Japan’s refiners facing hard choices, must seek alliances to ease closings

Aug. 3, 2009
Japanese refiners face a surplus of capacity at a time of massive global refining surpluses.

Japanese refiners face a surplus of capacity at a time of massive global refining surpluses.

Analysis by the East-West Center, Honolulu, of Japan’s oil-product demand and exports outlook estimates Japan’s excess refining capacity for 2009 at 780,000 b/d, 990,000 b/d for 2010, and 1.4 million b/d for 2015. These estimates are based on current refining capacity and assume 93% yield for main petroleum fuels.

To optimize production, logistics, and commercial competitiveness, Japan’s refiners must make strategic and innovative decisions because petroleum will continue to be a vital mineral used mainly for transportation and as feedstock for petrochemical production. And petroleum remains an important commodity for Japan’s energy security.

Forming alliances and joint ventures will help refiners ease the costly and socially and culturally complex processes of closing regional refineries. In particular, strategic alliances that come with crude supplies or product export outlets will help Japanese refiners prolong their refineries’ lives.

Countries like Vietnam, Indonesia, and to an extent China that have oil but insufficient refining capacity should be interested in such opportunities with Japanese companies so that they can reduce oil-product import dependency while avoiding at that same time large investments to build their own refineries. Japanese refiners can utilize their existing refineries and support energy security in the region as well.

The inevitable conclusion, however, is that substantial refining capacity in Japan must close. We expect refining margins to become more negative in line with global refining 2010-11, resulting in closures in Japan of 0.5 million b/d to 1 million b/d starting in 2011. Although many Japanese refiners are unwilling to entertain this dire prospect, it is difficult to see any other option.

Petroleum product demand

Following a 2.8% decline in 2007, Japan’s petroleum product demand fell further in 2008, by 4.4% to 4.6 million b/d. Demand for all products, except fuel oil, contracted on a year-on-year basis. Fuel oil demand, including crude oil for direct burning, increased by 7.1% due to large-scale nuclear power plant shutdowns and a consequent increase in thermal-power generation.

Tokyo Electric Power Co.’s 8.21 Gw Kashiwazaki-Kariwa nuclear power plant remained closed through 2008, while more maintenance shutdowns, including some unplanned, took place in Japan. Gasoline demand contracted by 4.4% compared with 2007, to 985,000 b/d in 2008, amid high prices and a slowdown in consumer spending.

Gas oil demand fell by 7.8%, mainly as a result of reduced land transportation by trucks, which reflects sagging industrial activity. Naphtha demand contracted by 8.2% and will likely remain weak for the foreseeable future amid increasing competition from ethylene crackers in the Middle East and China.

Reduced exports, restricted corporate investments, and dull consumer spending will put further downward pressure on the Japanese economy. Forecasts of Japan’s economic growth rates for 2009 are expected to be lower than 4.0% vs. 2008, with marginal growth envisioned in 2010, assuming an economic recovery in Western countries.

We forecast Japan’s oil-product demand in 2009 will contract by 5.8%. Demand from the industrial sector will continue declining; specifically, fuel oil will be worst hit by the downturn of industrial production, and demand will decline by 21%, compared with 2008.

Total power generation is also forecast to decline by more than 4% as power demand from the industrial and commercial sectors declines noticeably due to the economic recession. In addition, the situation with the troubled Kashiwazaki-Kariwa nuclear power plant is improving, easing the power sector’s fuel oil demand. TEPCO resumed operation of one of the seven reactors in May and will resume the second as early as August.

TEPCO’s fuel demand has been already falling this year due to weak demand. For January-May 2009, Tokyo’s low-sulfur fuel oil consumption fell by 39%, compared to the same period a year earlier, and direct use of crude oil fell by 59%.

Gasoline demand will be almost flat compared with demand for 2008 instead of dropping continuously because drivers are encouraged to drive more as retail gasoline prices are falling and expressway tolls have been reduced.

The maximum toll for passenger cars on expressways across Japan (except for the Tokyo and Osaka metropolitan areas) was reduced to 1,000 yen (US$10) for unlimited distances on weekends and national holidays from Mar. 28, as part of economic stimulus measures. Japanese consumers had often refrained from driving because of expensive tolls.

For the medium term, after 2010, Japanese demand will likely be affected by such structural factors as an aging and shrinking population and its changing lifestyle. The National Institute of Population and Social Security Research forecasts that the total population will decrease to 122 million in 2020 from 128 million in 2007.

