Japan Deregulates Its Electricity Sector

8 MINS READDec 26, 2013 | 10:52 GMT
Japan Deregulates its Electricity Sector
Emergency crews try to fix power lines in Miyagi prefecture, Japan, in March 2011.
(MIKE CLARKE/AFP/Getty Images)

Resource-poor Japan has taken a step to revitalize its domestic energy sector. In mid-November, Japan's upper house of parliament approved a comprehensive reform of the country's electricity sector. The reforms mark another step in Prime Minister Shinzo Abe and the Liberal Democratic Party's economic revitalization plan, which has also included fiscal and monetary stimulus packages. The reform plan calls for near-complete deregulation of the sector in the hopes that it will lead to increased efficiency and lower energy prices. Even if this part of the plan proves successful, many of the problems with the sector are structural — namely the resumption of nuclear power and the high cost of importing natural gas and oil, which must be addressed eventually to put the country on a more sustainable path for its energy needs.

Japan's modern electricity sector is largely a relic of the American occupation following World War II when nine regional electric utilities were set up across Japan (a tenth was set up in Okinawa, which returned to Japanese control in 1972). These vertically integrated companies controlled power generation, transmission and distribution for their defined regions, operating effectively as monopolies over their geographic areas. Over the course of Japan's economic boom from World War II until its financial crisis in the early 1990s, these utilities became powerful political actors and were entrenched in Japanese politics, specifically Japan's dominant Liberal Democratic Party, which led the government almost exclusively from 1955 to 2009.

The electricity sector's structure led to a grossly inefficient system and resulted in higher electricity costs. During the stagnation and recession of the 1990s, Tokyo considered liberalizing several sectors of the economy in an attempt to spur growth, and first attempted to deregulate the power sector in 1995. However, political pressure from the powerful utilities resulted in only partial deregulation in that it established a few independent power producers to compete with the established producers and allowed for electricity trading between the regional grids. Between 1995 and 2010 several more proposals were made, but the impact was limited. Indeed, to this day, the regional monopolies produce more than 95 percent of Japan's electricity and there is limited connectivity between each regional utility's power grids.

Besides the energy sector's organizational problems, Japan's status as an island chain with limited natural resources at its disposal for power generation also complicates its reform efforts. Although the country has some hydroelectric power plants and other sources of renewable energy, Japan's only large-scale energy options are to import fossil fuels for power generation, which leaves the country strategically vulnerable, or to construct nuclear power plants, as it has done over the past several decades. Though nuclear power plants require imports of nuclear fuel, prior to the Fukushima meltdown Tokyo viewed nuclear power as a quasi-domestically produced power supply and pushed for it to be the backbone of the electricity generation fleet. Furthermore, in 2010 the Democratic Party of Japan launched a plan to increase the share of domestic sources of electricity from 38 percent to 70 percent by 2030, driven largely by increasing nuclear power.

The Fukushima disaster turned these ambitions on their head. The government shut down all nuclear reactors in response to the accident, with the last one going offline in September. It is not clear when or even if they will be restarted. Even if they are restarted, this resumption of power generation would be phased in, meaning the most pronounced effects would not be felt until about 2020. The political consequences from the accident were also dramatic: Public outcry following the nuclear meltdown undermined the power of the regional monopolies, and unhappiness with the government response to the accident led to the defeat of the Democratic Party of Japan, which briefly held power from 2009 to 2012. The Liberal Democratic Party was restored to power in 2012, and that party's deep connections with the electric utilities — which know that the public is demanding reform and that the Japanese economy needs it — made reform more likely. Indeed, the Liberal Democratic Party ran on a platform that included a partial restart of nuclear power plants — by far the most economical source of electricity for power generation.

This confluence of factors allowed Abe and the Liberal Democratic Party to push through Japan's first comprehensive energy reform of the postwar era in November 2013. The reform plan has three key components. First, Japan will establish an independent systems operator that will control electricity flows across the entire country by 2015. Second, by 2018 Japan will deregulate the retail market allowing consumers to choose their retail providers. Finally, by 2020 Japan will break up transmission and distribution sectors. These changes would effectively allow the generation sector to be opened up to competition without the severe limitations seen today. Additionally, Tokyo will regulate electricity tariffs until the process is completed and full competition can take hold.

