The Japanese petrochemicals industry is entering a new phase which should see it become leaner and more efficient as it seeks to leverage the country's technological advantages in order to compete on the Chinese market, according to the latest Japan Petrochemicals Report.

The report's outlook for the Japanese chemicals industry in 2010 is negative due to weak demand from the automotive, electronics, construction and housing industries. The sharp drop in global demand following the financial crisis in late 2008 has hit Japanese producers, a situation that has been exacerbated by the appreciation of the yen. The Ministry of Economy, Trade, and Industry (METI) estimated domestic ethylene production declined 6.6% to 6.43mn tonnes in 2009, following a decline of 11.3% in 2008, although cracker utilization rates had bottomed out in Q109 and started recovering from Q209. Chemical makers adopted emergency measures in Q408 and Q109 to cope with the downturn, with major overhauls of business structures, asset swapping, plant closures and consolidation. However, Japan's petrochemicals sector has long been viewed as in need of consolidation, particularly in ethylene. The competitiveness of naphtha crackers in Japan, which are relatively old and small in scale, need to be addressed. Japan chemical makers rely on imported naphtha as their main feedstock, whereas the global trend led by the Middle East is towards cheaper ethane feedstock.

Japan's ethylene capacity stood at 7.73mn tonnes per annum (tpa) in 2009, but was operating at around 70% in 2009 and the report doubts it will come close to 2007 and 2008 operating rates again until the industry carries out radical restructuring over the next two to three years. The process of consolidation and building alliances within the sector is complicated by the integration of cracker units with downstream production. However, by 2014, it is believed cracker capacity will have been up by over a fifth to around 6mn tpa. Further downstream, the most vulnerable area for reduced capacity is LDPE, which is rapidly being replaced by other lighter weight and more versatile thermoplastics. LDPE capacity is set to fall by over a half to 600,000tpa, leading to an 18% reduction in PE capacity to 2.94mn tpa. Given the problem of over-capacity in China, the Japanese PVC sector is set for a 10% decline in capacity to 1.9mn tpa. Weak market conditions with poor sales volumes are expected to persist throughout 2010 and margins will remain under pressure unless companies improve their profitability and business fundamentals. Restoring high stability of earnings, supported by an effectively diversified business portfolio, will remain essential in maintaining margins. Petrochemicals producers are responding to recession with intensified efforts to rationalise commodity product lines and focus on automotive, electronics, environmental technology and other areas that play to the country's technological strengths. The country lacks raw material and is at a cost disadvantage in domestic petrochemical production, so it is forced to rely on its human resource advantages and technology. The focus of energy efficiency in the long-term offers significant opportunities for new high-value materials, while Japan is ideally placed to take advantage of the long-term growth in the Chinese and Indian automotive industries.

Japan is at the top of the Petrochemicals Business Environment Ranking for Asia with 80.2 points, down 3.1 points from the previous year due to a forecast decline in capacity and a deterioration in country risk scores. It is 3.0 points ahead of its nearest rival, Taiwan. It is falling behind China in terms of the size of its petrochemical industry, but has a regulatory structure that is conducive to investment. The key problems for Japan are the cost of production and a slowdown in key markets. Nevertheless, the country retains major advantages, particularly in research and development.