Japan's Oil Demand Could Rise -- or Fall

There are seriously diverging views on the demand for oil in Japan as the country works to recover from the devastation caused by the earthquake and tsunami that struck the country’s northeast coast last month. Some observers have estimated that it could cost as much as $200 billion to rebuild, while the Japanese government itself estimates that costs could run to $300 billion.

The International Energy Agency (IEA) states in its Monthly Oil Market Report that the effects of the loss of 9,700 megawatts of nuclear power generation capacity and 1.4 million barrels/day of refining capacity are still being evaluated. The IEA also notes that in addition to the loss of nuclear power generation, another 8,500 megawatts of oil-, gas-, and coal-fired generation is also offline.

Even if the nuclear capacity is restored, that restoration will take years. In the short-term, fuel-switching appears to be the answer. The IEA estimates that the downed nuclear plants would generate 60 terawatt-hours of electricity in a year, and if that were replaced entirely by oil-fired generation the additional oil consumption would reach about 200,000 barrels/day.

However, IEA expects natural gas, imported as LNG, and coal are likely to play a larger role in power generation. Gas-fired plants operating at 70% of capacity could meet the shortfall. In general, power generation is not expected to raise demand for crude oil by much as the country rebuilds.

Electricity generation isn’t all there is to getting Japan back on its feet. Two scenarios have emerged — one optimistic and the other, not surprisingly, pessimistic.

The optimists argue that the area most severely damaged by the earthquake and tsunami is, for Japan, sparsely populated and does not have many energy-intensive industries. There is also plenty of spare industrial capacity in Japan, even if it is old. The country’s GDP is expected to come in as originally projected, up 1.6% over 2010, but second quarter GDP could be lower than expected, and will be made up in the second half of the year as the country hits its stride in rebuilding. Under this scenario, oil demand would change little.

Pessimists acknowledge that the worst affected region does not contribute much to GDP — about 4%. But just-in-time inventory processes and other supply chain issues are spread around the country and could affect up to 12% of GDP. If rolling blackouts are required due to lack of power generation, pessimists think that as much as 40% of the country’s GDP could be affected. Restoring the nation’s supply chains would not only be costly, but could also take much longer to complete. Interestingly, even this scenario does not see much change in demand for crude oil.

Japanese demand for crude fell in March, mostly due to the loss of nearly 30% of the country’s refining capacity. As those refineries are repaired and reopened, demand is expected to previous levels. Because the only driver for a significant demand increase from Japan is for oil-fired power generation, and because that is not a likely outcome, Japan’s effect on world crude demand is ultimately no different from what it was before the disasters struck.

Paul Ausick