East Asian Economic Strategies

The New Australia–Japan Energy Relationship

Visiting Fellow, RIETI

Australia is Japan’s most important energy supplier, supplying over 34 per cent of Japan’s energy imports, or 30 per cent of total energy demand in 2022. Japanese investment and energy purchases over decades has helped build Australian prosperity. But that’s in fossil fuels and change is already underway as both countries transition to net zero emissions by 2050. The bilateral economic relationship will need a total transformation.

The economic partnership between Australia and Japan underpins a deepening people-to-people and political relationship as the two US allies become more important to each other strategically in an economically and geopolitically uncertain international environment.

Australia has what Japan doesn’t: huge endowments of natural resources. For the last decade Japan relied on imports for 90 per cent of its energy needs. Stable institutions, a well-functioning democracy and a commitment to the international market mean that Australia is a stable and secure supplier, able to mine and ship natural resources with world-class efficiency. Openness to foreign investment has brought technology, market links, certainty, as well as capital that helped Australia extract natural resources more cheaply than Brazil or countries in West Africa. And Australia and Japan are geographically close — much closer than South America or Africa are to Japan.

METI’s statistics show two-thirds of Japan’s coal imports and roughly 36 per cent of its liquified natural gas (LNG) imports are from Australia. The Japan–Australia Investment Report by Australian law firm Herbert Smith Freehills finds Australia supplies 75 per cent of Japan’s coal and 43 per cent of LNG. Outside of crude oil, Australian resources fuel Japan’s economy. That extends to strategic raw materials too — Japanese steel mills procure more than 60 per cent of their iron ore imports from Australian mines.

It’s no wonder that last year over 40 per cent of Mitsui’s global profits were made in Australia — in some years half of Mitsui’s profits are generated in Australia. It’s a similar story for Japan’s other trading houses with around 35 to 40 per cent of Mitsubishi Corporation’s profits generated in Australia and 20 per cent for Itochu in the last year. Mitsui has invested more in Australia than it has in all of North and South America.

Japanese investment continues to flood into Australia focused on energy security and decarbonisation. According to JETRO, Japanese companies invested more in Australia last year at $10.1 billion, than in China where they invested $9.2 billion in direct investment. That makes Australia the third largest destination for Japanese investment after the United States and Germany. Japan is the second largest foreign direct investor in Australia and fourth if portfolio investment is included.

With Australia supplying one third of Japan’s total energy imports, the next most important sources are Saudi Arabia at 15 per cent of imports, UAE at 12 per cent and Russia at less than 9 per cent, followed by Indonesia and Qatar.

Why then did former Japanese Ambassador Yamagami Shingo undertake a campaign in the Australian press arguing that Japanese companies see Australia as becoming a “sovereign risk” in April this year before his departure?

Inpex president and CEO Ueda Takayuki also unleashed at Australian politicians and industry leaders in Canberra the same month, going as far as to say Australia’s gas policies threaten world peace.

Coinciding with Ueda’s comments was the announcement that Japan would buy more gas from Russia at above the G7 agreed price cap. Japan continues to invest in the Sakhalin oil and gas projects.

With Russia’s invasion of Ukraine, Japan is understandably worried about energy security. The Australian government has made some interventions in the energy market to ease the pressure on household energy prices in these unusual times of war-induced energy price inflation.

Those interventions have included gas and coal price caps and reservations and a “safeguard mechanism” that will help reduce emissions at Australia's largest industrial facilities. Apart from the price caps that are a distortion in the market excused by the government at a time when war has disrupted international gas markets, the other policies are consistent with Australian energy security and energy transition priorities. Western Australia already has a domestic gas reserve operating and certainty was needed after Australia ran out of gas on its East Coast in 2017, having to buy it back from Japan at a hugely inflated price.

It was energy policy uncertainty in Australia over the past decade that led to under investment in both renewable energy generation and fossil fuel extraction. This was exacerbated by increased litigation by environmental activists towards expansions of existing projects and the development of new projects. There is more certainty now with the Australian public sending a clear message to the political parties in Canberra that they want accelerated action on climate change policies, even as they manage higher energy prices.

