Abstract: The article examines the complex relations between economic attractiveness and political impediments in Japan’s energy sector. It discusses modern trends in energy mix and consumption and highlights the country’s extreme import dependence on energy sources. While resource-rich Russia in geographical proximity is a natural partner for energy cooperation, the potential for such cooperation is far from developed due to each country’s domestic policies and historical complications in bilateral relations. Considering the uncertainties in Japan-Russia relations, the article constructs several scenarios for future collaboration in response to possible shifts in Japan’s domestic energy policy and potential changes in political risk for Japanese investments in Russia in response to political developments in the latter.
Keywords: Japan’s energy policy, Japan-Russia relations, energy export, FDI, political risk, scenario-building
Introduction
In an era of globalization, opportunities for countries’ successful developments stem from a greater interdependence of national economies, accelerated cross-border trade flows, and increased foreign direct investment. However, political environments in each country, combined with a history of bilateral political relations, define the institutional context that facilitates or inhibits mutually beneficial cooperation. Complex relations between economic attractiveness and political impediments are particularly evidenced in the global energy sector, where matters of energy security and relevance to national political interests complicate the potential for economic cooperation between countries. These problems are further aggravated in cases of countries highly dependent on foreign energy sources. Since the mid-20th century, the world’s approach to energy has experienced a crucial shift. Beyond its use for electrification and the sustainment of societies, provisions of energy supplies have become essential to national security, affecting domestic infrastructure, military strength, and a nation’s measure of power and influence. Simultaneously, global crises, such as the 2008 financial crisis or the 2020 coronavirus pandemic, have exposed vulnerabilities in global energy supply chains. Hence, obtaining maximum energy self-sufficiency, minimizing risks in importing energy sources, and preserving relations with reliable energy trade partners is crucial for survival in an energy-hungry world. These concerns, however, have significantly marginalized Japan – the world’s third-largest economy, yet one of the world’s most over-dependent energy consumers by GDP[1]. Amidst heavy investments in and dependence on regions with high political risk, primarily the Middle East, accompanied by a diminishment of domestic energy production, the diversification of energy supplies in Japan becomes critical in an increasingly competitive global energy market. This strive for diversification, in turn, encourages energy-cooperation with countries rich in LNG, oil, and coal resources.
For Japan, a country extremely dependent on hydrocarbon imports, such cooperation is a logical way to address domestic energy resource scarcity[2]. Russia, as one of the top global exporters in geographic proximity to Japan, is a natural partner for cooperation in the energy sector[3] [4] [5]. In turn, it is in Russia’s best interests to extend and diversify its energy exports [6] to and engage in technological cooperation with Japan[7]. However, the potential for Japan-Russia cooperation is impoverished and far from developed due to each country’s domestic policy orientations and historical complications in Japan-Russia foreign relations[8] [9].
As such, this paper addresses the Japan-Russia energy cooperation challenge that demonstrates the collision of economic advantages and political constraints in this cooperation. Furthermore, the analysis of dynamic trends in domestic policies, bilateral political relations, and political risk for Japanese investment in Russia sets the stage for predictions of potential scenarios for the future. Overall, the paper responds to the question: what are the economic implications of the political context to the potential of Japan-Russia relations in the energy sector, or in other words, what are possible solutions to this energy cooperation paradox?
This agenda defines the outline of the paper. First, it offers an overview of the Japanese energy sector and displays its extreme dependence on energy imports. Next, the paper focuses on one of the most advantageous potential sources in response to Japan’s high demand in hydrocarbons, namely Russia. It further explores the structure and dynamic developments in Japan-Russia energy cooperation and addresses critical political constraints and limitations for this cooperation. Considering the uncertainties in the political context for Japan-Russia energy cooperation, the paper constructs several scenarios about future economic collaboration in response to possible shifts in Japan’s domestic energy policy and potential changes in political risk for Japanese investments in Russia in response to political developments in the latter.
Japan’s domestic energy economics
Japan’s energy sector: structure and trends
Historically, in the second half of the 20th century, Japan’s highly advanced economy grew increasingly dependent on manufacturing, resulting in high national energy usage. Particularly since the 1970s, its “economic miracle” powered energy consumption into a decades-long growth in power generation, increasing annually generated electricity from 485 Twh in 1980 to 1, 030 Twh in 2007[1].
As of 2016, around three-quarters of Japan’s energy continued to be used for industrialization, primarily for vehicles, factories, and heating, while only the remaining fourth is used for direct electrification[2]. This sustained growth has made Japan one of the world’s largest energy consumers, with annual rates remaining around 940 Twh per year behind only the United States and China. Hence, due to the crucial role of energy in Japan’s economy and continued demand for it, the Japanese government emphasizes the importance of accessible lower-cost energy supplies.
As of FY 2017, Japan’s energy mix was primarily composed of fossil fuels, namely coal, oil, and LNG, as well as a significant combined percentage of nuclear, hydroelectric, and renewable energy (Figure 1).
