Tokyo Drifts From GCC's Trade Sphere

Despite efforts to enhance bilateral relations, trade with Japan is becoming increasingly irrelevant to the GCC's economic future. Published in Bloomberg Businessweek, 13 October 2014

When the Fukushima Daiichi nuclear power plant suffered a catastrophic failure on 11 March 2011, oil and gas imports suddenly became a lot more important for Japan. With the atomic energy industry shut down, Tokyo needed to find new sources of energy very quickly.

The obvious place to look was the Gulf, with its plentiful supplies of crude oil and liquefied natural gas (LNG). That year Japanese imports from the GCC grew by more than $40 billion, with $14.6bn of that figure from Saudi Arabia, $13.5 billion from the UAE and $8.4 billion from Qatar. The following year, they increased by a further $15 billion.

Like other Asian buyers of Gulf energy, the trade balance between Japan and the GCC is massively and consistently in favour of the latter

More recently the level of trade has fallen slightly, as the immediate energy crisis has passed and oil prices have eased. Even so, the GCC’s exports to Japan were worth 50 per cent more in 2013 than in 2010, the year before the nuclear disaster.

“Japan remained the world’s largest LNG importer [in 2013], with post-Fukushima demand for LNG persisting at record levels,” said Christof Rühl, the then group chief economist at BP, in a speech to the World Petroleum Congress in Moscow on 16 June, shortly before he joined the Abu Dhabi Investment Authority as head of research. “But its gas fired power plants are now operating at full capacity, and so Japanese imports have stopped growing.”

Like other Asian buyers of Gulf energy, the trade balance between Japan and the GCC is massively and consistently in favour of the latter. The trade surplus has been well over $100 billion four of the past six years and is on course for a repeat this year. According to the Japan External Trade Organisation (Jetro), in the first five months of this year the GCC enjoyed a trade surplus of more than $53 billion.

However, once you look beyond oil and gas the significance of the trading relationship starts to fade. Other GCC exports to Japan range from aluminium to chemicals and seafood, but all pale in comparison to the energy sales. The biggest category of goods the GCC imports from Japan is machinery and transport equipment, which was worth a total of $12.8 billion last year — more than half of which was vehicles. The value of most other categories of goods can be counted in the millions rather than the billions of dollars.

That does not stop the flow of kind words, however. Last August, Japan’s Prime Minister Shinzo Abe made a trip to Bahrain, Kuwait and Qatar, and spoke about a desire to expand the trade relationship with his hosts.

“I intend to deepen the cooperation between Japan and Qatar across a broad range of areas such as political and security matters, economic issues, education, agriculture, medical technologies and services, and culture and exchanges of personnel rather than having our relations stay limited to the area of energy,” he said at the Qatar Japan Business Forum in Doha on 28 August.

Abe has been a fairly regular visitor to the region in recent years. Last year, he was also in Saudi Arabia where he signed an agreement on the Promotion and Protection of Investment between the two countries and again pushed the idea of expanding trade relations, practicing a little Arabic along the way.

“In the years ahead, Japan and the Middle East will make a leap beyond the dimension of trading oil and gas, and strengthen our economic and business ties all across the sectors,” he told an audience at King Abdulaziz University in Jeddah on 1 May last year. “For Japan and the Middle East, the 21st century will be a century of coexistence and co-prosperity, or al-ta’aish.”

It may be hard to transfer that vision into reality, however. As a proportion of total GCC trade, commerce with Japan has in fact been declining in importance in recent years, partly as a result of Japan’s economic malaise. The country’s economy has grown by an average of just 0.8 per cent in real terms over the past 20 years, according to Japan’s Ministry of Economy, Trade & Industry, and the latest GDP figures do not make for happy reading. With figures for the third-quarter not due until mid-November, Japan’s GDP fell 6.8 per cent on an annualised basis in Q2.

Andrew Rose, Japanese Equities Fund Manager at asset management firm Schroders, says things may improve before the year ends. “It seems reasonable to expect growth to resume in the third quarter,” he says. “Some of the data surrounding consumption [since the end of June] is more encouraging, survey data surrounding private capital spending is indicative of a rebound and exports are finally showing some signs of responding to the currency’s weakness.”

Even so, there appears little chance of a fundamental change in Japan’s trade with the GCC, given that the weakness of the Japanese economy is keeping demand for energy supplies more muted than they might otherwise be.

“Exports from the GCC to Japan over the past 15 years have declined from 25 per cent of total GCC exports to 15 per cent last year,” says Garbis Iradien, deputy director of the Washington DC-based International Institute of Finance (IIF). “The Japanese economy has been stagnant for the past 15 or 20 years and it’s being overtaken by China and, in the future, may be overtaken by India and South Korea also. I can see in the next 10 years that the share of oil and gas exports to Japan will continue declining while the share to China and India will continue rising.”