The pace of aging is also rapid, i.e., the ratio of population aged at and older than 65 at 21.5% in 2007 is envisioned to increase to 28.4% in 2020 and 30.0% in 2030. As a result, the share of the productive population (aged between 15 and 64) is forecast to decline to 59.5% in 2020 and to 59.2% in 2030, from 65.0% in 2007.

Since the labor force is one of the main factors supporting economic activities, population economists hold that the declining productive population will cap economic growth, unless productivity increases with technological innovation and some effective measures taken by the government and private sectors to increase the labor force. Also, the declining population with an aging society will lead to less spending in households and dull consumer spending.

For the medium and long term, energy use and oil consumption will be affected. Aging in particular will directly and negatively affect driving and new car sales. Furthermore, the younger generations now are less interested in owning cars. For them, a car is no longer the status symbol as it used to be. With the economic downturn, many also prefer saving instead of spending money and therefore rely on Japan’s well-established transportation system to get around instead.

Energy efficiency in various goods, including electrical appliances in household and automobiles will continue improving. New technologies such as sophisticated hybrid cars and electric vehicles will all weigh on oil demand. Based on the above, we forecast Japan’s average growth rate for 2010-15 at –2.5%/year and for 2015-20 to be –1.3%/year (Fig. 1).

Refining capacity

Japan has 4.8 million b/d of refining capacity after Nihonkai Oil closed its 40-year-old Toyama refinery in March 2009. It was the smallest refinery the Nippon Oil group owned, with its main objective being to supply LSFO to Hokuriku Electric Power. With this closure, the Nippon Oil group owns 1.3 million b/d of refining capacity (Fig. 2).

Three of the refiners listed in Fig. 2 have foreign firms as their shareholders. Saudi Aramco is a 15% stakeholder in Showa Shell, Abu Dhabi’s IPIC is a 20% stakeholder in Cosmo Oil, and Brazil’s Petrobras is an 87.5% stakeholder in Nansei Sekiyu in Okinawa. Tonen General is ExxonMobil’s subsidiary.

Nippon Oil, Japan’s leading refiner, and Nippon Mining Holdings (Japan Energy) announced plans to merge by setting up a joint-venture holding company in April 2010. They will reduce their combined crude distillation capacity by 400,000 b/d accordingly. This reduction includes closure of the Toyama refinery and change in ownership of the Osaka refinery. The 115,000 b/d Osaka refinery, to be owned jointly by Nippon Petroleum & Refining and China National Petroleum Corp. will become an export-oriented refinery, as CNPC is considering marketing all the products from the Osaka refinery. Meanwhile, the total capacity of the two Mizushima refineries (455,000 b/d each)—one each owned by Nippon Oil and Nippon Mining Holdings—will be reduced through rationalization.

In the future, Japan’s demand cut of the barrel is forecast to continue to be lightened. Some investment plans have been made to cope with the changing demand pattern—which continues to lighten with industrial demand declining significantly—and optimize existing capacity, along with eyeing more product exports. In view of the envisioned decline in fuel-oil demand, the following two refiners plan to add new units:

Taiyo Oil to add a 25,000-b/d residue fluid-catalytic-cracking unit at the Kikuma refinery by fourth-quarter 2010 and Cosmo Oil to add a 25,000-b/d coker at the Sakai refinery by April 2010.

Except for these two, there will be no major investments in conversion units until 2015, as refiners reduce crude distillation unit capacity in the face of falling domestic demand and growing difficulty in exporting refined products.

Product balances

In 2008, Japan’s total product output fell 2.0% (81,000 b/d) to 3.9 million b/d. Output would have been much lower if Japan’s nuclear power plants were operating normally. Japanese refiners have been supplying additional LSFO to electric utilities because of a series of nuclear-power plant shutdowns that led to increased thermal-power generation. TEPCO had to substitute the 8.21-Gw base-load nuclear power generation capacity with thermal power generation and power purchases throughout 2008.

Increased exports helped refiners ease throughput cuts as well. Japan’s product exports increased to 375,000 b/d in 2008 from 267,000 b/d in 2007. It should be noted that we treat bonded bunker sales and bonded jet-fuel sales as domestic demand; therefore exports represent only genuine exports.

Diesel exports increased to 220,000 b/d in 2008—which accounts for nearly 60% of Japan’s total exports, from 142,000 b/d in 2007. Asia—mostly China and Singapore—accounted for 55% of Japan’s total exports, followed by Oceania (Australia and New Zealand, 25%), Europe and CIS (8%), North America (6%), South America (Brazil, Chile, and Colombia, 6%), and the Middle East (1%).

Meanwhile, product imports in 2008 declined by 1% compared with 2007, with naphtha and LPG being imported much less than in the previous year.

