Japan is prone to oil shocks, but less than you might think. Don’t panic!

• Japan is less exposed than market thinks: Heavy reliance on Middle Eastern oil makes Japan vulnerable to geopolitical shocks. Yet, strategic reserves, low oil intensity, diversified LNG sources, and near-term ramp-ups in coal and nuclear provide meaningful buffers and help stabilise electricity supply.

• Inflation risks are contained for now: Core inflation remains below 2%, supported by utility and fuel subsidies that help ease near-term cost pressures. Fiscal measures are in place to combat cost-push inflation, but we also acknowledge prolonged geopolitical tensions can pose upside risks to the economy.

• Corporate and structural strength intact: Japan’s economy benefits from low oil intensity, and new growth engines such as robotics and semiconductors are less exposed to oil shocks. Corporate sentiment remains generally positive, with earnings expectations resilient despite.

• BOJ positioned to normalise rates: The Bank of Japan remains on track for gradual rate hikes. Persistent yen weakness and controlled inflation create incentives for tightening, which could support the currency and reduce imported energy costs.

• Investment opportunity amid sell-off: Current market pessimism has created attractive entry points. Structural growth drivers under “Sanaenomics” remain intact, supporting a constructive long-term outlook for Japanese equities, with the Nikkei 225 index offering ~21% upside by FY2029.

With oil prices currently surging on the back of geopolitical conflict in the Middle East, Japan is among the first major economies feeling the strain.

As of 31 March 2026, the Nikkei 225 Index has surrendered all of its year-to-date gains. The strong momentum that followed the emergence of “Sanaenomics”, after Prime Minister Sanae Takaichi secured a decisive victory in February, has quickly faded. What was once a market buoyed by reform optimism and growth expectations is now grappling with external shocks and rising uncertainty.

Investor sentiment toward Japanese equities has deteriorated sharply in recent weeks. This naturally raises the question: does this shift alter our positive view on Japan’s structural investment story?

Why did Japanese equities sell off?

The country is structurally exposed to oil shocks. It imports nearly all of its crude, with roughly 94% sourced from the Middle East (Figure 1). This leaves Japan uniquely vulnerable the closure of the Strait of Hormuz.

Unlike China, which has spent decades diversifying its import sources, Japan remains heavily tethered to the Persian Gulf. Any prolonged disruption risks not only higher oil prices, but also physical supply constraints, a combination that markets are quick to price in.

Figure 1: Japan sourced nearly 94% of its oil from the Middle East

Japan is exposed to oil shock, but it has toolkits for mitigations

Despite this vulnerability, Japan is far from unprepared.

On 16 March 2026, Tokyo began releasing 80 million barrels of oil reserves, equivalent to roughly 45 days of domestic demand, to stabilise markets and ease panic. Before the release, it held a total stockpile of an estimated 470 million barrels, one of the largest in the world. This buffer is no coincidence. Since the 1973 oil crisis, Japan has made energy security a national priority. Its reserve levels far exceed the IEA’s 90-day requirement, underscoring a long-standing strategy of “over-preparation”.

More importantly, Japan’s resilience lies in how little oil it consumes.  Japan consumes roughly 3.1 million barrels of oil per day and has a low oil intensity of around 0.25, significantly below regional peers such as India (0.51), South Korea (0.49) and also China (0.33). This means Japan requires substantially less oil to generate each unit of GDP, underscoring its structural efficiency and resilience to oil price shocks. This efficiency translates into a remarkable 250 days of supply coverage, more than double that of most major economies, providing a powerful buffer against prolonged supply disruptions.

Table 1: Japan has the largest days of supply of oil globally

	Strategic Petroleum Reserves (Million barrels)	Days of Supply
China	1400	100
Japan	470	250
US	416	120
South Korea	150	208
India	37	10. 70 days if include commercial stockpiles
EU	No disclosure	Mandatory >90 days under IEA rules
*The SPR and Days of Supply data are both estimates. Source: IEA, US department of Energy, Reuters, The Economic Times.

If oil remains Japan’s key vulnerability, LNG presents a more reassuring picture. Japan has actively reduced its dependence on the Middle East, with LNG imports from the region declining from 23% in 2013 to around 11% in 2025. In its place, Japan has pivoted toward more stable suppliers such as Australia and Malaysia (Figure 2). Crucially, much of this supply is secured through long-term contracts, which help reduce exposure to spot price volatility and enhance supply reliability. Additionally, Russia’s Sakhalin-2 remains an important energy source for Japan. Japanese firms, including Mitsui & Co. and Mitsubishi Corporation, retain equity stakes in the project, while recent temporary flexibility around Russian energy sanctions have allowed continued imports. This provides Japan with an additional buffer against near-term energy shocks.

