The re-election of the Shinzo Abe government in October 2017 has reinforced support for Abenomics (Japan Revitalisation Strategy), which is the government’s signature economic revival strategy centred on monetary and fiscal policy measures accompanied by structural reforms (the three-arrow approach). As a key component of the third arrow, that is, structural reforms, the government has been working on an aggressive three-stage electricity system reform programme that was announced in April 2013.
The reforms were adopted in the wake of the major earthquake and the resultant Fukushima nuclear disaster in March 2011. The incident exposed the adverse aspects of Japan’s regional monopoly structure in the power industry wherein the 10 vertically integrated regional utilities or electricity power companies (EPCos) are constrained by their inability to transmit power beyond regional boundaries and handle changes in the energy mix.
With little competition, the regional monopolistic structure has maintained a strong control over prices. The ongoing reforms aim to secure stable and affordable power supply, as well as expand consumer choices and business opportunities. The success of electricity reforms is critical for reviving the economy. Early gains are evident in the positive GDP growth experienced by the country. Japan registered an annualised economic growth rate of 1.6 per cent in the fourth quarter of 2017, much higher than the expectations of 0.9 per cent growth. This marks the eighth straight quarter of expansion backed by strong private consumption and rise in industry spending.
Status of Japan’s electricity reforms
First-stage reforms
Notable progress has been made in the implementation of power reforms, a trend that is expected to continue for at least the next couple of years. The first stage of the reform policy was accomplished by April 2015 with the establishment of the Organization for Cross-regional Coordination of Transmission Operators (OCCTO). OCCTO has been assisting in the development of transmission and distribution (T&D) systems that is necessary for the cross-regional utilisation of power resources, and strengthening of the nationwide capacity to ensure a demand-supply balance in both normal and contingency situations. For smooth system operations, OCCTO has notified general service guidelines, which act as the guiding principles for T&D operations as well as wheeling of electricity by T&D companies.
All power companies are mandatorily required to join OCCTO and provide interconnection to new power sources. OCCTO has over 1,100 registered members including the 10 EPCos, two transmission companies (Power Development Company Limited or J-Power and Hokkaido Northern Power Transmission Company Limited), 24 specified T&D business operators (which supply power to certain specified areas using their own infrastructure), besides numerous retail and generation companies.
Second-stage reforms
The second-stage reforms opened up full retail-level competition in April 2016. These reforms were enabled by the amendments to the electricity law enacted in June 2014. While retail competition is not new to Japan as loads over 50 kW have been opened up for competition by the Ministry of Economy, Trade and Industry (METI) (which has been administering the Japanese electricity market reform programme) in phases since 2000, the latest reforms have expanded its ambit to the residential sector. This residential market, which was valued at JPY 8 trillion and comprised 85 million customers prior to full retail liberalisation, expanded the liberalised market size to JPY 18 trillion according to government estimates. The entire landscape of the electricity retail business has changed. There are about 500 registered electricity retail companies. By end-2017, 4.6 million consumers switched to a different retailer. Further, the negawatts trading market, whereby utilities pay for the amount of electricity saved by consumers, was successfully launched in end-2017, with a bid quantity of 1 GW.
In terms of the regulatory set-up, the Electricity and Gas Market Surveillance Commission (EGC) (formerly the Electricity Market Surveillance Commission, which was formed in September 2015, but changed its name in April 2016 with the addition of the gas surveillance function) is responsible for granting electricity retailer licences and supervising electricity retailers to ensure their compliance with the law. It may be noted that under the second stage, the law retains the regulation of retail prices for consumer protection. However, the third-stage amendment empowers the METI minister to designate areas where retail price restrictions will remain and decide on the timing of lifting of such restrictions by area. This decision has to be made in consultation with the EGC.
