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Friday, January 18, 2019

The Ripple effect from Japan

by Fabio Scacciavillani


The recent earthquake, tsunami and nuclear emergency in Japan has had a devastating effect, not only on the country but on the global economy

The massive earthquake, the ensuing devastating tsunami and the nuclear emergency that occured in Japan recently struck at a critical time for the world economy. The global recovery from the financial crisis, driven by the performance of emerging markets, was already faltering because China and other large Asian economies had had to confront an inflation threat after six quarters of buoyant expansion.

But advanced economies (including Japan) were still struggling to clear away the rubble left by the quasi meltdown of the global financial system and there was barely any visible light at the end of the tunnel. In the US, the labour market, despite massive fiscal and monetary stimuli, was timidly showing some signs of life, while in Europe the uncertainty over public debt sustainability (and the solvency of the banking sector) in peripheral countries was making investors nervous and meant that politicians were walking a tightrope.

Against this backdrop, the sudden outbreak of revolts in North Africa, followed by unrest in the Arab world, came to exacerbate an undercurrent of oil market tensions which compounded a generalised increase in commodity prices hitting lower income households worldwide.

The catastrophe in Japan, which is still unfolding and the extent of which will not be known for months, poses a series of threats to global recovery and alters profoundly the outlook for energy markets. A shock in the third largest economy, with a sizeable structural current account surplus and massive net creditor vis à vis the rest of the world, has notable implications for all asset classes. Obviously commodities and building materials prices will come under pressure once the reconstruction efforts get into full swing, in six to nine months.

But a more insidious risk is represented by the deterioration of an already precarious government account. In Europe, after Greece and Ireland, the domino effect has hit Portugal and it might now hit Spain. Even the United States is facing a mounting tide of public liabilities, and the political stalemate between the President and Congress is inducing pessimism over a swift return to fiscal prudence. The measures taken in Japan to foster growth and confidence are swelling a river of red ink that has been flowing for years in the land of the Rising Sun. In essence the three largest economies on the planet (considering Euroland as a single entity) are confronting a serious hazard over public debt sustainability.

Furthermore it seems fair to say that financial markets are likely to re-assess the risk to global growth prospects and take a more cautious approach, especially on equities that have rallied on somewhat optimistic expectations of a brighter picture in the US. Emerging markets typically suffer the impact of heightened risk aversion through capital outflows and credit-tightening from international lenders.

For our region, the long term impact will come, not surprisingly, from the energy markets and in particular the consequences of the Fukushima disaster. Nuclear energy, on which many senior policymakers were counting to meet the targets for carbon emissions cuts, agreed internationally, has come under severe scrutiny. Germany, where Angela Merkel has suffered a resounding defeat in a local election, which benefitted the Green Party, is on course to phase out many of its nuclear plants. In the US, President Obama has ordered a comprehensive review of all nuclear facilities, Italy has decided a moratorium on its nuclear programme and will hold a referendum in June. Even the Abu Dhabi government intends to re-examine its project and worldwide nuclear facilities will undergo a stress test to re-evaluate their safety. Even though the reactors under construction will be completed, for example in China, the much touted ‘nuclear renaissance’ has been stalled.

This means that traditional fossil fuels will have to be substituted for nuclear power and the type of fuel most likely to benefit, due to its lower carbon emissions and its wide availability, is natural gas. In fact gas prices, which had been weak for months, have suddenly picked up after the Fukushima incident. But also, the price of oil is likely to receive a boost. Japan is the third-largest global oil importer. Coming behind the US and China, in 2010 it consumed 4.40 million barrels of oil per day, a level which is likely to have dropped to 4.25 million barrels per since the earthquake, according to the International Energy Agency (IAE). The reactors affected by the earthquake accounted for production of up to 9,700MW - a level which looks set not to resume for at least a year, if at all. According to the IEA, it takes almost 40 barrels of crude oil to replace 1MW of nuclear power. If oil were to be the sole replacement fuel, Japan would require 375 mb/d. And even if a mix of crude, gas and coal were to be used, there would be an impact on the oil market which would be compounded by the closureof nuclear plants in other countries.

But have the Gulf countries managed to elude the effects of the Japanese crisis?

Only to a certain extent. Energy prices are still hovering dangerously around a level that risks sapping the financial recovery. The shock demand induced by the Japanese earthquake, in conjunction with further supply disruptions in the Middle East, could pull the world back into a recession and we could assist in a replay of the boom and bust episode of the summer of 2008. For this reason, Saudi Arabia, which is the main producer of oil and the only one with the capacity to increase oil production substantially is trying hard to offset any shortfall. Overpriced oil is not in anyone’s interests.

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