In Japan’s power supply structure, hydrocarbons account for 87.5%, with 23.4%, 25.1%, and 39.0% being attributed to LNG, coal, and oil, respectively as of FY 2017[3]. Demand for and the consumption of oil in Japan has been continuously decreasing since the oil crises of the 1970s in a national effort to diversify energy sources. Despite this, oil remains the largest source of primary energy consumption in Japan[4]. Natural gas is Japan’s second-largest source of energy and powers much of the electricity in the nation. However, LNG dependence has also created vulnerability for Japan in times of crisis, such as during the COVID-19 pandemic. In March 2020, due to LNG’s poor long-term storage, Japan only had a two-week stockpile that threatened the 40% of electric power generation that LNG provides[5]. In 20103, coal accounted for 27% of Japan’s electric capacity. This percentage reflects Japan’s long-term dependency on coal despite the international backlash, as Japan was the world’s top coal importer until China overtook it in 2012[6].
Japan has also seen significant increases in renewable energy, which accounted for 16% of Japan’s power source mix and 8.1% of its total power generation in FY 201717. Japan’s renewable energy percentage (excluding hydroelectric) in FY 2017 was higher than that of China, Canada, or France, and approached that of the U.S. at 9.9%17, reflecting Japan’s energy policy emphasis on developing green alternatives to its heavy hydrocarbon dependency. However, despite optimistic trends, renewable energy has been hindered by geographical features, domestic environmental restrictions, and continued government insistence on the use of cheaper fossil fuels, which maintain dominant usage in Japan.
The nuclear energy sector has seen the most rapid transformation in Japan in the past decade. Prior to the 2010s, the ratio of Japan’s use of nuclear energy demonstrated progressive annual growth and acceptance despite the social stigma around nuclear reactors in Japan, stemming from the bombings of Hiroshima and Nagasaki. Nuclear energy generation had significantly increased, from approximately 1% of Japan’s energy supply in FY 1973 to representing over one-tenth of the energy supply and 27% of total domestic power generation in FY 2010. However, in response to a change in government policy after the 2011 Great East Japan Earthquake and Tsunami that destroyed the Fukushima Daiichi Nuclear Power Plant, as of FY 2017, only 3.1% of total power generation in Japan was derived from nuclear power sources, marking the end of the 20th century’s “nuclear renaissance”[7].
Due to the decrease in the availability of nuclear energy, Japan’s other energy sources, particularly the hydrocarbon and renewable energy sectors, have been forced to bear the burden and overcompensate to account for the loss, reflecting increases in their proportions of Japan’s energy mix. As a result, Japan’s LNG annual imports increased by 24% from 3.5 to 4.3 trillion cubic feet between 2010 and 201217 and accounted for 18% of Japan’s energy supply in FY 2010 but increased to 23.4% in FY 201717.
Considering Japan’s pivot in energy policy, the Japanese Ministry of Economy, Trade, and Industry (METI) also formed a long-term energy outlook in 2015 for FY 2030, supplemented by their plan to become carbon-neutral by 2050[8]. The outlook focuses on three major concerns: environment, economic efficiency, and energy security. Environmental policies reflect a continued strive for clean, renewable energy as well as a gradual return to higher levels of nuclear power generation. Economic efficiency also relies on the reduction of costs of electricity for consumers through the reallocation of nuclear power generation, expected to reach its pre-2011 level of a 25% energy production ratio17. Finally, Japan’s energy security projections refer to an increase in its self-sufficiency rate, generated by a diminishing use of hydrocarbons.
Overall, Japan’s energy sector responds to the growing demand in energy consumption. Its structure is dominated by hydrocarbons along with major fluctuations in nuclear energy generation and the accelerated use of renewable sources. However, the future trends and energy mix face uncertainties stemming from domestic policy decisions and the availability of external sources in importing countries.
Japan’s essential energy problem: dependence on imports
While Japan is willing to develop alternative energy sources, including solar, geothermal, wind energy, as well as owns advanced technologies in nuclear power generation, hydrocarbons dominate the energy mix. This structure creates unprecedented pressure and dependence on fossil fuels energy imports in spite of recent efforts to increase Japan’s own natural gas production in the north of the country. The country’s energy self-sufficiency ratio remains extremely low, 9.6% in 2017, ranking it the 2nd lowest of the OECD countries, ahead only of Luxembourg17.
Historically, Japan’s island geography and isolated strategic position in the East China Sea, far from rich hydrocarbon sources in the Middle East and Southeast Asia, reflects the vulnerability of international energy imports. Through the development of the renewable, hydroelectric, and nuclear energy sectors in the second half of the 20th century, Japan has made attempts to alleviate this dependence on imports by deterring its fossil fuel dependency of 94% in FY 1973 to only 81.2% in FY 201017. Yet, the shift in energy dynamics after 2011 with revised nuclear energy policy, has resulted in the most substantial increase in Japan’s dependency ratio in decades, reaching the level of 87.4%17. As such, Japan must emphasize and sustain positive relations with its current trade partners to guarantee a steady inflow of energy inputs, regardless of suppliers’ regional political tensions or instabilities.
With Japan’s 99.7%, 97.5%, and 99.3% dependence17 in FY2017 on imported crude oil, LNG, and coal, respectively, relations with importing countries and an awareness of their dependency and political risk are crucial to the stability of Japan’s energy-imports.
Crude oil imports in Japan are vastly dominated by sources from the Middle East, with Saudi Arabia accounting for 38.6%, the UAE for 25.4%, and Qatar and Kuwait for a combined 15.6% of oil imports to Japan17. The overdependence on these countries requires significant oil stockpiling in case of political destabilization or regional conflicts. In addition to sources in the Persian Gulf, Japan relies significantly on oil imports from Russia, its fifth-largest source, which is transported to Japan via multiple Arctic transport projects.
