Like many markets, the Japanese power market is reforming, liberalising and diversifying to support the rapid buildout of new renewable energy resources and adjusting to the influx of intermittent generation that comes with it. Taking cues from markets that have travelled similar paths like Germany, the UK and the US, Japanese regulators have been crafting a unique power market to balance the classic energy trilemma of security, economy and sustainability. These market changes mean that prospective and current asset owners participating in Japan’s power market will need to navigate new standards and face new challenges, but will also be able to tap into new opportunities.
An Overview of Japan’s Evolving Market
Japan’s market has remarkable growth in renewable generation, with particularly strong solar capacity and a growing pipeline of wind assets. Renewables now account for over 20% of Japan’s electricity generation, and the country is taking steps to almost double that to 36-38% by 2030 to meet ambitious climate targets.
The government clearly recognizes that in order to achieve those targets, they need not only continued strong growth in renewable capacity but also an economic way to dispatch power and encourage the market to ensure a secure supply. Simply continuing with the status-quo is not a viable solution; when renewable assets are not obligated to participate in the market and can simply put power to the grid and receive a fixed Feed-in-Tariff, regardless of the market’s supply and demand, then the system suffers. Renewables in Japan already severely impact the day ahead prices of power, frequently driving the price to near zero on sunny days in many regions, and giving the price a pronounced “duck” curve. That effect coupled with no obligation to participate in the market means the market has inadequate information on the supply and demand situation, and it reduces the liquidity in intraday markets and makes for inefficient dispatch of the available assets. In short, it drives up the costs of the renewable transition.
So it follows naturally that as a part of this journey, Japan’s power markets have transitioned from a Feed-in-Tariff (FIT) to a Feed-In-Premium (FIP). This new subsidy mechanism means that asset owners now have to sell their power in the market, and then receive a premium payment on top of their market revenues to ensure that the asset generates a minimum level of income per MWh produced, and it is also possible to sell power at a premium to the previous FIT price. It is a bankable and proven structure, quite similar to the way Germany’s market is structured with its strike price mechanisms. In both cases, renewables are trying to achieve a reference price set by the government which gives asset owners the confidence to invest in new generation while still being required to participate in the market. Compared to the FIT mechanism, there are significant new risks since selling the wrong quantity can result in imbalance costs for the generator, and failing to achieve the reference price can result in a loss of income. However for some generators, the market opportunity clearly outweighs the downside additional costs, and we are already seeing assets transitioning from FIT to FIP.
In Germany, the transition was extremely beneficial for the TSOs and the end consumers. The new obligations created a need for support from specialist traders like Trailstone who have increased the forecasting capability of the system, reduced the requirements for reserves and increased the liquidity in the intraday markets—all of which reduced costs for the system. As Japan moves further down this path, it is no surprise that many Japanese energy companies are looking to the west to learn from Europe’s experience. In turn, European energy companies are looking to Japan as an opportunity to apply lessons learned from their 10+ years of experience at home.
In addition to governmental support, the global move towards generation assets being built under a corporate power purchase agreement (PPA) is also playing out in Japan. These “additionality” PPAs help corporates demonstrate their commitment to the country they operate in by not putting the costs of their ESG and green marketing initiatives onto the end consumers. It is a hugely significant move by the corporates concerned and demonstrates a real recognition that they want to take genuine responsibility for their environmental credentials. However, these unsubsidised PPAs can also create enormous headaches in hedging and managing the volumetric supply risks which are often difficult to manage for both the asset owner and the corporate PPA provider.
To properly manage these risks, an active trading and risk management team must constantly monitor the position and adjust trades in the forward or futures markets. We believe that it is a natural fit for traders to form the backbone of the market as asset owners and corporates look to professional risk managers to minimise their exposures.
This new role of energy traders managing intermittency risks will naturally increase the volumes of power traded in EEX and TOCOM futures markets, with a corresponding increase in market liquidity. In a virtuous cycle, increased liquidity will also benefit flexible assets like batteries and pumped hydro by allowing them to optimise revenues to capture the value of their flexibility across multiple timeframes and flatten the duck curves to the benefit of the intermittent generators.
Power market liquidity has a very significant benefit for end consumers. Visibility of power prices, and by extension the net supply and demand curve, enables participants to plan and act in good time to minimise market risks. This ensures the lowest cost marginal MW to be activated which reduces risks for supply companies so they are better able to manage their positions and provide power to consumers at a lower cost.
As Japan works to reach its climate goals, its energy markets are evolving dramatically to accommodate more intermittent renewable energy. The work of the Japanese regulators so far is hugely encouraging, but there is still some way to go to reap all the benefits of liquid futures, spot and intraday markets. In the meantime, asset owners have two different and potentially attractive routes to build their assets, either as FIP or Corporate PPAs—a level of optionality that we expect to be extremely positive for the transition and environment.