Japan’s coming reconstruction

The unimaginable tragedy that struck Japan in the form of the record-magnitude earthquake and tsunami, compounded by the ongoing nuclear crisis, presents one of the greatest challenges ever for the nation. The images of the destruction and impact it is having on the people are heartbreaking, and we hope the country will recover soon and strongly.

The massive hit to the world’s third-largest economy and chemical producer has two major near-term impacts: one on demand and the other on production.

DEMAND-SIDE IMPACT

All of Japan’s automakers halted most production lines in the country and there have been numerous disruptions to manufacturing, from automotive to energy. This is already sapping demand. Crude oil prices plunged early last week, along with naphtha – a critical feedstock to Japan’s petrochemical sector.

Confidence in the local economy was not at a high point before the tragedy, and this will only ebb further in the near term as caution reigns.

The demand destruction will have a far-reaching impact worldwide. Laurence Alexander, chemicals analyst at global investment bank Jefferies & Co., notes that in the near term, “a shock to Asian demand could also undercut North American [chemical] exports and, indirectly, margins.” Companies and analysts will be assessing the Japan impact for weeks to come.

At an investor conference hosted by global financial institution Susquehanna International Group in Boston, Massachusetts, US on March 15, “high oil prices and Japan failed to dent chemical company economic and earnings outlooks,” according to Susquehanna chemical analyst Don Carson. “While equity and commodity markets have traded off with the natural disaster in Japan and volatile oil prices due to political turmoil in the Middle East, managements continued to be cautiously optimistic on the economic outlook.”

However, this could quickly change, depending on the nuclear situation.

SUPPLY-SIDE IMPACT

The impact on the chemical supply-side is more obvious. A number of crackers are down or operating at reduced rates, causing supply disruptions down the chain. The near-term impact has been spiking prices.

Asia paraxylene (PX) prices hit a record high following a force majeure by JX Nippon Oil, Japan’s largest exporter of PX. Asia caprolactam prices have also spiked on panic buying from Taiwan’s nylon producers.

But the forces of supply shortages and demand destruction will collide – and it remains to be seen how it will all play out. In the short term, styrene butadiene rubber (SBR) prices are expected to fall as Japan’s auto production is stymied.

Much on the overall supply and demand situation will depend on how and if the nuclear situation can be controlled. A major nuclear catastrophe on top of the existing devastation would have dire consequences worldwide, not the least on sentiment.

RECONSTRUCTION PHASE

But once this plays out, Japan can proceed on to the next phase – reconstruction. The resilience of the Japanese people in the face of this tragedy is admirable. There is no doubt that the nation has the full capability to recover, given the proper support and resources.

Japan may one day emerge from this with a revived economy, jump-started by looser monetary policy and huge reconstruction efforts. Its central bank has already injected 28 trillion yen ($350bn, €253bn) into the financial system in several steps.

In reconstructing the energy and chemical sectors, tough decisions will have to be made. In a likely move away from nuclear power, Japan will need much more oil, natural gas and coal for its energy needs, along with any alternative energy solutions.

In the chemical sector, Japan’s naphtha crackers have become increasingly uncompetitive in the global context with their relatively small size and lack of advantaged feedstock.

Consolidation of certain crackers has been planned for years and some progress was being made, but it has been painfully slow. Here the industry will have a chance to reevaluate its long-term position.

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