Japan Demand to Hit Oil Market at Tricky Time

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Mar 17, 2011, 05:35 ET

LONDON, March 17, 2011 /PRNewswire/ -- The impact of changes in energy demand caused by the crisis in Japan will be exacerbated by the fragile state of the global oil market, according to energy price reporting agency Argus.

The market had just started to deal with the loss of Libyan supplies when the 11 March earthquake and tsunami hit Japan, severely damaging ports, power stations, refineries and other energy infrastructure. Over 1.2mn b/d of Libyan crude exports has been lost to the market in March, after the country lurched into civil war following protests that began on 17 February. Saudi Arabia has said it will increase exports in compensation, but the exact amount, quality and timing of these extra supplies is uncertain.

The impact of the Japanese earthquake on oil demand is still being assessed. Economic activity will fall in the short term, causing a reduction in oil use. But severe damage to a number of nuclear power reactors will force utilities to turn to oil and natural gas-fired plants to replace lost generating capacity, boosting demand for fuel oil, low-sulphur (sweet) heavy burning crudes, and LNG.

Short term effects on products

In the short term, refinery shutdowns have cut product supplies, cutting exports and leading to higher product prices. Japanese exports may continue to be cut as output is diverted to the domestic market.

Earthquake and tsunami damage or power shortages shut 1.7mn b/d of Japanese refining capacity — 35pc of the total — on 11 March. Several plants have restarted, but about 600,000 b/d remains shut, comprising two refineries that have suffered major damage and will be shut for months, or perhaps permanently, and two that are still undergoing safety checks.

The ministry for energy and industry (Meti) has asked refiners whose plants are still operating to boost throughputs and divert exports to the domestic market. Product exports were 550,000 b/d in January-February. Most of these went to neighbouring countries or to South America, and these consumers will have to find alternative supplies.

Japan exported 340,000 b/d of diesel and jet fuel last year, mainly to other parts of Asia-Pacific. Large exporters such as South Korea and India are likely to fill the gap left by Japan, but this could reduce the flow of middle distillates from Asia-Pacific to Europe, where diesel supplies look tight.

Non-Japanese cargoes previously destined for Europe are now likely to be used within Asia-Pacific to offset the slowdown in supplies from Japan. In this way, the loss of Japanese refining capacity to the disaster has tightened product markets globally, but some of this impact will wear off fairly quickly as refineries in Japan come back on steam.

Meti has authorised the release of 8mn bl of product stocks by reducing mandatory stockholding by private-sector firms from 70 to 67 days of net imports. The government controls 300mn bl of mainly crude stocks.

Meti estimates current oil product needs in earthquake-hit areas to be 240,000 b/d. Meti is asking refiners in western Japan to boost runs to supply 130,000 b/d of products to affected areas. The 10 refineries in western Japan, with a combined capacity of 1.7mn b/d, will raise run rates to 95pc from 80pc.

Some effects of the disasters in Japan are less bullish for oil products. The shutdown of petrochemical crackers in Japan after the earthquake could leave European refiners with a growing naphtha surplus. Prices in northwest Europe slipped to a $5/bl discount to crude at the end of February, and could deepen as demand in Asia-Pacific falls.

Once again, the impact of Libyan shortfalls has to be considered together with the Japanese disaster. Naphtha exports from Libya, which were 30,000 b/d, came to a halt on 25 February, even before fighting spread to the main oil port of Ras Lanuf, tightening supplies in the Mediterranean. Libya normally exports around 130,000 b/d of products, mainly naphtha, LPG and low-sulphur fuel oil (LSFO), and imports transport fuels. This product trade has all but stopped, along with the country's exports of over 1.2mn b/d of crude.

Bullish for heavy sweet crude

Higher demand for oil for power generation is likely to boost heavy sweet crude, particularly grades used as direct-burning crude in power plants. Japanese firms are already buying heavy sweet crude for power generation with loading dates out to May. Some are offering to swap sour crude for prompt medium and heavy-sweet burning grades, such as Indonesian Minas, Duri, Cinta, Widuri, Vietnamese Sutu Den and Sudanese Nile Blend. And refiners will want heavy sweet crude to produce more low-LSFO. Grades such as Angola's Hungo are best suited for refining into LSFO.

Chevron is supplying Japan with May-loading Minas crude. China's CNOOC is supplying one May-loading cargo each of Cinta and Widuri crude. Term contract holders of Sutu Den, including Japanese trading firm Itochu, will ship April-loading cargoes to Japan. Trading firms Trafigura and Arcadia may be supplying Nile Blend, possibly from floating storage off Singapore. Japanese Inpex obtained 200,000 bl of April-loading Attaka from Pertamina after both parties agreed to swap the cargo with a future loading of Inpex's Indonesian light sweet Handil Mix cargo.

Longer term bullish

Oil prices initially fell on news of refinery shutdowns and damage to nuclear power stations. The immediate impact on oil demand is certainly negative, but the longer-term effect will be positive, as oil-fired plants are deployed to replace lost nuclear capacity and damaged infrastructure is rebuilt. A rise in Japanese demand for oil for use in power generation comes at the same time as growing concern over supply, as unrest spreads in north Africa and the Middle East.

