The short-term human cost of the devastating earthquake and tsunami that hit Japan in March, damaging the Fukushima nuclear power plants, was plain to see from every TV channel and newspaper headline. Since then, the world has had to look at the long-term effects of the disaster, which will be keenly felt in the world’s commodity markets, not least in the energy sector.
There were noticeable immediate effects, with some commodities trading lower as markets took stock of the impact on Japan’s gross domestic product (GDP) of damage to infrastructure, the closure of some industrial capacity and disruptions in power supply. Soon, however, the focus shifted to the changes that will happen in Japan’s energy matrix, with the loss of capacity in nuclear power being factored in, and concerns of the safety of nuclear generation coming to the fore once again.
The scale of the incident is comparable with the Three Mile Island disaster in the US in 1978, which cost the US economy more than $1bn and took 15 years to clear up. There is, therefore, a need to consider the impact on Japan’s domestic energy policy, but the consequences of the Fukushima disaster will be pronounced across global energy markets.
Changing energy profile
Japan already imported about 85% of the energy it used, nuclear power representing just over 10% of energy consumption. The profile of Japan’s energy consumption will inevitably change, echoing trends seen after the 2007 earthquake in the country that caused the Kashiwazaki-Kariwa nuclear plant to shut down.
Then, lost nuclear capacity was replaced by other fuel sources, including coal, natural gas and petroleum products. After the Fukushima disaster, Japan is mainly turning to gas-fired power generation to fill the gap in both the short and long term, so its demand for liquefied natural gas (LNG) is growing significantly.
“Oil demand from Japan dipped in the short run, but it coincided with events in Libya, which masked its effect on price. We are forecasting a lift in Japan’s GDP this year, so demand will be up across the whole range of energy commodities,” says Helen Henton, head of energy and environmental research for Standard Chartered Bank in London.
“LNG cargoes are being diverted to Japan, which took its largest amount of LNG in March,” says Biliana Pehlivanova at Barclays Capital in New York. “We expect to see more over the summer. A lot of nuclear capacity is offline, so they are using thermal generation to make up the shortfall.”
Worldwide impact
The effect of this rising demand is already being felt around the world. After Fukushima gas prices went up by about 15% over two weeks.
“The forward price for UK winter gas is about 72p [$1.17] per therm, and last year in the coldest December for 100 years the price was only 62p per therm. Either the market expects an even colder December, which is unlikely, or tension in the Middle East and north Africa, and growing demand for LNG outside Europe is pushing up prices,” says Mark Lewis, managing director for commodities research at Deutsche Bank.
Even so, upward pressure on gas prices has so far been held back. First, March, April and May are ‘shoulder’ months, where milder weather means Japan’s domestic power demand is relatively low. Second, there is a natural cap on Japan’s short-term LNG demand.
“Some thermal capacity was damaged, too, and in any case there is not enough to make up for the losses in nuclear capacity. Japan simply does not have 13 gigawatts of thermal capacity to spare in the region that needs it. There has been some price impact on LNG, but we have not seen the price jumps that we saw in 2007 with nuclear shutdowns in Japan. At this time of year, power loads are not at their peak, but LNG demand will rise in the summer, so we may get price spikes then,” says Ms Pehlivanova.
Four years ago, when Japan needed an injection of LNG, it came from the Middle East and north Africa, where political unrest now puts significant and reliable LNG cargoes in peril. Fortunately, LNG capacity in Qatar has risen considerably in the past four years, and in the short-term both South Korea and Russia have promised to send LNG cargoes to Japan. Looking ahead, cargoes previously intended for Europe are likely to go to Japan instead.
Meeting demand
For now, there is room in the gas market to absorb higher levels of demand from Japan. Before the disaster, the market expected a surplus of LNG, so this brought the market back into balance; most do not believe prices will return to 2007's record levels in the near future.
“If the market had been tight before the earthquake then the spike in demand would see Japan have to outbid other countries to get LNG, but in fact supply growth has outpaced demand growth, so the spike in Japanese demand has brought markets into balance. However, Japan's LNG consumption will be up for a long time because the damaged nuclear plants won't be coming back online,” says Ms Pehlivanova.
Japan lost 10 gigawatts of nuclear capacity, which may never come back. About 70% will be replaced by gas-fired generation, and Japan imports all its gas. For the moment, European supply easily takes up the slack, says Deutsche Bank’s Mr Lewis. “Europe has had chronic oversupply of gas for two years, so some gas that would have come to Europe as LNG will go to Japan, which will probably see a permanent rise in gas demand of 12 billion [cubic metres] per year. About half of that will come from LNG that would have gone to Europe, thereby reducing the EU’s oversupply.”
Gas is the most viable substitute and not only because of the market surplus. There are alternatives such coal and oil, but these markets are tight and they do not meet Japan’s environmental objectives.
“The next cleanest [fuel] after nuclear is gas, although that is not all that clean. The timing has been fortuitous in that the increase in gas demand came at a time of the shale gas revolution in the US, so there is a lot of LNG around,” says Ms Henton.
But this permanent rise in Japan's need for LNG will inevitably have long-term implications. After years of LNG liquefaction capacity coming online, less is planned going forward, so the market could be far tighter next year.
“The world has had years of record growth in new liquefaction capacity, so there is a lot of LNG available in 2011, but there is not much new capacity planned for 2012, so from next year, the market could be tighter. It depends partly on Europe's ability to switch between LNG and pipeline gas,” says Ms Pehlivanova.
Gas under pressure
Gas prices in the US rose immediately after the incident at Fukushima, with the market anticipating a permanent step up in demand for LNG. This rising price trend comes, however, at a time when natural gas is relatively cheap, not least because of the sheer scale of shale gas discoveries in recent years.
It had been widely expected that a continuing glut of shale gas production, in which US companies have invested heavily, would continue to bring prices down at a time when domestic demand had been falling anyway as a result of the financial crisis. The US has been importing less LNG, making more available for Europe and Asia.
This apparent glut will most likely not last, as LNG is diverted to Japan away from Europe, and as demand picks up in line with recovery. The pick-up may be accentuated further by a rethink of the relative merits of nuclear versus gas-fired power stations in both Europe and the US.
In Europe, price sentiment has been bullish, but the picture is slightly different as long-term gas prices are indexed to oil. This means that Natural Balancing Point (NBP) prices in the UK, for example, are trading at a significant discount, but high oil prices mean that gas does not appear to be cheap at the point of consumption. The debate about whether this indexation to oil should continue will go on, fuelled by the prospect of Europe's oversupply being eaten away.
Environmental concerns
As Europe’s energy matrix changes in light of Fukushima, there may also be renewed vigour in the debate on carbon emissions.
“People had forgotten the implications of a nuclear disaster, but it is now back in people’s minds, so the policy debate must go on. We need coal, oil and gas in the future to meet our energy needs, so carbon capture and storage could be the real winner here. It is technically possible, it just needs to be commercial, which requires policy and regulation,” says Ms Henton.
Across the energy markets and beyond, the consequences of the events of a few short tragic days in March will continue to be felt for years to come.
