April 2019

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Asia: Japanese refining moves towards consolidation and increased efficiency

According to recent statements of leading Japanese analysts in the field of refining and the country’s largest producers, the Japanese refining industry is moving towards consolidation and an increase in efficiency.

Gerden, E., Contributing Writer

According to recent statements of leading Japanese analysts in the field of refining and the country’s largest producers, the Japanese refining industry is moving towards consolidation and an increase in efficiency. This move is being implemented by the ever-growing pressure from the government and tightening competition with sophisticated refineries that have started operations in the Asia-Pacific region.

It is expected that the implementation of these plans will be achieved by the adoption of new production standards in the industry and the transfer of some of its capacities outside the country.

The ongoing growth of production costs and a gradual decline of oil products demand domestically have created conditions for the consolidation of the country’s refining sector. This initiative has spurred many local producers to consider consolidation with other producers to save on costs and to increase efficiency.

For example, Idemitsu Kosan merged with its local rival, Showa Shell Sekiyu, in a deal worth approximately $5.6 B. The combined firm would account for approximately 30% of Japan’s domestic gasoline sales—second only to JXTG Holdings, which controls about half the market.

Analysts believe the deal will allow both Idemitsu and Showa Shell Sikiyu to accelerate expansion in the domestic market and to raise competitiveness of the Japanese refining industry in the international arena. The latter is especially important due to a rapid expansion of refining capacities in some emerging nations in the Asia Pacific region.

According to sources close to Idemitsu Kosan and Showa Shell Sekiyu, the ongoing consolidation of the industry is a result of market pressure, which has been put on producers by the Japanese government in recent years. Such pressure, according to producers, had the form of mandatory requirements to process more high-margin products, as well as to continue investments in cleaner fuel technologies.

For example, in 2018, the Japanese Ministry of Economy, Trade and Industry (METI) instructed some domestic refiners with weak capabilities for processing residual oil to achieve a 5% increase within the next 2 yr–3 yr. Simultaneously, those refineries, which already process high volumes of crude oil, will face a lesser increase of 2% or 3.5%.

According to state plans, this should help to make these refineries more competitive with imports. The Japanese government promised producers to provide subsidies for their capital spending and to provide other support to them to meet with new requirements. The total amount of support is equivalent to approximately $200 MM.

Fig. 1. A view of Vladivostok. Located in Russia’s Far East, it is  a potential site for the building of a proposed refinery by  Japanese operators.
Fig. 1. A view of Vladivostok. Located in Russia’s Far East, it is a potential site for the building of a proposed refinery by Japanese operators.

According to state plans, the latest round of modernization of the domestic refining sector should be completed by the end of the 2021 fiscal year. The government hopes the current requirements will force enterprises to make large-scale investments in a further modernization of their production capacities to increase production efficiency.

Clean-fuels investments

In addition to modernization, the Japanese government hopes to encourage domestic refineries to invest more in cleaner fuel production technologies, as well as in the construction and modification of sulfur-cleaning equipment to ensure the production of low-sulfur fuels. Since 2000, Japan has invested nearly $2.7 B to develop clean-fuels technologies. Those investments were also part of the country’s Low-Carbon Society Strategy.

According to a spokesperson of METI, the increase in efficiency standards is the only way for the Japanese refining sector to stay afloat and remain competitive in global markets. In recent years, the Japanese refining industry has been faced with serious difficulties. In fiscal year 2017, Japan’s oil demand decreased 30% to 3 MMbpd. This decline forced the Japanese government to begin implementing strict control initiatives for the activities of domestic refineries and the general situation in the sector.

With an aging population, an increase in the usage of electric vehicles and the growth in renewables and nuclear power restarts, analysts forecast that Japan’s oil demand will continue to decrease until at least 2030.

A decline in domestic oil demand has already led to the decline of operable domestic refining capacity, which has decreased to approximately 2.83 MMbpd in 2018—below domestic demand of 3 MMbpd. In turn, the decline in refinery utilization has resulted in a wave of increased prices on oil products for local customers. Most Japanese analysts believe this factor, along with a strict tax policy and a traditional lack of resources, remains among the major problems of industry growth.

New capital investments?

Most refined oil products are consumed by the country’s transport and industrial sectors. The country is dependent on kerosine and low-sulfur fuel oil imports. Despite the existing problems, Japan continues to remain the second-largest consumer of oil and refined oil products in the Asia-Pacific region.

The country plans to retain its status in the long-term that will require the establishment of additional refining capacities. While building new large-scale refineries within the territory of the country is nearly impossible—primarily due to high costs, overpopulation and environment issues—the government, along with local producers, are considering investing in building new processing facilities in neighboring states.

One possibility involves the use of Russia’s Far East as a production and export hub for the supplies of finished oil products to Japan. Earlier this year, Russian media reported plans that Japan was considering investing in the construction of a large-scale refinery in the Primorye region of Russia’s Far East. This investment was also discussed during a recent visit of Russia’s President Vladimir Putin to Japan and his meeting with the Japan’s Prime Minister Shinzō Abe. The facility is attractive to Japanese investors as construction in Russia’s Far East would be significantly more cost-effective than building the same type of facility in Japan.

The new refinery is expected to be one of the largest in the Asia-Pacific region. The refinery would receive crude oil feedstock from Russian oil production. Most of the facility’s finished products would be exported to the Japanese market.

According to the Russian Ministry of Energy and some Russian independent experts in the field of refining, the project could be very important and beneficial for the Japanese market. “Even in the case of 100% funding of the project from its own resources, it will be more profitable to Japan to establish a plant on the coast of Russia than within its own territory,” said Alexey Belogoryev, head of the expert-analytical department for the fuel and energy complex of the Russian Energy Strategy Institute. “Due to strict environmental legislation and overpopulation, the building of any new large-scale refineries from scratch in the territory of Japan will be highly unlikely for both Japanese and foreign businesses during the next 10 yr–15 yr.”

At the time of this publication, several of Japan’s largest oil products consumers—particularly located in Hokkaido—have expressed interest in a new, Russian-based refinery. HP

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