ANALYSIS-Uncertain Japan looks to spot crude market in 2010

Published: 03 Nov 2009 00:45:13 PST

* Japan crude buyers look to cut 2010 term supplies

* Bigger, diversified, spot purchase potential seen

SINGAPORE, Nov 3 - Hit by the twin woes of dwindling demand and hefty financial losses, Japanese refiners may ask for something during talks to secure long-term crude deals that was unthinkable even a few years ago -- supply cuts.

The world's third-largest crude oil importer, which has been paying a premium to secure the bulk of its long-term needs since the oil shocks of the 1970s, may instead boost purchases from the spot market to allow it to better adjust to fluctuating demand.

This could prompt the Asian nation, known for running Middle Eastern grades almost exclusively in its refineries, to diversify its crude purchases and optimise its crude slate, even as it continues to refine less and less petroleum.

Annual supply talks for import contracts that run along the calendar year have already begun and will to pick this week at the Asia-Pacific Petroleum Conference (APPEC) in Singapore, although Japan firms also set contracts to run with the fiscal year that starts in April and other times of the year.

Since the oil shocks of the 1970s Japan has placed a premium on having "secure supplies", importing around 75 percent of its crude via term contracts, more than South Korea, which imports about 60 percent, and the U.S., which imports about half.

For a graphic showing a rough breakdown of Japan's term and spot crude imports since 1975, click: http://r.reuters.com/nyw36f

For a graphic showing the share of spot vs term crude imports since 1975 click: http://r.reuters.com/pew36f

Until recently the strategy of Japanese refiners has been to maintain term contracts but reduce spot purchases to offset declining demand from Japan's greying population and green energy push, but the global economic crisis means this strategy is no longer feasible.

"The decline in Japanese oil demand is so steep that it's forcing refiners to cut even term volumes," said Osamu Fujisawa, an oil economist at industry consultants FE Associates.

"I've never heard of that happening before," said Fujisawa, who has 45 years experience working with Japan's oil industry.

Japan shipped in 15 percent less crude oil between January and August from a year ago, and the lowest amount for the period since 1989, according to data from the trade ministry.

Underscoring the trend, last week top refiner Nippon Oil Corp and smaller peer Nippon Mining Holdings Inc said their merged JX Group would move forward by a year a plan to cut oil refining capacity by 400,000 barrels per day (bpd).

But the abundance of contracted crude has been masked by production cuts from the Organization of the Petroleum Exporting Countries, which has agreed to cut 4.2 million bpd of oil output since last summer to shore up market fundamentals.

"Presently we have been told by oil producing nations that we will get 15-20 percent less crude from contractual volumes, and so far, I have not heard of any companies having trouble with this," said Akihiko Tembo, the chairman of No.3 refiner Idemitsu Kosan at a press conference in Tokyo last month.

But with OPEC ready to boost output if it sees a real supply shortages and a fall in inventories, and after crude hit one-year high last month, a problem could be just around the corner.

A COMEBACK IN SPOT CRUDE DEMAND?

Crude traders say that while falling demand is likely to reduce the overall amount of crude imports in Japan, the increased concerns over buying a large amount of crude via term contracts could force refiners to increase their spot purchases.

"This year OSPs from some producers have not been stable. You could even argue they've been volatile, and that could help push some refiners towards taking more spot cargoes," said a Japanese crude trader, referring to official selling prices.

Term volumes of Saudi Arabia Arab Light to Asia have been over $1.10 a barrel higher on average than spot assessments of comparative medium heavy Qatar Marine crude, and around 65 cents more expensive than Oman crude, between January and October this year, according to Reuters data.

The same was also the case for term volumes of Iranian Light to Asia, with the medium-heavy grade nearly $1.50 a barrel higher on an average than spot assessments of Qatar Marine crude, and about $1.00 more expensive for Oman crude.

Adding to the higher prices, reselling and destination restrictions placed on many grades sold via term contracts could also lead buyers to cut their contracts from producers such as Iran, Kuwait and the United Arab Emirates.

"Japanese refiners have tended to be conservative, largely sticking to what they have for term contracts. But now because of the economics, instead of just buying PG (Persian Gulf) grades, they may start buying more of other similar grades," said another Japanese crude trader.

That could lead Japan to buy more middle and heavy sour crudes such as Russian benchmark grade Urals crude, Azerbaijan Azeri Light, and maybe even grades from Latin and South America, traders said.

Some Japanese oil firms are already increasing their reliance on the spot market.

Small refiner Taiyo Oil Co has reduced its buying of crude via term supplies to 70 percent this year from 90 percent, industry sources have said.

And over the past few months, Nippon Oil has been heard buying more spot cargoes, prompting some crude traders to wonder if the oil firm has already cut some of its term volumes, and if it could lead to them being a bigger spot buyer next year.

At other Japanese firms, sources with knowledge of buying strategies said they were eyeing taking around 25 percent of their crude from the spot market next year, but added the rate is likely to increase if demand improves.

"If fundamentals come back next year then refiners will have to buy more on the spot market, but if they don't, companies will be covered by term volumes," said one crude trader in Japan.