Last Friday, Japan was hit by a devastating earthquake, later upgraded to a Richter scale of 9.0 by Japan's Meteorological Agency. It triggered a large-scale tsunami, causing severe damage to many coastal installations, including nuclear power stations and oil refineries. From the most recent updates, approximately 9,700 megawatts of nuclear power generation capacity has been shut down, representing about 30% of Japan's total nuclear power generation capacity and 7% of Japan's total power generation capacity. About 1.5mbd of oil refinery capacity has also been halted, equivalent to about one-third of Japan's total refining capacity.

We see the impact on the energy market coming from two aspects:
Firstly, the mix of Japan's electricity generation source will need to be rebalanced. Japan relies on nuclear power for about one-quarter of its total electricity generation, while conventional
thermal power accounts for 65% of total generation capacity. Of the 65%, coal, LNG and oil make up approximately 25%, 30% and 10% respectively. Due to high oil prices over the past few years, oil-fired power plants in Japan are used primarily as extra capacity to meet peak demand.
With explosions in some nuclear plants and the subsequent radioactive scares, it's very likely that a significant amount of nuclear power generation capacity will remain shut for a long time. Given the existing mix, the supply shortfall from nuclear will have to be filled by coal, LNG and fuel oil. The rebalance should be supportive to these substitutive energy sources. That said, there is likely to be some short term demand drop due to general slow-down of economic
activities and as short-term imports dip due to damaged infrastructure.

Secondly, the shut-down of several oil refineries will affect refining margins, product cracks and Japan's oil import/ xport balance. The damage to Cosmo Oil's 220kbd refinery at Chiba seems severe as fires continued there over the weekend, which could see the refinery remain out of operation for a long time. Several other refineries have also been reported as shut. These will support refinery margins and product cracks in general. However, we don't see significant
upside in the margin and cracks, given abundant spare capacity in the global refining industry.

The refinery shut-down also affects Japan's import/export balance. While Japan imports
all of its crude oil, it typically exports around 200kbd gasoil/diesel and is broadly balanced on gasoline. It is also shown as net short in fuel oil during 2010, as the economy recovered (see graph). Within this context, the refinery shutdown is likely to cause more imports on gasoline and fuel oil and less export of middle distillates. The latest weekly Japanese oil inventories show gasoline and distillate stocks both at around historical seasonal lows. Therefore, it must rely on
imports/exports to balance the change in domestic supply. We've also analysed the oil product demand after the Kobe earthquake in 1995; the impact on oil demand from the earthquake
was mixed and short-term. We expect coal, LNG and fuel oil, as substitutes for nuclear power generation, to be supported by the loss of nuclear power generation capacity. Refinery shutdowns in Japan are likely to boost refining margins and product cracks in general,
and to have a knock-on impact on Japan's oil product balance. That said, there is likely to be some short-term demand drop due to a general slow-down in economic activity and a
short-term import dip due to damaged infrastructure.