Slick operators: Japan's upstream industry gets a crude awakening: from refining the world's most volatile commodity to refining the way it does business, Japan's upstream industry faces tough times in a deregulated world

Japan, Inc., Oct, 2003 by Yaeko Mitsumori

WITH HARDLY ANY 0IL of its own, Japan's relationship with the black stuff has always been a delicate balance. Its upstream industry has always hd to concentrate on research and development in some of the most sensitive spots around the world. Now a landmark decision has tipped that balance, and left government policy on the upstream oil industry in total disarray. The decision to dissolve the Japanese National Oil Corp (JNOC), has turned the industry upside down, and brought a previously closed world into the open.

To make matters worse, the plans laid out by the Japanese government to solve the problem are facing an investor rebellion: The Japan Oil Development Co (JODCO) raised a surprise objection to the rehabilitation schemes. The decision to dissolve the JNOC--slated to be closed down for good in 2005--was largely based on the mountain of debt that the company had amassed over its long and inglorious history. The move is part of a wider plan by the Ministry of Economy, Trade and Industry (METI) to establish a "core company" to take over the upstream oil business of JNOC. The original idea was that JODCO would then step in to assume the operations, but when the shareholders threw their wrench into the proceedings, METI was forced to reconsider its strategy.

At least METI's upstream business strategy is growing a little clearer: It has been putting an emphasis on gaining more so-called "self development oil fields"--oil fields in which Japanese oil companies are directly involved in the development work from the earliest stages of the business. Projects include geological surveys and the physical digging of trial wells.

This development is largely the result of a disastrous event: In 2001, the Arabian Oil Co. lost its concession in Khafji Island in the Neutral Zone between Kuwait and Saudi Arabia. METI has been struggling ever since to obtain new "self development oil fields." So far, however, the tally is not impressive. JODCO has a meager 12 percent stake in only five oil fields in the oil rich United Arab Emirates (UAE).

The decision to terminate JNOC was also based on intense criticism of the company's management. The enormous debts alone were enough to persuade most observers that the company was poorly run, but management became so reckless that it eventually started to receive blunt attacks from the government's upper echelons. (Former MITI Minister Mitsuo Horiuchi was one of JNOC's more outspoken critics.)

To fill the gap that will be left by JNOC, METI has devised a scheme whereby the three leading upstream companies in Japan--JODCO, Inpex and Sakhalin Oil and Gas Development (SODECO)--will merge to form a core company with total responsibility for all upstream operations. Hiroshi Shiono, the head of the Energy Council's subcommittee on the emerging strategy, explains that the government strive to make the new group a "national flag company." While it will not be big enough to compete with the major players such as ExxonMobil or BP, it will have the size and reach to rival some of the world's second-tier oil companies.

In METI's post-JNOC scenario, JODCO, which imports about 220,000 barrels of crude oil per day, including 110,000 billion barrels per day of equity oil, will now become the central pillar of the new company.

JODCO is one of the largest oil importers in Japan, but it too is saddled with massive debts accrued during its earlier days. Inappropriate capital management policies were the chief culprit: According to its financial statement of December 2002, JODCO has run up a total of [yen] 307.6 billion in debts, including both short-term and long-term borrowings. In a controversial effort to allow the new company a trouble-free takeoff, METI took the unprecedented step of relieving JODCO of its debts under the terms of the then newly enact ed Civil Rehabilitation Law.

By timing this move before the three-way merger officially took place, METI ensured that its grand plans were left seemingly unthreatened on the fiscal front. The Civil Rehabilitation Law, partly modeled on the US bankruptcy law's Chapter 11, has been in place since April 2000, offering failed Companies a lifeline 1hat helps them recover as soon as possible.

Under METI's new vision for upstream oil in Japan, JODCO filed its application for debt protection in the Tokyo District Court on March 19. By June it had compiled its rehabilitation plan, and a creditor's meeting was held on July 9 involving all of JODCO's 25 creditors. At that meeting, the company won support from more than half of the creditors for its rehabilitation plan, and the Tokyo District Court duly granted its approval. The rehabilitation plan was reported on the Kanpo, or Japanese Federal Register, in late July.

The JODCO rehabilitation plan is a relatively straightforward document stating that all of the capital offered by investors will be forfeited, and all creditors except JNOC will write off the interest due on their loans. (principal is to be paid back fully within one month). 51 percent of the loans of JNOC (including the principal and interest) will be written off. Of the remaining 49 percent of JNOC debt, [yen] 10 million will be paid back in cash within one month, and the rest will be converted into newly issued JODCO shares within one year.