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Quantifying Japan’s Trade Vulnerabilities

Feb. 29, 2016 Analyzing who has more at stake in Japanese imports – Japan or its suppliers.

Briefing

|February 29, 2016

By Jacob L. Shapiro

With commodity prices low and little indicating that they are going to rise any time soon, it is important to identify countries that are most vulnerable to these shifting trade conditions. Official figures released in February show that Japanese exports decreased by 13 percent in January compared to the previous year, indicating Japan is also feeling the impact of the global exporters’ crisis. However, the country’s imports also declined by 18 percent, which begs the question: What are Japan’s biggest weaknesses when it comes to trade?

In terms of GDP, Japan is the third largest economy in the world, and yet, Japan’s economy is beset with a fundamental weakness. The minerals and raw materials necessary to maintain Japan’s industrial growth and high quality of life simply do not exist on the Japanese islands. Even before the Fukushima nuclear reactor accident in 2011, Japan relied on foreign sources for close to 80 percent of its energy supply. Since 2012, that number has risen closer to 91 percent, according to the U.S. Energy Information Administration (EIA). Here, we will examine Japan’s trade vulnerabilities based on two important commodities: oil and coal.

Calculating Japan’s Import Dependence

At Geopolitical Futures, the model that informs all of our work is, for the most part, qualitative. A model that pays little attention to quantitative data is inherently limited; a model that is only driven by numbers is also inadequate. In the first book Dr. George Friedman co-wrote about international affairs, “The Coming War with Japan,” he identified this dependency on imports in the Japanese economy. Friedman developed a quantitative methodology for judging not just how vulnerable Japan is to potential disruptions of mineral supplies, but how dependent the sellers of those minerals are as well. This methodology does not take into account the potential for political and military disruptions; for that we rely primarily on our qualitative model. Together, these two tools give us a very clear picture of Japan.

The equation Friedman created integrates a few key variables and is described in detail in the chart below.

japan-vulnerability-coal-oil

After following this equation, if the resulting figure is greater than 1, Japan is more dependent on the trading relationship than the exporter, and if the figure is lower than 1, it is the exporter, and not Japan, that is more dependent. This gives us a rough measure of relative vulnerability for the countries in question – one that is useful for analyzing the countries that Japan is most dependent on for mineral imports, but also how that dependency shifts over time. The following graphic contains data for oil and coal imports at three distinct points in time: 1991, 2001 and 2014.

Oil: Relative Security in Supply

Despite the fact that Japan imports virtually all of its oil, and despite the fact that oil accounts for 15 percent of Japan’s total imports, Japanese oil security is stronger than one might expect. In 1991, Japan actually was in a very strong position relative to its suppliers, as the graphic shows. In 2001, this was still true, even though Japan’s relationships with Saudi Arabia and the United Arab Emirates had begun to change. In 2014, the most recent period for which complete and reliable data is available, the relationship with Saudi Arabia continued to trend in the direction of declining vulnerability for the kingdom and increasing vulnerability for Japan. This is because the total value of Saudi exports increased by almost six times in the last 15 years, and because Saudi Arabia makes up a greater proportion of Japanese oil imports than it used to. Russia has seemingly appeared out of nowhere. It is more dependent on Japan than Japan is on Russia, but less dependent than some of the other countries listed in 1991. Exporters of oil to Japan need the Japanese market more than Japan needs them.

There is also another factor to observe that is not contained within the data. Between 1980 and 2010, Japan recorded a trade surplus every year. But the Fukushima nuclear disaster in 2011 meant that Japan had to significantly increase its import of energy sources like oil and coal, to compensate for nuclear power going offline, at a time when oil prices were already fairly high.

japan-balance-of-trade

According to the EIA, nuclear power accounted for 27 percent of power generation in Japan, and after 2011, Japan relied on oil, coal and natural gas to replace the lost nuclear power. These three sources accounted for 44 percent, 27 percent and 22 percent of total energy consumption respectively. Since 2013, the result has been annual trade deficits. Japan still ran a trade deficit in 2015, but the gap fell 77.9 percent year-on-year. Low oil prices are ushering Eurasia’s ongoing crisis into a new level of volatility, but for Japan, lower oil prices are a most welcome development.

These data demonstrate that, in economic terms, disruptions in the oil market are not particularly significant threats to Japan. Still, it is important to remember that this measurement is relative. In fact, these data also underline Japan’s most pressing vulnerability in its oil supply. In 1991, Japan imported significant quantities of oil from Indonesia and China. Historically, Japan depended on East Asian countries for roughly 20 percent of its needs. Today, however, all of Japan’s top five oil suppliers are Middle Eastern countries – according to U.N. Comtrade data, about 83 percent of Japanese oil imports come from the Middle East. The real vulnerability for Japan is the source of it imports.

Japan imports a significant amount of oil from only one non-Middle Eastern country – Russia – but it only accounted for just under 8 percent of Japanese oil imports in 2014. Even though these Middle Eastern oil exporters are highly dependent on the revenues they get from exporting to Japan, disruptions in supply resulting from war or other catastrophic events in the Middle East would also put Japan in a very difficult position.

Coal: A Key Vulnerability

Although Japan has had to increase its imports of coal since 2011, coal still only makes up about 2.5 percent of the total value of Japanese imports. But the graphic above illustrates that Japan is much more vulnerable as an importer of coal than oil. Japan was highly dependent on imports of Australian and U.S. coal in 1991, and it remained so in both 2001 and 2014, though its vulnerability towards Australia has fluctuated over the past 25 years. Domestic coal production in Japan ended in 2002, and since then, Japan has imported all of the coal it uses. Coal remains an important source of energy in Japan.

The most striking observation from the data as it pertains to coal has to do with China and Indonesia. In 2001, Japan was even more dependent on China for coal imports than it was on Australia. China, however, is increasingly dependent on coal imports itself – China passed Japan as the world’s largest importer of coal in 2012, a spot Japan held for three decades. Over a period of 13 years, Japan had to find a new source of coal to replace what it lost from China, which has significantly increased Japan’s vulnerability to both Australia and Indonesia, which together account for 82 percent of all Japanese coal imports.

It is interesting to note that Australia, which has been hit hard by falling prices in commodities across the board, is much more vulnerable to China than it is to Japan, despite the fact that Australia exported more coal to Japan than China in 2014. Using Friedman’s equation, China’s relative dependence on imports of Australian coal is 0.47, while Japan’s relative dependence is 3.69.

Conclusion

Quantitative data has a tendency to be ascribed a larger degree of legitimacy than qualitative data. We, however, view this as one of the pitfalls of quantitative data because an over-reliance on numbers leads you to miss other important factors. Indeed, even the numbers themselves are often suspect; in the data used to calculate Japanese vulnerabilities to oil imports in 2001, it was necessary to make a few estimates where data simply did not exist.

The figures presented here are all rough measures of vulnerability. They are a useful tool to establish a baseline for analyzing the import-export relationship between different nations and the vulnerabilities of a particular nation’s economy. These figures, however, are also not meant to be used as a golden compass – there is no silver bullet measurement that can tell you everything. Our model tells us that, as China continues to falter, Japan will grow more assertive in East Asia, both to fill the vacuum left by China and also to secure its supply lines so that it can guarantee that its imports can make it to the Japanese islands. The data offered above is simply one part of our larger model, and is useful in terms of conceptualizing Japan’s vulnerability in more concrete terms.

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East Asia

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Japan