(originally published in Japanese on 14 March 2025)
Japan’s Ministry of Economy, Trade and Industry has been conducting a review of electricity system reform through its Subcommittee on Electricity and Gas Basic Policy. On 27 January 2025, the committee presented its “Draft Review Results.” The electricity system reform was initiated in response to the nuclear power plant shutdowns and supply-demand pressures that occurred in the wake of the accident at TEPCO’s Fukushima Daiichi Nuclear Power Plant in 2011. Implemented reforms include full liberalization of electricity retailing in 2016 and legal unbundling of the transmission and distribution sectors in 2020. Various problems have come to light, however. In this column, I would like to offer an assessment of the “Draft Review Results” with an eye on further institutional reforms to be formulated.
Concerns Raised in the Review of Electricity System Reform
The “Draft Review Results” states that while “a certain degree of progress” has been made on electricity system reform and “positive results can be confirmed” on the whole, “challenges remain in relation to maintaining and securing supply capacity and addressing the sharp rise in international fuel prices.” The review was conducted from three main viewpoints: (1) “stable supply of electricity”; (2) “suppressing electricity rates to the maximum extent possible”; and (3) “expanding choices for consumers and business opportunities.” Of these, (1) stable supply of electricity seems to be the greatest concern. Specific issues that are mentioned include “securing investment in power sources to ensure the necessary supply capacity,” with particular emphasis on [ensuring sufficient] “adjustment power and inertia force to enable the supply stability traditionally provided by thermal power.”
Based on this recognition, the report raises three “directions toward which the electricity system needs to move.” These are (1) “stable electricity supply”; (2) “decarbonization”; and (3) “stable price levels.” The report gives special importance to the first of these directions, supply stability. For example, expressions such as “decarbonization of power sources with the fundamental premise that stable supply is ensured” and “phasing out inefficient coal-fired power plants with the fundamental premise that stable supply is ensured” occur repeatedly in the report. Stable supply is given priority over decarbonization. This is probably why the report suggests that other power sources are needed in addition to (unstable) renewable energy.
Referring to specific measures for the stable supply, the report continues, “It is difficult to see any improvement in the predictability of recovering investments in power sources, so it is necessary to continue maintaining and securing the supply capacity essential for a stable electricity supply, taking into consideration assessments of the capacity market and long-term decarbonized power source auctions.” Also, “Since large-scale power sources require massive investments and long total-project time-scales, there are substantial risks of revenue and cost variations. In the current business environment, e.g., in a liberalized power market, there is a high level of uncertainty about future power revenues.” Therefore, “To achieve power decarbonization and supply stability, institutional measures to deal with the revenue and cost fluctuations arising from market environment changes during the project period...” [will be implemented]. This likely refers to support initiatives like that of the UK’s RAB model for nuclear power generation.
How will a Stable Electricity Supply be Secured?
It goes without saying that supply stability is extremely important for electricity systems. Yet, there is something odd about the way the concern is framed as shown above. It is true that the integration of inherently variable renewable energy sources presents challenges to supply stability. The key to overcoming these lies in flexibility, as practiced in Europe. Although using nuclear power for supply capacity and thermal power and other sources for adjustment capacity can also be effective, they are only one part of a multifaceted range of measures. A wide variety of other means are available, including inter-regional exchanges of electricity across power grids, pumped hydro, use of negative pricing and other market mechanisms, demand response measures, and the use of battery storage and virtual power plants (VPPs). The case of South Australia illustrates the importance of sensibly combining these options, and it proves that it is not necessary to think that thermal power must remain the primary power source at all costs. (See Column of 25 September 2024, in Japanaese.)
A high level of uncertainty is not the only reason for the sluggish investment in large-scale power sources. High costs are probably a fundamental factor, too. In light of the need for both decarbonization and energy security, the basic view in Europe is that most future power plants will be based on variable renewable energy sources, with low levelized cost of electricity (LCOE) and short project lead times. Therefore, if Japan insists on increasing its use of nuclear power and decarbonized thermal power, discretionary government intervention, like that of the RAB model, will be necessary. In other words, a market system that enables market players to make rational choices between a variety of power options will be required. This is what should be at the heart of electricity system reform.
The importance of supply stability was also stressed in the report of the Electricity System Reform Expert Subcommittee back in 2013. The starting point for reform at the time was outlined as follows. “If, after the nuclear power plant disaster and subsequent strains on power supply and demand, the same electric system is maintained, it may not be possible to ensure a low-cost supply of electricity in the future.” More specifically, since “the inherent risks of the established system of securing supply capacity with large-scale power sources, i.e., the inflexibility of adjusting supply and demand through price, have now been exposed, supply-demand balance is expected to be achieved through demand-side measures such as demand response and distributed power generation.” It has also become necessary to demonstrate “the function of adjusting supply and demand on a nationwide scale” through inter-regional power grid operation. For this reason, the government stated that it would try “to maximize the benefits of competition by eliminating factors” such as “restrictions on entering the retail market, low liquidity of trading in the wholesale electricity market, and questionable neutrality in access to transmission and distribution networks,” as well as “by creating a competitive market.”
