【Hourly Matching Council Report】Power Sector Reform in Japan

Japan's power sector faces a daunting challenge of simultaneously ensuring a stable supply of electricity, improving economic efficiency, and further expanding renewable energy.

Amid current inflation, high interest rates, and population decline, explosive growth in electricity demand driven by data centers, the shift to EVs, and the repatriation of production facilities may necessitate the largest expansion of power generation and grid infrastructure in 40 years.

In this context, while discussions on power system reform continue domestically, international standardization in the decarbonization sector is advancing rapidly overseas, creating a situation where a unified solution to these two incompatible agendas remains elusive.

Regarding decarbonization, efforts to revise the GHG Protocol’s Scope 2 guidelines are underway globally.

Against this backdrop, discussions are currently underway in Japan regarding reforms to the trading system for electricity and environmental credits—which form the core of the domestic power system—as outlined below.

Discussions on Domestic Power System Reform Proceeding in Parallel with Global Decarbonization Rule Revisions

Japan’s electricity market is composed of multiple systems separated by function, such as electricity volume, supply capacity, balancing capacity, and environmental value.

First, electricity volume trading takes place at the Japan Electric Power Exchange (JEPX), where supply and demand are adjusted in 30-minute intervals through the day-ahead spot market and the intraday market.

In fact, approximately 30–40% of total demand passes through this market, serving as the procurement foundation for retail electricity suppliers; however, a key challenge is the high risk of price volatility due to its strong susceptibility to fuel prices and supply-demand tightness.

To complement this, a capacity market has been established to secure future supply capacity, and a demand response market has been developed to maintain real-time supply-demand balance. In the capacity market, kW-value is secured through auctions four years in advance, while the demand response market ensures grid stability by trading ΔkW and kWh separately.

Furthermore, mechanisms to promote stable power procurement, such as the consideration of a baseload market and medium- to long-term trading markets, are also under discussion.

On the other hand, regarding environmental value, the system is centered on the non-fossil certificate market, where trading occurs separately from electricity itself. While FIT certificates and non-FIT certificates circulate through auctions and bilateral contracts, prices tend to remain at the lower limit, presenting the challenge that they are not functioning sufficiently as incentives for renewable energy investment.

Furthermore, the GX-ETS, which will become fully operational in fiscal year 2026, is a system that places a price on emissions themselves, making the issue of double taxation with non-fossil certificates and the consistency between systems key points of debate.

As such, because Japan’s electricity market is fragmented into separate systems based on function, its structure does not necessarily allow price signals and investment incentives to work in unison. As a result, the system makes it difficult to simultaneously achieve a stable power supply, economic efficiency, and decarbonization. While a comprehensive review is currently underway through discussions on medium- to long-term trading markets and real-time markets, ensuring consistency among these systems remains a major challenge.

Moving forward, a transition to a market design that integrates electricity volume, environmental value, and temporal information is required. In particular, there is a need to enhance the temporal and spatial granularity of GHG Protocol Scope 2—a topic currently under active international discussion—and to ensure consistency.

Going forward, we must transition to a market design that comprehensively integrates electricity volume, environmental value, and temporal data. In particular, we are called upon to rebuild the overall policy and regulatory framework while ensuring consistency with the increasingly sophisticated temporal and spatial granularity of GHG Protocol Scope 2, which is currently the subject of international debate.

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Progress Report: Japan’s Power Sector Reform (Hourly Matching Promotion Council)

Below is an overview of each market and a summary of the system reform measures currently being discussed by government-appointed committees and other bodies.

1. Wholesale Electricity Market (JEPX)

The wholesale electricity market (JEPX) is a market where power generators (sellers) and retail electricity suppliers (buyers) trade the actual amount of electricity (kWh) to be generated and consumed. Currently, approximately 30–40% of Japan’s total electricity demand is traded through this market, making it a critical procurement base for retail suppliers.

In terms of the trading timeline, the market is divided into the spot market (day-ahead market), which primarily takes place the “day before” actual supply and demand, and the intraday market, which takes place on the “same day (immediately before actual supply and demand)” to respond to fluctuations in supply and demand.

Trading is conducted in 30-minute intervals throughout the day, and a single-price auction system is used, in which prices are determined by matching the bid prices and quantities submitted by sellers and buyers.

