On April 4th The Bank of Japan (BoJ) announced an expansion of its asset purchasing program by a whopping ¥7 trillion per month for the next two years, with the stated goal of stoking a 2% inflation rate within at period. While the currency and bond markets are going ballistic trying to digest this news, and large Japanese exporters (e.g. Toyota, Mitsubishi, Toshiba) have seen outsized jumps in their share prices, the knock-on effects in other industries have yet to be picked up on.
The import of liquefied natural gas (LNG) into Japan has ramped up significantly since the disaster at Fukushima prompted an industry-wide shut down for nuclear power. Prices have followed suit, with the total cost of LNG imports rising 25% in 2012 to $66 billion. This has hit Japanese power producers hard, with fuel costs increasing by double digits in each of the past two years.
These increases have attracted significant investment in new gas projects, particularly in Australia, which has recently taken over the top spot as a supplier of LNG to Japan. This means big exposure to a currency-induced demand shock, fueled by the latest monetary expansion.
A weakening in the yen is certainly an implicit goal of the new monetary stimulus, even beyond the dramatic decline it has posted in the last six months. Presumably if the BoJ is successful in keeping the yen down, it will lead to increased overseas demand for Japanese exports, and an increase in industrial activity. F or LNG prices though, this scenario is actually a double-whammy, with higher import costs on top of rising demand for energy. In this case, one would expect the already-squeezed utility companies to look for alternatives and potentially accelerate the restart of the nuclear industry.
The BoJ is not, however, the only game in town when it comes to money creation and asset purchases. China and the US have both dramatically increased their own money supplies since the GFC, and certainly wouldn't be shy about devaluing their own currencies if they felt it would improve their own economic conditions, China in particular. Competitive currency devaluation between these three forms the worst-case scenario for Australian gas producers: the Reserve Bank of Australia has been far more cautious in reducing interest rates than the US, Japan, or China. Historically (e.g. pre-war Europe), currency wars lead to a sharp decrease in trade - combine that blow to demand with a sharp change in the exchange rate, and you have a real disaster brewing for the LNG suppliers.
So the question of how to trade this: I started this article on the weekend, thinking that it was still early days with respect to Japan's new stimulus program, and it might pay to wait another couple of weeks to gauge the response to it. The slip in Chinese economic data released today sent a ripple through the market Australian market, and may be a bellwether of things to come.
Woodside Petroleum is the largest independent Australian oil and gas company, giving it the highest exposure to this LNG play without the fallback of being heavily diversified across other geographies (as is the case with the large international producers). American investors can trade the stock on the OTC Pink sheets market (OTCPK:WOPEY) - it's not the first place I usually go looking for stocks, but with a market cap of $30 billion on the ASX, and an average volume in the thousands per day, liquidity and disclosure aren't issues here for small investors.
The stock is trading strongly, up over 25% to $38, from its low last May at $30. The start-up of production at their Pluto LNG facility was a significant factor in Australia becoming Japan's top LNG exporter, and contributed nearly a quarter of the company's (record) $6.22 billion in revenue, with only 8 months of production in 2012. That represented 24 of their 85 million barrels of oil equivalent total energy production, and it is expected to grow to 40% in 2013. Two bombshells can be found on page 15 of their 2012 annual report:
Between 2011 and 2014 the majority of Woodside's equity volumes will be subject to some form of price renegotiation. Pricing discussions are underway for Pluto, targeting similar market price outcomes as other relevant Australian benchmarks for deliveries of long-termv olumes into Japan.
So the output of a project that is expected to contribute 40% of their 2013 total is still undergoing pricing discussions, and the majority of all their volumes will be subject to renegotiation during an unprecedented period of currency volatility from their top customer. A downturn in Japanese gas demand could produce a nasty surprise to the downside here for a company that is otherwise generating a lot of positive news.