Shell Japan deal signals further refiner consolidation

[TOKYO] Idemitsu Kosan Co's agreement to purchase most of Royal Dutch Shell Plc's stake in Showa Shell Sekiyu KK and pursue a full merger may signal broader consolidation as Japan's refiners confront declining demand.

Idemitsu Kosan on Thursday said it will pay about 169 billion yen (S$1.87 billion) for a 33.24 per cent stake in Showa Shell. A full combination of the two would create a company with about a third of the domestic gasoline market, putting it on par with JX Holdings Inc, the country's largest refiner.

Oil demand in Japan has been declining as the nation's population shrinks and as a shift to more energy-efficient cars prompts refiners to lower output. The government, a backer of industry consolidation, has asked for cuts in processing capacity as the US boosts exports and new production redraws global gasoline and diesel trade flows.

"Japan's refineries are facing a long-term structural decline in demand, and refinery margin trends have been unstable," Norimasa Shinya, an analyst at Mizuho Securities Co, wrote in a July 30 note. The announcement "could trigger industry consolidation that could lead to a better operating environment for the domestic refineries." A surplus of providers is one of the biggest challenges facing Japan's refinery industry, Takashi Tsukioka, president of Idemitsu, said Thursday at a briefing.

"There is still room for further consolidation in the industry" even after a merger between Idemitsu and Showa Shell, Mr Tsukioka said.

Idemitsu rose as much as 4.9 per cent in Tokyo trading on Friday. Showa Shell, which surged as much as 13 per cent on Thursday after the Nikkei reported that Idemitsu would become its largest shareholder, fell as much as 3.3 per cent.

By all accounts, some consolidation is already under way.

TonenGeneral Sekiyu KK, Japan's third-biggest refiner by revenue, agreed in December to link its Chiba refinery with Cosmo Oil Co's neighbouring plant to increase production efficiency.

Cosmo Oil has held talks with other companies on possible partnerships for its Sakai and Yokkaichi refineries, President Keizo Morikawa told reporter in May.

Idemitsu and Showa Shell first raised the possibility of a tie-up in December after the Nikkei newspaper reported Idemitsu would acquire Showa Shell via a tender offer. On Thursday, the presidents of both companies repeated several times that they want to merge their businesses based on "a spirit of equals," though no details were provided.

Demand for oil product is forecast to fall 6.8 per cent by fiscal year 2019, the Ministry of Economy, Trade and Industry said in an April draft report. The government has warned it isn't realistic for Japan with less competitive refineries to make up for a decline in domestic demand by expanding exports of oil products in coming years.

US petroleum product exports to Japan rose 13 per cent in the first three months of this year, data from the Energy Information Administration shows.

Japanese refiners may be forced to cut about 10 percent, or 400,000 barrels a day, of the country's total refining capacity by March 2017 to meet the government's rules, the trade and industry ministry said in June 2014.

A merger of Idemitsu and Showa Shell would mean "efficiency improvements in the use of raw materials and semi- finished goods, streamlining of distribution and lower selling costs," Hidetoshi Shioda, an analyst at SMBC Nikko Securities Inc, wrote in a July 30 note.

Idemitsu has three refineries with total capacity of 535,000 barrels a day, making it the third-biggest processor in Japan after JX and TonenGeneral Sekiyu, according to data compiled by Bloomberg. Showa Shell also owns three refineries with combined capacity of 445,000 barrels a day, according to the data.

BLOOMBERG