Furthermore, to promote fair competition, guidelines require major power companies with market dominance to participate in a “voluntary initiative” whereby they supply all surplus electricity at marginal costs, such as fuel expenses.

The biggest issue with JEPX is the extremely high risk of price volatility. Prices in the spot market fluctuate wildly, directly influenced by changes in international fuel prices (such as LNG) and shifts in the supply-demand balance caused by weather conditions. In fact, during the period of soaring fuel prices starting in fiscal year 2021, market prices skyrocketed, leading to a series of withdrawals and business suspensions among new power suppliers that had relied excessively on spot procurement.

As a result, confusion arose, with many consumers forced into unintended contract terminations or transitions to guaranteed minimum supply, leading to sudden changes in electricity rates that were socially unacceptable.

To prevent a recurrence of such situations, the Agency for Natural Resources and Energy’s Working Group on System Review and other bodies are proceeding with the following revisions.

Introduction of an obligation to secure a certain level of supply capacity:

To prevent retail electricity suppliers from relying excessively on the spot market, the introduction of regulations is being considered that would require them to secure a certain percentage of supply capacity through physical contracts or other means in stages—for example, 50% of projected demand three years in advance and 70% one year in advance.

Establishment of a “Medium- to Long-Term Trading Market”: Separate from the highly volatile short-term market, efforts are underway to create a new market for standardized medium- to long-term products with delivery periods of one or three years. This would allow both retailers and power generators to plan for stable procurement and investment returns in terms of both volume and price.

Consideration of Introducing a “Simultaneous Market”: Currently, electricity (kWh) is procured on JEPX, while balancing power (ΔkW) is procured separately on the supply-demand balancing market; this has contributed to inefficient power plant operations and soaring prices. To resolve this, full-scale discussions are underway to establish a “simultaneous market” that allows electricity and balancing power to be traded and matched simultaneously, while taking grid constraints into account, thereby enabling the most economical operation of power plants.

2. Baseload Market

Since the full liberalization of the retail electricity market in 2016, the baseload market has enabled new retail electricity suppliers (new power companies) to access low-cost electricity on terms equivalent to those of the former general electricity suppliers (major power companies).

The focus is on power sources known as “baseload power,” which are capable of generating electricity at low operating costs and with high efficiency. Specifically, this includes coal-fired power, conventional hydroelectric power (run-of-river), nuclear power, and geothermal power. These sources require high initial investment and are difficult to develop from scratch, so major electric utilities and other entities own the majority of them. In the baseload market, major power companies and other entities are institutionally required to supply a portion of the electricity generated by their baseload power sources to the market at a fair price. Once a transaction is concluded, electricity is delivered over a fixed period—typically one year—via the previous day’s spot market.

In this process, any difference between the spot market price and the executed price in the baseload market (such as inter-area price differentials) is settled retrospectively.

However, several issues are currently emerging in this market.

• Increased price risk: Due to high volatility in spot market prices, settlement prices deviate significantly from contract prices, exposing both sellers and buyers to substantial price risk.
• Decline in supply volume: As a result of the expansion of wholesale transactions (non-discriminatory wholesale) through direct bilateral contracts between major power companies and new power suppliers, the volume of electricity supplied to the baseload market under the system is on a downward trend.
• Distortion of J-POWER’s Supply Obligations: An unreasonable situation had arisen in which J-POWER, in order to fulfill its market supply obligations while complying with the government’s “Rules for Restricting the Operation of Inefficient Coal-Fired Power Plants,” was forced to procure the shortfall from the spot market rather than from its own power generation sources.

In response to these challenges, the Agency for Natural Resources and Energy’s System Review Working Group and other bodies are proceeding with the following revisions.

• Revision of Rules: A revision was implemented to deduct a certain amount from J-POWER’s supply obligation to align it with the operation restriction rules.
• Mitigation of Excessive Price Difference Risks: System improvements are being implemented, such as adjusting the thresholds for compensating or collecting price differences.
• Phased Phase-out of the Market: As the primary reform policy, it is anticipated that the “Medium- to Long-Term Trading Market,” which the government is currently establishing, will be able to replace the objectives and roles of the baseload market. Therefore, detailed discussions regarding the specific timing and process are underway with the aim of phasing out the baseload market itself in the future.

