ON 11 MARCH LAST YEAR Japan was rocked by one of the most powerful earthquakes in recorded history. Surveying the destruction wrought by the tremor, the subsequent tsunami and a nuclear meltdown, Prime Minister Naoto Kan declared it the greatest crisis Japan had faced since World War II.
As sirens and silences marked the first anniversary of the disaster a few months ago, Japan was still struggling to come to grips with the impact and repercussions of this crippling catastrophe. Those that hoped 3/11, as it’s become known, would trigger a rapid national rejuvenation, liberating Japan from two decades of economic and political torpor, have largely been disappointed.
Quite apart from the tragic cost in human lives, Japan is still paying a huge financial price for the disaster. The economic shock has been massive. Losses from the earthquake and tsunami alone were conservatively estimated at about 3.5 per cent of gross domestic product (GDP), and the broader negative economic impact has been substantially more.
Today the Japanese people are trying to rebuild much more than the shattered Tohoku region. While a shared sense of purpose drives discussion on issues ranging from energy and education to debt and demographics, the road to economic health is proving long and tortuous.
No to nuclear
Before the meltdown at Fukushima, nuclear power underpinned Japan’s long-term energy plan. It was widely viewed as the best means of boosting Japan’s energy self-sufficiency, which stood at just 18 per cent in 2009. At the start of last year, 14 new reactors were scheduled to come online before 2021 and nuclear power was slated to provide half of all Japan’s energy needs.
That energy plan lies in tatters. A white paper, approved by the Japanese Cabinet in October last year, calls for a reduction in the nation’s reliance on nuclear power. As at 5 May all of Japan’s 54 nuclear reactors were offline, leaving the country with no nuclear-derived electricity for the first time in more than four decades.
Just how long Japan proposes to keep its reactors offline is unknown. Officials are closely monitoring public opinion, which continues to run strongly against any restart despite concerted efforts to rebuild support.
“I’d say there’s a 60 per cent probability of Japan returning to nuclear energy in some form in the short term,” says Yoshimasa Maruyama, chief economist at the Tokyo-based ITOCHU Economic Research Institute. “In the long term, however, Japan will almost definitely say farewell to nuclear generated energy.”
Energy burden
The sudden withdrawal of nuclear power from Japan’s energy mix has had severe and wide-ranging consequences. The most obvious is an increased reliance on fossil fuels and reduced electricity generating capacity.
According to research by the Nomura Group, replacing nuclear energy entirely with fossil fuel-generated power will increase the cost of Japan’s annual fuel imports by ¥3.3 trillion (about US$41 billion). As Japanese households and companies now pay a combined total of about ¥16 trillion a year in electricity charges, passing on all of this increase to users would mean an electricity rate rise of about 20 per cent.
Such a rise would reduce disposable income and corporate profits and negatively impact the Japanese economy through lower consumer and capital spending. Nomura says that if all of Japan’s electricity generating companies raised their rates by 20 per cent simultaneously, Japanese GDP would fall by 0.6 per cent in the same year.
While such figures are purely hypothetical, they underline Japan’s critical need to source reliable and reasonably priced fossil fuels. The country’s trade balance slipped into the red last year for the first time since 1980, as imports of fossil fuels rose to fill the void left by the nuclear shutdown. With the arrival of summer, domestic energy demands will rise and the deficit is likely to worsen.
Gas, naturally
Much of Japan’s increased fossil fuel imports have been in the form of liquid natural gas (LNG). While Japanese imports of crude oil have also risen, LNG is seen as the cheaper and more carbon-friendly alternative. Supplies are also more secure, given the continuing problems in the Middle East. Japan has been the world’s top LNG importer for some time, with most supplies coming from Indonesia, Malaysia and Australia.
LNG tankers from as many as 12 countries dock weekly in Japanese ports. In Japan’s 2011-12 financial year LNG imports increased nearly 18 per cent year-on-year to 83.18 million tonnes, and the International Energy Agency (IEA) estimates this may rise to 87 million tonnes for the 2012-13 financial year if Japanese reactors remain offline. Japan’s growing appetite for LNG has already driven up prices significantly, especially within the APAC region. “In addition to increased volumes, higher prices are inflating the amounts paid for these imports,” says Hiroshi Hashimoto, a senior researcher with the Institute of Energy Economics in Tokyo. “Japan paid a staggering ¥4.8 trillion for its LNG imports in 2011, up 38 per cent on 2010.”
