Japan embarks on wave of refining consolidation

By Osamu Tsukimori and Aaron Sheldrick

TOKYO, Feb 16 (Reuters) -- Japan, which once consumed about 10% of global oil output in its refineries, is undertaking the biggest refining contraction of any country, ending a dominant era in oil markets while exposing itself to fuel imports from neighbours.

With four of its five largest refinery companies set to merge, Japan could be left with only 3.2 million bpd of refining capacity by 2020 and as little as 2.3 million bpd by 2030, according to a Reuters analysis based on discussions with industry officials, analysts, government officials and suppliers. 

Japan may have to rely on fuel imports from China and South Korea, countries with which it shares long-standing historical disputes.

The country's oil-refining capacity peaked at 5.6 million bpd in 1982, data from the BP Statistical Review of Energy shows, and that year global oil output was 57.3 million bpd.

Oil, and Japan's ability to refine crude into transportation and industrial fuels such as gasoline and diesel, built the country's modern economy. From 1965 to 1972, when Japan averaged 9.25% gross domestic product growth at the height of its economic miracle, the country more than doubled its oil-refining capacity to 4.6 million bpd.

"They were the pioneers of refining in the Asia Pacific (but) that has been slowly overtaken by the giants of China and India," said Suresh Sivanandam, senior manager, refining research Asia Pacific, at Wood Mackenzie in Singapore.

"There is no single country that has cut on such a scale before," said Sivanandam.

As recently as 2008, Japanese refining capacity was 4.65 million bpd, BP data shows, making it the world's fourth-largest processor at the time, behind the United States, China and Russia. In 2014, India overtook Japan for the first time after its capacity fell to 3.7 million bpd.

Japan's refiners are now vying for business from a shrinking, aging population that consumes less fuel because of more efficient vehicles and a turn to gasoline-electric hybrids.

Japan's refining pullback will change international oil markets as a customer that valued long-term contracts, and fostered relationships to sustain them, cedes to more spot minded, nimble traders from China and India.

The change will hit Middle East crude suppliers the hardest, said the analysts and officials that spoke to Reuters.

Additionally, such a savage cutback in refining capacity may expose Japan to a greater dependence on transportation fuel imports, Sivanandam said.

"They will have to import 200-300,000 bpd of gasoline, which is not ideal," he said, particularly in the peak summer driving period.

This amount of imports could potentially be about 36% of the country's gasoline demand by 2020, based on a forecast from Japan's Ministry of Energy, Trade and Industry (METI) that gasoline consumption will equal 830,000 bpd by then.

Japan's government is fine with this trade-off of fuel imports for crude imports, said a senior trade official. Japan depends on imports for all of its oil consumption needs.

Refineries have plenty of spare capacity now and will have in the future as the industry catches up with the reality of a population using less oil, said the official.

"Japan imports all of its crude and if imports of oil products surged, that would not heighten the supply risk substantially," said a senior Japanese trade official who declined to be named. "If imports surged, refiners would deal with it."

While Japan could cope with depending on gasoline imports, shutting refineries still poses other security issues, said Fereidun Fesharaki, the founder of FGE energy consultancy.

"When you close down the refineries you close down the less efficient ones, which produce more fuel oil," he said, adding that fuel oil filled the early gaps in electricity production after the Fukushima nuclear disaster shut reactors.

"So if you have (another) nuclear issue you need more fuel oil. This is a very important issue that most people have ignored," he said.

Recognising the refining overcapacity, Japan's government has pushed companies to shut less sophisticated plants. Bowing to the inevitable, refiners themselves are leading the consolidation.

First, Idemitsu Kosan Co on Nov. 12 agreed to take over Showa Shell Sekiyu, a smaller rival. Then, on Dec. 3, JX Holdings, Japan's largest refiner, agreed to merge with TonenGeneral Sekiyu by 2017, with a plan to streamline refinery operations. These were the first refining mergers since 2010.

Because of its size, JX is the most likely company to shut units once it completes the merger with TonenGeneral, the Reuters analysis shows.

"Japan becomes less important. That's the way it going to be, it is going to become a 2 million barrel a day market," FGE's Fesharaki said.