3. Electricity Futures Market

The electricity futures market is a market where electricity prices for a specific future period are agreed upon in advance and traded. It is characterized as a market where transactions are conducted as “financial instruments” that do not involve the actual delivery or procurement of electricity (spot/kWh), and it is primarily a cash-settled market.

In Japan, two markets coexist: the Tokyo Commodity Exchange (TOCOM), a subsidiary of the Japan Exchange Group (JPX), and the European Energy Exchange (EEX). A major difference from JEPX is that futures trading involves “financial instruments that do not entail the procurement of physical goods (delivery of electricity)” and relies on “financial settlement.”

The main participants in the futures market are as follows:

• Retail electricity suppliers: These participants aim to hedge against price volatility and seasonal fluctuation risks in markets such as the spot market of the Japan Electric Power Exchange (JEPX) in order to stabilize procurement costs.
• Speculative participants (traders, etc.): These are players whose objective is to profit from price fluctuations. Since the futures market allows for trading without underlying physical demand, numerous players other than power generators and retail electricity suppliers participate.

Meanwhile, the Agency for Natural Resources and Energy is moving forward with the creation of a “medium- to long-term trading market,” a market involving the physical delivery of electricity (kWh). Medium- to Long-Term Trading Market

Therefore, rather than categorically excluding futures trading, the policy is to continue examining the details of how to handle transactions that align with policy objectives (such as those appropriately linked to physical procurement), while monitoring trading conditions in the medium- to long-term markets and futures markets.

Furthermore, the government states that it will consider measures that take into account the reality that much of futures trading takes place on exchanges governed by foreign laws (such as EEX).

4. Supply and Demand Balancing Market

Balancing capacity refers to the “ability to flexibly increase or decrease output” used by general transmission and distribution operators to constantly match electricity demand (consumption) with supply (generation) and maintain grid frequency. The “Supply and Demand Balancing Market” is the venue where sellers—such as power generators and aggregators—and buyers—general transmission and distribution operators—conduct transactions to procure this balancing capacity on a wide-area and efficient basis.

Transactions in the Supply and Demand Balancing Market are conducted based on two values: “ΔkW (delta kilowatts),” which represents compensation for standing by to respond to instructions, and “kWh,” which represents compensation for actual increases or decreases in output.

There are five product categories ranging from “Primary” to “Tertiary 2,” classified based on factors such as response time. Currently, Tertiary 2 is traded on a “day-ahead” basis (the day before actual supply and demand), while other products are traded on a “weekly” basis (aggregating one week’s worth of data). The system is designed so that bids are awarded in order of the lowest ΔkW price.

To address various challenges, the following revisions are being implemented primarily by fiscal year 2026. Transition of all products to day-ahead trading and 30-minute intervals: By shifting all products from weekly trading to “day-ahead trading” and changing the interval to 30-minute slots, we will reduce bidders’ risk and increase the volume of bids.

• Optimization (reduction) of the tender volume: To prevent cost escalation, the market tender volume for Primary and Secondary Market 1 will be reduced from the current 3σ (sigma) equivalent to 1σ equivalent, and the shortfall will be supplemented through operations such as off-market capacity utilization agreements.
• Lowering Price Caps: We plan to lower the price caps for the primary and secondary (1) markets from the current 19.51 yen/ΔkW·30 minutes to 15 yen. If competition does not improve, we will gradually lower the cap to 7.21 yen.
• Consideration of Establishing a “Simultaneous Market”: In the medium to long term, efforts are underway to establish a new “simultaneous market” that optimizes and matches electricity (kWh) and balancing power (ΔkW) simultaneously to prevent competition for resources and inefficiencies.

5. Capacity Market

The capacity market is a market that trades the ability to generate electricity in the future (kW: supply capacity), rather than the actual amount of electricity generated (kWh).

It was established in fiscal year 2020 with the objectives of encouraging power source investment at appropriate times through the capacity reservation contract payments made to power generators and others, efficiently and reliably securing the supply capacity that will be needed nationwide in the future, and stabilizing wholesale electricity market prices. In principle, this mechanism evaluates the value per unit of capacity (kW) equally across all power sources, covering a wide range of sources including thermal, hydro (pumped storage), nuclear, renewable energy, and dispatchable power sources (demand response).

