Up Front

Upper House Elections Open the Door for Electricity Sector Reform in Japan

Alisa Schackmann and Charles K. Ebinger

The recent upper house elections in Japan fulfilled overwhelming expectations that prime minister Shinzo Abe’s Liberal Democratic Party (LDP) coalition would sweep majority control over the Diet. Moving forward, whether Mr. Abe decides to pursue his pet agenda of nationalist policies or, as he campaigned, to push rigorous economic reform through deregulation and fiscal stimulus bundled in his “Abenomics” initiatives, the prime minister will be under close watch both at home and overseas.

An issue that rarely makes headlines amid widespread discourse on broader economic and regulatory reform in Japan is the proposed restructuring of the country’s electric power system. The industry came under rigorous investigation following the disaster at the Fukushima Daiichi nuclear power plant in March 2011. Scrutiny revealed flaws in its regulatory structure including strong, historically co-operative ties between operators and regulators of nuclear power plants. While these ties were merely a component of traditional Japanese business culture in which continuity and a group mentality invite respect, they instigated widespread calls for reform to ensure that such friendly ties no longer jeopardize the health and welfare of the population. The current bill to reform the country’s electricity system is among the first policies to materialize in response to such calls for change.

There are 10 major electric power companies in Japan which, despite prior attempts by the government to liberalize the market, retain monopoly control over the regions they service; they are vertically integrated utilities responsible for generation, transmission, and distribution of electricity. The proposed bill outlines a three-phase process to encourage competition by deregulating the electricity retail market and unbundling electricity production and transmission between 2015 and 2020. The first phase will be dedicated to creating a national transmission oversight entity to regulate supply and demand on the grid. The second phase will remove regional monopoly control of existing utilities, encouraging new entrants and allowing consumers to choose their providers. The third and perhaps most transformative phase will not only abolish pricing regulations but also force utilities to unbundle their generation and transmission operations.

An unbundled and deregulated Japanese power sector may be subject to further changes in the upcoming years based on future legislation addressing carbon emissions, renewable portfolio standards, and nuclear power. If a financial mechanism such as a carbon tax makes its way through the parliament, companies that rely more heavily on coal, such as those in the north including Hokkaido Electric Power Company, might find it appealing to join forces with companies that have larger shares of nuclear or renewable sources. Another option may be to merge with a larger utility to garner sufficient means to develop capital-intensive renewable projects, such as large-scale offshore wind projects. Similarly, if power companies that have relied heavily on nuclear capacity, such as Tokyo Electric Power Company, become strained by newly established nuclear safety regulations or fail to win approval to restart nuclear operations before the plants are forced to retire, they will need to find options of substituting nuclear capacity with other sources. Other factors could also influence electricity sector reform: for instance, the Japanese grid is split between a 50Hz system in the east and a 60Hz system in the west. This split may result in a natural consolidation of utilities on each side. With limited interconnections between the two grids, companies will also have to compete for the option to service constituents across the split.

A previous attempt to push the electricity reform bill through the Diet ended in late June when, after having passed the lower house earlier in the month, it became entangled in pre-election politics and failed to reach the upper house for a scheduled vote before the session broke for the summer. After the elections, however, the bill is expected to face relatively little opposition compared to its days in the “twisted Diet.” The bill already has support of both the LDP and the opposition Democratic Party (DPJ) and will likely gain momentum when it circles back for votes in a newly cohesive Diet.

However, as experiences in other countries show – including here in the U.S. – restructuring the electricity market is no easy feat. If the bill passes without much change from its current form, utilities will be confronted with new challenges associated with adapting to competition and relinquishing control over the delivery of their power to end-use consumers. Without control of their transmission and distribution, utilities will have far less control over managing blackouts; with producer competition introduced, they will also lose the luxury of a guaranteed stream of revenue. The companies that currently control the grid thus view structural reform as a threat to their long-proven ability to provide reliable service.

Meanwhile much of the general population is convinced by popular media and politicians that restructuring will facilitate the integration of clean, non-nuclear forms of power generation and lower their electricity bills. Proponents of the bill also welcome restructuring as an opportunity for utilities and its governing entities to regain credibility among the general public. What these expectations fail to address is the possibility of blackouts becoming more frequent and end-user bills remaining high after structural reforms. Should this be the outcome, any reestablished approval of the electric power system would be short-lived.

The proposed electricity system reform bill would completely transform the Japanese power structure and may even go further to stimulate changes in the traditional culture and mentality at the root of the sector’s operations. Despite Mr. Abe’s victory on July 21, however, there is no guarantee that the proposed reforms will enjoy a smooth ride to implementation much less result in attractive benefits including lower domestic electricity prices. The prime minister has a trying road ahead in spearheading power sector reform especially in a country like Japan where pride in tradition is a fundamental part of the culture. Yet if successful, Mr. Abe will contribute to a tradition of resilience exhibited by Japan throughout history in the face of change from post-war reconstruction to post-oil crisis diversification.

The international energy community is no doubt curious as to what the elections mean for the future of nuclear power in Japan, the implications for the deployment of renewables, as well as what opportunities foreign fuels, technologies, and investment will have in a restructured market. Stay tuned for more on the proposed bill and these related issues.