Capacity Market Reforms Create New Opportunities Amid Tightening Supply

Japan’s capacity market is undergoing significant reforms as the country prepares for rising electricity demand, particularly from AI-driven data centers. These changes will reshape how future generation capacity is secured, with important implications for investment decisions, revenue opportunities, and business strategies across the power sector.

Capacity market main auction secures electricity supply from four years ahead

The capacity market, first introduced in 2020 and operated by the Organization for Cross-regional Coordination of Transmission Operators (OCCTO), comprises multiple auctions. The main auction (or single-year auction) (T-4) procures capacity (kW) four years before the delivery year. In the main auction, electricity retailers pay capacity contribution payments to OCCTO, calculated based on auction results, to fund payments to capacity suppliers (generators). The main auction is complemented by the incremental auction (T-1) and a proposed supplementary auction (see supplementary auction below). Additionally, the Long-Term Decarbonization Power Source Auction (LTDA) is also held under the capacity market framework with the aim of incentivizing investments in decarbonized power sources (see our latest update on LTDA).

The main auction (single-year auction) is the largest of these auctions in terms of capacity procured. The FY 2025 capacity market main auction for delivery in FY 2029 procured approximately 166.08 GW, covering about 87% of the FY 2029 target procurement volume of 189.97 GW (OCCTO). The total contracted value, after transitional adjustments, reached a record JPY 2.21 trillion, up 19% year on year. For the first time, clearing prices in every area exceeded the reference price (Net CONE: JPY 10,075/kW), signaling tightening supply capacity nationwide.

Stable power sources dominate bids

Four types of resources can participate in the main auction: stable power sources, variable power sources including renewables (standalone), variable power sources (aggregated), and command-based resources such as demand response (DR). Of these, stable power sources consisting of thermal, nuclear, pumped storage, and others make up the majority of the sell bids.

JERA’s Joetsu Thermal Power Station in Niigata, Japan. Thermal power plants are among the stable power sources that account for 92.8% of capacity offered in Japan’s FY2025 capacity market main auction. (Source: JERA)

In the FY 2025 auction, the total capacity offered nationwide was 172.31 GW, comprising 159.97 GW from stable power sources (92.8%), 4.35 GW from variable power sources (standalone) (2.5%), 0.84 GW from variable power sources (aggregated) (0.5%), and 7.15 GW from command-based resources (4.2%) (OCCTO).

Incremental auction falls short of capacity target

The incremental auction can be held about one year before the delivery year to procure any extra capacity needed to cover a shortfall identified after the main auction. The results of the FY2026 incremental auction for delivery in FY2027, published in August, showed that a total of 4.58 GW was contracted (OCCTO). All resources that submitted bids were awarded contracts, which was the first time this has happened since the capacity market opened. But even after accepting all offered capacity, procurement fell short of the target for FY2027.

The results of both the latest main auction and the incremental auction strongly suggest that supply capacity remains tight relative to OCCTO’s expected volumes, which has pushed OCCTO to revise its market design to increase secured capacity.

New supplementary auction and opportunities for unsuccessful DR resources

In August, OCCTO proposed a new supplementary auction under the capacity market to procure additional capacity one to three years before delivery. This auction would incorporate the short- and medium-term procurement measures previously defended and outlined by the Ministry of Economy, Trade and Industry (METI). Anticipating tight supply-demand conditions through FY2030, it would procure capacity from aging power plants scheduled for suspension or retirement that existing measures have failed to secure, potentially through multiyear contracts, to keep them available and operational.

In addition, OCCTO began discussing a mechanism to fill capacity gaps left by the withdrawal of command-based resources, including DR, from bidders that were unsuccessful in the main auction along with any additional eligible offers.

Successful bidders of command-based resources in the main auction must withdraw if they cannot secure resources and demonstrate their capacity in an effectiveness test two years before delivery. For the FY2021 main auction for delivery in FY2025, the withdrawal rate was 37% (OCCTO). Unsuccessful resources (in main auctions) can also participate in the incremental auction one year before delivery, but they have no opportunity to participate if that auction is not held. The new mechanism aims to provide more opportunities for these resources, and the measures are scheduled to take effect from the delivery year FY2028.

Reform can create new opportunities for existing and new resources

The restructuring of the capacity market, through the introduction of the supplementary auction and revised rules for command-based resources, indicates that OCCTO aims to make better use of existing resources that current market arrangements do not fully capture, to secure future supply capacity. The evolving market framework could create new revenue opportunities for both existing and new capacity resources, depending on the future auction design.

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