Japanese Refining Merger Talks Could Spur Consolidation

Japan facing refining sector overhaul; Idemitsu-Showa talks may spark more mergers. Falling oil demand pressuring sector.

Japan is facing a refining sector overhaul as its population ages and shrinks and the economy shifts from oil to gas, resulting in oil demand falling 2-3 percent a year.

Consolidation looks to have kicked off with Japan's No. 2 refiner Idemitsu seeking to buy No. 5 Showa Shell in a 500 billion yen ($4.2 billion) deal that would bring them close to industry leader JX Holdings (JXHGF).

"On the background of falling demand, it is better to do it (consolidate) together in terms of distribution cost," said Reiji Ogino of Mitsubishi UFJ Morgan Stanley Securities.

The combined company would have annual sales of about 8 trillion yen, making it the second biggest after the leader JX Holdings and control about 30 percent of Japan's gasoline market. JX has 33 percent of Japan's oil market.

Idemitsu is also considering acquiring No.4-ranked TonenGeneral Sekiyu KK, Sankei newspaper reported, although a company official said that reorganization with Showa Shell was a priority.

The birth of two refining giants could force other players like Cosmo Oil Co and TonenGeneral Sekiyu into action beyond last week's announcement to set up a venture to integrate their Chiba complexes from next January, industry sources said.

Consolidation is further supported by the crash in oil, which has seen prices almost halve since June, resulting in falling stock prices for energy firms and reduced asset values, offering opportunities to cash rich investors.

Idemitsu and Showa Shell aim to reach an agreement early next year in the first reorganization of oil refining industry in Japan since JX was created in 2010, a source with knowledge of the matter said on condition of anonymity.

Industry sources said that Royal Dutch Shell (RYDAF), which has sold numerous assets this year as part of restructuring and cost saving, is keen to sell its 35 percent stake in Showa Shell and likely to cooperate in the deal.

Saudi Arabia's state-owned oil firm Saudi Aramco also owns about a 15 percent stake in Showa Shell. Both Royal Dutch Shell and Saudi Aramco could not be immediately reached for comment.

Shares in Showa Shell closed up 27.7 percent at 1,302 yen on Monday, while Idemitsu ended up 2.5 percent at 2,075 yen.

By Osamu Tsukimori