The earthquake and tsunami hit Japan with tremendous force and consequence. It is estimated that the damages caused by the earthquake are 50% higher than the damages from last major earthquake in 1995, and it is by far the biggest natural catastrophe in Japan’s history. The earthquake hit about 250 miles NE of Tokyo, affecting the East shore primarily, and fortunately most ports were not heavily damaged and are expected to re-open this week.
As an emergency response to the disaster, Bank of Japan injected a record 15 trillion yen ($183 billion) on Monday, March 14th, to help exporters (weaken yen), since a sluggish stock market and a strong yen would be the most detrimental outcomes for the Japanese economy at this point. The Japanese government is preparing a fiscal response as well, for approximately 1.3 trillion yen. The earthquake damage is estimated to cost more than 20 trillion yen, and the natural disaster has caused nuclear reactors to malfunction, claiming thousands of lives and still counting.
Japan’s Role in Global Markets
As the third largest economy after the United States and China, Japan is a major player on the global raw commodities markets. It plays the role of a major importer of corn, soybeans, meats, natural gas, oil and copper. In this context, the US happens to be a main producer and exporter of some of those commodities; therefore, it is worth while to take a closer look at historical supply-and-demand facts in the global trade, as well as changes in demand from Japan post-earthquake, and the impact of those changes on commodities markets.
Energies at a glance
At the time of this writing, Japanese stock market index shares plunged about 11%, the largest sell-off since 2008 on news related to more explosions at a nuclear plant. The story is still unfolding and the final extent of the damage and how Japan is going to cope with lower nuclear energy supply remains to be seen. Nuclear energy makes about 11% of total energy output (see graph below); however, nuclear explosions and leaks have further reaching economic and social consequences than just the loss of an energy source.
What we know is that Japan is the world’s largest importer of liquefied natural gas (LNG), which is most cost-effective to transport over long distances where pipes are not available. Having only 16% energy self-sufficiency, Japan is the second largest net importer of oil. Therefore, any major disruptions can impact the global trade in a significant way. Oil is the most consumed resource, although the Japanese government diversified from it representing an 80% share of energy consumption in the 1970s to 45% in 2009.
Natural gas meets about 20% of Japanese energy needs, and Japan relies heavily on imports. Japan is the largest user of LNG, accounting for 35% of the global trade. Most of the world’s liquid natural gas (LNG) trade happens in the Pacific Basin between Japan, Korea Taiwan on the demand side and Qatar, Malaysia and Indonesia on the supply side. In response to last week’s disaster, Qatar, the world’s largest LNG exporter, said that it is willing to supply Japan with any quantity. Indonesia, Japan’s largest exporter of LNG, and the world’s third, is also ready to meet the increased demand. Reports show that Japan’s LNG import terminals are operating normally. Since the earthquake halted 11 of the country’s nuclear reactors, it is expected that the demand for LNG will increase by as much as 424 billion cubic feet a year if the reactors remain defunct. In 2009 Japan consumed 3,536 cubic feet, which will result in a LNG demand increase of 12% if the lost nuclear energy were to be entirely replaced by an increase in LNG.
As the figure above shows, the US is not one of Japan’s suppliers of natural gas and does not even export the commodity. However, the US is the world’s primary consumer and second largest producer, relying on just some minor imports to supplement its internal demand. The recent US shale gas deposit discoveries show 1000 trillion cubic feet of new supply, enough to provide the country with 45 years worth of natural gas. Therefore, the US and Japan do not compete for the same resource, and the NYMEX natural gas contract should be little affected by the earthquake. In fact, the NYMEX contract trades at 70% below its 2008 peak, and it is unlikely that Japan’s demand is going to provide any price support (see NGJ11 monthly continuous contract below).
On the other hand, the next-month delivery of natural gas in the UK trades only 24% below 2008 heights.
Historically, crude oil has proven to be a commodity that is very sensitive to the overall state of the global economy and also to geo-political concerns. From this perspective, it is the most politicised commodity. Recently, the instability in the Middle East pushed oil back above $100 per barrel. As mentioned previously, Japan is the world’s second largest crude oil importer and 45% of its energy needs is provided by oil. Currently 80% of its imported oil comes from the Middle East, but Japan is looking to diversify its imports and purchase more from Africa or Russia.
Diversifying may take some time, and increased demand for reconstruction projects combined with instability in the Middle East could trigger another spike in oil prices. For the short-term however, the OVX – Crude Oil sentiment index – is off from fairly high levels, and considering the cyclical nature of volatility; we should expect less volatile trading sessions ahead.
Although this material is not as popular with the media as crude oil or gold, it is in fact a reliable economic indicator. Copper is used in construction – electrical and electronics industries- and a demand increase points towards economic recovery or expansion. The US, Russia and Japan are the world’s largest consumers of copper. Copper-rich countries are Chile, Peru, South Africa, USA, Canada and Russia. Therefore, although a major consumer, Japan is not a major producer – it is a significant importer. For now, Toyota & Sony, two major Japanese manufacturers have halted production, but most plants should become operational again. Once infrastructure rebuilding efforts are begun, copper will follow suit and become a very sought after commodity in the years to come (see monthly May 2011 futures continuous contract COMEX – HGK11 below).
Japan is also the largest importer of corn and the demand for it is expected to fall as the earthquake and tsunami disrupted about 20% of livestock-feed output, according to the Japanese agricultural ministry. Ports and feed-making plans were also damaged. USDA’s long-term projections show that Japanese imports should remain steady over the next decade at 16 million metric tones, while the global trade will increase from 92.6 to 113.2 metric tones. As the world’s largest exporter, the US is expected to maintain its share of the global market between 52 and 54.6 percent. Moreover, 2010/11 world-ending stockpiles are slightly higher than the previous year’s. Generally speaking, grains prices are usually influenced by the annual battle for acreage in the USA due to crop rotation, US dollar, and weather patterns during the harvest season in major producing and/or exporting countries – US, Argentina, China, Russia and Ukraine.
Japan is Asia’s second importer of wheat; however, it is believed at this point that the impact on milling plants should be limited since they are located inland. The major wheat exporters are the US, Australia, the EU, Argentina and Canada. According to USDA projections, demand growth in this market is expected to come from Africa and the Middle East region: Algeria, Saudi Arabia or Egypt. 2010/11 world’s ending stockpiles are approximately 13% higher than 2008/09 figures, but slightly lower than 2009/10 numbers. Therefore, wheat prices should not be directly affected by the Japanese disaster.
Japan is the second major soybeans importer after the European Union, while the US is the largest soybeans exporter, but similarly to corn and wheat, the demand for soybeans is not expected to increase substantially.
As a major meat exporter, the US has a love-hate relationship with some Asian and European countries because some of protectionist government’s measures (particularly Korean and Russian) to ban meat imports for various reasons (read excuses) in order to shield their own producers from American government subsidised agricultural products. Japan is the third-largest export market (after Mexico and Canada) for US beef and a major buyer of dairy products. Also, Japan is the world’s largest pork importer, but the demand growth is limited due to a mature market with aging population. From a fundamental perspective, except for the short run, the Japanese demand for meat imports is not expected to change substantially.
The fundamental and technical data support the contention that there is going to be increased demand for energy (natural gas and crude oil) to make-up for the lost nuclear reactors, and increased demand for construction materials to rebuild the country’s infrastructure. Therefore, global prices for natural gas, crude oil and copper are expected to rise, and companies operating in this area should see more opportunities. Grains and meats, however, show a mixed picture, perhaps a spike in demand in the near term to replace the lost live stock and feed materials, followed by a return to normal demand levels in the long run.