Following the admission at the end of August that Tepco had been falsifying safety report statements from its nuclear power plants since the 1980s, the Ministry of Economy, Trade & Industry (METI) forced the closure of one plant as punishment. A further eight reactors have been shut down for safety tests.

The news is bad not only for Tepco, but also for the government in its attempts to diversify Japan's energy sources. The development of meaningful nuclear generation capacity had been an important part of the process whereby dependence on imported energy was to be reduced. Already under attack from the environmentalists and others concerned about the potential for nuclear disaster, Tepco's shameful confession is likely to freeze plans for further nuclear plants.

Japan's drive for energy diversification has multiple - and often contradictory - impulses. One urge is the move away from oil in general and another is the move away from reliance on the Middle East. However, success in both areas has been limited. Although a handful of contracts already signed will lead to the commissioning of a few more nuclear plants, the expansion of nuclear power as a proportion of Japan's power supplies has reached its political limits at about 12 per cent. The growth of liquefied natural gas (LNG) has been impressive and is likely to continue, but it is happening at the expense of coal rather than oil imports. In addition, increased use of LNG - it accounted for about 13 per cent of the primary energy supply in 2001 - has, to a certain extent, led Japan back to dependence on the Middle East: a significant proportion is sourced from Abu Dhabi, Qatar and Oman.

Imported crude oil still accounts for about 51 per cent of Japan's energy needs, and few analysts expect this figure to fall significantly in the years ahead. And, for now, the reliance on the Middle East is unaltered, accounting for 88 per cent of crude imports last year.

'The diversification away from Middle Eastern oil has been difficult for a number of reasons,' says Ken Koyama, general manager of the Department of Energy Studies at Japan's Institute of Energy Economics (IEEJ). 'The domestic demand of what used to be regional exporters such as China has turned them into net importers of oil and is obviously limiting our regional supply.'

There are also practical considerations. 'Japanese refineries built in the 1960s and 1970s were designed to take Middle Eastern crude,' says Shigeru Sudo, senior analyst at the International Development Centre of Japan (IDCJ). 'Cheaper West African crude is bad for the refineries, Russian crude is good, but the cost of transportation is high. With our fleet of VLCCs [very large crude carriers], the Middle East continues to be the best region for supply and quality. The physical properties of the oil are a constraint on diversification.'

Nevertheless, changes are afoot among the suppliers of the 3.8 million b/d from the region. As figure 1 shows, a growing proportion of oil has been lifted from Iran and Qatar over the past five years, as traditional dependence on the UAE and Saudi Arabia has declined (see table).

The shift in emphasis partly reflects the decline in Japanese upstream interests in the region. Concessions in Saudi Arabia, Kuwait, the Neutral Zone and Oman have either expired or been lost in the past three years and Japanese oil companies have found the going hard in negotiations with Abu Dhabi. 'The problem Japanese companies face is that in the past they have brought little more than cash to the table,' says an industry source in Tokyo. 'The emphasis has been on securing supply rather than developing concessions. But regional governments want more now: they want cutting-edge technology, commitment and real resources to be deployed, and Japanese companies have found it hard to convince them.'

Some lessons have been learned. Tokyo's refusal to provide financial and technological support for Saudi Arabia's East-West railway proposal is widely regarded as one of the decisive factors in Arabian Oil Company's exit from the Saudi-controlled area of the Neutral Zone. When negotiations opened with Tehran over the development of the massive Azadegan oil field, Japanese oil companies were better positioned, with a $3,000 million financing line in place with six Japanese trading companies. President Khatami confirmed in late 2000 that a Japanese consortium comprising Japan National Oil Company (JNOC), Indonesia Petroleum, Japan Petroleum Exploration Company and Tomen Corporation would work alongside the Royal Dutch/Shell Group in Azadegan.

