Bullish and bearish opinions on Japan’s oil demand prospects are outlined in latest Oil Market Report

19 April 2011

Optimistic and pessimistic scenarios from analysts all over the world who are assessing Japan’s economic growth in the aftermath of last month’s earthquake and tsunami are forecasted to lead to different trajectories of short-term oil demand, according to the International Energy Agency’s latest Oil Market Report (OMR).

The report – a monthly IEA publication which provides a view of the state of the international oil market – acknowledges that there is a wide diversity of opinion of both the short- and medium term consequences of the devastating event.

A key uncertainty, the OMR notes, relates to the cost and economic impact of the damage. While many observers have put the cost of the disaster at USD100-200 billion, which equates to between 2-4% of the country’s Gross Domestic Product (GDP), the Japanese government has estimated that costs could stretch as high as USD 300 billion.

“The range of estimates stems from the difficulty of evaluating the earthquake/tsunami’s indirect effects, ranging from the impact on industrial supply chains to consumer confidence, and hence colours views regarding future levels of economic activity and oil demand,” the OMR states.

Optimistic narrative

The IEA’s report goes on to explain that a positive outlook argues that Japan’s most devastated region, northeastern Tohoku, is relatively sparsely populated and has few energy-intensive industries; most are located in the Tokyo region and in southern Japan, and remain intact.

On top of this, industrial spare capacity, while old, remains plentiful and widespread throughout the country.

An optimistic assessment also finds that after the initial shock, which is likely to depress GDP growth in the second quarter of this year, economic activity would rebound in the second half of the year, boosted by reconstruction efforts covering housing, industrial areas and infrastructure. As such, GDP growth for the whole of 2011 could match, if not exceed, the January prognosis from the International Monetary Fund, which was +1.6% year-on-year in 2011, according to its World Economic Outlook Update.

“Effectively, under these circumstances, which for the time being underpin this report’s oil demand assumptions, the earthquake would have only affected the distribution of quarterly economic growth, but not the annual growth level itself,” the OMR states.

Pessimistic scenario

A more negative view, the OMR explains, acknowledges that the affected region accounts for a small share (about 4%) of GDP but notes that supply chains extending across the entire country have been disrupted given the pre-eminence of just-on-time inventory and production techniques, hence potentially directly affecting up to 12% of GDP.

“Factoring in rolling blackouts as well, some 40% of GDP could be affected in one way or another [with the more pessimistic scenario],” the authors explain.

“Given extensive infrastructure damage (roads, ports, refinery/petrochemical and power generation/transmission facilities), system flexibility and reduced business confidence on the back of the unfolding nuclear crisis at the Fukushima plant, proponents of this analysis content that supply chains would not be easily restored.”

Consequently, the pessimistic scenario contends that Japan would experience a marked economic slowdown with 2011 GDP averaging barely +0.5% year-on-year.

“Moreover, the country’s economic woes would also spill over to other countries, since Japan is effectively an economic hub where many key regional – and global – supply chains originate or end, particularly for high-technology products.”

Power sector demand may trump economic outlook

The IEA has reworked its estimate of 2011 Japanese oil demand using the more optimistic of these two scenarios.

However, “the outlook hinges less upon the economy, and more on likely petrochemical and power developments,” with fuel oil and low-sulphur crude use increasing to meet power generation needs following the shut down of 9.7 gigawatts of nuclear capacity.

As a result, under the optimistic view, total product demand could increase slightly in 2011 versus a prior forecast envisaging annual decline. Yet, even under the pessimistic scenario, oil demand is expected to remain static year-on-year, rather than decrease, owing to the boost from the power sector.

Ultimately, the short-term trajectory in oil demand will depend on Japan’s ability to meet peak summer power demand with limited thermal-fired generation capacity, which also includes liquefied natural gas and coal.

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