Under the current system, a main auction is held four years in advance of actual supply and demand to secure generation capacity. As a general rule, a “single-price system” is adopted, whereby a single price is applied to all winning bids. The demand curve used in the auction is based on “Net CONE”—the net fixed cost of constructing new power generation facilities—as the benchmark price, with a ceiling set at 1.5 times that amount.

However, in recent years, due to rising prices and increased maintenance costs associated with the aging of power generation facilities, there has been a sharp increase in the number of power sources bidding at prices exceeding the current benchmark price (Net CONE). As a result, a succession of power sources have failed to win bids due to exceeding the upper limit price. In the most recent FY2024 main auction, the target supply reliability was not achieved in four areas—Hokkaido, Tohoku, Tokyo, and Kyushu—highlighting significant challenges in ensuring a stable power supply.

To address this issue, the following revisions are being advanced by the Agency for Natural Resources and Energy’s System Review Working Group and other bodies.

First, a significant increase in the benchmark price (Net CONE) and the price cap. Reflecting the latest power generation cost verification data, the benchmark price is expected to be raised to approximately 20,000 yen/kW—more than double the current level—and the price cap will be raised accordingly. This will increase the likelihood of securing power sources that previously failed to win bids.

Second, the introduction of “changes to the contract method (mitigation measures)” to prevent a sharp increase in the “capacity contribution fees” borne by retail electricity suppliers due to the price hike. Proposals under consideration include setting a cap on the single-price zone—where the same price applies to all power sources—and applying a multi-price system (contracting at bid prices) to the range above the benchmark price, or establishing a two-tier single-price zone.

Third, to reflect actual conditions regarding severe weather response and maintenance plans, revisions are being made to the rules for calculating target procurement volumes (demand curves)—such as further subdividing monthly assessments and revising the allowable annual suspension volume—to ensure that supply capacity is secured in a manner more closely aligned with actual conditions.

6. Long-Term Decarbonized Power Source Auction

The Long-Term Decarbonized Power Source Auction is a bidding system launched in fiscal year 2023 to promote new investment in decarbonized power sources. Relying solely on the “capacity market,” which secures supply capacity for a single year four years in advance of actual supply and demand, made it difficult to ensure predictability for recouping the massive initial investment required for new power generation facilities. Therefore, this auction guarantees a fixed-cost level of capacity revenue for winning bidders for a period of 20 years in principle, creating a mechanism to support investment.

The program targets new construction and replacement projects for decarbonized power sources with an output of 100,000 kW or more. Specifically, this includes co-firing or exclusive burning of hydrogen and ammonia, battery storage, pumped-storage hydroelectricity, nuclear power, and biomass power generation; long-duration energy storage systems (LDES) were also added in the most recent call for proposals.

Current System and Challenges While bids are conducted for a mix of power source types and winning bidders can expect long-term fixed-cost recovery, they are required to remit “90% of revenue from other markets”—such as the wholesale electricity market—to the government during operation.

However, power generators have pointed out that this “90% remittance rule” “dampens incentives to secure revenue through innovation and ingenuity.” In fact, the first round of bidding saw few projects other than battery storage and pumped-storage hydroelectric power, and the current situation is that the policy has not been able to strongly promote new investment as intended. Furthermore, rising costs due to recent inflation (increases in construction costs and interest rates) are also making investment decisions difficult.

Proposed Revisions (Direction of Review) In response to these challenges, the Agency for Natural Resources and Energy’s System Review Working Group and other bodies are considering the following revisions for the fourth round of bidding:

• Revision of the price cap (threshold): Consider raising the upper limit on bid prices in light of factors such as inflation.
• Improvements based on operator needs: Strengthening functions to encourage investment, such as establishing new safety net mechanisms that go beyond mere fixed-cost support to help operators secure profits through innovation and ingenuity.
• Refinement of rules: Establishing procedures for preliminary reviews of hydrogen, ammonia, and CCS (carbon capture and storage) projects; defining the nature of price competition; and developing rules for market exit after winning a bid.

7. Non-Fossil Value Trading

“Non-fossil value” refers to the environmental value—such as “zero-emission value” (the fact that no CO2 is emitted) and the contribution to improving energy self-sufficiency—possessed by power sources that do not use fossil fuels, such as renewable energy and nuclear power. “Non-fossil certificates” are instruments that extract and make this value tradable. “Traceable non-fossil certificates,” which include information such as the power plant’s location and power source type, can be utilized in international initiatives such as RE100.

