Japan: securing sustainability

Japan’s cement industry is expected to have advanced modestly in FY21, and while significant declines are unlikely going forward, growth potential is lacking. Therefore, the sector is looking to secure sustainability through price increases, enhancing businesses outside core cement segments and accelerating its move towards decarbonisation. By Hajime Inoue, Japan Credit Rating Agency, Japan

The key focus point for the Japanese cement industry in 2022 can be summed up as follows: cement price increases. At the end of 2021, all domestic companies announced their intention to carry out record price increases and are presently in negotiations with customers. Although increases have been announced on a number of occasions, results have basically been favourable. However, if the current hikes are achieved, they would not only contribute to producer profitability but also benefit the future sustainability of the industry.

Demand trends

Japan’s cement demand (domestic sales plus imports) peaked at 86.3Mt in the fiscal year ended March 1991 (FY90), around the end of the economic bubble. Since then demand has been on a long-term downward trend due to economic stagnation and reductions in public works projects, among others. In the wake of reconstruction efforts following the Great East Japan Earthquake in 2011, cement demand inched up. However, since FY14 it has been stagnant.

In FY20 cement demand fell by 5.6 per cent YoY to 38.67Mt, a negative figure for the second consecutive year. Consumption fell to less than 40Mt for the first time in 54 years (since FY66). The reason behind the decline is that there were only a small number of construction works in preparation for the Tokyo Olympics and Paralympics, and that non-urgent construction works were postponed or discontinued due to the COVID-19 pandemic.

According to forecasts made by the Japan Cement Association (JCA) in February 2021, domestic demand in FY21 (1 April 2021-31 March 2022) is expected to reach 39Mt, up 0.9 per cent YoY, indicating a halt in the declining trend. While government demand is likely to level off, private demand is assumed to recover in terms of capital investments on the back of a pick-up in corporate performance. However, demand from April to November 2021 was 2.2 per cent less YoY, slightly lower than expected.

Structural problems are behind the sluggish growth in domestic demand over recent years. Municipal civil engineering and public works, which use a large amount of cement, are decreasing. As construction workers and skilled workers are aging in comparison with other industries, it is difficult to increase the amount of construction works. In addition, due to a lack of manpower, the precast method and steel frame construction with less use of cement are increasing.

However, large-scale redevelopment in urban areas, the extension of the Linear Central Shinkansen line and the Shinkansen line, and construction of large-scale projects such as the Osaka Expo are planned going forward. Moreover, infrastructure construction is expected to ramp up under the government’s national resilience measures, among others. These works use a large amount of cement. Hence a further significant decline in domestic demand is unlikely to happen.

Structure and reorganisation

There are 17 companies that produce cement in Japan. Of these, the five major listed companies are: Taiheiyo Cement Corp and Sumitomo Osaka Cement Co (both of which are specialised cement manufacturers), Mitsubishi Materials Corp, Ube Industries and Tokuyama Corp (non-specialised manufacturers whose primary earnings come from non-cement related businesses).

When high economic growth in Japan ended in the 1970s, all manufacturers experienced significant financial distress due to plummeting demand and surging energy costs. During the 1970s-80s, cement companies managed to gain earnings, supported by national political measures, but in the 1990s, industry realignment started in earnest, mainly through mergers among major manufacturers. As a result, the market became an oligopoly, dominated by three major firms with a total share exceeding 80 per cent. However, because the reduction in production capacity was somewhat slower than the fall in cement demand, the industry failed in a complete departure from an industry structure with excessive competition.

Triggered by the revision of the Building Standards Act and a decline in construction demand stemming from the Lehman Brothers shock in the latter half of the 2000s, the industry faced a substantial decline in domestic demand and utilisation rates fell significantly. Companies carried out structural reforms, such as a reduction in capacities and restructuring, in an attempt to build an earnings structure that could withstand the possibility of domestic cement demand falling to 40Mt. Consequently, the supply-demand gap was solved and the capacity utilisation rate has remained at a high level of around 90 per cent since FY11. However, the rate has been on a downward trend since the latest peak in FY17. As earnings capacity has become more resistant to falls in the utilisation rate thanks to structural reforms, and the fact that utilisation rates tend to decline when waste processing increases, there does not seem to be an imminent risk. However, caution is required because a decrease in output will also lead to a decrease in waste processing fees, which are an important source of earnings.

