Japan pulling the plug on support for JNOC's E&D investments

As if Japan's petroleum companies having to cope with the crushing downstream competition at home were not enough, Japan's government has recently agreed to pull the plug on continuing financial support for state-owned upstream company Japan National Oil Co. (JNOC).

Unlike most foreign oil majors, which derive a significant proportion of their profits from exploration and development, Japanese E&D activity is minimal, making the domestic refining and retail markets the sole areas of significant revenues and profits.

For several decades, companies such as Mitsubishi Oil Co. were able to attempt to diversify their revenue base by investing in E&D with considerable financial support from JNOC. But all that is now likely to stop as the government abandons its expensive energy security policy for one based on financial rates of return.

JNOC retrenchment

JNOC was established in 1967 to finance Japanese efforts to explore for and develop oil supplies overseas, a step seen as crucial to the nation's energy security. Japan imports virtually all of its oil, with 80% coming from the Middle East.

The state-run company quickly amassed a mountain of bad loans through aggressive investment programs and loan guarantees to Japanese exploration firms.

Under the plan, the ailing public corporation will be urged to release its equity stakes in Indonesia Petroleum Ltd. and other viable companies over a period of about 10 years, preferably through public offerings, while liquidating a further 27 subsidiary companies. Development rights held by the 27 firms would be partially sold to private-sector developers in neighboring prospect areas to raise funds to help clear its ?1.4 trillion of non-performing assets. By using the proceeds to write off part of the soured investments in and loans to oil exploration firms, Japan's Ministry of Trade and Industry (MITI) hopes to narrow JNOC's losses to ?400 billion by 2020. It adds that, if crude oil prices rise substantially and the yen becomes much weaker, the government-funded corporation can even expect a surplus of up to ?200 billion.

The list of 27 includes three of five state-run oil exploration companies: Japan China Oil Development Corp. (JCOD), Sakhalin Oil Development Cooperation Co. Ltd. (SODC) and Arctic Petroleum Corp. of Japan (APC). JCOD is the only company among the three currently producing oil. There are no plans to begin production at APC, while operations at SODC have virtually stopped.

Lack of strategy?

JNOC will also consider stopping lending, in principle, to private-sector oil exploration firms, limiting its involvement in equity investment in promising projects.

Analysts point out that the move reveals a JNOC without a coherent global strategy. On one hand, JNOC is overwhelmed by an unsustainable level of debt. But, on the other, it has always been the cornerstone of successive governments' energy policy of reducing Japan's dependence on crude oil imports. It is therefore vital, the analaysts say, that both these issues be tackled immediately and effectively, adding that, although the JNOC restructuring program will have a cleansing effect, its effects will be limited unless it is accompanied by a complete review of government energy policy. In the analysts' view, the government must overhaul a regulatory system that is notoriously unconducive to upstream operations. This includes stipulations that the bulk of crude produced abroad must be brought back to Japan.

The toll of years of such stifling legislation has meant that Japanese oil companies are notoriously inward-looking, and in spite of heavy subsidies for E&D, many continue to have a poor view of the upstream sector.

"E&D is such a hit-and-miss affair, and now with JNOC threatening to withdraw funds from all but the most promising projects, there is less and less incentive for us to get involved," one senior industry official said.

What's needed

But, above all, the government must set in place mechanisms that will enable the upstream sector to become stand-alone and to ensure that E&D projects are financially viable, the official noted.

"Basically, the oil industry feels completely abandoned by the government," said ING Barings oil analyst Keiko Sasaki. "At home, it can no longer rely on the protection against imports by outsiders, and any E&D strategy has been effectively scuppered by the withdrawal on financial support. And it is very obvious that they are having a great deal of trouble in finding their way in this new deregulated environment.

"However, what is equally clear," Sasaki added, "is that we are yet to see the actual costs of deregulation. For the past 11 years, Japanese oil companies have managed to somehow survive, while all the time sinking deeper and deeper into the quagmire. But many really are now on the verge of going under."