The call for deregulation of Japan's internal markets is usually made by outsiders trying to break in. Frustrated by the high cost of entry, foreign companies rage against rules, regulations and restrictions which seem to discriminate and exclude. The US has come close to declaring a trade war to force Japan to change its ways. It seems odd that the deregulation of Japan's oil industry should be having the opposite effect. Rather than piling in to take advantage of deregulation.
foreign oil companies are looking for ways to bail out.
Their doubts about deregulation seem well-founded. When the monopoly on oil imports held by Japan's 29 refining companies expires on 1 April, anyone can apply for a licence to import gasoline, gasoil and kerosine. There is unlikely to be a flood of applications, however. Companies must meet a 70-day stockpiling requirement and very strict specifications for products. Profits from refining and retailing are already poor and the competition will further reduce margins. Most of the big players will wait and see how deregulation actually develops but US refining company Caltex has already pulled out of its 44-year old joint venture with Nippon Oil, selling its stake for $2,000 million. Others may follow.
The changes will also affect Japan's relations with its main oil suppliers in the Middle East. The region provides more than 75 per cent of oil imports, much of it under term contracts between Japanese trading houses and national oil companies. After 1 April the need for greater flexibilitymay lead to a fall in the volume of oil that refiners buy on contract and a switch to greater reliance on the spot market. The trading houses are not expected to cut their term contracts by much, for fear of damaging long-term supply relationships, but the volume of oil they move in the spot markets is likely to increase. Having set up task forces to assess deregulation the trading houses are sanguine about its likely impact.
The tenacity of the trading houses relations with Middle East suppliers has been demonstrated by their continued purchases of Iranian crude oil under contract, despite pressure to join the US embargo. Japan imports about 400,000 barrels a day (b/d) from Iran and although the volume dropped by 12.6 per cent in the first half of 1995, contract liftings were virtually unchanged.
The next test will be whether Japanese buyers persist in their loyalty when the first term contracts for 1996 are agreed. Ideally. the trading houses would prefer a new mix of contract and spot purchases from Iran.
Security of supply is an obsessive concern which has led Japan to look for alternatives to its heavy reliance on Middle East oil. Purchases from China and Indonesia rose in the 1980s and Japanese oil exploration companies have become much more active in Asia.
Such endeavours have delivered only modest returns.
Imports from both China and Indonesia have peaked and are set to decline gradually as both countries export less of their dwindling reserves. Neither can match the potential of the Middle East over the long term. On the exploration side, Mitsubishi Oil made a major offshore find in Vietnam in mid-1995, which could produce up to 130,000 b/d, but the region has been more noteworthy for its disappointments.
With Middle East oil on the rebound climbing back to nearly 78 per cent of Japan's oil imports in 1995 - the primacy of the region as a source of supply is firmly reestablished. Volumes were slightly lower in the first half of last year but there was no sign of greater diversity. The UAE continued to dominate with a 26.7 per cent share of all imports, closely followed by Saudi Arabia on 19.2 per cent. Indonesia, which ranked third with a first-half market share of 8.3 per cent, is the only notable non-Middle East supplier apart from China, which ranks eighth with a 5.3 per cent share.
Japan's flat domestic economy accounts for the lacklustre growth in demand.
Although the Middle East claimed a larger market share in the first half of 1995, actual deliveries were down by 1.2 per cent, according to the Petroleum Association of Japan. Sales of diesel and fuel oil were down while gasoline and gas oil rose in spite of the prolonged recession. Strong petrochemical activity boosted demand for naphtha and a hot summer raised gasoline demand as Japanese holiday-makers took to the road in air-conditioned cars.
Other developments also supported demand. Restrictions on the location of petrol outlets were removed in October 1995, increasing competition in the retail sector and bringing pump prices down.
Helped also by the strength of the yen, the retail price of gasoline fell by about 6 per cent, stimulating sales.
Japan has sought to offset its consumption of Middle East oil by acquiring upstream interests in the region. The oldest and largest interest in the area, the majority Japanese-owned Arabian Oil Company (AOC), is now coming to the end of its concession in the neutral zone shared by Saudi Arabia and Kuwait.
Japan has sought and received assurances from Saudi Arabia that the agreement will be renewed in 2000 and Kuwait is likely to renew in 2003 when its agreement with AOC expires. AOC produces about 300,000 b/d and is expected to start a horizontal drilling programme this year to sustain output at 300,000-350,000 b/d for the foreseeable future from the Khafji and Hout fields. Much of the infrastructure, some of it installed in the late 1950s and early 1960s, also needs renewal.
Japan has smaller interests in two prolific Abu Dhabi-based joint venture oil companies. The Japanese consortium Jodco has separate 12 per cent stakes in both Zadco and Adma-Opco which produce about 500,000 b/d and 420,000 b/d respectively.
The Japanese equity share of production in the two companies is relatively modest at 110,000 b/d in total. Under long-term proposals Zadco production could rise to 600,000 b/d. Further increases are also considered possible. Other producing Japanese upstream interests are in Oman where Japex produces about 10,000 b/d, and a small stake in Egypt.
There is almost no prospect of upstream expansion in the region unless Japanese oil companies pursue prospects in Iran and Iraq or strike lucky in Yemen where there is modest exploration activity. Japan is unlikely to take more than a passing interest in Iran or Iraq for fear of crossing the US but is maintaining cordial relations with the national oil companies.
Efforts to cement the ties with Saudi Arabia through the creation of a refining joint venture in Japan have flagged since negotiations collapsed in 1993. At one time progress with the plan for a 450,000 b/d Saudi-Japanese refinery was implicitly linked to renewal of the AOC concession but this seems to have now lapsed.
Saudi prospects Saudi Arabia is still pursuing the project but the proposed Japanese partnership has disintegrated. The probable shake-out of the refining sector as it adjusts to deregulation and the need for clarity about its future economics makes it unlikely that the project will be revived any time soon. The biggest partner in the original plan was Nippon Oil, which bought Caltex out of their Japanese joint venture and may not be keen to enter another refining partnership.
Japan's effort to diversify its primary energy sources may actually have the unexpected effect of compounding the reliance on the Middle East. Long-term plans for cutting oil consumption depend on its replacement by nuclear power and natural gas in the energy balance. Oil's share of overall energy consumption has fallen from about 75 per cent in the mid-1970s to 57 per cent today but plans to push it below 50 per cent look increasingly fanciful. This target implies rapid expansion of nuclear capacity and higher natural gas use.
The expansion of nuclear capacity is well below target due to construction delays and technical setbacks and is unlikely to reach its projected share of overall energy consumption.
Prospects for gas, imported as liquefied natural gas (LNG), are much better. However, the shift to gas leads inexorably back to the Middle East which has several LNG schemes under preparation. Indonesia, Malaysia and Australia are the main established suppliers of LNG but Abu Dhabi has doubled its output for the Tokyo-based utility Tepco and Chubu Electric is the first customer for Qatargas. The next time Japan goes shopping for LNG it will have to consider options in Oman, Qatar and Yemen alongside the remaining potential in the Far East.
In the meantime, low prices are enabling oil to recapture market share and slow the drift to gas. Real oil prices are falling to levels that are little higher than before the first oil shock of the 1970s while LNG, which is costly to develop, is priced according to an index of oil price movements. Cheap oil makes the gas alternative look expensive and the high initial capital cost of developing LNG capacity is making gas even less attractive. While this is welcome news to Middle East oil producers it risks making a mockery of plans to reduce the reliance on a region that is associated in the Japanese mind with turbulence rather than tranquillity.
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