In addition to following EGC regulations, retailers are recommended to follow the guidelines released by the METI to further protect the rights of retail customers. The guidelines set out various rules relating to the disclosure of information to customers, sales activities, electricity supply contract terms and conditions, handling of customer complaints and procedures to terminate electricity supply contracts. These guidelines, initially formulated in January 2016, are revised from time to time. The latest revision took place in June 2017, whereby the METI added specific rules for enhancing consumer protection and for retailers to indicate the value of non-fossil fuel energy in line with the scheduled introduction of a trading market of non-fossil fuel energy value. Although the detailed framework for this new market (proposed to be opened at the Japan Electric Power Exchange in 2019) is yet to be finalised, it will help electricity retailers to accomplish their obligations under the law to procure, by 2030, at least 44 per cent of their power for retail supply from non-fossil fuel sources (renewable and nuclear energy). This will, in turn, assist the country in meeting its greenhouse gas (GHG) emission reduction commitment of 26 per cent by 2030 from the 2013 levels. By 2050, Japan aims to achieve an 80 per cent reduction in its GHG emissions under the Plan for Global Warming Countermeasures based on the Paris agreement.
In order to promote renewable energy in a cost-effective and sustainable manner, the old feed-in tariff (FiT) system (in effect since July 2012) was revised on April 1, 2017. The revision pertained to the establishment of a new approval system by the METI; introduction of a new renewable energy cost effectively through auctions, setting of medium-term and long-term tariff targets; notification of multi-year tariff for better rate visibility; and change of power purchasers under FiT from power retailers to T&D operators. Significantly, under the new approval system followed by the METI, renewable plants have to enter into a grid connection agreement with T&D companies or have in-principle open access to the power grid. Another important change is that T&D companies, which are responsible for demand-supply adjustment, become purchasers of FiT electricity in place of electricity retailers.
The METI has been issuing guidelines from time to time to facilitate neutral and fair implementation of reforms. Earlier, in October 2016, the METI in consultation with EGC established guidelines for approaches to public calls by T&D companies for procurement from other businesses to adjust necessary electricity volumes (given that these companies are required to control frequencies and adjust the supply-demand balance in their electricity service areas). These guidelines aim to ensure fairness and transparency in the procedures so that T&D companies avoid treating specific power sources favourably and bearing can excessive costs.
Further, in March 2017, the METI approved the applications for approval of wheeling service provisions submitted by the 10 EPCos. This includes the provisions concerning negawatt trading that allow businesses to resell the amount of electricity saved by consumers. The applications also took into account the provisions of the February 2017 ministerial ordinance for “partial revision of the rules for rate calculation concerning the wheeling service provisions for T&D companies”. The ordinance itself was passed for clarity on rules for fare adjustments arising from the imbalance between planned and actual generation. This is important as T&D companies have been obligated to purchase FiT electricity since April 2017 and for maintaining the demand-supply balance.
As a result of full retail market liberalisation and supportive policy measures, power demand from non-EPCo retailers is estimated to have risen by two-thirds. Within one year of opening of the retail segment for residential consumers, non-utility players captured 4 per cent of the demand from this segment. With this, non-utility players met over 9 per cent of Japan’s electricity consumption by March 2017. According to government estimates, the amount of energy plans sold is expected to increase nearly threefold by 2020 from the 2015 levels.
Third-stage reforms
To consolidate the expected gains from full retail liberalisation introduced in the second stage, the third and final stage of reforms provides for the legal unbundling of nine of the 10 EPCos into generation, T&D and retail segments by 2020. For the tenth region (Okinawa region), a system based on the specific area features will be established. The third-stage reforms have been facilitated by the passage of the Amended Electricity Business Act on June 17, 2015. According to this, companies conducting the T&D business will be prohibited from conducting the power generation and retail businesses from April 1, 2020. Unbundling could take place either through a holding company format or an affiliated company set-up.