There have also been moves towards the reorganisation of production. In February 2020 Mitsubishi Materials and Ube Industries started discussions and deliberations on the integration of the two companies, scheduled to be carried out in April 2022. A final agreement on their integration was signed in September 2020. The two firms had previously established the UBE-Mitsubishi Cement Corp in 1998 to integrate sales functions. Now, they intend to complete a full integration that will include production functions. The aim is to optimise the production structure and rebuild the sales distribution system, among others.

Meanwhile, local small-and medium-sized plants with limited export opportunities are experiencing reduced operations, in some cases, affected by decreasing local cement demand as public works are shrinking. It can be assumed that cement plants that are uncertain about the future and have a low output will consign production to other companies or join a major company’s group. There are actual cases of business alignments including consignment production.

Effective use of wastes

Each cement company has been undertaking energy-saving efforts for many years. Through the process, the industry has developed technologies that effectively utilise wastes and byproducts as clinker raw materials and thermal energy substitutes, contributing to saving natural resources and the reduction of greenhouse gases. On the other hand, the profits of each company depend heavily on income from processing wastes and fees from byproducts, and it has been said that Japan’s cement industry cannot manage to stay in business without this income.

In FY21 of the total amount of used wastes and byproducts, fly ash and blastfurnace slag, accounted for 28 and 27 per cent, respectively, together making up nearly half the total raw materials. As natural disasters have increased in recent years, each company is also responding by processing hazardous wastes.

Looking at the trend of wastes and byproducts used per tonne of cement, the amount peaked in FY13, reaching an upper limit as a substitute for raw materials (see Figure 4). However, there is still room for the use of waste as energy. Companies have strengthened the handling of waste as an energy substitute, such as refuse-derived fuel/municipal solid waste, wood waste from construction sites and waste plastics. In addition, they are trying to increase revenues by expanding the acceptance of difficult-to-process wastes with high processing fees such as chlorinated plastics.

Coal consumption and prices

The main fuel in the Japanese cement industry is coal, which is used for production and in-house power generation. In FY20 coal consumption fell by 1.8 per cent YoY to 6.05Mt. In response to stricter CO₂ emission regulations, each company is striving to reduce coal usage by introducing biomass power generation and promoting the use of alternative waste fuels, among others.

The import prices (CIF unit prices) of thermal coal soared from autumn 2016 due to increased demand in emerging countries and other factors, and continued to rise until autumn 2018. Prices subsequently declined, affected by a downtrend in coal consumption in Europe owing to environmental issues, a slowing overall economic growth rate in emerging economies, and other factors. Partly due to the COVID-19 pandemic, import prices fell to the previous bottom level in autumn 2020. However, from the beginning of 2021, coal prices have surged due to an increase in demand with the resumption of global economic activities. Meanwhile, supply has been sluggish as coal producers seem to be cautious about investing amid the growing trend of decarbonisation.

Cement price increases

In response to rising coal prices, each Japanese cement company has announced their intention to increase cement prices. Following industry leader Taiheiyo’s price hike announcement in October 2021, all major cement companies announced plans to raise prices. The increases are more than JPY2000/t (US$17/t) – the largest price rises ever.

In 2017 cement companies had announced a price rise of JPY1000/t, but this target was not reached. However, it was far back in 2008 when they successfully obtained prices close to their price hike targets. Since then, price rises have been announced many times but failed to achieve satisfactory results. The risk of excessive supply has not been completely eliminated. In addition, there are about 2900 ready-mixed concrete firms (SMEs) between cement companies and general contractors that are end-customers. This complicated distribution system is a factor that is weakening cement producers’ pricing power.

Looking at historical cement and coal price trends, cement prices were not lowered even when coal prices fell. All companies say that given the current level of profit margins, they cannot secure sufficient cash flow to properly proceed with the maintenance and renewal of aging facilities, and are aiming to sell at more appropriate prices for a long time. Therefore, they do not lower prices even when coal prices decline and continue negotiations for price increases intermittently. Meanwhile, ready-mixed concrete prices have been on an upward trend in recent years. This is mainly due to the pass-on of the increase in aggregate prices. As aggregate supplies, a natural resource, tend to be short, each ready-mixed concrete company has accepted price increases in preference to cement. Some ready-mixed concrete cooperatives are now announcing large price increases to accept cement price increases as well.

The sudden rise in coal prices has been rapidly squeezing company profits. The simultaneous timing of price revisions announced by major companies seems to suggest their strong willingness towards price increases (see Figure 5).

Cement imports and exports

Japan’s cement imports are marginal and in FY20 amounted to 0.02Mt. Cement imports hit 3.651Mt in FY89 during the peak period for domestic demand but dropped suddenly amid shrinking consumption in recent years.