To sum up, 12 years ago, the utilization of market mechanisms was viewed as a sensible way of ensuring supply stability. The government aimed at reforms to promote decentralization to pursue this vision as far as possible. That is why measures to promote competition, including the unbundling of utilities’ generation and transmission systems became a major point of contention. And why a “transition to a new regulatory structure” was mentioned. However, the recent review expresses concerns about a lack of investment in large-scale power sources such as nuclear and decarbonized thermal power. This can be interpreted as a return to a centralized system in which the construction of such plants is supported by government intervention. This signals an intention to change the direction of electricity system reform. The figure below is a diagram that I frequently make use of. In 2013 Japan was aiming for the first quadrant (top right), where the European and American approaches overlap. It has now returned to a “mixed system” around the middle of the map.
Figure Types of electricity system reform
Why not Make Use of Market Mechanisms?
The 2013 report of the Electricity System Reform Expert Subcommittee emphasized the “utilization of market mechanisms.” The push for reform was driven by the “de facto monopoly held by the general electric utilities” and the “lack of competition” that previously prevailed. The government now appears to be rethinking its policy. Is it because market mechanisms were fully exercised for the past 12 years to result in significant harm?
As I have repeatedly pointed out, this is unjustified. (See Columns of 5 July 2023 and 25 December 2024.) A succession of anti-competitive practices has come to light in the past few years. These include information leaks by a number of general electrical transmission and distribution operators, cartel behavior by the Kansai Electric Power Company, Inc. and other incumbent utilities, and market manipulation by JERA. Since a fair competitive environment does not exist in Japan, market functions cannot be utilized in a healthy way. Thus, while there are negative effects of not utilizing market mechanisms, there seems no harm of utilizing them. Therefore, the recent review should have thoroughly discussed the negative effects of not utilizing market mechanisms.
Yet, the “Draft Review Results” makes no mention at all of cartel behavior or market manipulation. On the information leak incidents, the report refers to “incidents of inappropriate conduct by major electric power companies” without discussing them in any depth, concluding that “at this point in time at least, there is no need to institutionally require separation of ownership.” There is an inescapable sense that interest in market mechanisms has greatly declined over the past 12 years.
Electricity systems that do not make use of market mechanisms no longer exist in most developed countries in the US and Europe. As well as high costs, such systems are problematic in terms of supply stability. As the report of 12 years ago stated, we should know this from first-hand experience. Since then, the demand for decarbonization has grown stronger and we have faced another energy crisis. But these facts have only intensified the need for purely domestic renewable energy; they do not suggest its limitations. The shortcut to ensuring both a stable power supply and decarbonization is a decentralized system centered on renewable energy with suitable power grids that takes full advantage of battery storage, rational demand-side behavior, and market mechanisms.
Outlook for the Electric Power System
As argued in this column so far, Japan’s electricity system is on the verge of reverting to its situation before the Fukushima nuclear accident. This is a shift in policy direction that I have pointed out repeatedly. Now, finally, it has been spelled out more clearly. The 7th Strategic Energy Plan marked a dramatic change away from post-Fukushima energy policy. The electricity system reform implemented in response to the disaster have also sought to follow a direction that is consistent with the plan.
It might be argued that it is perfectly reasonable for Japan to opt for a “mixed system” (see the Figure) that is different to that of developed countries in the US and Europe. However, as an overseas observer pointed out the other day, energy companies in the US and Europe are not likely to enter an electricity market where even unbundling of utilities’ generation and transmission systems has not satisfactory achieved. In such a market, electricity supplied is pricy and renewable-derived power is limited. Therefore, US and European user companies, too, are likely to stay away from investing in Japan. We need to think carefully about what kind of electric power system and industrial reality will be protected in Japan as a result of this approach.
On the other hand, there is no returning to a legal monopoly. However lacking the fruits may be, now that the door to liberalization has been opened, it cannot be closed. Over the past 12 years, there have been changes that are worth appreciating, such as the certain level of progress in inter-regional transmission operations and the boom in battery storage utilization in the last few years. A grid master plan for inter-regional transmission operations has been formulated, with planned construction of long-distance transmission lines. This process needs to be accelerated. Thanks in part to subsidies, the adoption of battery storage for grids is growing rapidly. This is anticipated to improve supply-demand adjustment. These measures increase flexibility and are consistent with the utilization of market mechanisms. Even with a certain amount of discretionary support and government intervention, the construction of large-scale power sources will not be easy. We need to keep in mind that the use of market mechanisms is the fast track to decarbonization and the stability of electric power supplies in Japan.
[Column Series] Japan’s Electricity System Restructuring: Review and Points for Discussion