Crude runs in other Asia-Pacific countries may rise even further to compensate for some of Japan's lost output. Throughputs in China, India, South Korea and Singapore are at record highs and 1.5mn b/d up on this time last year, driven by strong regional demand growth. Oil sales in India and South Korea grew by 5pc in January. And China's appetite for diesel is showing no signs of flagging — apparent demand (refinery output plus net imports) rose by over 15pc in December and January.

Crude prices are already high, particularly in Europe, which normally buys at least four-fifths of Libyan crude. Libya's light sweet crudes produce high yields of jet and low-sulphur diesel, and refiners are struggling to find similar quality alternatives.

And Libyan crude produces LSFO when processed, especially in simpler refineries without upgrading capacity. European LSFO markets have tightened since last month because the loss of 1.5mn b/d of Libyan light sweet crude output has cut yields of the product.

The loss of LSFO supply from refined Libyan crude could hardly come at a worse time for Japan. It is LSFO that forms the most significant alternative feedstock for power generation in Japan, along with sweet crudes used for burning, LNG and coal.

A lull in fuel oil imports from Europe and potential demand from Japanese utilities following the earthquake have already strengthened Asia-Pacific fuel oil prices relative to crude, narrowing the discount to $2/bl from $10/bl a week ago. LSFO has already risen by up to $2/bl compared with high-sulphur grades in Asia and Europe since the earthquake.

Japan's ability to import its preferred grade of fuel oil — low-sulphur waxy residue (LSWR) — as well as burning crudes, such as Minas, is hampered by falling supply. Indonesia is exporting only five cargoes or about 30,000 b/d of LSWR in March, and shipments are likely to fall next month. Pertamina is shutting 200,000 b/d of crude capacity at its 260,000 b/d Balikpapan refinery for 40 days of maintenance from 1 April, which will reduce LSWR supply further.

Demand forecasts

The earthquake and tsunami have knocked nuclear reactors with 8.9GW of generating capacity off line at four power plants. And 3.5GW of capacity at the plants was shut for maintenance at the time, leaving a quarter of Japan's nuclear generation capacity shut after the disaster.

Another 19 thermal power units were shut after the quake, although at least five have since restarted. Oil-fired power stations will have to be brought back on stream to replace output from the damaged nuclear plants.

When the 8.2GW Kashiwazaki-Kariwa plant closed because of earthquake damage in 2007-08, utility consumption of fuel oil and burning crudes rose to 750,000 b/d in the two winter quarters, 220,000 b/d up from a year earlier.

Demand for oil for electricity generation could be far greater this time, as more nuclear capacity is off line. Some extra power will come from gas and coal-fired plants, but most of Japan's spare capacity is oil fired. Argus calculates that 300,000 b/d of fuel oil and burning crudes will be required to generate the power lost from closed nuclear capacity.

Japan will rely more on oil for power generation at least until the end of this year. But extra oil demand will be tempered by damage to Japan's economy.

Argus suggests that GDP shrinkage will reduce oil demand by 400,000 b/d in the second quarter, meaning a net loss of demand of 100,000 b/d, compared with a year earlier, once the impact of higher oil imports for the power sector is factored in.

But reconstruction efforts would then kick in, limiting the loss of oil demand caused by economic problems to zero by the fourth quarter, so that net oil demand rises by over 250,000 b/d in the second half of 2011.

This unexpected rise in oil demand in Japan comes on top of forecast world oil demand growth of 2pc, at a time of concern over supply from the Middle East and north Africa. The combination of rising demand and supply constraints is bound to keep oil prices higher than consumers had expected at the end of last year.

About Argus Media

Argus is a leading provider of price assessments and indexes, business intelligence and market data on the global crude and products, natural gas, coal, electricity, emissions and transportation industries. It is headquartered in London and has offices in Houston, Washington, New York, Portland, Johannesburg, Dubai, Singapore, Tokyo, Beijing, Sydney, Moscow, Astana, Kiev, Santiago and other key centres of the energy industry. Argus was founded in 1970 and is a privately held UK-registered company. Learn more at www.argusmedia.com.

Argus has set up a web page with free news alerts about the impact of the Japanese earthquake on energy markets at www.argusmedia.com/japan.

Argus experts are available for comment on the impact of the Japanese earthquake on energy markets. Contact:

Jason Feer, Head of Argus Asia, Singapore - tel +65 6496 9966 or email [email protected]
Ian Bourne, Editor in Chief, London - tel +44 20 7780 4200 or email [email protected]
Tom Reed, Editor - Argus Asia Gas & Power, Argus China Petroleum, London - tel +44 20 7780 4200 or email [email protected]

For further information about Argus contact Seana Lanigan in London at +44 20 7780 4200 and email [email protected] or Zhilin Yuan in Singapore at +65 6496 9966 and email [email protected].

SOURCE Argus Media