Crisis in Japan and what it means to oil and fuel markets

Words cannot describe the human and emotional impacts of the devastating Japan earthquake, tsunami, and the still-unfolding nuclear disaster at the Fukushima Daiichi power plant. Nearly half a million people have been displaced, forced to find shelter from the snow and freezing temperatures, and the death toll—currently estimated to be 6,911—continues to climb with more than 10,000 people still missing.

My heart goes out to those who are suffering, but the purpose of this article is not to describe the deeply emotional impacts in Japan, but rather to speculate about what the situation there means to the world oil market in general and the U.S. diesel fuel market in particular. I hope that my analysis does not seem cold-hearted.

Looking forward it is difficult to know how the trilogy of crises will impact oil and fuel markets because, 1) the crises are still unfolding, and the impacts of the crises on oil and fuel consumption act in opposition” 2) the impacts of the crises on oil and fuel consumption act in opposition.

On the one hand, the earthquake and tsunami destroyed manufacturing facilities and, therefore, industrial capacity and production on much of Japan’s east coast have declined. Hence, the direct and indirect demand for oil and fuel generated by industrial activity has declined.

The vast majority of destruction due to the earthquake and tsunami is concentrated in three of Japan’s 47 prefectures: Ibaraki, Tochigi, and Fukushima. According to Statistics Japan, production in the Ibaki prefecture exceeded 12.4 trillion yen in 2007, earning it an overall 8th place ranking. Tochigi was ranked 12th, and Fukushima was ranked 19th. Together these three prefectures are responsible for 8.37% of Japan’s production (measured by value). The destruction in these three prefectures will have a profound impact on industrial production.

On the other hand, the ongoing meltdown of the Fukushima Daiichi nuclear power plant means that the grid-based energy required for emergency response and recovery activities will not be met from there. Similarly, the Fukushima Daini nuclear power plant located just to the South is not likely to return to service soon, either. Together these plants comprised 18.4% of Japan’s nuclear energy generation and more than 2% of total energy generation.

According to the International Energy Agency, the short-term switch to oil, coal, and gas-fired power plants is likely to be “significant.” Platts calculates that if the shortfall in power generation is met by oil-fired power plants alone, Japan’s oil consumption would rise by 200,000 barrels per day. However, it is likely that natural gas and coal plants will ramp up to meet some of this demand. Because oil-fired power plants are in the process of being phased out, these plants have much excess capacity that can be ramped up rather quickly.

Ramping up oil-fired power plants requires more fuel, and this brings up a second complication. Japan, who happens to be the number two oil importer behind the U.S., has also suffered significant damage to three oil refineries. The Wall Street Journal (WSJ) reports that “Japan’s overall refinery runs were around 4.0 million barrels a day, but this immediately fell to 2.7 million barrels a day when the disaster struck.”

The WSJ further reports that Akihiko Tembo, chairman of the Petroleum Association of Japan, is confident that by the end of the month refining capacity will have recovered to 3.4 million barrels per day, with the balance lost to extensive damage to the Sendai, Kashima, and Chiba refineries.

The loss of refining capacity means that imports of oil for on-grid power generation will be supplanted by imports of refined fuel oil. Barclays predicts imports of refined oil will rise by 143,000 barrels per day to meet on-grid power generation. Of course, there are limitations imposed by the electrical grid, so the total energy demand generated through emergency response and recovery on Japan’s east coast cannot be met entirely by increased energy generation on Japan’s west coast. Consequently, much of the energy requirements for the response and recovery will come from diesel generators. So the demand for imported diesel and fuel oil climbs ever higher.

Looking past the short-term, there are indirect impacts as well. The Financial Times reports that “although it is still too soon to know how the crisis at Fukushima will end, already the harrowing scenes from the site are provoking a widespread re-examination of nuclear safety that will, at the very least, lead to significant delays in new investments, an inevitable rise in cost, and probably more rapid closures of existing plants.”  Hence in the long-term, we may expect alternative energy sources to be pursued… and at the global scale, oil, which satisfies more than 33% of energy demand, is a proven “alternative” energy source.

Looking forward, it is difficult to know what is going to happen with oil and fuel markets, and uncertainty breeds volatility. The crises in Japan will certainly increase the amount of fuel oil and diesel that the country will consume as a proportion of total energy consumption. But the magnitude of impact on total energy consumption is difficult to know. It looks to me like diesel markets will tighten, especially on the U.S. West Coast as refinery output will be diverted to Japan to aid the response and recovery effort. To sum up, don’t look for prices to decline or stabilize anytime soon.

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