Energy Law

Entering Japan’s Liberalised Power Market: Risks & Rewards for Global Players

Japanese Attorney at Law - Bengoshi L.L.

• 9 min read
Slide overview of Japan's liberalised power market: OCCTO, JEPX, capacity auctions, grid limits, and foreign renewable opportunities.

TL;DR

  • Japan’s power sector has moved from regional monopolies to full retail liberalisation (2016) and legal T&D unbundling (2020).
  • New markets—day-ahead (JEPX), Capacity, and Long-Term Decarbonisation Auctions—aim to ensure liquidity, reliability and climate targets.
  • Recent fuel-price shocks exposed retailer fragility, grid bottlenecks, and dominance of incumbents, prompting tighter oversight.
  • Foreign firms can succeed in renewables, trading, tech, and services, but must master complex rules, manage volatility, and navigate competition law.

Table of Contents

  1. The Road to Liberalization: Key Reforms
  2. Market Structure and Key Players
  3. Navigating the Wholesale Market
  4. Ensuring Long-Term Supply: New Market Designs
  5. Competition Law and Regulatory Oversight
  6. Recent Challenges and the Retail Landscape (2021-2023)
  7. Opportunities and Considerations for Foreign Businesses
  8. Conclusion

Japan boasts the world's fifth-largest electricity market, a sector undergoing a profound and complex transformation. Driven initially by the pursuit of lower prices and enhanced supply stability, particularly after the 2011 Great East Japan Earthquake, and now increasingly by decarbonization goals, the market is shifting away from vertically integrated regional monopolies towards a more competitive, unbundled structure. This ongoing evolution presents both significant challenges – underscored by recent global energy price volatility and domestic supply concerns – and compelling opportunities for foreign businesses with expertise in generation, trading, technology, and services. Understanding the intricacies of this market is key to navigating its complexities.

The Road to Liberalization: Key Reforms

Japan's electricity market liberalization has been a gradual process, starting in the 1990s and culminating in significant reforms over the last decade:

  1. Phased Market Opening: Liberalization began with large-scale generation (1995), extended to high-voltage retail customers (starting 2000), and finally achieved full retail liberalization, including households, in April 2016.
  2. Institutional Framework: Two key organizations were established:
    • OCCTO (Organization for Cross-regional Coordination of Transmission Operators - 電力広域的運営推進機関): Created in 2015, OCCTO coordinates nationwide grid operations, manages cross-regional power flows, oversees supply-demand balancing, and plays a crucial role in ensuring network stability and long-term supply adequacy.
    • JEPX (Japan Electric Power Exchange - 日本卸電力取引所): Launched in 2005, JEPX operates the primary wholesale electricity markets, providing a platform for generators and retailers to trade power and establishing benchmark prices.
  3. Legal Unbundling (法的分離): A pivotal step occurred in April 2020 with the legal separation of the transmission and distribution (T&D) divisions from the generation and retail arms of the former regional monopoly utilities. The aim was to ensure neutral grid operation and prevent incumbents from unfairly disadvantaging competitors in accessing the network. Strict rules, including information firewalls and restrictions on concurrent positions, were implemented, although recent events have raised questions about their practical effectiveness.

Market Structure and Key Players

The liberalized market consists of distinct segments:

  • Generation: While new players, especially in renewables, are entering, generation capacity remains dominated by the large, established power companies (often referred to as incumbents or 大手電力会社 - Ōte Denryoku) who evolved from the former regional monopolies, along with the semi-governmental Electric Power Development Co. (J-Power).
  • Transmission & Distribution (T&D): These operate as regional monopolies, legally separated but often still within the same corporate groups as the incumbents. They are responsible for maintaining the physical grid infrastructure within their service areas and operate under a regulated revenue cap system designed to incentivize efficiency. They also provide the "last resort supply" (see below).
  • Wholesale Market: JEPX is the main venue, hosting spot (day-ahead) and intraday markets. However, a significant portion of electricity is still traded through bilateral contracts, many of which are long-term agreements involving incumbents, limiting liquidity available to new entrants on JEPX. Mechanisms like the Base Load Market aim to improve access.
  • Retail: Since 2016, any registered company can sell electricity to end-users. Hundreds of new entrants ("Shin-Denryoku" - 新電力) emerged, competing against the retail divisions of the incumbents. However, incumbents retain a very high market share (70-90% in most regions), and regulated tariffs (経過措置料金 - keika sochi ryōkin) remain available for residential and small business customers served by the incumbent "deemed retailers" (みなし小売事業者) due to regulatory findings of insufficient competition in these segments.

