Richard Koo “Last Friday’s earthquake was Japan’s largest ever and struck a devastating blow to the nation, especially to the Tohoku region in the northeast. With towns and cities completely washed away by the tsunami and mountain villages rendered unreachable by rescue teams as a result of landslides, it is thought that the number of dead may exceed 10,000, with hundreds of thousands forced out of their homes. I would like to express my sincere condolences to those affected by the disaster.

The quake has already interrupted the production of food, energy, and manufactured goods, with conditions not expected to return to normal for weeks or months. It appears increasingly likely that economic activity will suffer even in areas not directly hit by the earthquake or the subsequent tsunami as rolling power outages, disruptions to the transportation network, and supply chain problems interfere with production.

The uncertainty surrounding the situation at the nuclear power stations in Fukushima is also a major negative both in terms of the energy supply outlook and the psychological impact on the public. Official statements in the initial stages of the crisis were inconsistent and far from convincing, which has served to breed distrust of the government both inside and outside Japan.”

 

Can peak demand be met? — We are being asked a lot whether it will be possible to supply enough electric power if surplus capacity is operated at full tilt. Electric power supply/demand is complicated by the issue of sourcing from other firms as well as from the power company’s own facilities. Below we summarize the situation but we conclude that it will not be easy to get hold of enough power (Figure 1). Over the long term, the capacity loss could be made up through measures such as the construction of new LNG power stations but we would expect this to take three years or more. Ways of quickly sourcing enough power include the early restart of nuclear plants currently undergoing routine maintenance and manufacturing industry building

Any fix from other regions, nuclear? — With TEPCO and Tohoku Electric, who have traditionally worked in tandem, both suffering, supply from western Japan is the only geographical fix, but only 1mn kW is available, due to the east/west difference in utility frequencies, and we have already counted this in TEPCO’s supply capacity. As for idled nuclear capacity, TEPCO has 3.3mn kW at Kashiwazaki-Kariwa, while Tohoku Electric has 1.1mn kW at Higashidori, which we believe was not affected by the tsunami, and 2.2mn kW at Onagawa, but restarting these is unlikely to be politically possible before summer.

On energy — The explosion and shutdown of nuclear power plants would increase Japan’s demand for fossil fuels, at least in the near term. The short supply of power has led to the shutdown of auto plants and other factories. But the ultimate impact of the disaster on fossil fuels is not clear. On the one hand, nuclear power could be seen as dangerous, and the global economy may rely more on fossil fuels going forward until a safe and economical substitute is available; on the other hand, the quake could be linked to global warming in which too much consumption of fossil fuels was one of the key causes, and thus the result could be just the opposite. What is clear is that the near-term volatility in the global oil market should continue, alongside the MENA crisis.

On China’s trade — China’s exports to Japan were about 8% of the total in 2010, and imports from Japan about 12% of the total imports, both down from about 18% a decade ago. In 2010, about 72.5% of China’s exports to Japan fell into five industries: machinery (39.2%), textile (18%), chemicals (5.6%), base metals (5.6%), and food (4.1%). Meanwhile, exports of autos and transportation equipment were only 2.9% of exports. Of China’s imports from Japan, 85.3% came from five key industries: machinery (48%), base metals (11.1%), autos & transport equipment (9.4%), chemicals (8.4%) and optical, photographic and musical instruments (8.3%). China imports more nuclear reactors & machinery (22.5%) than it exports (16.8%).

Food inflation trends show significant disparity across the entire region — Food prices have become a serious issue in VN, IN, KR and CH, but remain relatively benign in SG, TW, MY and PH. We attribute this to four factors: source of food supply, how the food in the CPI basket is defined, FX appreciation, and domestic food subsidy policies. With food prices expected to be problematic this year, coupled with an increase in energy prices, commodityfueled inflation pressures will likely remain a lingering issue for the region.

Against this backdrop, monetary conditions are still loosening for many — Our MCI estimates show that monetary conditions in the last 6-12 months have largely been “loosening” for all countries except the Philippines and India, though in the latter’s case, policy looks loose relative to LT history. This implies more room for Central Banks to tighten monetary policy further

Energy prices adding fuel to the fire

We’ve recently upgraded our oil price forecast, with our colleagues calling for WTI crude oil prices to reach $100/bbl in 6-12 months’ time (previously forecasted at $93/bbl), after oil prices have already risen about 24% in the last five months. Improving confidence in global recovery should continue to support prices, on top of support from investment flows. 3 The direct impact of energy prices on inflation should be less than that of food, as the weight of energy is less than 30% the weight of food in the region’s CPI basket. Moreover, the pass thru is also blunted in a number of countries in that subsidize fuel and other energy prices to varying degrees –China, India, Indonesia, Malaysia, Pakistan and Vietnam.

Headline already seeping into core
Core inflation pressure is already creeping higher in many countries. We think inflation concerns in Asia go beyond food and energy as the risk rises that it seeps into core. The most acute core inflation pressures can be seen in India, which come against a backdrop of very strong growth and a more prolonged high headline inflationary environment, and in Vietnam where the macro policy credibility of the Central Bank is weak and the currency has sharply depreciated. However, we are also seeing rising core momentum in other countries, particularly China, Malaysia, and Singapore and, to a lesser extent, Indonesia and Thailand. In general, core pressures are seen in the large domestically-driven economies as well ASEAN, but seem generally more benign so far in Taiwan and Korea
Eastern Japan Earthquake / Energy Sector Alert: Looking at the Short-Term and Long-Term Issues

Intensifying polarization

We see increasing polarisation within the Asia technology sub-sectors and classify stocks either Bullish or Bearish. We are Bullish on select end-products (ie, smartphones, tablet PCs) and Bearish on desktop PCs and feature phones.

We are Neutral on LCD-TVs (including LED-TVs) owing to severe oversupply and much weaker-than-expected demand. The solar industry (Bearish) appears to be entering oversupply in 2011 with reduced policy subsidies. We are Neutral on IT services & software amid expectations of moderating revenue growth in 2012F, increased supply-side risks, limited operational scope and increased taxation.

Top BUYs: SEC, HTC and TPK. Meanwhile, we are cautious on names with weak growth prospects, PC-related components, feature phone-related components and LCD and LED-related components, including MediaTek, Taiwan DRAM names and Seoul Semi (all REDUCE).

Irrespective of industry trends, we like PC player, Acer, for its cost control and customer mix. We also like HCL Tech in IT services & software for its competitive positioning vs MNC vendors, operational scope and earnings growth potential.

Finance Minister Yoshihiko Noda said yesterday that the size of the supplementary budget related to the Eastern Japan earthquake “will have to be larger than that for the Great Hanshin Earthquake although we do not have a concrete figure in mind yet.”