Similar mechanisms include “Green Power Certificates,” in which private organizations certify the environmental value of renewable energy, and “J-Credits,” in which the government certifies greenhouse gas emission reductions and absorption achieved through energy conservation and other measures. In contrast, Non-Fossil Certificates are a national system specifically focused on the environmental value of electricity.

Additionally, the “GX-ETS” is an emissions trading system set to begin full-scale operation in fiscal year 2026. It is a system that mandates the procurement and holding of emission allowances based on actual CO2 emissions, and thus differs in purpose and mechanism from Non-Fossil Certificates, which involve purchasing environmental value to claim the use of renewable energy.

Trading in non-fossil certificates takes place in two markets: the “Renewable Energy Value Trading Market,” which handles “FIT certificates” derived from FIT-eligible power sources, and the “Advanced Energy Act Compliance Market,” which handles “non-FIT certificates” derived from non-FIT power sources.

Auctions are held four times a year. In the Renewable Energy Value Trading Market, retail electricity suppliers, as well as consumers and intermediaries, participate and purchase certificates through a multi-price system. On the other hand, the Advanced Energy Act Compliance Market is primarily participated in by retail electricity suppliers, and transactions are conducted using a single-price system; however, the majority of non-FIT certificates are bought and sold through bilateral transactions between power generators and retailers or end-users.

There are various challenges surrounding non-fossil value trading. In the FIT certificate auctions, supply far exceeds demand, and the contract price remains stuck at the minimum price (0.4 yen/kWh).

This situation is viewed as problematic because consumers can procure certificates at low prices, which dampens their incentive to enter into long-term renewable energy procurement agreements (PPAs) with power generators. Furthermore, many non-FIT certificates are also traded near the minimum price (0.6 yen/kWh), and given the recent surge in prices, their real value as an incentive for maintaining and expanding renewable energy sources has diminished.

In response, the Agency for Natural Resources and Energy is re-examining the feasibility of raising the minimum price for FIT certificates and adjusting the maximum price. At the same time, the agency is moving forward with regulatory reforms aimed at establishing appropriate pricing for renewable energy and promoting investment, including a plan to raise the minimum price for non-FIT certificates to 0.8 yen/kWh by fiscal year 2028.

8. GX-ETS

The GX-ETS is an emissions trading system that forms the core of the “Growth-Oriented Carbon Pricing Initiative,” which aims to achieve both carbon neutrality by 2050 and economic growth. A voluntary pilot program began in the “GX League” in fiscal year 2023, and the system will become fully operational in fiscal year 2026 based on the revised GX Promotion Act. Furthermore, starting in fiscal year 2033, paid auctions for emission allowances are scheduled to be phased in for the power generation sector.

When the system goes into full operation in fiscal year 2026, it will target large-scale operators with direct CO2 emissions averaging 100,000 tons or more over the past three fiscal years, requiring them to participate.

Each fiscal year, companies are required to report their verified emissions data—as confirmed by a third-party organization—to the government and hold an equivalent amount of “emission allowances” by January 31 of the following fiscal year. In the event that a company fails to meet this obligation due to a shortage of allowances, it will be required to pay a penalty equal to 1.1 times the cap price.

For the free allocation of emission allowances, the “grandfathering method”—which gradually reduces allowances based on past emission records—and the “benchmarking method”—which uses the best emission intensity within the same industry as a standard—are employed. Companies adjust their emission surpluses or deficits by selling surplus allowances or purchasing deficient allowances through the emissions trading market established by the GX Promotion Organization. Furthermore, to prevent extreme price fluctuations in the market, upper and lower price limits are set in advance for emission allowances.

A major challenge moving forward is addressing overlaps with existing energy systems and clarifying cost burdens. In the electricity sector in particular, there are concerns about double regulation with the “Advanced Energy Act (Non-Fossil Certificate System),” which promotes the introduction of non-fossil fuel power sources.

It has been pointed out that if the costs of the GX-ETS borne by power generators are passed on to wholesale electricity prices, the burden on retail electricity suppliers will increase in conjunction with the cost of purchasing non-fossil certificates under the Advancement Act, ultimately leading to a double burden on consumers. Therefore, it is urgent to ensure consistency between the systems and to establish rules for appropriately and flexibly passing on the incurred costs to electricity rates.

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