The Middle East continues to play an important role in Japan’s LNG imports, accounting for a combined total of 21.7% of Japan’s energy imports, namely from Qatar, the UAE, and Oman. However, Australia (34.6%), as well as countries in Southeast Asia (Malaysia, Indonesia, Brunei, and Papua New Guinea) dominate the LNG market17. In addition, Russia remains Japan’s fourth-largest source of LNG, with the majority of imported LNG sourced from joint projects in eastern Russia.
Coal imports are primarily dominated by Australia, which accounts for 71.6% of Japan’s coal imports. Japan remains Australia’s largest LNG and coal buyer[9] and boasts strong, long-term relationships through joint trade and investment projects. Australia is followed by Indonesia at 11.8% and Russia at 10.7%, which benefits from its rich natural resources, high quality of coal, and geographic proximity to Japan.
Overall, Japan is heavily dependent on energy imports, however this dependence has visible regional distinctions as displayed in Figure 2.
An evaluation of Japan’s energy import partners reveals the dominance of three global regions: the Middle East, Southeast Asia and Oceania, and Russia. Due to its dependency on international imports, regional security is crucial for Japan both in the Middle East and Southeast Asia to guarantee the safe transport of energy resources. Associated political risks and the cost of transportation, as well as the long shipping period, depend on the safety of the regions from which Japan exports and through which it transports. Transport of LNG from the Persian Gulf, for example, takes approximately one month to reach Japan and results in substantial transportation costs.
An example of the risks associated with dependency on a region with high political risk is the June 2019 Gulf of Oman incident. In this conflict, two Japanese ships bearing the Japanese flag were attacked by mines from Iran that heavily damaged the ships. The incident was especially sensitive to Japan’s relations with the Middle East because it occurred during Shinzo Abe’s visit to Tehran. Additionally, with Japan’s political proximity to the United States, tensions with the Middle East make Japanese tankers passing through the Strait of Hormuz increasingly vulnerable to retaliation from political challengers. With 88% of Japan’s crude oil imports originating from the Middle East, the fine line between crude investment and political intentions makes it a high risk for Japanese foreign policy in the region. Although tankers passing through the Strait of Malacca in Malaysia are less susceptible to political conflict, the Japan-bound tankers must pass through the South China Sea to reach their destination. As such, current tensions between Japan and China regarding territorial disputes in the South China Sea put Japan’s energy supply chain reliability at additional risk.
Imports from North and Central America, which remain significantly present in the Japanese energy market only in coal imports, reflect a close relationship between the U.S. and Japan, despite the higher transport costs and prices of the U.S.-sourced hydrocarbons, including shale.
However, a geographical analysis reveals that Russia is the only key player significantly present in all three types of fossil fuel imports to Japan and positioned among the top five importers for all three categories.
Japan’s critical post-2011 need for energy cooperation
In March 2011, the Great East Japan Earthquake and Tsunami destroyed three reactors at the Fukushima Daiichi Nuclear Power Plant, resulting in nuclear fallout and high levels of radiation exposure. In response to the disaster and public pressure, the plant’s owner TEPCO (Tokyo Electric Power Company) initiated a government-funded decommissioning of the plant that pushed Japan to adopt a plan to phase out all nuclear power plants by 2040, a plan supported by then Prime Minister Yoshihiko Noda[10]. The major shift in nuclear energy-related policies in Japan gave rise to an intense search for alternative energy sources, specifically fossil fuels, to respond to the changes in the structure of energy redistribution.
The restructuring of the energy sector responded to undesirable social consequences of previous policies. The greater reliance on fossil fuels has caused a change in energy prices in Japan, particularly increasing the price of electricity for consumers[11]. For example, from 2010 to 2017, electricity prices in homes have increased by 23%, while industries have seen a 27% increase in electric power rates17. Additionally, the temporary shift away from nuclear energy has resulted in severe revenue losses for government-sponsored electric utilities and has contributed significantly to Japan’s high government debt[12]. The increased fossil fuel usage is also making Japan’s unequally distributed aging population especially vulnerable to the incessant use of hydrocarbons in the next 30 to 40 years[13], as levels of air pollution and greenhouse gases in Japan persist despite recent record lows in emissions[14]. Thus, the re-distribution of energy sources in Japan since 2011 and the emphasis on increased fossil fuel usage have negatively affected key national sectors and require future development of alternative dependency scenarios.
The perceived changes in Japan’s domestic energy policy are necessary because, although Japan could continue its current heavy reliance on fossil fuels, the associated costs and domestic challenges carry severe negative consequences. Furthermore, Japan’s increasingly high rate of energy consumption after 2011 creates heavier import reliance on markets outside of Japan, minimizing Japan’s self-sufficiency ratio and adding to problems of energy security. Hence, Abe cabinet’s policy accompanied by an increase in nuclear energy, support for coal energy, and the reduction of the use of oil and LNG have led to a somewhat decreased Japanese interest in joint large-scale investment projects in hydrocarbons with Russia. Additionally, the continuation of the Abe Cabinet member’s terms under the Suga administration reaffirm the Japanese government’s consistence stance on energy investment and dependence abroad.
Overall, Japan’s protection of energy security is equated with a guarantee of national security[15]. As such, to optimize the safety of energy transport, it is in Japan’s best interest to decrease dependence on the heavy trade flows in the Persian Gulf and the South China Sea. Hence, options for the diversification of Japan’s energy import portfolio and the possibility of capitalizing on relations with Russia are on the table.
