How Oil Prices Impact the Japanese and South Korean Economies: Evidence from the stock market and implications for renewable energy
(Previous title) How Oil Prices Impact the Japanese Economy: Evidence from the stock market

Fossil fuels dominate Japan and South Korea’s energy supplies. In Japan 85% of energy came from fossil fuels in 2023 and in Korea 79% came from fossil fuels. Oil was the largest source, with 38% of energy supply in Japan and 37% in Korea coming from oil. Both Japan and Korea have pledged to cut greenhouse gas emissions and reach carbon neutrality by 2050.

Both countries also wrestle with energy security. In Japan 99.6% of crude oil supply came from imports in 2023 and in Korea 98.9% came from imports. As Figure 1 shows, oil prices are volatile.

This discussion paper investigates how oil prices impact sectoral stock returns. Black (1987) reported that sectoral changes in stock prices presage sectoral changes in output, profits, or investment. Examining how oil prices impact sectoral stock returns can thus shed light on how they will impact sectoral sales, earnings, and investment.

This paper thus examines the response of stock returns to oil price changes to shed light on how oil prices impact economic activity across sectors in Japan and Korea. It has been revised to include results from Thorbecke (2024) and additional policy implications. The results indicate that many sectors in both countries are exposed to oil price changes. Tariffs, trade wars, and geopolitical shocks will continue disrupting oil markets. The findings indicate that the resulting oil price changes will whipsaw the economy. Governments should respond by expediting the shift to renewable energy sources.

Japan in 2025 approved a plan to reduce greenhouse gas emissions by 63% by 2035 and by 73% by 2040 relative to 2013 levels. The plan involves raising solar energy sources from 9.8% in 2023 to between 22% and 29% in 2040, raising nuclear power sources from 8.5% to 20%, and reducing fossil fuel sources from over 80% to between 30% and 40%. Korea plans to decrease greenhouse gas emissions by 40% by 2030 compared to 2018 levels. Because so many firms are exposed to oil price changes, Japan and Korea should be more ambitious in switching from fossil fuels to renewables. Investing in technologies to improve wind, hydro, and solar power would not only help them to reach their climate goals but also reduce firms’ exposures to oil price changes. Some steps that Japan and Korea can take include:

1. i) Increasing trade in renewable energy with Northeast Asian neighbors;
2. ii) Strengthening the infrastructure for receiving, storing, and distributing power produced by their neighbors;
3. iii) Overcoming the lack of room for solar farms in Japan and Korea by researching and employing perovskite solar cells;
4. iv) Encouraging airlines to reduce their carbon footprint by using sustainable aviation fuel, reorganizing flight plans, releasing the landing gear later, and employing fuel efficient planes;
5. iv) Encouraging hotels to switch to renewable energy sources;
6. v) Levying a small tax on tourists to help fund decarbonization efforts at airlines and hotels;
7. vi) Subsidizing specialized schools and vocational colleges that teach future farmers to use smart farming and ICT methods that are more environmentally friendly;
8. vii) Encouraging cosmetic producers to switch from using petrochemicals to using oleochemicals obtained from vegetable oils and other products derived from renewable materials;
9. viii) Promoting the use of electric vehicles instead of internal combustion engine vehicles by increasing the number of charging facilities, ensuring their full functioning, and raising the quantity and quality of charging infrastructure at travel hubs such as highway rest stops;
10. ix) Reducing the share of high global-warming potential gases used in manufacturing semiconductors, reducing the energy requirements of furnaces, clean rooms and other machines used to make semiconductors, transporting the final semiconductors to customers in fuel-efficient ways, and consciously designing chips that employ less energy, such as by layering integrated circuits on top of each other in a 3D manner.

Source: Federal Reserve Bank of St. Louis Fred Database.