Many players in the LNG market are now enjoying a position of unprecedented power, procuring cheaper LNG destined for Europe and selling it into the APAC market at much higher prices. The different gas pricing mechanisms in the Atlantic and Pacific basins mean LNG can now fetch a price five or six times higher than it would in Europe or North America. Spot Asian LNG prices hit a four-year high of US$18 per million British thermal units in May, up more than 35 per cent year-on-year.
Unsurprisingly, Japan is making concerted efforts to mitigate the huge burden that additional LNG imports – especially those involving gas bought at inflated spot prices – are placing on its energy users and economy. The country will host a public forum of LNG producers and consumers in Tokyo in September, hoping to promote dialogue that will lead to a new LNG world order.
Some Japanese LNG buyers want to build alliances with other APAC region buyers with the aim of negotiating bulk contracts at more competitive prices. Others have decided to invest heavily in upstream projects, tapping gas at source to guarantee supply and lower prices.
In May, energy companies from Japan, South Korea and China announced a collaboration with Shell that will see billions of dollars worth of Canadian LNG shipped to Asia from 2019 onwards.
“APAC gas consumers are definitely more collaborative now than in the past,” says Alan Troner, president of Asia Pacific Energy Consulting (APEC). “In the past countries such as China were very hand-to-mouth with regard to LNG imports. Regional price hikes and price discrepancies between Atlantic and Pacific basins, coupled with the growing importance of LNG in Japan’s energy mix, mean Japanese buyers are examining all the options when it comes to securing supplies at the lowest possible prices.”
Shale gas to the rescue
Australia is the fifth largest LNG exporter in the world, exporting 19 million tonnes last year. The Australian LNG industry has seen several colossal projects start in recent years, however, and exporting capacity is expected to rise dramatically over the next decade as they come online. On the back of rising demand Japan is becoming heavily involved in the country’s burgeoning LNG sector.
In January Japanese energy company Inpex teamed up with French company Total SA, signing off on a deal to extract gas from a remote spot in the Timor Sea and pipe it to Darwin. In May Mitsubishi Corporation and Mitsui & Co announced they were spending US$2 billion to buy a stake in the Browse gas field off the coast of Western Australia.
LNG exporters in Australia and other APAC countries are facing stiff competition for contracts with Japanese buyers. The US has recently perfected a means of extracting natural gas from shale – the so-called shale gas revolution – meaning its natural gas production and inventories have increased significantly over the past two years. Its upstream, transportation and LNG infrastructure is already well developed.
Japanese companies are already looking to North American shale gas as a means of securing new, long-term LNG supplies at knockdown prices. Three major deals have secured a Japanese presence in North American projects scheduled to start delivering cargoes by 2020.
“Shale gas could be the deus ex machina for the US and Japan,” says Yoshimasa Maruyama.
Adds Hashimoto: “Future linking of LNG prices to the North American benchmark price may not always mean cheaper LNG, but it could certainly introduce a different pricing mechanism. This could trigger a reconsideration of the pricing policies of different LNG suppliers.”
Foreign focus
Uncertainty over Japan’s long-term energy policy is affecting the strategy of many Japanese corporations, which are now slashing domestic investment and embarking on or ramping up overseas projects.
In PricewaterhouseCoopers’ 15th Annual Global CEO Survey, 86 per cent of Japanese CEOs reported an intention to change their company’s strategic plans – as opposed to 62 per cent in North America and 64 per cent in Western Europe. Nearly 70 per cent of those CEOs reported a desire to spend more time developing business in new markets. Research data from the Japanese Cabinet Office shows that the ratio of foreign to national production will rise from 18.4 per cent in 2011 to 22.4 per cent in 2016.
It’s not only energy worries that are refocusing the attention of Japanese firms abroad. A strong yen is leading more Japanese firms to seek overseas acquisitions; Japan’s outbound mergers and acquisitions amounted to a record US$80 billion in 2011, up from US$34 billion in 2010.
The yen has long been treated as a safe haven by investors whenever European or North American economies have taken a turn for the worse. It appreciated to a record high of ¥75.35 against the US dollar in October last year, and in May surged to its strongest level against the euro in more than a decade as the eurozone crisis rumbled on.