Post unbundling, the T&D businesses will remain regional monopolies and returns on investment will be guaranteed through tariff regulations for these companies. As mentioned earlier, they (currently the T&D companies) will continue to be obliged to maintain high quality power supply including stable frequency, and voltage and demand-supply balance of the electrical system. A code of conduct will be imposed on transmission/distribution businesses post unbundling to ensure that they do not thwart competition in the liberalised sectors by giving preferential treatment to their group companies.
The EPCos are conscious of the impending structural reforms and have started preparing themselves to quickly and flexibly adapt to the new business and regulatory environment that is expected 2020 onwards. For instance, the Chubu Electric Power Company (Chubu EPCo), which is the third largest of Japan’s 10 EPCos, in April 2016 established an autonomous business structure by forming in-house power generation, network, and customer service and sales companies. This segregation will not only enable the company in smooth unbundling but also enable the different corporate structures to focus on their respective business domains and take enhanced measures to survive the market competition in anticipation of future changes. In order to consolidate its generation business, the Chubu EPCo in partnership with Tokyo Electric Power (TEPCo), formed a company named JERA Co., Inc. in April 2015. The joint venture aims to increase its presence in the fuel and power generation markets through the integration of the associated businesses of the two EPCos.
Issues and challenges
Given the rapid pace at which the industry landscape is changing, both existing and new players are facing several issues and challenges. While it is being hoped that non-discriminatory and fair T&D operations will be achieved through structural unbundling, critics have emphasised the need for separate ownership of grid functions rather than simple legal unbundling as planned. Further, regulatory oversight by a strong independent authority will be essential to reap the full benefits of liberalisation. Conditions facing new players remain unfavourable in both wholesale and retail markets. Retailers are mandated to secure adequate supply by the regulator, indicating its risk-averse attitude towards them.
Renewable energy players often cite difficulties in obtaining grid access despite the allowance of third-party access. It has been recognised that the concept of “connectable amount” followed by T&D companies for accommodating renewable energy (considering demand-supply balance) acts as a bottleneck for expanding renewable capacities. To resolve this issue, a government committee in charge of the network has recommended replacing the rule of connectable amount with the concept of “connect and manage” adopted in the UK.
Besides poor interconnection between former monopoly regions, the two-frequency system (50 Hz and 60 Hz) also poses an additional challenge, making flexibility difficult. For this, the German partner of the study programme of the German-Japanese Energy Transition Council (GJETC) in its November 2017 report (on New Allocation of Roles and Business Segments of Established and New Participants in the Energy Sector Currently and Within a Future Electricity Market Design) suggests increasing converter capacity as a cheaper solution than switching to one of the two systems.
Another policy-level issue is the ambiguity about the future role of nuclear energy in the energy mix. Japan is increasing its share of renewable-based resources in the generation mix, focusing more on solar power. While revised FiT policies are expected to promote other renewable energy sources as well, renewable and nuclear power have been used interchangeably in the electricity retailer obligation to achieve the 2030 GHG emission reduction targets.
Till 2026, about 23,783 MW of net generation capacity will be added including huge thermal-based new capacity (accounting for 57 per cent of new capacity addition). Japan is the biggest importer of liquefied natural gas in the world and imports may grow significantly in the coming years. As the cost of imported fuel for generating electricity is very high, it has become necessary for the country to continue its energy conservation and efficiency efforts. Clarity on nuclear energy’s role is also important from the system operation point of view as different approaches are required to deal with baseload or intermittent sources of energy in the system. Although energy transition and liberalisation are separate matters, Japan has an opportunity to incorporate energy transition measures during the process of liberalisation.
The way forward
Challenges notwithstanding, the country has made important progress in market liberalisation and promotion of renewable energy. A lot of work needs to be done to promote greater transparency in the market and create a level playing field for new players. The next couple of years are crucial for the Japanese electricity sector. It will be important to deal with the challenges associated with structural unbundling of the EPCos as well as ensure smooth energy transition. It is imperative that the government ensures timely implementation of the announced reform measures as the long awaited economic turnaround of the sector rests on it.