The Japan-Russia Energy Relationship
Japan’s geographical neighbor to the northeast, Russia, presents an opportunity for the development of strong mutual energy ties, exemplified by hydrocarbon import flows and existing Japanese private and government investments in LNG projects in eastern Russia. However, the historical and political context of relations between the two countries limits the scope and possibilities of cooperation due to bilateral conditionality and the dependence of international energy policies on domestic political landscapes.
Economic opportunities
Given the structure of outsourcing energy resources, Japan relies heavily on imports from Russia. Transport from its northern neighbor, which is only 28 miles away from the Japanese islands at its chokepoint, is quick, efficient, and relies on existing transportation and logistics infrastructure. The energy-rich region of Eastern Russia in reasonable proximity to the Japanese island of Hokkaido provides an opportunity for LNG, oil, and coal exports that can help fulfill Japan’s scarcity in hydrocarbon resources. Hence, the potential for Japan-Russian cooperation is feasible and attractive for Japan’s energy source diversification.
A keystone of the existing Russia-Japan energy relationship is the Sakhalin LNG project off the eastern coast of Russia. Sakhalin-I, supported by Exxon Mobil (USA), Videsh (India), Rosneft (Russia), and Sakhalin Oil and Gas Development Co. (SODECO, Japan), guarantees the Japanese government-owned SODECO a 30% stake in the project. The Sakhalin I project marked the start of modern economic relations between Russia and Japan in 2005, remaining the single largest Japanese government backed investment in Russian energy. A breakdown of the composition of SODECO reveals a combination of private company interests, such as through sogo shosha Marubeni and Itochu, in combination with semi-autonomous governmental companies JAPEX and Inpex, as well as a 50% stake in Sakhalin-I by the Ministry of Economy Trade and Investment (METI). The high degree of government involvement and assurance attests to the project’s vital role in national security and foreign relations rather than it solely being a source of private investment.
In addition, Sakhalin-II, including the planned expansion of the pipeline, is owned by Gazprom (Russia), Shell (USA), and Japanese corporations Mitsui and Mitsubishi, and provides Japan with a combined stake of 25.2%. In 2016, the Sakhalin LNG facility exports to Japan accounted for 65% of the total 10.9 million metric tons of LNG exported[16], demonstrating Japan’s key investment role in the joint projects. Furthermore, since 2011, there has also been significant momentum in revitalizing energy relations between Moscow and Tokyo. The bilateral efforts are evidenced in memorandums of understanding, such as the one signed by Russian NOVATEK and the government-owned Japan Oil, Gas and Metals National Corporation (JOGMEC) in 2018[17], that demonstrate continued symbolic interests in joint-cooperation in both Eastern Russia and the Arctic.
Despite mutual historical challenges and the countries’ different approaches to cooperation, Japan’s abovementioned high rate of energy consumption is an ideal counterpart for Russia’s high rate of energy production[18]. For Japan, this cooperation would support the need for self-sufficiency by diversifying import partners beyond the politically vulnerable Middle Eastern and unsafe Southeast Asian transport routes. As previously mentioned, the proximity of the Russian peninsula contributes to crucial security for LNG imports, particularly considering the hydrocarbon’s short-term storage. Furthermore, most of Russia’s joint large-scale planned or running liquefied natural gas projects include either a Japanese private company owner or the involvement of JOGMEC. Beyond improving Japan’s energy source distribution, the opportunity for a strong energy-relationship with Russia becomes equivalent to the impact of strong bilateral political cooperation for Japan and can serve as a foundation for cooperation in other areas of mutual interest.
Russia maintains similar reasons to contribute to its effort in attracting Japan-related investment. Considering the stagnating demand for Russian fossil fuels in the West, spurred by controversy and sanctions over Russia’s annexation of Crimea and situation in the Ukraine, Russia’s “pivot to Asia” in search of desirable Asian markets finds an opportunity in Japan’s lucrative high-consumption market. Due to Japan’s close cooperation with American oil and gas companies, a stronger relationship with Japan would provide the U.S. with more incentives to continue their high-stake investment in energy projects in Russia. Additionally, with existing projects in south-eastern Russia carried out in cooperation with China, Japan’s high-transparency and business-oriented culture would provide an excellent supplementary opportunity for Russia’s upper hand negotiation and impede the development of a Russia-China economic alliance.
In broader terms, Japanese experts encourage the country to design and implement a long-term energy strategy for Russia which responds to new uncertainties in political risk, the development of energy markets in northeast Asia, and an understanding of Russia’s needs to make the best use of Japan’s competitive advantage in terms of technology, experience, and know-how in energy conservation, environmental protection, or renewable energy[19]. Furthermore, integrating “green” components and compliance with the Kyoto Protocol in designing and implementing large-scale projects supported at the government level may contribute to connecting points between two countries and help diversify Japanese investment in Russia[20].
Political context of bilateral energy relations
Three dimensions shape the political landscape for Japan-Russia relations in the energy sector. First, it is the domestic political balance and the ruling party’s approach to Japan’s energy mix and international trade. Second, it is the broader context of Japan-Russia bilateral relations complicated by territorial disputes and lack of a peace treaty. Third, it is the level of political risk for energy imports and Japanese expenditures when investing in Russia and its energy sector. These political factors complicate energy relations between the two countries and add uncertainty to future developments.
