Japan's nuclear knock-on effect

Nuclear industry proponents may well be issuing pleas to “act logically”, but that's not the way many people react in a crisis, least of all the financial markets.

It took just one hour after the Japanese Prime Minister expressed his alarm at elevated radiation levels, which he said were now a threat to human health, for investors to wipe more than $350 billion from the value of Japan's stock markets on Tuesday, with those falls spreading quickly to Australia and other Asian markets, and then on to Europe and the US. Total market losses for the day attributed to the nuclear crisis: more than $700 billion.

Investors are a fickle lot, and they may just as likely wake up one morning this week – should the nuclear crisis be resolved – and decide on a massive buying opportunity.

However, the broader impacts of the nuclear events should not be underestimated: it's not just the short-term impacts on supply chains, there will be long-term impacts on the outlook of the global nuclear energy industry, global energy markets, and by extension the course of emissions reductions plans in Europe and Japan – the most proactive regions to date – and their impact on climate change negotiations.

Deutsche Bank's Paris-based energy analysts, Michael Hsueh and Mark Lewis, said the nuclear crisis could be a “game-changer” for the EU energy markets, particularly the gas markets which have been over-supplied in the last two years, and which will now likely lose supply to Japan to make up for lost nuclear capacity. The analysts note that 9.6GW of nuclear capacity in Japan has been automatically shut down by the earthquake, and at least 2GW can be written off by subsequent events.

Given previous shut-downs, most of these surviving reactors (these do not include those offline at the time of the quake) can be expected to be out of service for some time. In 2007, a 6.8 magnitude earthquake in the Chuetsu area of Japan's Niigata Prefecture caused the shut down of four out of seven reactors with a capacity of 4.7GW at the Kashiwazaki-Kariwa nuclear power plant. Three reactors, with a combined capacity of 3.3GW, remain out of service due to ongoing seismic reinforcement works, inspections, and functional testing.

The Deutsche Bank analysts expect that gas will likely make up at least half and possibly all of the shortfall – possibly through more expensive peaking power stations. And gas prices will rise significantly in Europe, not least because gas will also be required to help fill the gap after the German chancellor's decision to immediately suspend operations at seven of its oldest nuclear reactors. “What seems already clear is that the terrible events in Japan have the potential radically to transform the outlook for EU gas markets over the next 3-4 years,” the analysts wrote. It will also have an impact on Australian gas demand, with subsequent flow on effects for local prices.

Lewis, in a separate note on carbon markets, says the German nuclear decision will have a significant impact on emissions reduction targets. If the nuclear reactors remain closed, as is conceivable, then this would leave a shortfall of 250 million tonnes in European carbon credits over the next 10 years, and of 370 million tonnes if the other 10 reactors were also phased out. Lewis notes that German leader Angela Merkel faces a crucial regional election in Baden-Württemburg on March 27, which is now expected to become a defacto referendum on nuclear energy. A TV poll there suggested 80 per cent of respondents would like to see the government's 2010 legislation allowing for an average lifetime extension of 12 years for all of Germany's nuclear plants to be revoked.

European carbon prices have jumped sharply in record volume in the past two days to close at €17.2 ($24), their highest level in two years. Deutsche has lifted its forecast to more than €21 by year's end. 250Mt over 2011-20 versus current estimates, while shutting down the seven oldest reactors permanently with immediate effect and closing the other 10 instead in line with the 2002 legislation would raise our forecast EUA demand over 2011-20 by 370Mt. “Today we are witnessing a perfect storm for the EU emissions trading system,” said Matthew Cowie, an analyst at Bloomberg New Energy Finance in London. During the next few months, “we have high natural gas prices and the probable closure of older German nuclear plants,” he said.

Steve Clayton, a London-based analyst at Mirabaud Securities, also says the lasting impact of the Japanese nuclear crisis will be a significant shift in energy policy in Europe. “The (Fukushima Daiichi) plant was engineered to be quake-proof, so whilst many unknowns remain about the eventual outcome, the one certainty is that engineering theory has been tested and found wanting,” Clayton writes.

He says the political task of securing approval for building new nuclear will be much harder from here onwards: “We doubt that it will matter much that Western Europe is much less exposed to risk of earthquake than nations in the ring of fire. Perhaps the governments of Europe will just press ahead, arguing that lessons have been learned since Fukushima was built, that the likelihood of a serious quake is low and that the costs of alternatives are too great. At which point someone will point out that the earthquake that rocked Italy in 1908 measured 7.5 on the Richter scale and triggered a tsunami in the Med that cost as many as 200,000 lives. Tens of thousands of demonstrators took to the streets of Germany at the weekend to protest against nuclear power, showing that public opinion runs high on this topic.

“In the UK the coalition administration has a lot of battles to fight.  New-build nuclear was controversial within the coalition long before Japan came along.  Whether the Conservatives will wish to take on what is likely to be a significantly strengthened opposition movement just as it is entering the toughest phases of its programme for fiscal and social reform is debatable.

“Events in the Middle East had been making new nuclear look more and more attractive; energy security was moving fast up the agenda. Security comes at a price and Europe may now be less inclined to pay the price of nuclear security. Without a major reversal of the direction of climate science, additional coal fired plants will not be the way to achieve energy security."

Clayton says this suggests that there will be additional emphasis placed upon LNG and renewables, with a new wave of combined-cycle gas plant construction and a renewed willingness to subsidise the cost of renewable energy sources. “After all, you only need one nuclear plant to melt down every 50 years to cause substantial additional costs to be incurred," he says.

“At the moment wind power is the alternative technology best placed to step into the gap, even if big arguments about alternate supplies for windless days rage on. The other impact is that power prices in general will be higher in a world that turns its back on new build nuclear. Much of Europe's coal fleet will have stopped generating before new nuclear stations would have opened, so will never benefit. But long dated generation assets such as CCGT plants, cleaner coal and existing nuclear facilities should all see enhanced returns as the supply curve shifts upwards, if nuclear new build is scaled back.”