TOKYO (Reuters) - Japan’s Idemitsu Kosan Co (5019.T) is buying a one-third stake in refiner Showa Shell Sekiyu 5002.T from Royal Dutch Shell (RDSa.L), moving it closer to a potential $4 billion (2.56 billion pounds) bid for its smaller rival in the country’s cutthroat refining sector.
Idemitsu Kosan, Japan’s second-biggest oil refiner, said it was paying 169 billion yen ($1.4 billion) for the 33.24 percent stake and would continue discussions on a merger.
The combined companies would control about 28 percent of Japan’s refining market, still behind JX Holdings Inc (5020.T), which has a 35 percent share.
Japan’s powerful industry ministry is keen to see consolidation in a refining sector where five big operators and three smaller ones vie for business from a shrinking population increasingly opting for more fuel efficient vehicles.
“If the deal goes through, there will be four major players. But that will not likely be the final picture, and I think further integration is possible,” Idemitsu Kosan President Takashi Tsukioka told reporters.
For Royal Dutch Shell, the sale raises funds when it is making further cuts to capital investment this year as it expects a downturn in oil prices to last for several years.
Shell on Thursday reported a 37 percent drop in second-quarter profits and said it expected $30 billion of asset sales between 2016 and 2018, on top of a total of $20 billion in disposals for 2014 and 2015 combined.
The oil giant said it should complete the Showa Shell sale in 2016 subject to regulatory approval and it would retain a 1.8 percent holding.
The sale means a sharply reduced presence in a downstream oil market Shell has operated in for more than 100 years.
A takeover of Showa Shell by Idemitsu would be the second merger in the industry since JX was formed in 2010.
Every week, nearly 20 gas stations close on average in Japan after demand fell by about 22 percent over the last decade and consumption is set to fall further, according an industry ministry forecast in April.
The recent downturn in oil prices has also meant Japanese refiners have suffered huge inventory losses, with Idemitsu reporting its first annual loss since listing in 2006.
A source told Reuters in December that Idemitsu aimed to buy shares in Showa Shell in a tender offer that could be worth as much as 500 billion yen ($4 billion).
Saudi Arabia’s state-owned oil firm Saudi Aramco also owns about a 15 percent stake in Showa Shell.
Idemitsu said it would pay 1,350 yen a share for the Shell shares, almost 23 percent above Showa Shell’s close on Wednesday. Idemitsu Director Susumu Nibuya said the funds for the acquisition of the shares would be financed via debt and that the two firms would seek to integrate fully as soon as the share acquisition is complete.
Showa Shell shares ended up 6.2 percent on Thursday after soaring as much as 13.4 percent on a report on the sale, while Idemitsu ended down 4 percent.
JPMorgan advised Idemitsu on the Showa Shell purchase, the Japanese refiner said.
Writing by Aaron Sheldrick, Additional reporting by Taiga Uranaka; Editing by Ed Davies and Susan Thomas