(a) Changes in Japan’s domestic energy-tied policy
Following the closure of three reactors at the Fukushima Daiichi Nuclear Power Plant after the Great East Japan Earthquake and Tsunami, the Japanese government changed its policy towards one of a substantial reduction of the nuclear energy generation followed by greater demand in hydrocarbons. However, this policy towards the restructuring of the energy sector was accompanied by undesirable social consequences of greater reliance on fossil fuels which have caused a change in energy prices in Japan, particularly increasing the price of electricity for consumers[21]. For example, from 2010 to 2017, electricity prices in homes have grown by 23%, while industries have seen a 27% increase in electric power rates17. Additionally, the temporary shift away from nuclear energy has resulted in severe revenue losses for government-sponsored electric utilities and has contributed significantly to Japan’s high government debt[22]. The increased fossil fuel usage is also making Japan’s unequally distributed aging population especially vulnerable to the incessant use of hydrocarbons in the next 30 to 40 years[23], as levels of air pollution and greenhouse gases in Japan persist despite recent record lows in emissions[24]. Thus, Japanese government acknowledged the situation under which the redistribution of energy sources in Japan since 2011 and the emphasis on increased fossil fuel usage have negatively affected key national sectors and require future development of alternative dependency scenarios.
Hence, since taking office in 2012 and in response to disadvantageous situation in energy sector, Prime Minister Shinzo Abe advocated for the reversal of this policy and argued that Japan “cannot do without” nuclear power[25]. Abe pushed for a gradual return to restarting nuclear reactors, which actually began in 2015. This move was a key component of Japan’s “new energy policy” that was based on pragmatism, stability, energy cost reduction, and sustainability[26]. Under Prime Minister Suga, Abe’s policy of “nuclearization” is expected to continue, as previously shut-down plants continue to resume operation throughout the latter half of 2020.
Overall, the perceived changes in Japan’s domestic energy policy were deemed necessary to adjust to the knotty situation of current heavy reliance on fossil fuels, the associated costs and domestic social challenges, and increasing energy consumption after 2011. This in turn, is followed by heavier import reliance on markets outside of Japan, further minimizing Japan’s self-sufficiency ratio and adding to problems of energy security. Consequently, the Abe Cabinet’s political decisions addressed Japan’s interest in joint large-scale investment projects in hydrocarbons with Russia, supported by the continuation of the current administration.
Critical political issues in Japan-Russia bilateral relations
Japan-Russia economic relations in the energy sector face serious obstacles stemming from the political sphere. Namely, this is the historic collision between the two countries evidenced in the lack of a peace treaty and Russia’s drift towards greater isolationism in international relations accompanied by Western sanctions.
The key issue in the development of the Russia-Japan relationship is the territorial disputes over the Kuril Islands that determine the countries’ modern foreign policy tensions. Apart from a rich potential fishing economy, the islands provide a military-sensitive position at the meeting of the Sea of Okhotsk and the Pacific Ocean. The volcanic island chain’s sovereignty is symbolically re-evaluated annually at joint Russia-Japan government forums yet remains unsolved since 1945. This issue has also been recently exacerbated by Russian military flyovers over the islands as well as Russian officials’ visits to Japan-claimed islands, including Prime Minister Medvedev’s trip in late 2019[27]. Furthermore, for Japan, whose territory is 45 times smaller than that of Russia, strengthening territorial sovereignty and considering public opinion remains a key item in its political agenda.
Yet, the resolution of the conflicting situation around the four Kuril Islands remains uncertain. It is a sensitive topic in both countries, stemming from Moscow’s swinging position from the 1956 offer to concede two in return for the signing of the World War II peace treaty with Japan, Russia’s 2018 offer to sign the treaty without any preconditions, and the most recent Russian refusal of any territorial concession citing military, defense, and security issues. Japan’s firm stance on its claims over all four disputed islands is also unlikely to change as a condition for the signing of the peace treaty.
The other major political complication in Japan-Russia relations is an increasingly aggressive[28] and anti-Western Russian foreign policy that shifts in its global agenda towards multipolarity, and further to economic sovereignty, nationalism, and isolationism. Russia experiences enormous outflows of FDI (in 2018 alone, they exceeded 1 bln USD), causing many European and American private companies to distance themselves from the Russian energy market. This was accompanied by Western countries’ responses to Russia’s conflict with Ukraine and the follow-up sanctions imposed on Russia by Western countries, including Japan. While these sanctions had minimal effect on ongoing energy projects[29], METI attributed these effects to a slower pace in bilateral inter-government communication. Finally, Japanese companies acknowledge the conditionality of the U.S.-Japan strategic arrangements that guide Japan’s search for its allies’ support in addressing the politically vulnerable situation in the South China Sea.
The tone in Japan-Russia political dialogue was shaped by known personal relations between Abe and Putin. Abe has also employed more concessionary tactics in negotiation with Russians over the territory, making repeated efforts to strengthen relations and meeting President Putin for discussion despite the latter’s disinterest. Furthermore, these relations between two leaders have contributed to the development of bilateral ties in the energy sector. Since Abe re-assumed Prime Ministerial duties in 2012, he has met with Putin over twenty times (as of June 2018) and catalyzed these relations. In particular, all meetings involved discussions about Japan’s role in developing the Far East and Siberia and bilateral energy relations, and at a May 2016 meeting, Abe introduced the eight-point plan for governments’ collaboration in those areas[30].
