Analysis: Japan trade houses train spending power resources

TOKYO Wed Jan 18, 2012 4:55am EST

TOKYO (Reuters) - Japan's big trading houses are using financial firepower bolstered by a decade-long commodities boom and a yen near record highs to ramp up a natural resources buying spree.

Their multi-billion dollar bet on commodities demand from emerging economies will boost already fierce competition for emerging energy sources like shale gas and for top quality mines with high-grade ore and long mine life.

Trading houses like Mitsubishi Corp (8058.T) have set aside a record warchest of 2.6 trillion yen ($33 billion) in the two years to March 2013, which backed by a $130 billion government fund makes them formidable competitors in the race to secure the means to fuel economic growth.

For firms armed with a yen hovering around 77 to the dollar, just off a record high 75.55 hit in October, dollar-priced assets look like a good deal.

The top five trading companies, or Shosha -- which also include Mitsui & Co (8031.T), Sumitomo Corp (8053.T), Itochu Corp (8001.T) and Marubeni Corp (8002.T) -- resumed investment in commodities production in the late 1990s after having their fingers burnt in the 1980s.

These bets paid off handsomely, with profits at the six firms doubling in the 2000s when prices of base metals and energy surged in a global commodities boom sparked by China's robust economic growth.

"Shosha now have a bigger investment buffer, which allows them to take bigger risks. The capital base at some of the top firms has more than doubled in the past five to six years," Yasuhiro Narita, senior analyst at Nomura Securities, said.

A government 10 trillion yen ($130 billion) low-interest loan scheme, aimed at curbing the yen's strength and expiring end-September, is also available for companies looking for overseas mergers and acquisitions of natural resources.

This route for Japan to spend yen and buy dollars is an alternative to expensive interventions in the currency markets that have had limited impact on the value of the yen. Determined to ease the pain felt by the export-reliant economy, Japan's government spent a record $99 billion on October 31 on intervention in the currency market to weaken the yen.

The trading houses previously limited their role in energy projects to marketing and financing, taking stakes of 3-5 percent that didn't mean getting involved in operations.

But the Shosha are now seeking bigger stakes, as shown by a series of big deals announced in past months.

"I'm directing all our company divisions to chase bigger fish, not minute deals, in view of long-term benefit of the strong yen," Masahiro Okafuji, president of Itochu, told a news conference in November.

Shosha invest in hundreds of businesses ranging from noodles to hospitals around the globe, but natural resources are their core, accounting for up to 80 percent of their profits.

Bid prices of top-grade mines, particularly those already in operation, remain at record levels despite recent declines in commodity prices, as they are becoming increasingly scarce and are rarely put to the market for sale.

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Graphics on trading houses' 2012 output plans: link.reuters.com/cus35s

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Mitsubishi, Japan's biggest trading house, last year jumped into a high-profile face off between mining giants Anglo American AA.L and Codelco CODEL.UL, snatching 24.5 percent of Anglo American's Chilean copper properties for $5.4 billion. Rival Mitsui was looking to buy the same asset for $4.88 billion.

The valuation of the deal on the assets, including an expansion project and two unexploited mines with potentially large reserves, was 17.4 times EV/EBITDA, a measure of the value of the company in relation to its profitability.

This compares with 13.2 times for other copper transactions over the past 12 months, which RBS analysts put down to a lack of significant copper opportunities.

The deal suggests Mitsubishi assumes a long-term copper price of over $3.5 per pound, or $7,716 a tonne, said an equity analyst at a Japanese brokerage, who talked on condition of anonymity.

That is higher than research company Brook Hunt's estimate of $2.50 per pound, or $5,511 per tonne, an industry source said, but below current three-month LME price of around $8,000 per tonne.

"We believe a per-pound $2.5-$3.00 estimate is more or less a current market consensus. Mitsubishi's purchasing price could be a bit expensive," the Japanese brokerage analyst said.

Other high-profile deals include Itochu's $1.04 billion investment for 25 percent of U.S. oil and gas group Samson Investment Co, and Mitsubishi's buy-out of a multi-billion dollar iron ore development and infrastructure project in Western Australia.

"It's time to buy for Shosha. But the assets' valuations are high and there is a risk of overpaying," Jiro Iokibe, senior analyst at Daiwa Securities Capital Markets said.

LNG, OIL

A key focus for the shosha will be unconventional sources of energy, including shale gas, to fuel the economy of the world's third-largest oil consumer and top liquefied natural gas importer.

All of the five major trading houses have invested in shale oil and gas projects in North America for a total of more than $14 billion.

Sumitomo became the first Japanese firm to take part in shale gas development in December 2009, and the most recent was on January 6 when Marubeni said it would pay $1.3 billion for a stake in a privately help Texas-based project.

"The trading houses have real opportunities now to boost their exposure in the upstream liquefied natural gas (LNG) business," Simon Flowers, Wood Mackenzie's head of upstream corporate analysis, told Reuters during a visit to Tokyo.

"You may well see more equity taking in these projects by the Japanese utilities and quite possibly the trading companies. The new opportunities also extend to exploration, where we are seeing the global industry reach into new frontier basins seeking high impact prospects in new plays."

Wood Mackenzie estimates that there are still around 230 billion barrels of yet to be found reserves, of which two-thirds would be deepwater, unconventional oil and gas including shale gas and shale oil -- a challenge in terms of exploration and costs.

The trading houses are aiming to export abundant natural gas in North America as LNG to Japan as early as 2015, to tap the big price gap between the two markets.

Natural gas futures cost less than $3 per million British thermal (mmBtu) units in the United States, where supply has jumped thanks to shale gas.

In contrast a spot cargo of LNG sets you back $15.50/mBtuin Asia, largely on the back of demand from Japan that has spiked to replace lost nuclear power capacity after the Fukushima nuclear crisis.

"The United States and Canada have enough shale gas reserves for exports even after meeting their own demand," said a source involved in oil and gas development at a trading house.

"For Japan, it makes economic sense to bring their LNG here."

Japan's LNG imports are likely to have hit a record of around 80 million tonnes in 2011, up by 10 million tonnes from a year earlier, as nuclear run rates hit an all-time low of 15.2 percent last month.

While unconventional resources will be a top priority, the trading houses will not ignore more traditional forms of energy.

"The trading houses participate in shale gas from a long term strategy, but that alone would make us look way off balance," said a source at a major trading house.

"So in the short term we would need to handle traditional oil and gas projects that would generate profits."

RISKS TO STRATEGY

Shosha's aggressive investment in energy and base metals poses a risk of potential steep losses if commodity prices collapse amid a deepening debt crisis in Europe.

Demand growth in China, which consumes 40 percent of global copper output and buys around two thirds of global seaborne iron ore, is also a potential risk.

Not all bets have gone well.

The trading houses made heavy losses in the 1970s, 1980s and 1990s in economic downturns following the oil crisis and a burst IT bubble. Trading house Ataka was absorbed by Itochu in 1977 after its 230 billion yen bet on a Canadian oil refinery project soured.

Shosha have learnt from the painful experiences of the past and the quality of their investments has substantially improved over the past ten years, Teruo Asada, president of Marubeni, said.

"Now we don't go ahead without a solid risk management process, and that's a crucial difference from the past," Asada told Reuters this week.

"In those days, when investments were the sole aim, there were no such things like risk return calculations or strategy to add value. The disaster was a natural consequence."

($1 = 77.8 Japanese yen)

(Editing by Michael Urquhart and Simon Webb)

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