Figure 2: Japan sources most LNG outside the Middle East

Beyond LNG, Japan’s broader energy mix provides an additional layer of resilience. Coal, renewables, and nuclear collectively account for roughly 40% of total energy consumption (Figure 3), giving policymakers meaningful flexibility in times of stress. The government has temporarily lifted restrictions on coal-fired power plants, allowing utilisation rates to rise from around 50% to near full capacity starting April 2026. At the same time, the crisis has accelerated the restart of nuclear facilities, including the Sendai Nuclear Power Plant No.2 and Kashiwazaki-Kariwa Nuclear Power Plant.

Together, these measures are expected to stabilise electricity supply, and contain energy costs in the near term, providing a critical buffer against the broader oil shock.

Figure 3: Coal and nuclear provide 40% of Japan’s energy base

Inflation and growth concerns: contained for now, but risks are rising

The most immediate macro impact of an oil shock on a heavily import-dependent economy like Japan is cost-push inflation.

While coal and nuclear can help stabilise electricity supply, oil remains critical for transportation and logistics, meaning a sizeable portion of the economy still faces rising fuel costs. To cushion the blow, the government has tapped a JPY 280 billion fund to finance fuel subsidies. At the onset, subsidies amounted to JPY 30.2 per litre for gasoline, effectively capping retail prices at around JPY 170 per litre. This reduced the increase in gasoline prices to roughly 8%, compared to a potential 26% rise from February levels. Similar support measures have been extended to diesel, heavy oil, and jet fuel, acting as a temporary but effective buffer against rapidly rising energy costs.

Japan’s core inflation slowed to 1.6% YoY in February, below the Bank of Japan’s 2% target, supported by utility subsidies and ongoing efforts to stabilise food prices. However, the recent oil shock introduces significant upside risks.  Higher crude prices are likely to push inflation higher in March and April while energy-related pass-through effects remain a key concern. That said, fuel subsidies are helping to dampen the immediate impact, suggesting inflation should remain manageable in the near term.

The bigger issue is sustainability. The current subsidy pool is estimated to last less than a month. If the conflict extends into June or 2H26, support may need to be scaled back, especially given fiscal constraints under the government’s broader “Sanaenomics” stimulus agenda.

In the near term, the impact is largely concentrated in inflation. However, if the conflict persists, the drag on growth will become more pronounced.

Rising energy costs effectively act as a tax on the economy, eroding household purchasing power, increasing input costs for businesses, and weighing on Japan’s trade balance. The impact is most acute in traditional manufacturing sectors, which remain highly oil-dependent. Japan’s chemical and plastics industries, for instance, still rely heavily on naphtha as a primary feedstock, while transportation and logistics companies are direct consumers of fuel and therefore particularly exposed to rising costs.

Despite these pressures, Japan benefits from structurally low oil intensity. New growth engines such as robotics, semiconductors, and advanced manufacturing are far less oil dependent. These sectors are primarily powered by the national grid, increasingly supported by nuclear and renewables, and continue to attract strong policy and capital support under national initiatives.

Encouragingly, corporate sentiment remains relatively positive. A March survey by Nikkei Research shows that 40% companies still expect solid earnings growth while 44% expects broadly stable earnings. Based on our estimates, companies within the Nikkei 225 are still on track to deliver 9.1% YoY earnings growth, despite oil-related headwinds.

A weaker yen continues to provide support, as export-oriented manufacturers benefit from favourable translation of overseas revenues. Even with gradual tightening by the Bank of Japan, our expected USD/JPY range of 145–150 remains significantly weaker than the 10-year average of around 120, sustaining this tailwind. More importantly, key growth sectors remain structurally supported. Japanese semiconductor equipment and packaging companies such as Advantest and Tokyo Electron continue to benefit from strong AI-driven demand and national policy support, with many reporting 6–12 months of order backlog, helping to cushion near-term uncertainty.

BOJ: caught between growth and inflation but retains a strong incentive to hike

At its March meeting, the Bank of Japan kept interest rates unchanged at 0.75%, reflecting a cautious stance. The oil shock has complicated the policy outlook. On one hand, higher energy costs will feed into inflation, increasing pressure on the BOJ to tighten. On the other, they also erode household purchasing power and weigh on growth, arguing for patience.