With Putin’s perceived leadership through the 2020s, confronted with Abe’s departure from office in September 2020, the future of Japan-Russia relations remains uncertain and maintains vulnerability exacerbated by the ever-changing foreign policy stances of the Japanese cabinet. Suga’s Cabinet, in turn, has focused on economic revitalization and pandemic recovery and has set the inefficiencies of the Japan-Russia relationship aside. Consequently, Russian experts admit that “large energy projects are not possible without mutual political understanding” and are among preconditions for cooperation in the energy sector state energy trade infrastructure development, consideration and acknowledgment of partner’s long-term interests in restructuring trade flows, and require the redirecting of bilateral political relations towards a trust-based climate and a guaranteed governmental positive support of cooperation[31].
Political risk to Japanese investment in Russia
While proximity, specialization, market size, and market demand encourage economic cooperation between the two countries, their share in each other’s total foreign trade is far from distinguishable. Russian experts emphasize the “low intensity of trade relations,” as Japan’s share in Russia’s imports in 2005-2013 ranged between 1.5% and 3.2% and Russia’s share in Japan’s imports ranged between 1.2% and 3.1% [32]. Energy imports, namely fuels, from Russia to Japan dominate total Russian imports (83.2% in 2013) while machinery, transport, and electronics account for 83% of Japanese exports to Russia, shaping the trade structure in the form of “minerals in exchange for technology”42.
A similarly unfavorable pattern applies to FDI. Japanese outward direct investment in Russia, almost non-existent before the dissolution of the Soviet Union, in the decades that followed displayed growth however with utmost deviations in response to either government-backed mega-projects (like the Sakhalin projects) or politically motivated Western sanctions. According to the Japan External Trade Organization (JETRO), outward FDI peaked at 757 mln dollars in 2012, dropping to 109 mln dollars in 2016 and reaching the level of 396 mln dollars in 2019 (Figure 4)[33]. Japan’s presence in Russia accounts for 2.6% of total inbound FDI in 2018 and Russia’s investment presence in Japan in 2005-2013 ranged between 0.13% and 0.62%. However, selected industries like agriculture and forestry, extraction, car manufacturing, and energy resources are visibly higher, topping in energy with 13.4%, mostly concentrated in Eastern Russia42.
Source: [source” https://www.jetro.go.jp/en/reports/statistics.html]
About 600 Japanese companies have invested in Russia and annual surveys conducted by JETRO display only moderate optimism about doing business in this country. According to 2014 and 2015 surveys, Japanese businesspeople refer to multiple barriers and complications such as currency volatility, uncertainty in political and social development, and bureaucracy. Less than half of those surveyed expected an increase in profits and only 44% planned to grow their business further[34].
One of the key factors in low investment activity is the relatively high political risk for foreign direct investment in Russia[35]. Political risk, defined as “the probability that political decisions, events, or conditions will significantly affect the profitability of a business actor or the expected value of a given economic action[36],” can be high or low, being sourced in the actions of both governmental and non-governmental actors[37]. Russia’s high-risk assessment stems from a lack of modernization, unilateral economic profile, a lack of rule of law and high levels of corruption, bureaucracy, and international sanctions[38]. Leading European investment insurance group Credendo evaluates Russia’s medium/long-term political risk in 2015-2019 at 4/7, the expropriation risk at 5/7, and the political violence risk at 4/7 [39].
The dynamics in political risk for Japan’s foreign direct investment depend on changes in Russia’s domestic policies and their follow-up implications to the Russia-Japan Peace Treaty negotiations as well as the infrastructure and business climate to attract these investments. On the positive end of the spectrum, political risk could be diminished if Russia’s government opens and improves its relations with the West, as the removal of economic sanctions accompanied by visible progress in negotiations could lead to a possible formal signing of the Peace Treaty. The negative end of this spectrum is currently reflected in Russia’s growing nationalism, its aggressive foreign policy, and bending to economic isolationism accompanied by increased sanctions and the breakdown of relations with the West. Alongside governmental issues, there are also issues with private, non-governmental actors that include skyrocketing insurance premiums for Japanese investment in Russia in case of high risk, as well as constraints in financial operations and occasional prohibitive tariffs[40]. Here, on the negative side of the spectrum, such options will mean a higher probability of Japan’s investment loss in Russia or the loss of the value of investments in Japanese-Russian energy projects.
Japan’s FDI in Russia: Scenarios for the future
With swings in domestic energy policy in Japan, no simple solution to the territorial, political, and ideological divisions with Russia and relatively high political risk for the Japanese FDI in Russia, the strong presence of conditionality associated with political factors may continue to produce stagnation in bilateral economic relations and impede Japan-Russia energy cooperation. To best analyze the potential future for energy-tied trade and investment projects between Russia and Japan, it is crucial to identify the circumstances under which conditionality between the two countries is likely to occur. These “multiple futures” can take the form of distinctive scenarios for energy cooperation constructed in response to different combinations of internal and external factors that shape Japan’s imports from and investment in Russia.
Japan’s interest in developing an energy relationship with Russia will first and foremost depend on internal factors, namely its ratio of self-sufficiency and changes in its energy mix. The spectrum for this dimension depends heavily on political decisions about the future of the nuclear energy sector, and ranges from a rejection of nuclear energy sources (meaning growing dependence on hydrocarbons) to the aggressive construction of new reactors to diminish this dependence.
