Love is in the air among Japan's oil refiners.
After Idemitsu Kosan and Showa Shell agreed to a merger last week, the country's two biggest refiners -- JX Nippon Oil & Energy and TonenGeneral -- are in talks about doing the same, Nikkei reported earlier today. The deals would put almost 80 percent of the nation's refinery capacity in the hands of two companies, leaving Cosmo Oil, Taiyo Oil and Mitsui Oil as the only minority players.
The rationale behind the tie-ups is straightforward. Despite still being the world's biggest energy importer, according to National Australia Bank, Japan is giving up on the black stuff. Its population is shrinking, aging and driving less. When its motorists do get behind the wheel, it's increasingly that of a battery-powered, hybrid or even hydrogen-powered model. Industry is moving away from the viscous heavy fuel oil that powered its rise in favor of liquefied natural gas, which burns cleaner and whose price is slumping. The government wants the share of grid electricity generated from oil to drop to 3 percent in 2030, from 15 percent currently. Per-capita consumption of crude last year dropped to its lowest level since 1969.
The country's refiners have been shrinking capacity to meet this shift. Last year's capacity utilization level of 88 percent was the highest since 2005, according to Bloomberg Intelligence. But it's not enough. Total refinery capacity at the end of 2014 was still about 83 percent of its level 10 years earlier. In the U.K., an oil producer, total refining capacity is running at about 74 percent of 2004 levels.
That the capacity cuts to date are barely keeping pace with slumping demand is bad for refiners, and Japan's government has been pushing companies to consolidate.
The country's four publicly traded refiners (Taiyo is closely held and JX is part of the larger JX Holdings group) have lost an aggregate 177 billion yen ($1.4 billion) over the past eight quarters, according to data compiled by Bloomberg:
Losses have been heaviest at TonenGeneral and Idemitsu Kosan, whose plants have also been most idle. Utilization at the duo has averaged 70 percent and 78 percent respectively over the five years to 2013, according to Bloomberg Intelligence.
That would suggest those two will be the losers from industry consolidation, but the opposite may be the case. Details of the proposed transactions have yet to be thrashed out, but it's hard to believe government-brokered mergers in Japan's cozy corporate culture will be as hard on the weaker parties as their equivalents would be in the West.
Investors in TonenGeneral and Idemitsu Kosan will end up with either cash or shares in a better company at the end of the process. JX Nippon and Showa Shell will be saddled with weaker operations, and have to weather continuing headwinds -- according to the Energy Information Administration, Japan's petroleum consumption will fall by a sixth between 2010 and 2040.
Merging companies doesn't take away the need for capacity cuts, it merely shifts the group of shareholders who'll take the hit.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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