For retailers without their own generation (most Shin-Denryoku) and generators looking to sell surplus power, the wholesale market is critical, yet challenging:

  • JEPX Markets: The primary JEPX market is the day-ahead spot market, where power is traded in 30-minute blocks for the following day via a single-price auction. This sets the benchmark System Price, with Area Prices determined if inter-regional grid connections (interconnectors) are congested. An intraday market (時間前市場 - jikanmae shijō) allows for adjustments closer to real-time but has historically suffered from lower liquidity. Recent years (particularly 2021-2022) saw extreme price volatility on JEPX, driven by soaring global fuel costs (LNG, coal) and domestic supply tightness, creating severe financial difficulties for market participants.
  • Bilateral Contracts & Access Issues: New entrants often struggle to secure stable, competitively priced long-term bilateral contracts, as much low-cost generation capacity (especially from base load sources like coal, large hydro, nuclear) is controlled by incumbents or tied up in legacy agreements.
  • Mechanisms for Fairer Access:
    • Base Load (BL) Market (ベースロード市場): Established in 2019, this JEPX-operated auction requires large generators (incumbents, J-Power) to offer a certain volume of electricity generated from designated base load sources at prices reflecting their average costs. This aims to give new entrants access to cheaper, stable power, though its effectiveness has been debated, particularly when underlying fuel costs (like coal) are high.
    • Mandatory Backup (常時バックアップ - Jōji Backup): A legacy system where incumbents were required to offer wholesale power to new entrants in their area. While intended as a transitional measure to be replaced by the BL market, its usage persisted due to limitations in other procurement options. Issues regarding potential misuse (e.g., arbitrage against JEPX prices) have been noted, and it is expected to be phased out as market liquidity improves.
  • Interconnection Constraints: Japan's grid evolved regionally, resulting in limited transmission capacity between regions. This bottlenecks the flow of cheaper power from one area to another, hindering the development of a truly national market. To address this, OCCTO has implemented "indirect auctions" (間接オークション - kansetsu auction) to allocate scarce interconnector capacity based on price differentials between areas, replacing older "first-come, first-served" rules.

Ensuring Long-Term Supply: New Market Designs

A major challenge in liberalized markets globally is ensuring sufficient investment in generation capacity, especially for plants needed only during peak demand or as backup (the "missing money" problem, as spot market revenues alone may not cover fixed costs). Japan is tackling this through new market mechanisms:

  • Capacity Market (容量市場 - yōryō shijō): Launched its first auction in 2020 for delivery four years later (2024), this market pays generators for making capacity available, regardless of how much energy they actually produce. OCCTO calculates the required capacity for the entire country and procures it through a nationwide auction. Retailers ultimately bear the costs based on their peak demand. The market aims to provide revenue certainty for existing plants and incentivize investment in new ones needed for reliability. Initial auctions saw significant price volatility, leading to ongoing refinements of the market rules.
  • Long-Term Decarbonization Power Source Auction (長期脱炭素電源オークション): Recognizing the need for substantial investment in new low-carbon generation (renewables, nuclear, thermal with CCS etc.) to meet climate goals, this separate auction mechanism is being introduced. It will offer successful bidders long-term (e.g., 20-year) fixed revenue streams, complementing existing Feed-in Tariff (FIT) and Feed-in Premium (FIP) schemes for renewables and providing the certainty needed for large capital investments.
  • Reserve Power Auction (予備電源オークション): With older thermal power plants retiring, concerns about short-term supply adequacy during emergencies have grown. Plans are underway for auctions specifically designed to pay owners to keep designated retiring or mothballed plants available for operation as emergency backup capacity for a defined period.

Competition Law and Regulatory Oversight

Ensuring fair competition in a market historically dominated by regional monopolies is a continuous challenge requiring robust oversight:

  • Dominance Concerns: Despite legal unbundling, the former incumbents retain significant market power in both generation and retail segments within their traditional service areas. Their control over base load generation and large customer bases remains a key feature of the market.
  • Regulatory Bodies:
    • METI (Ministry of Economy, Trade and Industry): Sets overall energy policy and oversees market design.
    • OCCTO: Manages grid operations, balancing, and administers the Capacity Market.
    • JFTC (Japan Fair Trade Commission): Enforces the Antimonopoly Act (AMA), scrutinizing conduct such as cartels, bid-rigging, abuse of superior bargaining position, and potentially anti-competitive mergers.
  • Key Competition Issues:
    • Non-Discriminatory Wholesale Supply (内外無差別 - Naigai Musabetsu): A major focus has been ensuring that the generation arms of incumbents offer wholesale power to third-party retailers on terms comparable to those offered to their own affiliated retail divisions. Incumbents have made commitments to METI/OCCTO in this regard, subject to ongoing monitoring.
    • Market Manipulation: Preventing manipulation of prices on JEPX is critical. Guidelines prohibit actions intended to artificially inflate or depress prices. Incumbent generators offering surplus power at marginal cost is considered a safe harbor.
    • Information Firewalls: Preventing the T&D companies from leaking sensitive grid or customer information to their affiliated retail companies is crucial after unbundling. Recent high-profile investigations into alleged breaches highlight the ongoing risks and regulatory scrutiny in this area.
    • Cartels: The scale of the market and the limited number of major players create potential risks. The JFTC recently initiated action against alleged cartel activity involving several major power companies regarding customer acquisition.
    • Guidelines: Joint METI/JFTC "Guidelines Concerning Appropriate Electricity Transactions" provide detailed guidance on acceptable and problematic conduct under both energy regulations and the AMA.