Despite this slightly gloomy outlook, Japan still has some important strengths, which the likes of China and India have yet to fully match. These include its long history in developing technology and the fact that it is home to world-leading industrial companies and some of the biggest global consumer brands, particularly in areas such as the automotive sector and personal electronics. As a result, Japanese companies have a stronger, more diverse foothold in the Gulf economies than many other major Asian countries.

Among the leading examples of heavy industry investment is the Petro Rabigh refinery and petrochemicals plant in Saudi Arabia, which is a joint venture between Saudi Aramco and Japan’s Sumitomo Chemical that dates back to 2005. More recently, in December 2012, Isuzu Motors started up a truck manufacturing plant in Dammam, in the east of the country. The plant will make just 600 trucks a year initially, but the plan is to increase this to 25,000 vehicles a year in the future with much of the output exported to other countries in the region. It is not just Japan’s larger companies that Gulf governments would like to attract. Abdullatif Al Othman, governor of the Saudi Arabian General Investment Authority (Sagia), told delegates at the Saudi-Japanese Business Council held in Tokyo in February the organisation was “particularly interested in the [country's] small- to medium-enterprises”.

To date, Sagia has issued 95 licences for Japanese investment projects in Saudi Arabia. Across the border in the UAE, Japanese companies have an even larger presence. The Jebel Ali Free Zone (Jafza) in Dubai is home to 145 Japanese companies including the likes of Hitachi, Toshiba, Sony and Panasonic. For many of these companies, Dubai acts as a hub for broader regional operations.

Most Japanese companies in the emirates seem to be doing well these days. A survey by Jetro of Japanese business in Dubai and the Northern Emirates found that close to 65 per cent expected profits to increase in 2014 as a result of the improving economic conditions in Dubai and rising demand in nearby countries. More than 80 per cent said they expected to expand their operations in the coming two years.

In other corners of the Gulf, such as Oman, Japanese firms have a far smaller presence. However, Japan is more active than other large Asian economies in some important areas, which are more tangentially related to trade. It is, for example, a major provider of aid across the region – an approach that marks an important point of difference from other major Asian countries, according to some analysts.

“Japan is a significant aid giver,” says Ben Simpfendorfer, managing director of the Hong Kong-based Silk Road Associates. “Wherever you go across the region, there are signs saying Japanese aid agencies have funded the construction of this sewage project or that highway. This is the sort of spending that China needs to be doing.”

Japan’s navy, the Maritime Self-Defence Force, has also been closely involved in anti-piracy operations off the coast of Somalia and in the Gulf of Aden, which has helped to ensure the passage of cargo ships and other vessels heading to and from the Gulf. Some 20,000 ships pass through these waters every year, including around 2,000 related to Japan, according to the navy.

Helping to grease the wheels of trade, all the major Japanese banks have a long history in the region too, including Bank of Tokyo Mitsubishi, Mizuho Bank and Suitomo Mitsui Banking Corporation. In return, some Gulf banks have been dipping their toes into the Japanese market in novel ways. National Bank of Abu Dhabi (NBAD) last year issued a 15-year, $16.6 million bond aimed at Japanese retail investors. Known as an Uridashi bond, it was the first of its kind by a Middle East bank. In 2011, NBAD had also been the first Middle East institution to issue a Samurai bond, so-called because it is denominated in yen.

Despite such novelties, there is no getting away from the fact that oil and gas supplies remain the heart of the relationship. And as a result, most of the Gulf’s investments in Japan are centred on the energy sector. Among the most significant is the crude oil terminal that Saudi Aramco has built in Okinawa, in the south of Japan, which has a 6.4 million barrel capacity. Crude oil tankers from Saudi Arabia call in at the terminal to unload their cargo and from there oil is sent to customers around Japan as well as to other countries in Asia and even as far afield as the west coast of the US.

For all the public claims of a strong mutual interest in expanding trade between Tokyo and the Gulf beyond energy, there have been some significant sticking points. In particular, discussions on a free trade agreement (FTA) that began in April 2006 have to date failed to make a breakthrough and are currently suspended. Among the joint communiqués and statements issued by Japan and its GCC hosts over recent months, there has been little mention of this FTA deal, beyond an expression of intent to resume the talks without giving any timeframe for doing so.

Instead, bilateral agreements seem to be the order of the day. The investment promotion agreement that Abe signed in Saudi Arabia last year followed a similar deal with Kuwait in March 2012. Japan also has a nuclear cooperation agreement with the UAE that came into force in July this year and a similar pact has been mooted with Saudi Arabia.

Such arrangements tend to be easier to agree than a full FTA and, as a result, are perhaps a more realistic aim for the coming years. Hopes for a significantly wider trading relationship beyond oil may also have to be approached with a similar air of pragmatic realism.