Reforming Japan’s Capacity Market: Balancing Supply Security with Decarbonization

Japan is at a critical crossroads in its energy transition. On April 23, the Ministry of Economy, Trade, and Industry (METI) convened the 110th Working Group on Electricity and Gas Market Design to address a pressing issue: the current Capacity Market is struggling to secure enough power supply for the late 2020s without placing an undue financial burden on the public.

Japan operates a "Capacity Market" (main auctions held four years in advance) to ensure "kW" (availability) rather than just "kWh" (actual energy generated). However, the most recent auction for fiscal year 2029 revealed a structural flaw.

Bids in the Tohoku and Tokyo areas failed to meet the required supply reliability standards. Costs for maintaining aging thermal plants are skyrocketing due to inflation, labor shortages, and fuel uncertainty. Consequently, many power plants cannot break even under the current price caps (Net CONE—Net Cost of New Entry), leading them to withdraw from the market or refrain from bidding.

The Problem: Price Signals vs. Public Burden

The Japanese government faces a dilemma:

1. Supply Risk: If price caps aren't raised, more power plants (especially aging thermal units) will retire, risking blackouts.
2. Cost Risk: If price caps are simply raised across the board, the "Single Price Auction" system means even low-cost providers get paid the new high price, leading to a massive spike in the "capacity levy" paid by end-consumers.

To solve this, experts are proposing a "hybrid" model. Instead of a simple price hike, they are discussing a mix of Single Price (for the bulk of supply) and Multi-Price (pay-as-bid for the expensive remaining margin) to minimize the total cost to the public while keeping essential plants online.

GHG Protocol Scope 2 and the Decarbonization Signal

For international players, the most vital aspect is how this aligns with global standards like the GHG Protocol Scope 2 guidance (slated for revision in 2030).

Currently, Japan’s Capacity Market treats all "kW" essentially the same. However, as 24/7 carbon-free energy (CFE) and "Hourly Matching" become the global gold standard, the market must evolve. It is no longer enough to just have "available capacity"; the market needs to differentiate between high-emission legacy coal and flexible, low-carbon adjustments.

Future Outlook for New Entrants

The Working Group highlighted that the current 1-year capacity contract is insufficient to incentivize New Entry (Greensfield projects). Experts are calling for:

• Targeted Auctions: Separate mechanisms for new-build or large-scale repowering with multi-year revenue certainty.
• Regional & Temporal Granularity: Moving toward price signals that reflect grid constraints and the time-specific value of renewables.

The Bottom Line: Japan is moving away from a "one-size-fits-all" capacity price toward a more sophisticated, granular market. For those entering the market, the opportunity lies in providing "adjustment power" (like long-duration storage or pumped hydro) that can navigate the increasing complexity of a grid striving for both reliability and Net Zero.