Recent Challenges and the Retail Landscape (2021-2023)

The past few years have exposed significant vulnerabilities:

  • Fuel Price Impact: Soaring global prices for LNG, coal, and oil, exacerbated by the weak yen, sent JEPX spot prices to unprecedented highs.
  • Retailer Distress: Many Shin-Denryoku, heavily reliant on JEPX procurement and often operating on thin margins, faced severe "reverse margins" (逆ザヤ - gyakuzaya), where wholesale costs exceeded retail prices. This led to a wave of bankruptcies, market exits, and suspension of new customer intake.
  • Regulated Tariff Issues: Incumbent "deemed retailers" hit the caps on their regulated fuel cost adjustments, forcing them to absorb significant losses. Many subsequently sought (and are receiving) substantial increases to the base regulated tariffs, while others removed fuel cost caps on their liberalized retail plans.
  • Last Resort Supply Problems: As customers were dropped by failing Shin-Denryoku, many sought supply from incumbents, who were reluctant to take them on at standard (now loss-making) rates. This pushed many, particularly business customers, onto the "last resort supply" (最終保障供給 - saishū hoshō kyōkyū) tariff provided by the T&D companies. This tariff, designed to be punitive (1.2x standard rates), paradoxically became cheaper than soaring market rates, overwhelming the T&D providers and undermining its purpose. The pricing mechanism has since been revised to be market-linked.
  • Policy Response: Regulators have been actively responding by approving regulated tariff hikes, revising the last resort supply pricing, and initiating stricter financial screening and ongoing monitoring requirements for electricity retailers to ensure their viability and risk management capabilities.

Opportunities and Considerations for Foreign Businesses

Despite the challenges, Japan's electricity market transformation offers avenues for foreign participation:

  • Generation: Significant opportunities exist in renewable energy development (solar, onshore/offshore wind, biomass, geothermal), supported by FIT/FIP programs and the upcoming Long-Term Decarbonization Auctions. Grid-scale battery storage is also a growing area. Challenges include navigating local permitting, securing grid connections, land acquisition, and competing with established players.
  • Retail: The market is highly competitive and currently turbulent. Success demands sophisticated energy procurement and risk management strategies (hedging fuel and wholesale price exposure), efficient operations, and a strong customer value proposition beyond just price (e.g., green tariffs, energy management services, bundling).
  • Wholesale Trading & Services: Opportunities may exist in electricity trading on JEPX (requiring specific licenses), developing financial hedging instruments (currently limited), providing demand response or VPP (Virtual Power Plant) aggregation services, or offering balancing services as the market matures.
  • Technology & Services: There is demand for smart grid technologies, advanced metering infrastructure, energy efficiency solutions, grid modernization equipment, EV charging infrastructure and management platforms, and software for energy trading and risk management.
  • Navigating Regulation: The regulatory environment is complex and subject to frequent updates. Success requires staying abreast of changes in market rules (JEPX, OCCTO), METI policies, T&D network codes, and JFTC competition guidelines. Engaging with industry associations and potentially local regulatory counsel is advisable.

Conclusion

Japan's electricity market is in the midst of a generational shift. The move towards competition, unbundling, and decarbonization is creating a dynamic but challenging environment. While recent global energy shocks have exposed vulnerabilities and led to significant market turmoil, the underlying reforms continue to progress, supported by new market mechanisms like the capacity market and long-term auctions designed to ensure stability and guide investment. For foreign businesses, opportunities exist across the value chain, from renewable generation and grid technology to sophisticated retail offerings and trading services. However, success demands a deep understanding of the intricate market design, the evolving regulatory landscape, the persistent influence of incumbent players, and the critical importance of robust risk management strategies. Careful analysis and strategic positioning will be essential to navigate the complexities and capitalize on the potential of this major energy market transition.