Will Japan Gain from Falling Oil Prices?

Tobias Harris

Publications Will Japan Gain from Falling Oil Prices?

Despite Japan’s economy falling into recession following the April 2014 consumption tax hike, the country’s economic policymakers entered 2015 optimistic about the country’s economic outlook. Among the reasons for their optimism has been the steep decline in oil prices since mid-2014.

Speaking to the press following a meeting of the Japanese cabinet on January 9, Amari Akira, Economic Revitalization Minister, stated that the Cabinet Office estimates that the ongoing drop in crude oil prices could result in as much as a ¥7 trillion windfall for the Japanese economy. Given Japan’s dependence on imported fossil fuels – Japan is a top-three importer not only of crude oil but also of natural gas and coal – it is not surprising that the Abe government is upbeat about the benefits of cheap oil for Japan. Bank of Japan Governor Kuroda Haruhiko was similarly optimistic in remarks to the Keidanren on December 25, 2014, stating: “Japan, a commodity-importing country, gains a large advantage from the decline in crude oil prices, especially when the decline is caused mainly by supply-side factors such as developments in oil-producing countries as it is this time. On the price front, while the decline in crude oil prices puts downward pressure in the short term, it will lead to an improvement in the output gap and to an increase in underlying prices from a somewhat longer-term perspective.”

 

crude oil prices west texas intermediate

The consensus view is that Japan clearly benefits as the price of crude oil has not only fallen dramatically but is expected to continue to fall for at least several more months.

At a basic level, this view appears correct: paying less for imported fossil fuels should free up money for other uses including consumption by households. The falling energy prices should also boost household incomes by halting or at least slowing the yen’s weakening against the U.S. dollar and other currencies as Japan’s trade deficit shrinks. And the Abe administration will gain leverage in its push for wage increases, as will unions demanding larger pay packages when they negotiate with employers at the annual “spring wage offensive.”

While falling energy prices will, as Kuroda suggested, be disinflationary in the near term, if the price shock enables a rise in real wages and a boost domestic demand, Japan could replace unhelpful cost-push inflation with beneficial demand-pull inflation.

 

japans balance of trade

However, it is far from certain that wage increases will be large enough or widespread enough to trigger demand-pull inflation, and, in the meantime, disinflation could tarnish the reputation of Kuroda’s monetary easing particularly as the European Central Bank’s (ECB) own quantitative easing program puts downward pressure on the euro relative to the yen and boosts the competitiveness of European exporters. With the BOJ already dominating the market for Japanese government bonds, the only way Kuroda may be able to raise inflation in the face of disinflationary effects of falling energy prices is to hope that wages rise and that cheaper energy stimulates household demand for other goods. In the near term, the BOJ and Abe government can expect lower inflation than they desire.

Meanwhile, at the microeconomic level, it is not clear that households have begun to benefit from lower energy prices. Gasoline prices did not fall dramatically until late 2014 and they remain at roughly the same level as in recent years. The same pattern holds for other consumer-use fuels (mostly kerosene and other heating oils), as well as for heavy fuels used by trucks. Similarly, businesses and consumers may not yet be reaping the benefits of cheaper energy in their electricity bills.

 

nationwide average price of large truck fuel

nationwide average price of gasoline

Because a portion of electricity rates are adjusted based on input costs – and these costs lag behind market price movements – six power companies and four gas companies will actually raise their rates in February as liquefied natural gas (LNG) actually became more expensive due to yen weakness in the August-October period, which will serve as the basis for the next price revision. The Chubu Electric Power Company (Chuden), which serves Nagoya and central Honshu, will be raising rates by ¥105 in February, the biggest hike in Japan. In addition to these rate increases, in December the Kansai Electric Power Company (KEPCO) asked the Ministry of Economy, Trade, and Industry (METI) to approve a 10.23% increase in the regulated rate paid by households and a 13.93% increase in the liberalized rate paid by companies.KEPCO’s application for a rate hike, like the Hokkaido Electric Power Company’s (Hokuden) similar rate hike in November, is driven not by fuel cost or exchange rate considerations but by ongoing losses due to the financial burdens of offline nuclear reactors.

Falling fossil fuel costs could prove a political windfall for nuclear power opponents who seek to keep those reactors offline. In spring 2014, before crude prices began to plummet, the government pressed the Nuclear Regulation Authority (NRA) to focus its attention on reactors most likely to pass its stringent safety regulations, and which could therefore be fast tracked for resumed power generation. In September 2014, the NRA approved the restart of Kyushu Electric Power Company’s (Kyuden) two reactors in Satsuma-Sendai subject to local and prefectural approvals. By November, both approvals were issued, passing a final decision back to the NRA. While it looked at one point like the Sendai reactors would be restarted in January or February 2015, the process has stalled, reportedly because Kyuden has not filed paperwork necessary to receive the NRA’s final approval. As a result, the first restarts have been delayed until spring at the earliest.

The general public remains skeptical about nuclear restarts and the government has showed no great urgency in making the case for nuclear power. The issue barely figured in the December general election, and when asked directly at his New Year’s press conference how he intends to convince the public to support the government’s position on controversial issues like nuclear restarts, Prime Minister Shinzo Abe spoke in general terms about his plans for media outreach rather than specifically about nuclear power. In short, while restarts may be delayed for technical reasons, the government has opted to keep the subject off the political agenda for the time being – a decision that appears to have been influenced by falling energy prices.

Considering why crude oil prices have decreased by half over the past six months also sheds light on whether consumers and businesses will respond to lower costs by spending more on other goods – if and when those lower costs are passed along. If the decline has resulted mainly from a global supply glut, then perhaps falling fuel prices could provide a positive shock that will kick start sustainable economic growth in Japan, contributing to the success of Abenomics.

However, if the weak growth outlook in Europe, China, and many emerging markets has played a major role in falling prices, it is difficult to see the price decline as an unalloyed good for Japan. If countries providing key markets for Japanese goods and services are not buying crude oil, will they buy Japanese exports? If Japanese manufacturers do not expect exports and profits to grow in 2015, will they pay their workers more?

It is notable that although Japan’s trade deficit shrank dramatically in monetary terms in November 2014, the volume of goods exported shrank for the first time in three months, falling 1.7%. In other words, thanks to the dramatic fall in the yen following the BOJ’s October 31 decision to expand its monetary easing program, Japan earned more for its exports while selling less. Meanwhile, if consumers are pessimistic about the economic outlook over the next year – which the BOJ’s December livelihood survey found is the case – will they spend the savings derived from falling crude oil prices? While it is too early to answer this question, particularly since the outcome of the spring wage offensive will likely have a strong impact on consumer sentiment, falling energy prices alone seem unlikely to boost demand.

Finally, it is necessary to consider the geopolitical consequences for Japan of cheaper oil. To the extent that the current fall in prices destabilizes exporting countries and undermines the nascent U.S. oil boom – which depends on new and costly technologies – greater volatility in global financial markets and less predictable investment flows may result, complicating the Abe government’s bid to boost asset prices. While Japan’s dependence on Middle Eastern oil may insulate it from the current round of price instability due to low production costs in the region – in 2013 83% of Japan’s crude oil imports came from the Middle East – there is no guarantee that its suppliers will be shielded from instability indefinitely.

 

CY 2013 oil imports by region

While there is no doubt lower-priced imports of fuel will have positive effects for Japan, the overall economic impact remains uncertain.

 

ten largest oil exporters to Japan CY 2013

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