Q&A: Cosmo Oil's Mitsuyasu Kawaguchi

Japanese energy firm Cosmo Oil's general manager for crude and tankers Mitsuyasu Kawaguchi spoke to Argus' Rieko Suda about how the country's oil refiners coped with a turbulent 2020, and what to expect in the years ahead.

What is your view on the impact of the Covid-19 pandemic on the global economy and oil market?

The Covid-19 pandemic brought an unprecedented impact as it caused market turmoil by wiping off an estimated 30mn b/d of global oil demand at one point during the April peak. But the market turmoil abated in an unexpectedly short period of time, within the April-June quarter, as Opec and Opec+ were responsive in addressing the oversupply caused by the pandemic. It caused much bigger confusion in the oil products market compared with crude oil, where we directly faced market pressure.

Refining margins disappeared at one point around March and April, and so did the price spread between petroleum products. The pandemic created an environment in which no refinery could cope, even highly advanced, or complex, refineries with secondary units such as reformers, crackers and cokers. Confusion in the products market lasted for a while and is still continuing to some extent. The market is now back on a recovery track.

Has the pandemic brought a structural change to the global and Asian refining sector?

The oil refining industry faced drastic changes, such as depressed refining margins and a narrowing of the price spread. Merchant refineries were forced to lower runs as they were unable to find outlets for their products. Such merchant refineries are continuing to have a tough time, including those on India's west coast and in Taiwan, South Korea and Singapore. Global oil products demand is fortunately on a steady recovery track although there may be some unpredictables, and market order has been restored.

How has the pandemic impacted Japan's oil demand and refinery operations? What is your outlook for a recovery in domestic oil demand?

Japanese refiners were advantaged relative to those merchant refineries. They are "captive" in the sense that their refineries operate to fulfill demand from their own marketing outlets, such as networks of gasoline stations and pipeline links to adjacent industrial plants. They did not have to sell their products at a bargain price in the international market. The system, or "captivity," worked to their advantage.

Demand in Japan dropped sharply for all petroleum products temporarily in April and May, but demand for gasoline and diesel has nearly fully recovered within a relatively short period of time. There is a prevailing trend of a shrinking domestic market, by 2-3pc/yr, but demand for driving fuels, such as gasoline and diesel, could be sustained by increased car travel and strong demand for domestic cargo transport. The demographic drop in demand is something Japanese refineries will have to continue addressing in the years to come.

Is there any chance that Japanese oil firms will bring forward refining consolidation?

Japan's oil demand has been declining by 1-2pc/yr since the 1996 peak because of demographic issues. We have scrapped around 2.6mn b/d [of crude processing capacity] over the 25-year period. We, the private sector, have been adjusting our production capacity in accordance with government guidelines under the Act on Sophisticated Methods of Energy Supply Structures.

We need a long-term perspective in consolidating refining capacity in line with government guidelines and as part of the country's energy policy. We responded to the short-term shock brought about by the Covid-19 pandemic by meticulously optimising our refinery runs against demand from local outlets, also aided by the relative strength of the Japanese yen against the dollar. Such short-term impact did not trigger refinery closures in Japan.

What is the likely scenario for a recovery in jet fuel demand?

Jet fuel demand is affected by universal factors and has recovered to 50pc of previous levels overall. A recovery will remain largely vulnerable to the development of Covid-19 vaccines and the speed of injections. The International Air Transport Association (Iata) has forecast that global air travel will not recover from the Covid-19 crisis until 2024, but I have a feeling that it will return more quickly as vaccines are developed at a much faster pace than originally thought. I think Iata's prediction is conservative.

Japan's dependence on Middle East oil rose above 90pc in April-September. Can Japan continue relying heavily on Mideast Gulf supplies or should it reduce this dependence, given the region's geopolitical risks?

[Japanese crude imports increased] as Middle Eastern suppliers moved to protect their market share by dramatically reducing their OSPs. Japanese firms bought their crudes because they were cheap. We share [Japanese industry ministry] Meti's view that supply sources need to be diversified. Cosmo Oil in fact was the first Asian refiner to import US crude, in January 2016, after the [US] export ban was lifted. We have been making efforts along the line.

Source diversification is desirable but in reality may be difficult. Output is expected to decline structurally in the US. Upstream investments have sharply declined since 2014 or 2015 in non-Opec producer nations so oil output is unlikely to significantly expand outside the Middle East in any foreseeable future. Recent decarbonisation moves will also make it difficult for Japan to explore for a potential flagship upstream oil project outside the Middle East, even under a government initiative.

What is Cosmo's plan? Do you see changes in your crude supply sources in the next few years?

Cosmo Oil covers some 70pc of its total crude requirement under term contracts from the Middle East and the rest from the spot market. Taking into consideration that those volumes than can be resellable without destination clauses, we in effect must buy 50pc from the Middle East, but we are open to any good deals to cover the remaining 50pc, including crudes from the US, South America or Russia. We are willing to look for good buys outside the Middle East. When there are quality risks, we closely co-ordinate with our refineries.

Crude diversification is a means and not a purpose for us private-sector refiners. It is our purpose to find and buy competitive crudes. We are happy to co-operate in Meti's diversification efforts from an energy-security perspective, however.

What is your view on the potential of the Murban crude futures contract as a future benchmark for Asia?

The proposed contract has a bigger potential to succeed than previous attempts by Simex, Tocom and Shanghai. There has long been a debate over a new east-of-Suez benchmark to better reflect growing Asian demand. Murban has elements of success, such as ample 1.7mn b/d production and supporting infrastructure including the Habshan pipeline link to the trading and bunkering hub of Fujairah, as well as support from equity holders.

We also support the UAE's effort, but our capacity is limited. We, being a small company, are a price taker whether we like it or not. We will just adapt to marketing policies of oil-producing countries and address any risks. We will carefully monitor developments. But it is possible [for the Murban futures contract] to become a benchmark that can replace Dubai, or rank with WTI or Brent.

Mitsuyasu Kawaguchi will be one of the speakers at the Argus Crude Live virtual conference taking place on 26-28 January 2021. For full details of the conference program and how to register to attend, please visit our event page .

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