The Economic Impact of Japan's Monster Quake

by: Darrel Whitten

The largest natural disaster in Japan’s modern history began with a massive quake with a magnitude of 8.9~9.0 in the Pacific Ocean seabed off the coast of Sendai, north of Tokyo. The effect of this earthquake was like dropping a boulder the size of the Isle of Wight, the largest island in the U.K., into the ocean. It was up to 1,000 times more powerful than the one that hit New Zealand last month and immediately generated deadly tsunamis over 20 feet high. The quake was on par with the most powerful quakes in history, such as the 1960 Valdivia Chile quake (9.5), the 1954 Prince William Sound Alaska quake (9.2), the 2004 Sumatra Indonesia quake (9.1) and the 1952 Kamchatka Russia quake (9.0).

Scientists in Pasadena California now say the Sendai quake shifted the Earth on its axis and shortened the length of a day by a hair. In addition, the force of this massive quake moved parts of eastern Japan as much as 12 feet closer to North America, while Japan’s mainland has shifted downward about two feet.

The tsunamis however created substantially more damage than the quake itself. Coastal towns in Fukushima, Miyage, Iwate and Aomori prefectures in the Tohoku region of Japan were literally swept away, while nuclear power plants in Fukushima were damaged to the point of near core meltdown.

Quake Impact Not Yet Fully Discounted in Stocks

While impact on financial markets, the regional economy and Japan’s people (in that order) is short-term and recovery will eventually come, we do not believe that Japanese stock prices, which were down less than 200 points last Friday, have fully discounted this catastrophe. Immediately after the Kobe earthquake on January 17 1995, the Nikkei 225 lost around 8%, rebounded somewhat, and then eventually hit a low of 26% below the January 1, 1995 pre-earthquake high in July of the same year.

The knee-jerk reaction in the currency markets was a stronger yen, as traders braced for a repatriation of JPY now invested in US Treasuries and other foreign assets back to Japan. However, it is unlikely that a significant amount of funds invested overseas will actually be repatriated to pay for earthquake reconstruction.

As for the impact on JGB yields, the government plans to use JPY200 billion in contingency funds already available for immediate earthquake relief, and will then study a supplementary budget separate from the fiscal 2011 budget for which funding is still being debated in the Diet’s Upper House. For the immediate future, JGBs are more likely to benefit from a "risk off" movement in funds.

Tohoku Region Accounts for Some 8% of Japan's GDP

The most damage from the quake and tsunamis was seen in the Tohoku region, which accounts for some 8% of GDP. In particular, coastal cities in Fukushima, Miyage, Ibaraki and Aomori were hardest hit. These prefectures combined account for just under 6% of Japan’s GDP. Just how much gross domestic product in these prefectures will be affected is still unknown, but electricity, phone communications, roads and port lifelines in these prefecture have been severely compromised.

The worst hit city, Sendai, is in Miyagi prefecture, which has a GDP of about JPY8.5 trillion.

Standard & Poor’s believes the Japan quake is likely to be the most costly catastrophe ever. The costliest quake so far on record was the Northridge, California quake in 1994, which caused $15 billion of insured losses in today’s dollars. Insured losses of course are but a fraction of the total economic costs.

Some analysts believe the economic damage from Sendai quake will be less than from the Kobe quake in 1995, while we believe the Sendai quake could well surpass the economic damage from both the 2004 Indian Ocean tsunami ($10 billion) and the 1995 Kobe Japan quake ($100 billion).

After the Kobe quake, Japan’s industrial production dipped 2.6% MoM in January 1995 but bounced back 2.2% MoM in February and another 1.0% in March, and the entire cost of the Kobe quake was estimated to be around 2% of GDP.

A Credit Suisse report says the initial reports estimate a range from $10 billion to $50 billion. In Europe, the stocks of some of the world's biggest reinsurance companies, including Swiss Re (OTC:SWCEY), Munich Re and Hannover Re fell 4%~5% on Friday on concerns that the deadly combination of earthquake and tsunami will cost them dearly. The stock prices of Aflac Inc (NYSE:AFL) and Bermuda-based reinsurer Partner Re also saw selling pressure. Investors could also lose millions in investments through seven catastrophe bond transactions totalling some $1.5 billion with exposure to Japanese earthquake.

The stock prices of major Japanese non-life insurers like Tokio Marine (ADR:OTCPK:TKOMY), NKSJ Holdings and MS& AD Insurance also saw stock prices sell off heavily on Friday last week on the assumption they have significant losses from insurance claims.

Interrupted Semiconductor Supplies

Because Japan produces more than 40% of the world's NAND flash memory chips -- and 15% of its DRAM -- the earthquake could seriously affect worldwide semiconductor supplies, according to analysts such as Jim Handy of research firm Objective Analysis.

Even a two-week shutdown of fabrication plants would remove from production a sizable share of wafer production, causing major price swings and short-term shortages. Not everyone agrees with the Objective Analysis view, however. Market research firm iSuppli does not believe that DRAM and NAND production will be affected by the quake. Micron (NASDAQ:MU), Toshiba (ADR: OTCPK:TOSBF) and Elpida Memory production facilities in the region were far enough away from the tsunamis to avoid damage. That said, many electronic manufacturer factories in region won’t be buying or shipping product until earthquake damage is repaired. This includes Sony (NYSE:SNE), Murata (ADR: OTCPK:MRAAY), Renaissance Electronics and Shin-Etsu Chemical ( ADR: OTCPK:SHECY) factories.

Interrupted Automobile Supplies

Automobile shipments will also be disrupted, as the media showed pictures of Nissan (ADR: OTCPK:NSANY) autos in port for shipment being swept away by a tsunami and Nissan halted production at all four of its Japanese assembly plants. Toyota (NYSE:TM) has stopped production at two assembly plants and two parts factories in Tohoku, including one operated with Panasonic (PC) that produces batteries for hybrid vehicles. Honda’s (NYSE:HMC) Suzuka assembly plant was closed for only a short time on Friday but its Sayama auto assembly plant would be closed through Monday. Operations at the five assembly and parts plants for Fuji Heavy (ADR: OTCPK:FUJHY ) Subaru vehicles were halted.

Fire Damage at Petrochemical Plants

JX Holdings
(ADR:JXHLY.PK)and Cosmo Oil have had to shut down operations at facilities in Sendai and Chiba because of serious fires, as did JFE Holdings
. Chemical firms have also shut down operations in the area.

Damages and Cleanup of Fukushima Nuclear Power Facilities

In 2007, Tokyo Electric Power was forced to shut the Kashiwazaki-Kariwa Nuclear Power Plant after Niigata-Chuetsu-Oki Earthquake, and posted its first loss in 28 years. In 2008, the plant had not re-opened and Tokyo Electric posted its second loss.

TEPCO has a total of 10 nuclear power plants at two sites in Fukushima Prefecture that produce 9,000KW of power or some 20% of total power generated by TEPCO.

The explosion of the first reactor after it entered the early stages of core melt-down and the infusion of sea water to cool dangerously high temperatures in the reactor probably means the company will have to scrap this reactor. Replacing this 40-year old reactor with a state-of-the-art new reactor would cost about $6.6 million for a reactor with 2,200KW output capacity. In addition to lost revenues, repair costs and possible payments to residents affected in the area, TEPCO could see another couple of years of losses.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.