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- 1. GRADUATE INSTITUTE OF INTERNATIONAL AND DEVELOPMENT STUDIES Cooperation for Competition Japanese downstream sector should optimize its business model through maximized cooperation among domestic and international competitors in form of a large scale cross‐sectors vertical integration. DISSERTATION Submitted in fulfilment of the requirement for the Executive Master in International Oil and Gas Leadership (IOG) By Yuichiro Torikata Supervised by Professor Alexander Van de Putte 15 June 2015
- 3. List of Abbreviations CDU Crude Distillation Unit DTW Deadweight tonnage EIA Energy Information Administration IEA International Energy Agency IEEJ Institute of Energy Economics, Japan KBD Thousand barrel per day MBD Million barrel per day METI Ministry of Economy, Trade and Industry, Japan MOMR Medium Term Oil Market Report NOC National oil companies OECD Organisation for Economic Co‐operation and Development RHCU Residue hydrocracking units RFCC Residue fluid catalytic cracking TexEDC Texas Economic Development Corporation
- 7. Chapter 1: Underlining challenges for the Japanese downstream petroleum industry The government‐red refining capacity consolidation policy should be a catalyst to redesign Japan’s downstream sector business model. Japanese refining and petrochemical sectors are traditionally designed to satisfy domestic demand scattered across the nation. As a result, 23 refineries of average 170 KBD processing capacity1 operate mainly near major demand centres: Kanto (Tokyo), Chukyo (Nagoya) and Keihan‐Setouchi (Osaka). Each of these refineries connects to both independent and subsidiary petrochemical manufactures so that they constitute small petrochemical complex. From the peak in 1983 with as many as 49 refineries, there were 29 refineries of total 4.89 MBD processing capacity in Japan before METI’s first regulatory intervention in 2010. The first set of regulations mandates Japanese refiners to increase proportion of residue cracking units to total processing capacity. To achieve this mandate, refiners had two options: 1) to invest in new raise the ratio of cokers, residue fluid catalytic cracking (RFCC) units and oil residue hydrocracking units (RHCUs or 2) to reduce total refining capacity. In face of fast domestic demand shrinkage, Japanese refiners rather chose to reduce total refining capacity than to invest in new costly residue cracking units. Today, the remaining 23 refineries represent total 3.94 MBD processing capacity; thus, the consolidation rule achieved removal of some 1 MBD processing capacity over 3 years. The mandate equally improved degree of sophistication of Japanese refining facilities. Ratio of residue cracking units to total processing capacity in Japan today is as high as newly built refineries in its neighbouring countries. Figure 1. Ratio of residue cracking units to total refining capacity India Taiwan Japan China Korea Singapore US EU Russia Saudi Arabia Source: ‘Report on Market Structure of the Downstream Petroleum Industry’, METI, June 2014 In the meantime, the consolidation had effects on two major regrouping among 10 Japanese refining and marketing companies. In 2010, Nippon Oil and Japan Energy merged into JX Oil, which is today the world’s 16th largest refinery operator2 by processing capacity. In 2012, ExxonMobile’s decided to 1 ‘Report on Market Structure of the Downstream Petroleum Industry’, METI, June 2014. 2 ‘World's Largest Refiners’, PetroStrategies, Inc., http://www.petrostrategies.org/Links/worlds_largest_refiners.htm.
