Does Japan Really Need a $16 Billion Gas Pipeline?

It may help ensure energy security--but at a steep price

Immediately after the bombs started falling on Afghanistan, oil prices edged up, and Japan Inc. shuddered. With prices still volatile amid this open-ended global crisis, it's easy to see why Japanese companies are worried: Fully 99.7% of the nation's oil is imported. Now, with energy security an issue once again, government officials and Exxon Mobil Corp. (XOM ) executives are talking up a 2,100-kilometer pipeline that would carry natural gas from the Russian Far East to either Tokyo or Niigata, halfway down the Japanese archipelago.

At first blush, this seems logical. Geologists say the fields off Russia's Sakhalin Island contain 480 billion cubic meters of gas. That's enough to supply Japan with 8 million tons annually for up to 40 years. Some say piping the fuel would be cheaper than the current method of shipping it in and would help cut the country's sky-high energy prices (table). Besides, the Japanese are increasingly keen to reduce the use of such "dirty" fossil fuels as coal and oil in favor of gas.

INFLATED COSTS. Skeptics, however, point out that the Japanese government never met an infrastructure project it didn't like, and that this one would be prohibitively expensive. Routinely inflated construction costs, cumbersome engineering regulations, and prickly right-of-way issues with Japanese farmers and fishermen all threaten to trip up the best-laid plans. The Tokyo-based Mitsubishi Research Institute puts the cost at about $16 billion, nearly triple the price of a similar project in the U.S. or Europe. And while Prime Minister Junichiro Koizumi has vowed to rein in public spending, the government likely would have to help finance the project by taking an outright stake or by providing low-interest loans.

Then there is the question of whether Japan even needs a pipeline. Critics note that the nation already has access to plenty of gas from Indonesia, Malaysia, and Brunei. Besides, Japan's gas utilities are loath to commit to buying pipeline gas at a time when deregulation and sluggish economic growth make it hard to anticipate future demand. "It's hard to make a persuasive case for a pipeline," says Takashi Kunitomi, Tokyo Gas Co.'s corporate planning director.

ExxonMobil hopes to do so, though. In partnership with Russian and Japanese companies, the U.S. giant has spent $200 million developing gas fields discovered off Sakhalin in the 1970s. The pipeline would be a way to recoup that investment. Says Neil Duffin, president of Sakhalin-based affiliate Exxon Neftegas Ltd: "We believe the marketplace will look at it favorably."

ExxonMobil has a number of powerful allies, including Japan's Ministry of Economy, Trade & Industry. "It's an important project for building up Japan's energy infrastructure," says Hirobumi Kawano, director-general of METI's Agency of Natural Resources & Energy. METI aims to raise Japan's natural gas consumption from 13% of all energy consumed to 20% by 2010, in an attempt to cut carbon dioxide emissions--a key goal of the Kyoto Protocol on global climate change.

In the end, strategic considerations may win out. Long before the war on terror, Japan's energy supply was looking shaky. In March, Tokyo Electric Power Co. (TKECF ) was forced to suspend natural gas imports from the Indonesian province of Aceh for six months when supplies were cut off amid threats from a local secessionist group. Japanese also fear that further instability in Southeast Asia, where waters are already pirate-infested, could threaten the sea-lanes through which much of Japan's oil sails.

Also persuasive is the argument that a pipeline would provide an opening for new players such as electric power companies hoping to challenge Japan's established gas companies: They could bid for some of the gas and sell it cheap to industrial customers, thus forcing prices down across the board. Support in the business community is tempered, however, by concerns about the huge financing costs at a time when Japan's banks are increasingly risk-averse and the government is nearing a fiscal crisis. "We're all for having a pipeline if it's commercially viable," says Takashi Imai, who chairs both the Keidanren, Japan's leading big-business lobby, and Nippon Steel Corp. (NISTF ) "But we don't know that."

Japanese taxpayers may never know. ExxonMobil and its Japanese partners have no plans to make public the results of a feasibility study due next spring. So whether or not war disrupts oil supplies in the coming months, Japan seems likely to build the pipeline--even if it makes little immediate commercial sense.

By Chester Dawson in Tokyo.

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