Despite this near-term caution, we believe the Bank of Japan still retains a strong incentive to continue policy normalisation.

Japanese labour union, Rengo, secured wage growth of over 5% again this year in the Shunto spring negotiations. This comes alongside a recovery in real incomes, with real wages turning positive at +1.4% YoY in January after 13 consecutive months of decline. Together, these developments point to a strengthening domestic demand backdrop, providing the BOJ with scope to gradually exit its ultra-loose policy stance.

Importantly, the BOJ has raised its estimate of the neutral interest rate, the level that neither stimulates nor restrains the economy, to 1.1%–2.5% in nominal terms. This implies there is still meaningful room for further rate hikes from the current 0.75% policy rate.

At the same time, persistent yen weakness remains a key policy consideration. A gradual tightening path would help support the currency and reduce imported energy costs, offering a more sustainable solution than relying on short-term fuel subsidies.

Yen has room to strengthen despite near-term pressures

The yen has faced depreciation pressures earlier this year, driven by rate hike uncertainties and investor concerns over Japan’s fiscal position amid massive government spending. The recent Middle East oil shock has added further near-term downside risk. Over the past weekend, USD/JPY briefly touched 160 as Iran-backed Houthis joined the conflict, while diplomatic talks over the Strait of Hormuz failed.

Higher oil prices have intensified selling of the yen, as Japanese importers purchase USD-denominated energy, widening the trade deficit and creating a self-reinforcing downward pressure on the currency. Even the yen’s traditional safe-haven status provided little support this time, as the conflict is energy-focused and Japan is seen as particularly exposed.

In response, Finance Minister Shunsuke Katayama intervened verbally on 30 March, labelling the weekend move as “speculative” and emphasising action “on all fronts”. This helped push the yen back to the 159 level, though without materially strengthening it.

We believe the government’s decisive intervention continues to act as a defensive floor, keeping the yen below the 160 level. While a resolution to the Middle East conflict would be the most favourable outcome, the timing remains highly uncertain, and it is unrealistic to base expectations on it. More practically, the yen is likely to have greater room to strengthen once the BOJ resumes rate hikes, which, in our view, remains the central bank’s intended path. Such a move would signal the end of the “cheap yen” era, reducing incentives for carry trades and potentially triggering repatriation of Japanese capital, providing structural support to the currency in 2026.

Japanese equities: still constructive for long-term buys

The recent sell-off in Japanese equities is not irrational. It reflects Japan’s high oil import dependence, rising inflation and growth pressures, and concerns over a weakening yen. These effects could be significant if the Middle East conflict persists for a prolonged period.

While the recent sell-off is understandable, it is important to stress that Japan is not a passive victim. In fact, its resilience is likely stronger than the market currently appreciates. Compared to past oil shocks, Japan today benefits from a more diversified energy mix and a structurally low oil-intensity economy, reducing its reliance on oil for growth.

In our view, what differentiates Japanese equities today is that key structural growth drivers remain firmly intact. Monetary policy normalisation is progressing, reforms continue to enhance corporate capital efficiency, and the pro-growth framework of “Sanaenomics” provides a supportive backdrop to cushion near-term shocks. Taken together, these factors reinforce our constructive view on Japan, even amid heightened volatility.

Applying a fair P/E of 20X, the Nikkei 225 index could reach JPY 61,600 by FY2029 (year ending 31 March 2029), implying a 20.8% upside from the current level. Investors are recommended to take advantage of the recent sell-off, using the current attractive valuations as an entry point to buy Japanese equities and capture long-term structural growth opportunities.

Table 2: Recommended products for Japanese equities

Category	Products
UT	·         Eastspring Investments - Japan Dynamic AS SGD
ETF	·         Xtrackers Nikkei 225 UCITS ETF 1D (LSE: XDJP)

Table 3: Projections for the Nikkei 225 Index

	FY2026	FY2027E	FY2028E	FY2029E
PE Ratio (X)	22.3	20.4	18.3	16.6
Earnings Growth	26.7%	9.1%	11.4%	10.60%
Earnings Per Share	2,294	2,503	2,788	3,083
Dividend Yield	1.6%	1.7%	1.8%	2.0%
Target Price (JPY) (Based on fair PE ratio of 20X)				61,660
Upside Potential				20.8%
*Each fiscal year ends 31 March. FY26 refers to the 12-month period ended 31 March 2026. Source: Bloomberg Finance L.P., iFAST Compilations. Data as of 31 March 2026.

Figure 5: Share price vs. EPS chart for the Nikkei 225 Index

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.