Fitch: Planned Oil Merger in Japan Positive for the Sector

Fitch Ratings commented that Nippon Oil Corporation's (Nippon Oil, rated 'BBB'/Stable) planned merger with Kyushu Oil Company (Kyushu Oil) is a positive first step in the long overdue consolidation of the Japanese oil markets.

"Nippon Oil's planned merger with Kyushu Oil is a credit-positive development for the sector, which is suffering from chronic oversupply both in refining capacity and sales distribution," said Pekka Laitinen, regional co-head of Fitch's Asia-Pacific Energy and Utilities team. "Kyushu Oil has a refinery with a mid-size capacity of 160,000 barrels per day close to attractive Chinese markets providing a platform for increased exports, while the over-lapping distribution networks between both oil companies in the Tokyo area could be rationalised," added Mr. Laitinen.

Oil refining and distribution capacity has not reduced despite declining demand for oil products and consequently, price competition is significant and few participants have market power. Therefore, the continuing high price of crude oil is exerting pressure on Japanese oil companies' already tight margins. This trend is likely to accelerate further as energy efficiency improves and population shrinks. The merged entity aims to improve competitiveness in crude oil procurement, transportation and distribution. Moreover, the combined entity enhances Nippon Oil's strategic positioning as one of the main regional exporters of oil and petrochemical products.

While this merger is likely to strengthen Nippon Oil's business profile, it is far from being enough to solve the structural problems in the industry. Low profitability will continue until the available capacity is much more drastically cut or alternatively exported in much bigger quantities.

The merger negotiations are planned to be concluded by October 2008. Nippon Steel Corporation (rated 'A-' (A minus)/Stable) is the biggest current shareholder of Kyushu Oil holding a 36% stake, while Nippon Oil, Showa Denko, Mitsui & Co., Ltd (rated 'A' /Stable) and Marubeni Corporation (rated 'BBB-' (BBB minus)/Stable) each own 10% of the company's shares. Fitch notes that Nippon Oil is the leading oil refiner and petroleum marketer in Japan with JPY6.6 trillion in sales in FY2007; the merger with Kyushu Oil would raise its market share further by 5% to 30%.