As Australia accelerates its energy transition and decarbonisation, there will be more changes but the direction is clear. Australia and Japan need to work with industry to avoid a further “gas surprise”.

Ueda and Yamagami’s outbursts likely reflected concerns about future changes, including higher taxes on mineral extraction, more than the recent changes.

The Queensland state government recently increased coal royalties to capture windfall profits by coal miners. Australia pioneered a petroleum resource rent tax that taxes rents, or ‘super profits’, that result from very high international commodity prices for oil & gas and LNG. Those super profits are not the result of any innovation or further investment by energy companies and are on top of very high normal profits from increased prices. The natural resources are owned by the Australian community and the tax take for the Australian community is far lower than in Norway and other countries that extract natural resources.

The reason a mineral resource rent tax has not been introduced for iron ore, gas, coal and other natural resources, is because of the strong lobbying power by the major mining companies. It’s a tax that minimises distortions in investment decisions and is designed to be market-friendly. Ueda’s intervention is not unexpected, although it’s rare for such confrontational lobbying in public. Ambassador Yamagami’s campaign was highly unusual.

Australia has work to do in improving its investment environment, not just for Japanese companies. Australia has become a net capital exporter recently after consistently importing capital because domestic savings weren’t sufficient to fund investments. The investment needs, including infrastructure for a growing population, are still there, but investors are increasingly looking abroad. Some of that will change with more certainty in the direction of climate change and energy policies. But more work is needed.

One symptom of Australia’s uncertain investment environment has been its approach to discourage — and even block some — Chinese investment. Chinese capital, advanced technology and direct links into its huge domestic market will be important for Australia and Japan’s decarbonisation. Chinese investment into the development of cleaner energy sources in Australia will help reduce the risks and costs for Japanese investors.

After being the largest single destination for Chinese investment until around 10 years ago, the Australian government gradually lost confidence in the ability of its institutions to manage and regulate Chinese investment, which has collapsed. Getting the balance right and mitigating risks, instead of closing off opportunities, will become even more important with Australia being a major source of critical minerals. Japan is also a major investor in Australian projects that service Chinese markets.

It’s in Japan’s interest that Australia improves its investment environment so that energy prices remain competitive. There is no doubt about commitment to openness to the international market in the Australian community and there is widespread acknowledgement of the importance of the resource trade for prosperity.

The resource and energy complementarity between Australia and Japan will change dramatically, and at an accelerating rate, as both countries decarbonise their economies.

A new complementarity will not be realised through market forces alone because large-scale national investment in infrastructure in both countries is a prerequisite. An elevation of leadership, investment in both capital and human networks by government and industry from both countries and close cooperation will be needed to transform the bilateral energy relationship. Anything short of that is likely to frustrate the energy transition in both countries and see the withering of energy as one of the main pillars of the bilateral economic relationship.

The energy relationship between Australia and Japan thus needs to be completely reconceptualised. Instead of Australia shipping raw sources of energy to Japan, it may be cheaper and cleaner to produce intermediate or final goods in Australia, for example by processing minerals in Australia, and exporting the embedded energy to Japan and beyond.

Both countries need to lead on international standards and the development of regional and global frameworks for the trade in new sources of energy. For energy security, Japan will need more than one supplier and Australian industry will need more than one customer given the investment and scale that will be needed. That suggests a regional agenda for Australia and Japan.

It’s a huge agenda for Canberra and Tokyo with big strategic issues that recommend lifting bilateral stakeholder and policy dialogue to the highest level. That was one of the main recommendations from a major Australian report that I led on ‘Reimagining the Japan Relationship’ in 2021. The two governments should create a bi-national body to map out the energy transition with a medium to long-term view, help institutionalise and support the existing dialogues and cooperation mechanisms, involve significant experience and information sharing and focus on issues of mutual interest.

The natural resource trade between Australia and Japan took off after the 1957 Treaty on Commerce, only a dozen years after the two countries were at war. Political leadership is needed once again to effect the biggest change in the bilateral economic relationship since then—one that secures energy, decarbonisation, and prosperity for both the people of Japan and Australia.

June 21, 2023

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