading opportunities abroad. Yielding LNG market share to other regional players could be seen as a threat to these business models.” 

Threat of oversupply 

Japan’s need to shift volumes in the event of oversupply may be also driving the need for flexibility if a potential oversupply issue is looming.  

IEEFA predicts the four largest utilities – JERA, Tokyo Gas, Osaka Gas and Kansai Electric – could also see surplus rise to nearly 12 mt this decade from the current 9.8 mt. 

With global LNG markets headed for a period of oversupply this side of 2030, the sector is banking on emerging Asian demand from China, Southeast Asia and South Asia to balance the market, Doleman said.  

Noting that financial, structural and policy hurdles may slow down their ability to absorb supply, Doleman suggested that exporters, marketers, and portfolio players may have to compete with Japanese resales to absorb any of their volumes that are not covered by contracts with end users.  

“If spot prices fall low enough, some may find it hard to deliver volumes into Asian markets at a positive netback. Qatar has the lowest cost of production and would likely be able to sustain competition with other suppliers on the spot market in an oversupplied market the longest,” Doleman said. 

Overall, at the right price, there would be no problem with offloading extra cargoes in five- or 10-years' time, Ben Holland, a partner at K&L Gates oil, points out. 

“However, there may be points in the cycle where even without destination clauses being a problem, there's a practical problem of oversupply, in that the surplus couldn't be economically moved anywhere else because the contract price was too high compared to the market price. You could sell on the molecules, but you would be trading at a loss and so that would be an issue.” 

Principle of the matter 

Market observers caution that the issue is more about principle than resolving an issue with contracts being the prickly point.  

If Japan passes a law saying all contracts signed by Japanese companies cannot have destination restrictions, suppliers will likely have to consider whether they apply to existing contracts.  

“There would be options — for example, suppliers could choose not to supply to Japan,” a market expert suggested. 

If a contract falls within the scope of revised or fresh laws, it might need reconsideration by the parties involved. 

“[A buyer] may have to ask the supplier to renegotiate — and perhaps consider if there is a clause that said that if the law changes, the contract must simply abide by the law. If there isn't, then it’s sort of not really the supplier’s issue," the expert said.  

But any effort to ban the use of the destination clause would likely unsettle sellers – a London-based senior legal expert who regularly deals with Asian buyers  – said that axing the contentious clause would simply undermine the business model of the long-term major supply companies. 

“I think you'll be hard pressed to find the long-term established sellers agreeing to buyers' requests to send cargoes on to wherever the buyer wants [outside their agreed contracts],” the expert said. 

Part of the reluctance would likely relate to sellers maintaining their own trading desks. 

“They'll have their own hedging activities; they are making money off the margins around this stuff. So, why would they give that away to a buyer? If a buyer wants to perhaps aggregate, to start trading and hedging, and making additional margins around destination flexibility, they may need to find a way to do that for themselves,” the legal expert said. 

Operational issues would also make more flexible trading complicated and burdensome for the big-volume portfolio suppliers. 

“They've got five or six cargoes loading a day in Qatar – and with all the scheduling agreements and so on, it makes shipping less efficient if they suddenly have to provide flexibility on short notice,” an LNG consultant said. 

He said that any change in approach by the sellers would set a precedent.  

“So, if they give this flexibility, they’ll have other countries knocking on their door, saying ‘I need what you gave those guys – why is that not on my menu? I would have ordered that.’ 

“With the volumes the Qataris export, there’s just no upside for them to do this.” 

So far, there seems little sense in giving buyers flexibility, with the option left for Japanese utilities to consider the impact of offloading cargoes and reloading them onto ships they procure, at their own cost, a senior LNG consultant said.  

“That sets the alternative for the buyers and the Qataris will see how much of that they can extract for offering any destination flex. Ultimately both the Qataris and the Japanese need each other, and a compromise will be worked out.” -PS

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