A just released report by Goldman's Jeffrey Currie attempts to quantify the impact of the Tsunami on the Japanese economy from a commodity standpoint. Currie summarizes his conclusions as follows: "Assuming that the broader power grid infrastructure has not been permanently damaged, we believe today’s events are likely to put upward pressure on residual fuel oil and diesel cracks, LNG, UK natural gas and rice; downward pressure on naphtha cracks and Dubai spreads relative to other crude grades." Yet the thing we found more interesting than energy related bottlenecks was the disclosure toward the end of the report discussing the threat to the Japanese rice harvest: "In addition to the damage to energy infrastructure from the earthquake, the tsunami also impacted rice producing regions in Japan. While Japanese rice inventories are large, this puts the 2011/12 crop production at risk and may in turn drive Japanese rice imports higher, posing upside risk to current prices." Granted, Japan is not a big exporter of rice, but it is a top 10 consumer. Should the country's consumption (which is estimated at around 9 million metric tons) need to be satisfied by a surge in imports, and with the price of rice already dependent on the margin on speculative money, this could be the catalyst that send the grain, which has plunged in price over the past month, finally break beyond any potential manipulative price suppression schemes.
In addition to rice observations, below are the key energy market view from Currie:
26% of nuclear generation capacity down
Although all ports in Japan are currently shut down, once operations resume, and assuming that the broader power grid infrastructure in the region has not been permanently damaged, we expect a substantial rise in demand for substitute fuels for power generation. Specifically, we expect LNG, residual fuel oil and diesel imports to rise to help compensate for the 12.5 GW (500 kbdoe) of nuclear capacity shut down. Importantly, such disruptions in nuclear facilities may last for years, as it takes time to repair, test and re-authorize commercial operations. Importantly, the downside pressure on crude prices is likely a near-term effect only. In the medium-tolonger term, once refineries are operational, but with nuclear generation likely still disrupted, the net effect is to the upside for crude prices.
20% of refining capacity down
The marginal impact of today’s events in the oil product market may be even more significant than in the gas market, as not only demand has moved higher for these commodities, but also supply has shifted lower. Specifically, 935 kb/d of Japanese refining capacity appears to be shut down, based on various reports. But while this is likely to put upward pressure on products at the margin, it is likely to do the opposite for crude. In particular, we believe today’s events will put downward pressure on Dubai spreads relative to other crude grades, as Dubai’s demand has been the most affected.
In terms of specific trade recommendations:
After today’s earthquake, and assuming that the broader power grid infrastructure in the region has not been permanently damaged, we believe that the main impact to commodities will be:
Upward price pressure: Residual fuel oil and diesel cracks; LNG and UK NBP natural gas; rice
Downward price pressure: Naphtha cracks; Dubai spreads to other crude grades
Importantly, the downside pressure on crude prices is likely a near-term effect only. In the medium-to-longer term, once refineries are operational, but with nuclear generation likely still disrupted, the net effect is to the upside for crude prices Today’s earthquake will dramatically impact both supply and demand across the commodity complex. Specifically, in addition to the extensive damage to residential and commercial areas, 12.5 GW (500 kbdoe) of nuclear power generation capacity, 26% of total available capacity, and 935 kb/d of refining capacity, 20% of total, have been shut down (see Exhibit 1).
Summarizing the infrastructure damage estimates:
As to what happens once thing revert to somewhat normal:
All import capacity is currently shut down in Japan. However, once ports become operational, and assuming the broader power grid infrastructure in the region has not been permanently damaged, we expect a significant increase in LNG purchases and an even larger increase in residual fuel oil imports, so that both gas- and oil-fired generators can help compensate for the lost capacity. Importantly, this increase in demand for oil and gas is also likely to last for a number of years, as exemplified by the impact of Japan’s 2007 earthquake, given the time required to repair, test and re-authorize commercial operations at the damaged nuclear facilities. Out of the 8 GW of nuclear capacity shut down after the earthquake in mid-2007, only 5 GW have been restarted to date.
The risk of a substantial rise in global LNG demand as a result of the earthquake has already started to impact UK NBP prices, currently up nearly 5% in intra-day trading, at $9.60/mmBtu. Spot LNG prices for delivery in Asia, which had been declining for the past several days as winter demand in the region started to moderate, are also likely to rise quickly. Specifically, Platts’ JKM marker (delivery prices for spot LNG cargoes in Japan and Korea) was reported at $9.40/mmBtu as of yesterday. We believe these prices will need to rise to at least $1.50-$2.00/mmBtu above UK NBP levels, so as to cover transport costs to attract more LNG cargoes to deliver in Asia. We expect that this (potentially long-term) competition for resources will pose a significant upside risk to our UK NBP forecast of $7/mmBtu and $8.50/mmBtu for 2011 and 2012, respectively.
In the oil complex we expect today’s events to move naphtha cracks lower, as two naphtha-based ethylene crackers (828 ktpa of ethylene capacity) are down, but to broadly move cracks for other product higher. In particular, import demand for residual fuel oil and diesel, which can be used to generate power, is likely to rise, especially as Japanese refining capacity has also been affected by the earthquake.
In contrast with our bullish view for most products, regional crude oil prices are likely to move lower owing to refining capacity being shut down, especially while imports into Japan are restricted. In particular, the Brent-Dubai spread will likely widen, as Dubai crude is the grade whose demand is most likely to be affected by these events.
Importantly, the downside pressure on crude prices is likely a near-term effect only. In the medium-to-longer term, once refineries are operational, but with nuclear generation likely still disrupted, the net effect is to the upside for crude prices