'The situation in Iran has been positive, but the loss of upstream interests elsewhere has been a real cause for concern,' says Kazuhiro Morimoto, director of the Middle East & Africa office of the Trade Policy Bureau at the Ministry of Economy Trade & Industry (METI). 'We didn't want this and it doesn't mean our commitment to the rest of the Middle East is reduced.' Evidence of this can be seen in the government support for Japanese oil companies in negotiations over the shareholder structures of the UAE's Zakum Development Company and Abu Dhabi Marine Operating Company. It seems to be working: industry sources say Abu Dhabi has taken a more positive view of Japanese oil companies since 11 September.

However, the government's support has been tainted by the decision to wind up JNOC (see box). While in the short term this could weaken Japanese oil companies in the Middle East, in the medium term their position could be strengthened. 'The basic functions of JNOC - maintaining the national oil stockpile and providing financial support to overseas upstream operations - will be taken on by other institutions, though the full impact of the move will not be clear for months to come,' says the IEEJ's Koyama. 'JNOC's economic performance has been poor.'

The reform of Japan's energy sector - of which the dissolution of JNOC is just one of many components - is partly the result of a more sophisticated government policy. In the past, this was almost solely shaped by strategic concerns about the security of energy supply. This continues to top the agenda, but it has been joined by environmental issues - as reinforced by the 1999 Kyoto protocol - and a new focus on efficiency through competition. Energy policy has become an exercise in juggling all three issues; it is also encouraging more flexible thinking.

'The aim is to set up nine big integrated companies, liberalise the retail sector and eventually get new entrants into the generation sector,' says Koyama. 'From the diversification perspective, the government and the energy sector are discussing ways to incentivise the greater use of clean fuels such as LNG. There is talk of a new tax system for the energy sector, and this could have an impact on the fuel selected.'

The reform of the domestic market will have a major impact on the ways in which primary energy is imported. If legislation favouring LNG is introduced, the increased demand could bring a change in the shape of the market. 'We are already seeing buyers seeking far more flexible terms. The appetite for long-term contracts is declining and it is becoming a buyers' market as heavy grassroots developments in Malaysia, Australia, Brunei, Indonesia and the Middle East bring on expanded capacity,' says Koyama.

The impact on LNG exporters could be huge. A shift towards greater spot market activity could bring about the de-linking of the price of LNG from that of oil, as well as greater market volatility. In the past, spot market activity has been constrained by limited transport options and strict destination clauses that denied offtakers the right to resell. 'The Asian market is already becoming more liberalised and more competitive,' says Koyama. 'In March, for example, we saw Tepco lifting LNG from Malaysia on an FOB [free on board] basis.' Any moves in this direction will herald more challenges - but also more opportunities - for Middle East LNG exporters.

Fast though LNG sales to Japan might grow, oil will continue to provide the energy base load, and with dependence on the Middle East unlikely to be altered, the issue of security of supply remains important. One of the main responses is a two-part stockpiling programme. A national stockpile, currently managed by JNOC, of 315 million barrels - equivalent to about 80 days' consumption - is maintained. In addition, the private sector is obliged, on a pro-rata basis, to stockpile a further 70 days' worth of consumption, although the real figure usually hovers nearer 80.

'Recent experience has shown that this stockpile is really just for domestic needs, rather than shoring up regional markets during times of supply dislocation,' says Koyama. 'Oil is now a fungible commodity, so a crisis anywhere hits prices and this hits Japan. The government has been working hard to try and persuade regional neighbours that are not part of the IEA [International Energy Agency] to start building proper stockpiles themselves. Since 11 September there are signs that they are beginning to do so.'

With the reforms of the oil and energy sectors still in the transitional phase, and Japanese economic recovery still seemingly some way off, the government is continuing with its juggling act. 'They are trying to harmonise deregulation with energy security,' says IDCJ's Sudo. 'Fundamentally, this is not easy. For security of supply you specifically need to be upstream, you need concessions in the Middle East. In general terms, you need to create a situation of mutual dependence between the region and Japan.'

Mutual reliance and dependence take time to develop and will have more components than just the demand and supply of primary energy. Political engagement, foreign direct investment, trade links and tourism all have a part to play. As, in the near term, will deregulation of Japan's energy sector.