Effectiveness of the Plan

After all the reform measures are implemented, electricity prices will be lower than they would otherwise have been, though the most critical part of the reform as far as prices are concerned will not be implemented until 2020. Because power companies control the transmission lines until that time, they control access to them and can charge independent power producers high fees to access their transmission lines — unless Tokyo steps in, of course. Additionally, since that goal is seven years away, there is a great deal of uncertainty. At the moment, a window of opportunity exists that should allow the reforms to be implemented effectively — Abe and the Liberal Democratic Party have strong public approval ratings, elections are not required until 2016 and they have the ability to harness the bureaucracy.

However, the Democratic Party of Japan's victory in 2009 marked a substantial change in the domestic political landscape. Japan has seen an increase in party competition, with the Liberal Democratic Party's stranglehold on the government weakening over time. The public could dump the Liberal Democratic Party yet again, which could result in a failure to implement Abe's plan. Something similar happened when the Democratic Party of Japan took power and opposed the postal savings bank privatization that the Liberal Democratic Party had put into effect in the early 2000s during a period of what had seemed like strong political momentum under then-popular leader Junichiro Koizumi. While Abe's power sector reform appears to rest on firm public support, nevertheless there can be no assurance that Japan's political cycles will not interfere with its implementation.

Ultimately, some degree of reform seems likely to be implemented, and that will help introduce competition into the electricity sector and likely lower prices. However, the reforms are not merely administrative but also infrastructural and financial. As mentioned above, there is limited connectivity between each regional grid right now, requiring investment in building out transmission lines between them. Even more difficult to overcome, the grids in the northern half of the country and the grids in the south operate on different frequencies, thus requiring high-voltage, direct current transmission lines or frequency converters to share electricity between the two. These issues will require significant investment to resolve, which there will be no incentive to fund until after the power companies are split up.

Unlike most other industrialized countries, Japan's lack of domestic energy resources requires it to import all of its feedstock for fossil fuel. Additionally, natural gas prices in Asia are much higher than the rest of the world, putting the country at another disadvantage. Further complicating matters is Abe's economic initiative, dubbed "Abenomics," which involved a massive monetary stimulus plan in order to increase inflation to 2 percent and decrease the value of the yen, thus making Japan's exports more competitive and foreign currency earnings more valuable. However, a decreased value of the yen increases the cost (in yen) of importing expensive natural gas and other fossil fuels. This is one central reason why Abe's energy reform will include restarting some of Japan's nuclear power plants, though at this point the number that will be restarted is vague. In any case, the process of restarting nuclear plants will be slow and gradual, and only after 2020 will there be substantial cumulative effects.

This means that Japan will continue to rely on imported natural gas and, to a lesser degree, oil. After Japan switched off its nuclear power plants, natural gas and oil were the primary replacements. Japan also had to recommission previously mothballed thermal power plants to meet electricity demand. The result has been dramatic increases in liquefied natural gas and oil imports. Additionally, many of Japan's natural gas power plants are not modernized and it is estimated that more advanced and efficient natural gas power plants could allow Japan to cut liquefied natural gas imports by as much as 8 percent. Japan is already in the process of installing more efficient natural gas power plants, though this will also take time and significant investment.

Japan's huge new import costs have resulted in nearly unprecedented trade and current account deficits, which are putting pressure on Japan's overall financial balance. Monetary stimulus is limited by this component, as well as the fiscal constraints from Japan's huge debt. Pressure will build on Abe's government and future governments not only to break up the regional monopolies but also to restart the nuclear power plants. However, while that political battle has not yet been fought, there are fresh signs of stress within the Liberal Democratic Party — as evident by Koizumi's harsh criticism of Abe's support for resuming nuclear energy production — and it will take time for the public to reconcile itself to returning to large-scale nuclear power. Still, reforms in the electricity sector can at least boost competition and other mechanisms that can drive down electricity prices, thus helping Japanese exporters compete internationally, without fully turning back to nuclear power.

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