However, the likelihood of Japan’s pursuit of an energy relationship with Russia also depends heavily upon external factors, namely on the degree of political risk for Japanese businesses and investments in cooperating with Russia. The spectrum for this dimension ranges from lowering risk in response to a more positive climate for foreign direct investment in Russia and its further integration in economic collaboration with the West to substantial deterioration of this climate fueled by Russian nationalism and isolationism that may lead to the diminishment in the value of Japanese investment in Russia and investment loss.
Figure 5 displays five scenarios with the vertical axis representing the degree of political risk for Japanese investment resulting from changes in Russia’s policies, and the horizontal axis representing the range of Japan’s policies in terms of energy self-sufficiency. The size of the scenario bubbles reflects the perceived probability of each scenario.
Scenario 1: “Status Quo” (high probability).
The status quo scenario displays a situation in which the national policies in Russia and Japan toward one another do not drastically change in the next 10-15 years. Under this scenario of sustained political risk for Japanese investment in Russia and a slow increase in nuclear energy usage, a West-oriented Japan would continue its current projects in the energy sector but approach new projects with great caution. Since Russia is unlikely to form a close energy alliance with China to fulfill its energy surplus exports[41], Moscow will continue to encourage sporadic joint projects with Japan in hope of pursuing a serious advancement in their cooperative relationship.
Implications of this scenario fit the ruling LDP party continued majority in the Japanese parliamentary body (Diet) and the executive body (Cabinet), with projections to sweep the 2021 elections despite Abe’s departure. As such, the conservative Cabinet is likely to maintain its stance on Russia-Japan cooperation as a stagnated plan. Without a resolution of the Kuril Islands dispute no formal agreement or peace treaty would be signed upon the assumption of a current cabinet[42]. Considering Japan’s long-term agenda, the country is likely to gradually develop better levels of nuclear self-sufficiency but not achieve radical pre-2011 levels of nuclear energy usage and desirable self-sufficiency until the late 2020s[43]. Hence, Japan’s energy security will continue to depend on Middle Eastern political tensions, but like Russia, Japan will explore occasional connecting points for future hydrocarbon resources.
Scenario 2: “Worst Case Scenario” (moderate probability).
The worst-case scenario considers the intersection of a dramatic increase in Russia’s aggression on the world stage and Japan’s inability to improve its energy self-sufficiency. This scenario reflects pessimistic predictions about political risk for Japanese investment in Russia[44] due to Russia’s increased economic isolationism, human rights violations, and intellectual property theft alongside the negative effects of Western (and Japanese) sanctions on the Russian economy. It increases the probability of the loss of Japanese investment or the loss of the value of investment as well as a decrease in transactional transparency for Japanese companies, an undesirable change in LNG export cost and tariffs, or the disruption of the Sakhalin projects. In an extreme case, a cut-off from imported Russian hydrocarbons to Japan will cause a domestic manufacturing and economic crisis, catapulting current economic recession well into the future.
In addition, Japan’s low self-sufficiency rate means the country will increase dependence on imported fossil fuels and will be pushed towards an aggressive search for alternative sources for energy supplies worldwide, even at a higher cost.
Scenario 3: “Balanced response” (low probability).
This scenario reflects the presence of multi-directional forces in Japan-Russia relations in the energy sector. This unlikely scenario is characterized by Japan’s substantial increase in national self-sufficiency along with an increase in political risk for Japanese investment in Russia. A potential reduction in Russian oil, gas, and coal imports will have significant but not disastrous consequences on Japan’s energy sector because it will be compensated by a greater domestic reliance on nuclear and renewable energy. Under this scenario, it may be beneficial for Japan to consider the possibility of partial (or complete) withdrawal from significant projects with Russia, primarily in LNG. With a lower dependence on Russian LNG, accompanied by the availability of new energy sources (combined with potential lower risk access to hydrocarbons in the other regions) as well as an increase in nuclear and renewable energy, JOGMEC and Japanese private companies can instead redirect their investment toward projects that boost self-sufficiency.
Scenario 4: “Common ground” (low probability).
This optimistic but low-probability scenario combines Japan’s high import dependency with a decrease in political risk for Japanese investment in Russia. It responds to a potential reversal of Russia’s nationalistic policies, a reinstatement of democratic practices, and the removal of Western sanctions in the foreseeable future. Spurred by a restored international image and an inflow of foreign direct investment into the Russian economy, the decrease in political risk gives Russian energy markets a strong incentive to export more. This, in turn, provides Japan with an opportunity to extend cooperation to a broader range of joint projects, primarily on more LNG projects, spurring negotiations about efficient energy transportation from Sakhalin to Hokkaido as well as exploring further opportunities in oil and coal import projects.
This scenario can furthermore lead to new forms of large-scale intergovernmental cooperation between the two countries. Rather than relying solely on private co-investment in energy projects, both countries can expand cooperation to sectors beyond energy, resulting in an improvement of bilateral relations. The consequential resolution of a decades-long territorial dispute with Japan alongside the signing of the Peace Treaty formally ending World War II would also encourage foreign powers to re-evaluate the caution that previously surrounded cooperation with Russia.
Scenario 5: “Best Case Scenario” (low probability).