- 8. divest Japanese downstream business, and the Japanese subsidiary TonenGeneral bought the Exxon stake. TonenGeneral also consolidated its semi‐subsidiaries and acquired Mitsui & Co.’s downstream oil business arm to form the second largest Japanese downstream petroleum company by the processing capacity. In December 2014, Idemitsu, the 2nd largest company by sales, and Showa Shell Sekiyu KK, the 5th operator, reportedly started negotiation for merger. This announcement is now considered a prelude to further mergers and acquisitions among the Japanese downstream petroleum industry. The chapter 4 will discuss possible outcomes from the Idemitsu and Showa Shell merger. In comparison with Japanese oil refining business model, major refineries in the Asia Pacific region value economies of scale thus they are typically twice larger than these Japanese peers. Table 1, Refining Capacity among Major Refiners in Asian Pacific Region Refining capacity Japanese Average 170 KBD Korean Average 560 KBD Singapore ‐ Shell Pulau Bukom Refinery 500 KBD India ‐ Reliance Jamnagar Refinery 1240 KBD Source: METI, Shell Singapore, Reliance Industry Limited These Asian refineries in Korea, Singapore and India are designed to export their outputs while satisfying their domestic demands. As a result, these Asian refineries are also equipped with ample export loading capacities. For example, Ulsan refinery can load several products simultaneously at rates of 2,400kl/h to 3,300kl/h, Japanese refineries usually can load only one product at 1,000 kl/h3 . Although, profits made from oil products trading remain relatively marginal to profits from domestic sales3 , such large and centralised facilities have advantage to quickly seize trading opportunities when the market is favourable. Such large scale of these Asian refineries has strategic advantage to centralise their investments in focused facilities. In contrary, 8 companies of different sizes from 1,425.7 KBD to 100 KBD total refining capacity own these 23 refineries across Japan. Because these 23 refineries mainly locate near demand centres with limited land availability, a small refining unit of more than two companies locate next to others near cities like Tokyo, Nagoya and Osaka. In case of Sakai and Senboku city in Osaka prefecture, 3 refineries by three different operators totalling some 350 KBD processing capacity locate in radius of less than 2km. For two refineries in Chiba prefecture locate on the Eastern wing of Tokyo bay, these two refineries of totalling 415 KDB processing capacity locate next to other. Considering these two locations alone, there are clear opportunities to improve operational efficiency. Brandenburger and Nalebuff argue that business players can play multiple roles in a competition and a player, who is primary identified as a business competitor can simultaneously plays a complementor role4 . In the case of two refineries in Chiba, they are definitely competing to maintain their own market share in the Kanto area especially because oil products demand has contracted in 3 Takeo Kikkawa et al, ‘Prospective for International Diversification of Japanese Downstream Petroleum Industry’, IEEJ, March 2013. 4 Adam M.Brandenburger and Barry J. Nalebuff, Co‐opetition, (New York: Currency Doubleday, 1996).
- 18. Figure 3, Comparison between Domestic Sales and Domestic Tanker Transportation of Oil Products Source: Petroleum Handbook, JX Nippon Oil & Energy Cooperation similar to those domestic alliances is also happening beyond the national boarder; thus, an East Asian downstream petroleum cluster is gradually forming in an organic manner. Due to declining domestic demand for transportation fuels, Japanese refiners began to divert their redundant gasoline production capacities to petrochemical production. Japanese refiners have reconfigured their facility to increase aromatics production: mixture of benzene, toluene and xylenes. Aromatics are mainly produced from catalytic reforming of naphtha rather than ethane cracking, which mainly produces ethylene33 . As a result, unlike international ethylene markets, Japanese aromatics supply does not face severe competition from North America and Middle East where their cheap ethane feedstock enables competitive ethylene production. At the same time, demands for aromatic, particularly xylenes, grow fast in China and other Asian countries34 . Table 2, Ethylene and xylenes production capacity comparison by regions Total ethylene production capacity World Total Total Asia of which: Korea of which: Taiwan of which: China of which: ASEAN of which: India of which: Japan Total Europe Total Americas Total Middle East Capacity 2012 157.7 59.7 7.8 4.8 22.5 12.1 5.1 7.4 26.7 38.9 26.7 Capacity 2018 186.2 72.7 8.6 5 30.2 12.7 9.2 7.1 25.7 46.9 33.1 Increase12‐18 28.5 13.0 0.7 0.2 7.7 0.6 4.1 ‐0.3 ‐1.0 8.0 6.4 Total xylenes production capacity World Total Total Asia of which: Korea of which: Taiwan of which: China of which: ASEAN of which: India of which: Japan Total Europe Total Americas Total Middle East Capacity 2012 54.8 32.4 3.9 2.9 13.5 3.4 0.6 8.1 6.2 10.8 4.4 Capacity 2018 66.9 36.5 3.9 2.9 16.8 3.4 0.6 8.9 6.2 11.6 11.5 Increase12‐18 12.1 4.1 0 0 3.3 0 0 0.9 0 0.8 7.0 Source: World Petrochemical Products Outlook, METI, April 2014 33 Isabro Fukawa, ‘From Petrochemical to natural resource chemical’ Asahikasei Research Center, April 2014. 34 World Petrochemical Products Outlook, METI, April 2014.