Regarding Market Manipulation by JERAIn response to the Electricity and Gas Market Surveillance Commission's Business Improvement Recommendation

in Japanese

(Japanese original published on 5 December 2024)

On 12 November 2024, the Electricity and Gas Transactions Surveillance Commission ("EGC") issued business improvement recommendations¹ to JERA², Japan's largest power generation company. According to the recommendation, JERA "failed to offer a portion of the surplus power of the power generation units to be shut down while being aware that it would cause market prices to fluctuate" from at least April 2019 to October 2023. This constitutes "market manipulation," i.e., "not ... executing a transaction that has a material effect on the market price.” In this article, this issue will be discussed from the standpoint of fair market competition.

What is Market Manipulation in the Electricity Market?

In the day-ahead spot market for electricity, generators place bids to sell and retailers place bids to buy. As a result, supply volume and contract prices are determined at the intersection of the supply curve and the demand curve. This is supply-demand adjustment through the market. Generators who can only bid to sell at high prices and retailers who cannot procure sufficient volumes are eliminated from the market (except in over-the-counter transactions).

Now suppose hypothetically there is a power generator who is holding off on selling even though it would be profitable. Generally speaking, this is not likely to happen in a competitive market. This is because withholding sales means lower amounts of sales and profits for the power generator. However, if the power generator is a large-scale operator with market dominance, the story would be different. If the surplus power is offered for sale, the volume of bids will increase significantly and the contract price will be lower, making it easier for the new retailers, which are highly dependent on the day-ahead spot market, to procure power. In other words, by refraining from selling, the power generator can not only "earn an additional profit from the spot market through higher contract prices,” but also take advantage of competition in retail market with new retailers as one utility group. This is why this is considered market manipulation.

If such market manipulation is tolerated, the conditions of market competition cannot be said to be fair. Especially after market liberalization, the former monopolies continue to be the dominant operators, and it is easy for them to raise prices by holding back sales. Therefore, the "Guidelines for Appropriate Electricity Transactions³" stipulate that "it is strongly required in particular that all surplus electricity be bid at prices based on marginal cost," and that any market manipulation contrary to this is "problematic from the standpoint of fair and effective competition." Of course, market manipulation is not limited to the electricity market, and is severely punishable, up to and including imprisonment, in the securities and other markets.

Was There No Intention to Manipulate the Market?

In response to the business improvement recommendations, JERA issued a press release on the same day⁴. After acknowledging the basic facts, JERA stated that "the direct cause was the inadequate setting of the tool used to calculate the bidding volume.” In the daily practice of bidding for sales, "calculation of the amount of surplus electricity offered to the spot market" is performed on the information system, but JERA "assumed that the startup capacity was unbid when output constraints occurred due to grid constraints, etc." In short, it was a technical error in the system settings, and JERA defends that it "did not intend to manipulate the market for the purpose of benefiting from it.”

However, the EGC does not seem to accept such a defense. The rationale for this is explained in the Business Improvement Recommendations as follows. First, setting up an appropriate system for calculating the amount of electricity to be supplied was neither special nor difficult for JERA to handle. JERA's "internal regulations state that all surplus electricity should be offered to the spot market", and in fact the company has set this up appropriately in the Chubu area. The market manipulation was a problem limited to the Tokyo area.

Second, the issue was recognized early on within JERA: as of April 2019, "there were staff members who were aware of the issue," and by February 2022 at the latest, the responsible person (Director of the East Japan Plant Operations Center) was aware of the issue. In addition, according to an internal questionnaire, the majority of staff in departments related to supply and demand operations were aware of the impact of surplus power not being offered to the market, saying that it could lead to a sharp rise in market prices. Despite this, the problematic system settings were left in place until October 2023, when system modifications were completed, "causing unprovision of power to continue to occur.”

Therefore, the EGC concluded that JERA "was aware that it could raise market prices," and that it "must be evaluated as having a certain degree of intent to benefit from the increase in contract prices.” This is why JERA was deemed to have engaged in market manipulation and was recommended for business improvement.

