The Energy Knot
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
To say it’s been a challenging 15 months for Japan’s energy sector would be to engage in the very highest form of understatement. First the tragedy over Fukishima and then the ramping up of war rhetoric over Iran’s nuclear program by the U.S. and Israel have made the first year of Prime Minister Noda’s tenure a near nightmare.
On Friday he announced that the first of their shut down nuclear reactors would be going back online to produce up to 1100MW of power. When it was announced last year that Japan would eschew all nuclear power, it was obvious to most market observers that going cold turkey was not a practical solution for a heavily industrialized country that relied on nuclear power for 30% of its electricity.
Bearing the Brent
So, this announcement should come as no shock to anyone. Both Malaysia’s A-P Tapis Crude and Indonesia’s A-P Minas crude are pegged to Brent crude and currently trade at an $8 premium. All other grades of crude oil are quoted in relation to a premium based on these two grades of oil, over and above Brent, meaning that oil in Southeast Asia is close to the most expensive in the world due to local demand.
Brent is traded in the equity market as the United States Brent Oil Fund ETF (NYSEMKT: BNO) and has shed more than $28 per barrel since its peak in March.
The increased oil imports by Japan at record prices created a trade deficit for the 12 months ending March 31. Oil imports were up 29% while LNG imports were up a staggering 52% while the world economy was slowing down and electronics exports, a Japanese staple, were down 14.7%. Shares of the Nikkei 225, traded as the MAXIS Nikkei 225 Index Fund ETF (NYSEMKT: NKY), have been broadly range-bound between 8,500 and 10,200 since Fukishima. The Nikkei has shed 1700 since mid-March, but so far the low from the week of the Tsunami has held; having been tested now twice, both in January and earlier in the month.
Japan’s energy companies need to continue to develop new sources of oil. PeteroVietnam’s oil and gas division just invited a number of Japanese oil companies to discuss the development of 20 blocks off the coast of Vietnam as well as bid on infrastructure and refinery projects totaling $24.8 billion, or about 80% of the total capitalization of both the Ho Chi Minh City and Hanoi exchanges. JX Holdings, held by a number of ETFs, but is best represented by the SPDR S&P International Energy ETF (NYSEMKT: IPW), is currently operating in Vietnam and will be at that July meeting with PetroVietnam.
The Oil Must Flow
On top of the high costs and the record imports, the U.S. and the E.U. have been backing Japan into a corner over Iran, who supplies them with 9% of the crude oil needs. So, while the U.S. has granted Japan and others exemptions from the financial sanctions for agreeing to lower their importation of Iranian oil it does them no practical use if they cannot insure the cargo as well as the threat of repossession by the European banks for being in breach of contract on the loan. The Japanese lower House just passed a resolution providing an insurance guarantee on any shipments of Iranian oil. The E.U. banks may still press the issue as a breach of contract for just loading the oil in the first place.
How serious the U.S. and the E.U. are in attempting to destroy the economies of their friends is what we are going to find out in the next few weeks. Japan is definitely playing the U.S. and China off of one another as they try to maneuver around the obviously brewing trade/cold war between the two powers.
The Iranian oil flow’s importance to Japan cannot be overstated. They will not be bringing their entire fleet of nuclear reactors back online all at once. According to a Reuters story, the Ohi #3 and #4 reactors will be back online by the end of July. Japan will still be importing 900,000 barrels of oil per day through the rest of the summer, 25% more than they were importing before tsunami.
Cold War By Proxy
The timing of this announcement to restart the nuclear power plants was likely brought on by pressure from the U.S. over Iran’s oil. The Japanese Prime Minister commits political hari kiri to placate the U.S.’s foreign policy objectives in the Middle East. If, as I wrote last week on this issue, the fight over Iran’s nuclear energy program has become an opportunity to destroy the banking systems in Hong Kong and Singapore, who are rising in stature and power, then Japan’s agreement to openly trade Yuan and Yen, cutting the U.S. Dollar out of their trade entirely, becomes an even bigger deal than previously thought.
China is facing sanctions in less than two weeks, which would effectively cut China out of the international oil markets. But having swap lines open between both Japan and Hong Kong provides them access to the international markets using the others as proxies. This arrangement is very bullish for the CurrencyShares Japanese Yen ETF (NYSEMKT: FXY) because it gives China the means to sell either Yuan or U.S. Dollars in order to get Yen to trade. If the sanctions go into effect it would be hard to imagine that China would not accelerate divesting themselves of Dollars and U.S. treasuries completely and replacing them with Yen and JGB’s.
The U.S. has Japan trapped in a constrictor knot over its energy supply and is squeezing them to bring them to heel over Iran and to keep them from getting too close to China. To the mind trapped by mercantilism, the continued rise of the Yen versus the Dollar and the Euro is supposed to create export pain and can be used as leverage. The U.S. troops stationed in Japan and Okinawa don’t hurt either. The problem with that thesis, and mercantilism in general, is that the Yen has been appreciating versus the dollar for years and it has kept their economy afloat. Flat to falling consumer prices are the source of Japan’s ultra-high savings rate.
Japan’s economic problems are self-made by not allowing their banks to implode at any point in the last 20 years. Goosing exports only wins you short-term political points; it does not fix your economy. A stronger Yen means lower energy costs (fewer Yen chasing the same oil) and more profitable production for their exporting industries, offsetting the gains in the Yen. If BoJ continue to resist smashing the rising Yen it will continue to see real capital formation as the rest of the Pacific Rim look to them for leadership along with China.
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