Cement exports have been firm for many years as overseas customers also appreciate high-quality Japanese product.  In addition, total exports (cement and clinker) also play the role of an adjustment valve when domestic sales volumes decline.

Of the industry’s total cement sales in FY20, exports accounted for 20 per cent. All companies increased exports due to a fall in domestic demand. Exports for the year reached 11.11Mt, up 5.5 per cent YoY. The breakdown of end destinations is as follows: China (29 per cent), Singapore (15 per cent), Hong Kong (14 per cent) and others. Exports for FY21 are projected to be 11Mt, down 1.8 per cent YoY, according to a February 2021 estimate by the JCA. However, exports  in the April-November 2021 period were 6.9 per cent higher YoY, the pace of which was above expectations.

Earnings trends

Looking at recent trends of the cement-related segments of the five major companies, total operating income fell in line with a sharp decline in cement demand in the latter half of the 2000s. At that time, coal prices soared and the performance of each company’s cement business significantly worsened. Following structural reforms, such as the review of production systems, drastic cost reductions and the implementation of substantial price increases, operating income recovered after bottoming out in FY09. Total operating income over the FY13-16 period had been at a high level of around JPY120bn. Although domestic demand declined, lower coal prices underpinned income.

However, income has been on a downward trend since FY17. During FY17-18, increases in energy costs, such as coal, were not sufficiently included in cement sales prices. In FY19-20, income was significantly affected by a decrease in domestic cement demand.

Total operating income for FY21 is forecast to decline by 44 per cent YoY with the surge in coal prices having a significant impact. If only considering domestic cement businesses, some manufacturers will be in the red.

Challenges for Japan’s cement industry

The Japanese cement industry lacks growth potential. However, cement is an indispensable basic material for the development of critical utilities that protect the safety and security of people’s lives. Therefore, the sustainability of the domestic cement industry must be ensured and this requires cement producers to meet several challenges.

Progress in cement price increases

The current round of cement price increases aim to be the largest ever. There is strong willingness by each company to raise prices due to a decrease in earnings capacity caused by soaring coal prices. To a certain degree, price increases will be largely accepted, but what matters is the extent of the price increases. The current planned price increases not only account for an increase in coal prices but also for the rise in costs for logistics and personnel, among others things, which continue to ascend.

Moreover, the portion corresponding to expanding capital investment for modernising aging facilities and for reducing CO₂ emissions is also factored in. In other words, the current price increases are directly related to the industry’s future sustainability.

Looking at past price increase negotiations, companies failed to raise prices sufficiently even after prolonged negotiations. In 2008, when the price hikes were successful, prices rose sharply to reach targets in about six months. So now, companies need to finalise negotiations for short-term success.
Ultimately, the key consideration for the current round of price hikes is whether prices can attain the appropriate price levels outlined by cement producers to cover future investments in addition to evolving coal price increases.

Diversifying business revenues

The profitability of domestic cement businesses have declined significantly due to soaring coal prices. However, the degree of deterioration of each company’s performance is limited compared to when demand suddenly dropped in the latter half of the 2000s. Compared to that time, companies are today successfully operating well developed businesses outside of their domestic cement businesses, which is underpinning overall earnings capacity. As the earnings capacity of domestic cement businesses is expected to slow in the future, these other businesses are expected to be of increasing importance for specialist cement manufacturers.

Efforts toward carbon neutrality

Japan’s cement industry began tackling energy conservation measures and environmental issues early on, in the wake of pollution issues and the oil crisis. As a result, the industry has made considerable progress in terms of its social contribution and environmental measures in the area of waste and byproduct utilisation. Each company is making efforts to reduce CO₂ emissions by constraining the use of fossil fuels, expanding the use of substitute energy sources such as wastes and byproducts, utilising waste/biomass heat power generation, introducing energy saving facilities, etc.

In recent years, CO₂ emissions regulations have been rapidly strengthened to prevent global warming. The Japanese government declared in October 2020 that it aims to be carbon neutral by 2050. In response, the cement industry is accelerating its moves towards decarbonisation.

Going forward, new technological developments and capital investments for CO₂ emissions control will be required more than ever. Individual companies will be able to deal with it to some degree, but in the future industry-wide efforts such as the introduction of new technologies will become necessary.

References
¹ THE JAPAN CEMENT ASSOCIATION (2021) Cement Book 2021 Edition. Tokyo, Japan: The Japan Cement Association, 42p.

Note: This article was written based on information as of the end of January 2022.

This article was first published in International Cement Review in March 2022.