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January 21, 2015
Will Japan Gain from Falling Oil Prices?
by Tobias Harris
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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 [http://r20.rs6.net/tn.jsp?f=001z5dlR4-yP5TZDd-bd573FNpWuwc1BLy2ToPK6GZ3UQuLrNVlxv3yl_EjQqMdOmplRaXG-bAqGYY3DrXrZg8JjrHNK9ySWhbHslCyq75UC7n_6jWCKqTMYZyAbu6JuJqfSywUTOJ5xXYP1MOwH3qdQcUm_xEuxwddeDBVgl_EGKvEdz_PL8con8vwKOeq-Wqhy-hBy_f7aW93_nKi6KMeqMIfT6oHE3P3ejWzAaKcECw=&c=V2c2HHPFwXLLOmu15cdNZ9yGWtzQAzVpnMrLQwsyGLfMCFiHZMseFw==&ch=mfvIZDekiYuia_tgFmcCVCdpJZTDAvJTlaA2hn9s4iuSK8HzKfGDrg==]
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 [http://r20.rs6.net/tn.jsp?f=001z5dlR4-yP5TZDd-bd573FNpWuwc1BLy2ToPK6GZ3UQuLrNVlxv3yl_EjQqMdOmplSf60rWiUTJythDhWQSe2wMd1Upuzxq2p_VeWB7f0Ht9NdYHfM7Y7GBBOmAbPOQJqXwVQF6GOD84zUEd5FeVIp8x4DNqj5KS9SYbnZ0YX-lWUhb4LOOgz2fBPP6lK9hlxj_RMgAxMSksTKvdpBrznaw==&c=V2c2HHPFwXLLOmu15cdNZ9yGWtzQAzVpnMrLQwsyGLfMCFiHZMseFw==&ch=mfvIZDekiYuia_tgFmcCVCdpJZTDAvJTlaA2hn9s4iuSK8HzKfGDrg==]
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 [http://r20.rs6.net/tn.jsp?f=001z5dlR4-yP5TZDd-bd573FNpWuwc1BLy2ToPK6GZ3UQuLrNVlxv3yl_EjQqMdOmplNNxVwWZd8anE6c2ToetbtOS6NXHSWWm1KI1a6JOtpe4nTXTrqsQCs5sAIZXdDc2SBxilDuoYudhPdB3hTT-sq24922be7SlFv7GqibcX1sAXdaxpPSWlwrOvwwC5m8r8a-Qugrg6DOdHA9VVoDAf5JYgC-UFMCYLiu2RokvIp1qZu0BQK_MwuA==&c=V2c2HHPFwXLLOmu15cdNZ9yGWtzQAzVpnMrLQwsyGLfMCFiHZMseFw==&ch=mfvIZDekiYuia_tgFmcCVCdpJZTDAvJTlaA2hn9s4iuSK8HzKfGDrg==]:
"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."

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.

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. Because of 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 reactions.

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

Tobias Harris is the Economy, Trade, and Business Fellow at the Sasakawa Peace Foundation
USA. He is also an analyst of Japanese politics and economics at Teneo Intelligence,
a political risk advisory firm. Mr. Harris has written about Japanese politics for
publications including the Financial Times, Wall Street Journal, and Foreign Affairs
and regularly provides on-air analysis for CNBC, Bloomberg, and other networks.
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