While the Bank of Japan (BOJ) has an asset purchase program of ¥65 trillion and a lending program of ¥5.5 trillion, its attempts to weaken the overvalued yen have so far been largely ineffective.
“We would argue that the BOJ has been insufficiently bold in its efforts both to loosen monetary conditions and weaken the yen,” says Adam Slater, a senior economist at Oxford Economics in the UK. “The scale of its effort, in terms of expanding its balance sheet, has been modest compared to those of countries such as the US and UK, and exchange rate intervention policy has been inconsistent.”
Labour shortages are also a concern for many Japanese companies. According to government forecasts, Japan’s working-age population will have fallen by more than a third to 52 million by 2055. Despite the decline, the country has so far done little to open itself up to immigration.
“Japan must do something about its imminent lack of labour,” says Andrew Peyton, a Japan-based account executive with a US plastics company. “Demographic trends mean that it will either be forced to import labour or totally change production methods. In my opinion the introduction of free trade agreements and joining the Trans-Pacific Partnership Agreement [formed by Pacific Rim nations including Australia] would go a long way to solving these issues.”
“Japan also needs big improvements in productivity, especially in sectors such as services where productivity growth has been historically weak,” Slater says. “This in turn implies significant structural reforms that open these sectors up more to competition and reduce barriers to entry.”
Reasons for optimism
Of the myriad challenges facing Japan 16 months after 3/11, many relate to serious structural problems that the country’s economy was facing before the disaster. These include fiscal deterioration, the relocation of industry overseas, decreasing global competitiveness and an ageing society.
There are obviously no simple solutions to these problems. “A whole raft of policy measures are urgently needed,” says David Rea, an economist with Britain’s Capital Economics. “Japan must increase workforce participation, increase immigration, reduce government debt, encourage households to spend their savings, reduce regulation, reform the tax system… the list is very long.”
Many of Japan’s problems are the same as those of other industrialised nations, where globalisation is driving down wages and hampering growth. Weakness in domestic spending makes the Japanese economy overly dependent on capital expenditure and foreign demand, and Japan’s fortunes are increasingly tied to the health of the Chinese economy, itself susceptible to conditions in the economies of North America and Europe.
While Japan’s growing national debt is already gargantuan, the country is unlikely to suffer from a Greek-style implosion. In the words of financial services firm Fitch: “Japan has fundamental structural strengths, including one of the world’s most advanced high-income economies and strong public institutions.”
The Japanese Government now receives more revenue from bond issuance than it does from tax. However, the fact that most Japanese Government Bonds are held by domestic investors means this debt is reasonably sustainable; Tokyo can fund itself at a lower nominal cost than any other advanced economy. Still, stabilising and reducing public debt in the short to medium term is critical to maintaining domestic confidence.
While foreign direct investment in Japan was limited before 3/11, the recovery process is throwing up new opportunities. The earthquake-stricken area will prepare various “special zones for reconstruction”, where those establishing businesses will enjoy corporate tax-free status for five years, plus reduced local taxes and expedited regulatory procedures. Investment is open to both domestic and foreign companies.
“Japan’s review of energy policy will also create demand for renewable and energy efficiency technologies,” says Jun Arima, director general of JETRO (Japan External Trade Organization) in Britain. “Japan has recently introduced a very attractive feed-in tariff for renewable energy. Regulations hindering renewable energy development will also be reviewed.”
Perhaps Japan’s greatest asset is its people, who ably demonstrated their stoicism and survival instinct in the aftermath of last year’s disaster.
“We’ve seen Japan overcome challenges in the past,” says Nobi Yamaji, president of Rio Tinto Japan. “I’m confident that current issues surrounding energy and high yen valuation will be a catalyst for improvements and reforms that will benefit us all. These include significant changes in our energy consumption, an increased urgency to revolutionise the power industry and development of energy technologies.”
“I wouldn’t write Japan off just yet,” says Troner. “The country has huge problems to overcome and the earthquake of 2011 has undeniably impacted the economy in a negative way.
“But the Japanese are an incredibly smart and resourceful people. Without doubt they have the ingenuity to find new paths and innovative solutions to their problems.”
