New Structures in Japan’s Deregulated Electricity Market

Earlier this year we took a look at developments in Japan’s deregulated electricity market here on our blog, and it’s a topic we regularly cover in depth in our Monthly Market Monitor.  

Today we’re going to look at new structures the Japanese government is putting in place as part of the further development of the liberalized electricity market.  Although most of the concepts and terminology will be familiar to readers knowledgeable of other markets, there are noteworthy nuances in the way some of these structures are being implemented in Japan.  

Indirect Auction for Interconnection Usage Rights

Japan’s deregulated electricity market is fragmented into nine contiguous grid zones which correspond to the service areas of the incumbent utilities, and interconnections between the grid zones are limited.

Before October of 2018, the right to use the interconnections was awarded on a nominally first-come-first-served basis. Power generators who submitted annual baseload power schedules, such as nuclear and large-scale hydro and geothermal, were given de facto priority in this system; the thinking was that because baseload power plants generally have high construction costs and a long investment recovery period, it was only fair to give them priority.  

The Electric Power System Council of Japan (ESCJ), forerunner of OCCTO, used an opaque “certification system” to allocate interconnection usage rights during times of congestion in which “certified” power plants received priority. Names of certified power plants were not disclosed; however, from data released by ESCJ in 2013, we know that of the 41 certified plants, at least 29 were baseload plants. We also know that no renewable plants were certified.  

This created obvious disadvantages for new electricity retailers, many of whom don’t own any generation, baseload or otherwise, after the market was liberalized in April of 2016.  The “indirect auction” system was introduced in October 2018 to correct for this. The actual trading is executed through the Japan Electric Power Exchange day-ahead market.  

Baseload Market

The baseload market is an auction system which started in July 2019 for the trading of baseload power (nuclear, coal-fired thermal, large-scale hydro, and geothermal) on annual volume. The system is intended to level the playing field between incumbent utilities’ retail companies and new retailers by giving all retailers equal opportunity to purchase affordable baseload power through term contracts which help them manage price risk.  In practice, it appears that new retailers are not utilizing the system to the extent hoped, mainly because cash flow constraints make it hard for them to sign the long term contracts.  As a result, the value of operating this market is being heavily debated.  

The baseload power is mainly supplied by the incumbent utilities and J-Power, and is delivered through the spot market. 

Balancing Market  

The T&D companies are responsible to procure power to keep supply and demand in balance and to keep the grid stable after gate closure for the scheduling of power by retailers.  Since the retail market opened in 2016, they’ve used a public bidding system to ensure fairness and transparency.  The retailers ultimately pay for this power; it’s only sensible that the T&Ds be obligated to procure at a fair market price on their behalf – not, for example, through sole source contracts with the incumbent utilities of which the T&Ds used to be a part.  

Under the current system, the T&Ds procure balancing power within their own grid zones, which limits competition.  Beginning in FY 2021, they will be able to procure 45-minute response reserves (III-2; replacement reserve for FIT) on the new balancing market from within their own zones or from other zones. Trading of 15-minute response replacement reserves (III-1) will start in FY 2022, 5-minute response frequency restoration reserves (II-2) and synchronized frequency restoration reserves (II-1) in FY 2024, and 10-minute response frequency containment reserves (I) sometime thereafter.  

Capacity Market

The capacity market is a mechanism for the trading of generation capacity four years in advance.  What’s being sold here is not MWh of volume, it’s MW of capacity.  The thinking is that as the growth of new retailers drives more volume to the JEPX wholesale market, which only offers short-term trading, large generators will not have the level of certainty about revenue from electricity sales needed to invest in large generating assets.  Due to the long timelines involved in licensing and constructing large power plants, a mechanism is necessary to provide a baseline of certainty regarding revenue so that generators will continue to maintain the level of large scale generating assets needed to guarantee stable power supply in the country.  

Because this is being viewed as a matter of national energy security, fees are ultimately likely to be collected through an adder to consumer bills.  Retailers will pass the funds on to OCCTO, which will pay them to the generators.  

The auction is to be held once a year.  The first auction was held in early July for 177,470 MW of capacity; the results will be announced in late August.  

Non-Fossil Value Market

This market is a mechanism to capture environmental value which had been hidden in the electricity market.  Trading for FIT power sources started in May of 2018, and expanded to include a demonstration of certificates with a tracking system for location and type of generation in February 2019.  As of April 2020, all non-fossil generation became eligible for trading in this market. 

This is an important and somewhat complex market due to how intertwined it is with broader renewables policy and regulation, as well the different ways the value traded on the market is used by different players.  We’ll take it apart in depth in a future article.  

Stay Tuned

All of these mechanisms are part of feedback loops in which they affect and are affected by numerous other structures and dynamics in the market; most, if not all, of those other structures and dynamics are also still “moving targets.”  

We will return to these market mechanisms here and in other products to continue helping you peer around the corner and identifying risks to manage and opportunities to seize in the evolving Japanese power market.