Refiners will continue reducing fuel-oil output because of the “whitening” of the demand barrel. (Whitening of the demand barrel refers to the product mix growing lighter in hydrocarbon weight.)There are some plans to add conversion units, including cokers, to meet the changing demand pattern. The product balance outlook, however, will highly depend on how much products Japanese refiners will export.

In our view, Japanese exports to Asia including China will decline due to emerging new refining capacity for self-sufficiency. The Asian product market is expected to be a battlefield of product sales, and competition will become fierce. We must keep in mind that market competition will come from national oil companies that aggressively export to emerging markets, for example, India’s Reliance Industries Ltd.

Furthermore, the global environment surrounding the refining industry is restraining product exports from Japan to the US. Since second-quarter 2008, US demand declined initially because of higher prices. But demand continues to decline because of economic recession. The US has become a large gas oil exporter, looking for export markets in Latin America and Europe. Given that these changes had taken place in the past year, the US market has little room for product imports.

Especially with the economic downturn, it seems difficult for Japanese refiners to depend too much on exports on a full-cost basis. We believe, however, that there will be opportunities for Japanese refiners to export on a marginal basis; opportunities will be open if refiners seek a marginal profit through exports.

Based on FGE’s outlook for product demand and imports-exports, Table 1 summarizes Japan’s product balance outlook. Japan’s total exports for 2009 are forecast to fall to 280,000 b/d, of which gas oil accounts for 150,000 b/d, and further to 245,000 b/d in 2010.

Industry reorganization

Obviously declining domestic oil demand has a substantial impact on Japanese refiners—excess refining capacity over domestic demand. Our demand outlook and product exports indicate Japan’s excess capacity (based on current refining capacity and assuming 93% yield for main petroleum fuels) for 2009, 2010, and 2015 are, respectively, 780,000 b/d, 990,000 b/d, and 1.4 million b/d. Even assuming that Nippon Oil and Nippon Mining Holdings remove 400,000 b/d from the market (including the Osaka refinery), there still remains excess capacity. Japanese refiners are facing a surplus problem at a time of massive global refining surplus.

In order to optimize production, logistics, and commercial competitiveness, refiners must make strategic and innovative decisions because petroleum is an economic necessity and will continue to be a vital mineral to be used mainly for transport fuels and feedstock for petrochemical.

Forming alliances and joint ventures will become more important for the industry in order to help ease the costly, as well as socially and culturally complex processes of closing regional refineries. Especially, strategic alliances that come with crude supplies or product export outlets will help Japanese refiners prolong their refineries’ lives.

The strategic alliance between Nippon Oil and China’s CNPC to operate Nippon Oil’s Osaka refinery is one such new model, in which Nippon Oil will own 51% and CNPC 49%. Under the new plan, the Osaka refinery will be converted to an export-oriented refinery. CNPC will supply crude oil to the refinery and market all the refined products.

Indeed, this alliance will give Nippon Oil the alternative to keep the Osaka refinery operating.

Such countries as Vietnam and Indonesia that have oil but insufficient capacity should be interested in such JV opportunities with Japanese companies, as they can reduce product import dependency while avoiding investing large amounts to build their own refineries. Japanese refiners can utilize their existing refineries and help the energy security situation in the region as well.

In conclusion, the sharper-than-expected 2008 demand decline illustrates clearly that the base of Japanese refiners’ business is deteriorating quickly. The global economic recession is indeed worsening the environment surrounding Japan’s refining industry in 2009.

Along with the suggested strategic alliances and JVs, there is an inevitable conclusion that substantial refining capacity in Japan needs to close. We expect refining margins to become more negative in line with the global refining business in 2010-11, resulting in refinery closures in Japan (in a range of 500,000 b/d and 1 million b/d) starting in 2011.

Many Japanese refiners are unwilling to entertain these dire prospects, but it is difficult to see any other option. We believe the refiners will need to plan and adjust to the tough circumstances lie ahead. The merger between Nippon Oil and Nippon Mining Holdings will certainly make other Japanese refiners reassess their business strategies, and consequently, another wave of industry reorganization would take place.

The author

Tomoko Hosoe ([email protected]) is a project specialist at the East-West Center, where her primary focus is on downstream oil and natural gas and LNG East of the Suez, energy policy, environmental and nuclear power issues, with a special emphasis on Japan. She has participated in various projects involving Japan’s gas and power market deregulation, oil and gas demand outlook, and LNG pricing analysis. Hosoe holds a master’s in public affairs the School of Public and Environmental Affairs—Public Management—Indiana University.