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Oil prices set to rise after Japanese tsunami

Oilfield Technology,

The earthquake and tsunami that hit Japan last week is likely to have a significant impact on global energy markets.

Japan will rely more on oil for power generation at least until the end of this year, altering regional balances for some grades of crude and providing a large boost in demand for low-sulphur fuel oil (LSFO). And it will seek additional LNG supplies. The quake has also knocked out 25% of Japan’s nuclear capacity and one of its plants is on the brink of meltdown.

Tepco shut an additional 12 thermal generation plants after the earthquake. The utility Tohuko closed nine thermal power generation units because of the quake, including two gas-fired combined cycle units. But it is unclear how badly damaged these units are.

As a result of the massive loss of capacity, Japan has been forced to introduce rolling blackouts for three to four hours a day to compensate for the huge loss of base-load capacity in the energy sector. 

Indications about likely outcomes of the nuclear shutdowns can be gleaned from 2002-03 and 2007-08; the last time the Japanese power industry was affected by such widespread shutdowns.

Tepco was forced to take 17 nuclear power plants offline by April 2003, as a result demand for fuel oil and crude for burning in power plants rose by 54% and 33% year on year, as idle oil-fired power generating units were pressed into service. Fuel oil and burning crude demand rose by almost 300,000 bpd, compared with a year earlier, from mid-2002 until a year later. This time is likely to be no different.

Argus Media estimates that making up for the lost nuclear capacity following the events of 11 March will require additional fuel oil and crude demand of up to 300,000 bpd. But this extra oil demand will be tempered by the damaging effects of the natural disasters on Japan's economy. Lower GDP growth over the next six months would pull down overall oil demand growth, but reconstruction efforts would then kick in, leading to rising demand in the fourth quarter.

Expensive substitutes

Japan faces some problems in securing adequate supplies of LSFO and direct-burn crude. During the last major nuclear crisis, Indonesia was a regular exporter of Japan's preferred grade of fuel oil - low-sulphur waxy residue (LSWR) - as well as burning crudes, such as Minas. But Indonesia is now a net crude importer and rarely exports LSWR or Minas in significant quantities.

Alternatives to LSWR face environmental hurdles. The Japanese government imposes a 0.5% limit on sulphur content in fuel oil for burning by power generators, and they tend to use 0.3% sulphur fuel oil. High-sulphur fuel oil (HSFO) typically contains up to 3.5% sulphur, far above Japan's anti-pollution limits.

Prices of LSFO have already risen as exporters struggle to find suitable qualities for the Japanese market. In addition to strengthening LSFO prices, the increase in demand for oil for power generation from Japan will tend to support heavy crude, from which more fuel oil can be made, especially heavy sweet crude, with low sulphur content.

As a result, oil price rises caused by extra Japanese demand are unlikely to lead to a dramatic widening of premiums for middle distillates to heavier products, or for light crudes to heavy grades. This makes it different from the global price rally of mid-2008, in which diesel at US$ 200/bl reached premiums of US$ 100/bl to fuel oil when benchmark sweet crude prices were at almost US$ 150/bl.

Private-sector problems

Added to the uncertainty surrounding the fuels market in Japan are questions about how the private sector will respond to the planned rolling blackouts. Major exporters such as vehicle manufacturer Toyota are expressing concern about the impact of power cuts on their businesses.

Damage to Japan's refineries will in some cases take months to repair. Several have been seriously damaged, while others are expected back onstream relatively soon. Countries with excess refining capacity are likely to benefit from Japan's misfortune.

It looks increasingly likely that Japanese demand for fuel oil and crude may push up prices, as utilities struggle to keep the lights on in Japan to help the country recover from this huge disaster.

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