Finally, the best-case scenario would involve Japan’s strong efforts to diversify its energy mix, re-establish and grow its nuclear energy sector, decrease self-sufficiency, and capitalize on positive changes in Russia and its relations with the West. It will set the stage for the broadening of energy cooperation beyond hydrocarbon imports and will initiate joint projects in adjacent spheres, notably in nuclear energy and “energo-bridge” to connect countries’ electric grids in the future. For example, Japan’s growing demand for nuclear fuel imports will offer attractive export and technology exchange opportunities for Russian companies. In particular, progress in intergovernmental cooperation will make Russia an important player in Japan, and even include platforms for research and development between major nuclear energy players such as Rosatom and TEPCO. Additionally, strengthened economic cooperation may facilitate developments in political negotiations over the Kuril Islands, finding mutually acceptable and politically beneficial solutions for both countries.
Conclusions
This paper addressed the public choice problem by using the example of Japan-Russia energy cooperation and the potential for Japan’s FDI in Russian energy sector. It connected recent developments in Japan’s energy sector and trends in domestic policies in Japan and Russia with future scenarios of Japan-Russia trade and investment projects in the energy sector. It demonstrated Japan’s low self-sufficiency rate and high dependence on energy supply imports and discussed the conditions for such hydrocarbon imports that are associated with high transportation costs and risk as well as with importers’ political uncertainties. It further emphasized that, with a presence in all major energy supplies, Russia is uniquely positioned in Japan’s energy import mix to develop upon its relationship with Japan. However, economic opportunities in Japan-Russia energy cooperation are limited by their political environments, which demonstrate the energy cooperation challenge in balancing economic attractiveness and political barriers.
The paper developed a strategic perspective on the interplay between economic drivers and political challenges in Japan’s energy policy. The predictions for the future presented in this study are mostly pessimistic. Based on the analysis of trends in Japan’s energy mix, its imported energy sources, and on the review of bilateral political relations accompanied by political risks for Japanese investment in cooperation with Russia, it is not likely that substantial changes will occur within the medium-term timeframe. This trend will be driven by domestic political agendas in both countries, evidenced in the perceived stability of Putin’s rule in Russia in the 2020s and the Suga Cabinet’s policy of a slow gradual revival of the nuclear energy sector. Combined with uncertainty about negotiations over the Peace Treaty, the bilateral energy relationship will most probably sustain existing projects between Japan and Russia but will not lead to breakthroughs in cooperation.
However, in the long run, the situation may change in response to shifts in domestic policies and new critical global factors and may positively or negatively develop through one of the other four scenarios introduced in this paper. In the case of accelerated nationalism and isolationism in Russian politics and a lack of resolution over the Kuril Islands, risks for Japanese foreign investments in existing energy supply projects with Russia may increase and force the Japanese government and private business to desperately seek energy inputs in other countries or even withdraw from joint projects in Russia.
Optimistic scenarios are unlikely in the medium-term range. However, despite their low probability, they should be considered in creating outlooks responding to the reallocation of resources and the re-assignment of responsibilities in strategic decision-making. These scenarios reflect the possibility of a reversal in Russia’s relations with the West and a U-turn in FDI flows accompanied by the potential signing of the Peace Treaty. In the best-case scenario under these conditions, Japan and Russia can extend their cooperation to joint research and innovative start-ups in existing energy supplies and in nuclear energy that combine their respective advanced capabilities and explore other mutually beneficial areas for cooperation.
This study has both, theoretical and practical implications.
The findings presented herein may contribute to developments in institutional economics and, more precisely, the public choice approach to political economy that has long stated that nations adjust trade and investment ties to satisfy security as well as economic welfare goals[45] [46]. Empirical evidence may further be considered in predictive models that display significant causality between trade and conflicting political relations, more pronounced in strategic goods like minerals or fuels[47]. Furthermore, the paper explored political risk factors in foreign investment that have been receiving growing attention in academia[48] [49]. Finally, a multi-disciplinary approach to economic cooperation within a political context may offer valuable insights and predictions about future developments in international economic relations.
Practical implications of this study may assist business managers and policy makers in their strategic decisions about long-term economic cooperation between Japan and Russia and add arguments to political negotiations. In particular, major Japanese investors and government stakeholders should consider a “multi-scenario future” pattern in decision-making in energy sector, design action plans in response to each potential scenario with the framework for allocation of resources, run “stress tests” that consider potential shifts in developments in response to the changes and factors discussed in this paper.
The paper has known limitations due to insufficient availability of financial and business data about private investment projects and lack of knowledge about failed international business negotiations or cross-border mergers and acquisitions. Furthermore, ambiguities in methodology and data complicate the transition of qualitative findings into predictive econometric models.
Overall, the paper discussed the conditionality of economic cooperation stemming from alternative combinations of political factors and suggested a closer look at complex scenario-building to forecast and best prepare for challenges in a future Russia-Japan relationship in the energy sector. In conclusion, the study encourages stakeholders with business interests in the energy sector, government strategy-makers, and business leaders to carefully evaluate a complex and complicated set of political-economic factors in pursuing international business.
Anastasia Gracheva is a senior at Columbia University and the Paris Institute for Political Studies (SciencesPo Paris). She is a Sumitomo Corporation of Americas Predoctoral Fellow at Columbia Business School and was named a Saltzman Student Scholar at Columbia University’s Arnold A. Saltzman Institute of War and Peace Studies. Her research focuses on Japan’s economic policy and the role of political risk in energy security and cooperation.
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