Japan's crude import cuts to intensify Mideast contest for China

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* Refining capacity to fall to around 4 mln bpd in 2014

* To import less crude from Saudi Arabia, UAE, Kuwait and Qatar

* Japan may import oil products during peak demand

By Florence Tan and James Topham

SINGAPORE/TOKYO, Aug 19 (Reuters) - Japanese oil refiners will cut their capacity to the lowest in four decades next year to meet a government deadline, slashing the country's Middle East imports and tightening regional fuel supplies.

Imports of crude by the world's No. 3 oil consumer could fall by up to 320,000 barrels per day (bpd) -- down nearly 9 percent on last year -- with Saudi Arabia, the United Arab Emirates, Kuwait and Qatar bearing the brunt of the cuts.

The contraction in one of the world's biggest oil markets adds to falling demand from the United States as shale oil output booms, and from the ailing European economy. As import demand elsewhere falls, top oil exporters are competing more intensely for the biggest growth market -- China.

The combination of a declining, ageing population and improved efficiency have cut deeply into Japan's fuel consumption. The decline in 2014 demand is almost as much as the 380,000 bpd by which China's appetite for oil is expected to grow next year.

By March 2014, Japan's total refining capacity will fall to its lowest level since 1970 or just below 4 million bpd, dropping about 1 million bpd -- or 20 percent -- from 2010, when Tokyo issued a mandate to slim down the bloated sector with falling domestic demand.

Japan's refiners will benefit by increasing throughput at remaining facilities, but less spare capacity could lead to a growing dependence on imports of oil products such as kerosene and gas oil to meet peak seasonal demand.

Japan has already cut about 700,000 bpd of refining capacity since 2010, Thomson Reuters data shows. Still to come, two major producers are due to close one refinery each by next March.

JX Holdings will shut the 180,000-bpd crude distillation unit (CDU) at Muroran in Hokkaido, while Idemitsu Kosan Co is scrapping its oldest 120,000-bpd unit in Tokuyama, Yamaguchi Prefecture.

EFFICIENCY BOOST

The cuts follow a 2010 directive from Japan's Ministry of Economy, Trade and Industry (METI) aimed at boosting the efficiency of Japan's refiners, many of which were operating below capacity in an overcrowded market.

The directive mandated an increase in the ratio of residue cracking units to CDUs by the end of March 2014. This would allow refiners to use cheaper, heavier oils, which they could process further and export. Alternatively, refiners could meet the target by closing old, inefficient facilities.

Most refiners chose to shut inefficient units rather than invest in upgrades.

"The refiners as a group have found new cracking units difficult to justify due to falling market demand," said independent oil analyst John Vautrain, pointing to a declining population and higher fuel efficiency.

Refiners instead are targeting higher crude throughputs to boost returns, with JX and Idemitsu, for example, aiming for 90 percent to 95 percent of capacity utilisation, company sources said.

"That's the name of the game. Reducing surplus capacity will allow local refineries to maintain higher throughput," a Tokyo-based trader said. "It's looking more positive than two to three years ago when the Japanese refining sector was looking like doomsday."

The shutdowns mean Japan could cut crude imports by close to 320,000 bpd next year if JX and Idemitsu maintain current refinery utilisation rates at 80 percent, Reuters calculations show. If the two refiners raise run rates to 90 percent, imports would fall by about 140,000 bpd.

Most of the cuts will come from Saudi Arabia, the United Arab Emirates, Kuwait and Qatar, who provide the high sulphur crude used by the refineries to be shut down, although this could be offset in the near-term by lower supply from sanctions-hit Iran.

Japan's crude diet is also likely to shift to lighter grades such as Abu Dhabi's Murban which produce more valuable middle distillates and less fuel oil, traders and analysts said. Fuel oil demand is expected to fall in Japan when more nuclear reactors restart and as the power sector uses more coal and natural gas.

RAISING RUN RATES

How much refiners will be able to increase crude runs will depend on factors such as the strength of domestic oil demand, whether or not it will be cheaper to import oil products than to produce, and if Japanese oil exports can be competitive.

Japan's refineries have been traditionally higher-cost than peers in South Korea and Singapore given greater labour and operating costs, while some producers are not equipped to load large product cargoes for export.

The latest closures may not improve the competitiveness of Japan's industry as it has chosen not to pay for upgraded facilities to use cheaper crude, said Vautain.

"Reducing fixed costs would make the refiners more profitable, but has less impact on the incremental refining costs that govern international competitiveness," he said.

Domestic demand is expected to be weak, but exporters could get a boost from the weaker yen.

Oil product demand in Japan is expected to fall 1.8 percent a year on average over the next five years through 2017/18, according to government estimates.

But as Japan's spare refining capacity shrinks, the supply of oil products could tighten during peak maintenance and demand seasons, leading to more imports.

This could provide opportunities for South Korean and Singaporean refineries to export oil products to Japan.

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