The Journal The Authority on Global Business in Japan

In February, the ACCJ Energy Committee issued a Viewpoint encouraging Japan to adopt market mechanisms promoting investment in demand-side as well as supply-side energy resources. Why? We no longer live in a world in which building new power plants—or updating older ones—is the only way to keep up with society’s shifting energy needs.

In addition to diversifying supply-side resources (e.g. with distributed generation and more renewable energy options), competitive energy markets around the world are promoting investment in means of adjusting demand itself, both short-term peak demand adjustment mechanisms (“demand response”) as well as long-term improvements in energy efficiency.

We see this, for example, in the PJM Interconnection—the regional transmission organization that oversees grid operations and the electric transmission system across 14 US states, from the East Coast to the Midwest. Delivering power to over 60 million people, PJM operates one of the world’s largest competitive wholesale electricity markets.

Power is purchased based on auctions of various types, including payments for “capacity,” or commitments to provide enough power to meet future demand. The idea here is to direct investment a few years ahead of delivery, creating an ongoing, flexible market for whatever resources will best meet future energy needs.

Since there is no functional difference between a megawatt of power from a power plant and a megawatt of reduced power in PJM’s capacity auctions, the auctions encourage investment in—and create long-term price signals for—a wide variety of energy resources. Whether clean energy, fossil fuels, or demand-side resources like energy efficiency or demand response, every resource bids into the auction at its total cost of operation (capital costs plus operational costs). Bids are collected from lowest to highest cost, until enough capacity has been acquired to meet demand. The most expensive capacity commitments, those that do not meet the “clearing price,” are rejected.

At this year’s auction—at which payments for 2019–2020 capacity commitments amounted to $6.9 billion—over 10 gigawatts (GW) of demand response cleared the auction, in addition to 1.5 GW of energy efficiency, 5 GW of new combined-cycle natural gas generation, 969 megawatts (MW) of wind generation, and 335 MW of solar generation capacity (double the amount from the previous year).

At the same time, 2,600 MW of coal commitments and 1,500 MW of nuclear commitments failed to clear the auction, with a number of aging coal-fired and nuclear power plants now likely to be shut down as a result. The market has spoken, and it has shown that new sources of capacity (including demand response, efficiency, and renewables) can play a much greater role—and do so sooner—than just about anyone would have predicted.

Contrast this to Japan’s 2030 “energy mix” forecasting, announced just last year. In addition to restarting most idled nuclear plants, the government has forecast the development of 27 GW of new coal capacity. On this latter point in particular, Japan is at odds with the world’s other major economies, which are rapidly moving away from publicly supported investment in carbon-intensive power generation. This is not just a policy decision, but a market-based one.

In 2015, the Diet passed legislation that should eventually lead Japan to adopt a market-based electricity supply system, but so far no one knows when this system will start or what it will look like. Whatever the result, it is crucial that Japan prioritize the design of deep, liquid wholesale markets so as to encourage investment in lowest-cost, most-efficient technologies and services.

At PJM and elsewhere, costs of electricity from low-carbon energy sources are declining faster than expected due to rapid, market-driven technological advances and accelerated economies of scale. By sticking to politically determined rather than market-determined energy targets, Japan risks shackling itself to high-carbon, overly expensive, and ultimately stranded asset investments that are not in line with global market trends. Japan could save its citizens money, promote domestic energy innovation, and reduce energy imports by adopting a market-based approach.

Dr. Ken Haig is co-chair of the ACCJ Energy Committee and director of regulatory affairs at Opower Japan
It is crucial that Japan prioritize the design of deep, liquid wholesale markets.