Nature of the Problem: Fair Competitive Environment is not in Place

This problem of market manipulation is extremely serious. This is because it confirms once again what the author has long pointed out (columns: 12 April 2023 and 2 December 2022), namely, that a fair competitive environment has not been established in the Japanese electricity market. The major retail operators have engaged in a cartel with each other, the major general transmission and distribution companies have leaked information to the retail division of the same group, and now Japan's largest power generation company has engaged in market manipulation. If these things happen in rapid succession in just two years, or if they have been going on since the late 2010s, the competitive environment is doomed. This is also related to the fact that the three divisions of retail, transmission, and power generation are managed in an integrated manner. During this period, the continuous rise in spot prices forced nearly 20% of the new retailers to withdraw from the market or go bankrupt or out of business⁵, and the above-mentioned fraud is likely to have been a contributing factor. The basic premise of the power system reform has collapsed, and there is no way for either new retailers or new power generators to compete.

This has been to the great disadvantage of consumers. In its Business Improvement Recommendations, the EGC estimated that "in a little more than three years, there was a possibility of additional bids for the sale of approximately 5.4 billion kWh, of which approximately 650 million kWh may have been executed," and that in November 2021, "in certain frames, the contracted price may have fallen by 50 yen/kWh or more.” This is a vicious problem, considering that soaring electricity prices have become a social issue and that electricity subsidies have even been provided, which goes against the government policy of decarbonization.

However, the Agency for Natural Resources and Energy, which is in charge of the electric utility industry, does not seem to consider fair competition as an important issue or a critical situation. As evidence of this, in the series of reviews of the electricity system reform, the theme of "improvement of a fair competitive environment" was not addressed head-on, nor was the series of competition-impeding misconducts reviewed again, but only mentioned by a few experts in the discussions. Rather, the report concluded positively on the "improvement of the retail business environment," saying, "It can be evaluated that some progress has been made in the environment for new entrants' access to power sources, thanks to the efforts of operators to promote non-discriminatory wholesale transactions."⁶ Although a fair competitive environment is the foundation for rational supply-demand adjustment and is considered the top priority of power system reform from the perspective of stable supply, the report seems to prioritize "securing investment in power sources to ensure the necessary supply capacity" in a discretionary rather than market-competitive manner.

EGC’s Further Efforts are Expected

Needless to say, the biggest problem lies with the dominant operator, which committed the competition-deterrent fraud of market manipulation. However, the penalties under the Electricity Business Act are extremely lenient, as the business improvement recommendations are not accompanied by any fines. Since the market has been liberalized, it should be considered that even the former general electric utilities will seek to maximize profits by exercising market dominance. It is essential to take an approach based on the ethical doctrine that human nature is inherently evil and drastically strengthen regulations and penalties for acts that impede competition in order to prevent a recurrence.

In this light, the EGC is extremely responsible for the market manipulation from April 2019 to October 2023, a period that includes the possibility of competition impediments by the dominant operator, which the author pointed out in January 2021 when extreme spike of the spot price occurred. Although the Business Improvement Recommendations dare to mention that "it is difficult to find any evidence of significant fluctuations in market prices during summer and winter, including the spot price spike in the winter of FY2020," EGC should thoroughly verify the scope and impact of the market manipulation and fully disclose relevant information.

Nevertheless, the author would like to give the EGC a certain degree of credit for its actions this time. This is because the Business Improvement Recommendations seem to be the result of autonomous action by the regulator. In the past, cartels were uncovered by the Japan Fair Trade Commission, and the leakage of information gave the strong impression that the investigation was conducted passively in response to a self-report by KEPCO. Again, it is possible to criticize EGC for finally getting off its backside in response to the long-standing suspicions, but the text of the Business Improvement Recommendation is specific in its rationale and estimates and conveys an attitude of admonishing a party that does not readily admit to market manipulation.

Japan's electricity system reform appears to be moving away from its original philosophy and towards a different philosophy that does not presuppose fair competition. However, this will not bring about lower electricity prices, stable supply, or decarbonization. A fair competitive environment is absolutely essential as a prerequisite for all of these, and we can only hope that the watchdogs of the competitive market will rise to the occasion. EGC itself will not be able to fulfill its role as a watchdog if it does not have sufficient authority and personnel to do so. Certain summary of the review of the regulatory body, the EGC itself, was issued in June 2024, pointing to a policy to "strengthen professionalism," "increase staffing," and the addition of powers such as "the power to order the suspension of operations and conduct criminal investigation⁷.” We hope that these will be implemented in a thorough manner as soon as possible, and that a fair competitive environment will be established in Japan's electricity market.