{"id":4435,"date":"2019-06-03T16:46:55","date_gmt":"2019-06-03T07:46:55","guid":{"rendered":"http:\/\/www.cnic.jp\/english\/?p=4435"},"modified":"2019-06-05T14:47:35","modified_gmt":"2019-06-05T05:47:35","slug":"the-capacity-market-an-overview-and-issues","status":"publish","type":"post","link":"https:\/\/cnic.jp\/english\/?p=4435","title":{"rendered":"The Capacity Market: An overview and issues"},"content":{"rendered":"\n

By Matsukubo Hajime (CNIC)<\/em><\/p>\n\n\n\n

\"\"
23 April 2019, Tokyo: CNIC’s Matsukubo Hajime speaks at a public seminar on the capacity market. Raising awareness and understanding of this difficult issue is an important CNIC mission. Interest was high and there were many questions from participants. <\/figcaption><\/figure>\n\n\n\n

The reform of the Japanese electric power system, including the\nderegulation of electric power retailing and the separation of power\ngeneration and transmission, occasioned the creation of several new markets. One\nof these, the capacity market, when looking at examples from other countries,\nhas effectively metamorphized into a subsidy for nuclear and coal-fired\ngenerating plants. With the market design as it is currently being considered,\nthe size of the capacity market will likely be around 1.4 trillion yen, which\nwill finally be levied from electricity bills.<\/p>\n\n\n\n

Background<\/strong><\/p>\n\n\n\n

Until the reform of the electric power system, the generation, transmission\nand distribution, and retail of Japan\u2019s electrical power was almost totally\nmonopolized by the former ten regional \u201cgeneral power companies,\u201d including the\nwell-known Tokyo Electric Power Company (TEPCO) and Kansai Electric Power\nCompany (KEPCO). These are the \u201cformer general power companies\u201d (below, \u201cFGPCs\u201d).\nHowever, due to calls demanding a more diverse electricity supply, the\ngovernment gave cabinet approval to the \u201cPolicy on Reform of the Electricity\nSystem\u201d in 2013. The aims of the \u201cPolicy\u201d included complete deregulation of\nelectric power retailing and the separation (\u201cunbundling\u201d) of electricity\ngeneration and transmission.<\/p>\n\n\n\n

The government then\npursued electricity system reform based on this cabinet approval, complete\nderegulation of electric power retailing being achieved in 2016 and legal unbundling\nof the power transmission and distribution sector to take place in\n2020. As a result, the share of marketed electric power held by power companies\nthat were new entrants into the market (\u201cnew power companies\u201d) expanded from\n5.2% before deregulation to 14.3% in October 2018.<\/p>\n\n\n\n

Expansion of the\nshare of the new power companies means that the FGPC share shrank.\nSince the FGPCs own around 80% of the total installed generating capacity, from\nthe viewpoint of the FGPCs, they now hold surplus generating capacity. In this\ncase, they have two main options. One is to shut down or decommission surplus\npower plants, and the other is to sell the surplus power on the wholesale electricity\nmarket and reap the profit from the sale of the electricity.<\/p>\n\n\n\n

Electric Power System Reform and the Risk of Power Supply Shortages<\/strong><\/p>\n\n\n\n

In normal commercial operations, there would be no obstacle to shutting\ndown or decommissioning a power plant which could not be run at a profit, but\nthere are cases with electricity when that should not be done. The reason is that\nif the demand and supply of electricity are not balanced then there is a risk\nof large-scale blackouts occurring. Especially problematic is how to maintain\nsupply in the face of demand peaks, which may occur several times each year,\nand when there is a large-scale blackout due to sudden power plant outages, as\nhappened during the TEPCO Fukushima Daiichi Nuclear Power Station accident in\n2011 and the Hokkaido Eastern Iburi Earthquake in 2018. Under the former\nregional monopoly system, the Electricity Business Act compelled FGPCs to\nsupply power in such cases. For this reason, FGPCs maintained power supply facilities,\nsuch as unprofitable power plants (e.g. oil-fired power plants) or ageing\nplants, to meet this demand.<\/p>\n\n\n\n

Since deregulation\nof the electric power system, however, this compulsory supply is no longer\nimposed on FGPCs but on retail electricity businesses. Seen from the viewpoint\nof the power generation side, if there is no requirement to maintain capacity\nin excess of the demand that it is obligated to supply, for instance through\none-on-one contracts with other businesses, then it has the option of shutting\ndown or decommissioning unprofitable power plants. If these plants are closed\ndown without substitute facilities being made available, there will be a high\nrisk of capacity shortages occurring at times of peak demand or supply\nemergency, etc.<\/p>\n\n\n\n

Expansion of Renewable Energy, Power Demand Reduction and the Risk of Power\nSupply Shortages<\/strong><\/p>\n\n\n\n

At the same time, issues have also appeared\nin the selling of surplus electricity on the wholesale electricity market due\nto the rapid expansion of electricity generation by renewable energy sources\n(\u201crenewables\u201d). <\/p>\n\n\n\n

In general, the\nconstruction of power plants entails huge costs. However, since fixed costs\nsuch as construction costs have already been invested, the decision about\nwhether or not to generate electricity is not based on a consideration of the\noverall costs but on whether the short-run marginal cost (SRMC) (e.g. the\nincrease in overall power generation costs when an output of 1kW is maintained\nfor 1 hour, these costs being mainly fuel and maintenance, including labor,\ncosts) is low and whether the electricity can be sold at a price exceeding the SRMC\non the wholesale electricity market. For the electricity generating business,\nthe differential in the wholesale electricity market price and the SRMC is the\nprofit it stands to make. Furthermore, the generating systems with the lowest SRMC\nare the renewables, solar and wind power, whose fuel costs are zero.<\/p>\n\n\n\n

Provided demand is\nunchanging, when large amounts of this kind of cheap electricity become\navailable, the wholesale electricity market price will naturally fall. Electricity\ngenerating businesses that have been selling their electricity on the wholesale\nelectricity market will no longer do so when the SRMC of generation exceeds the\nwholesale electricity market price. Even if they are able to sell their\nelectricity, since the market price is falling, their profits will be reduced.<\/p>\n\n\n\n

For instance, in\nthe Kyushu Power Company and Shikoku Power Company (both FGPCs) regions, cases\nhave arisen where in certain time zones roughly 80% of the total supplied electricity\nwas derived from solar or wind power. In time zones when power cannot be\ngenerated from solar power facilities, this large supply of cheap electricity\ndoes not occur. Thus, when considering the overall system, due to the\nintroduction of renewables, revenue from the sale of electricity on the\nwholesale electricity market declines to the extent that time zones occur when\nthere is low-priced electricity available. In addition, since the TEPCO Daiichi\nNuclear Power Station accident, there have also been efforts made to conserve\nenergy, causing demand itself to show a significant reduction. As a result of\nthis expansion of renewables and demand reduction, profits have fallen and the\nmaintenance of unprofitable power supply facilities has become a major burden\non electricity generating businesses.<\/p>\n\n\n\n

Further, in the\ncase of the construction of a new power plant, when the wholesale electricity\nmarket price converges on the SRMC, there is the possibility that the huge\ninitial investment in plant construction cannot be recovered. Therefore, for an\nexisting power plant, since the investment has already been made, the decision\nto operate the plant can be made on the basis of the SRMC, but to construct a\nnew power plant it is necessary to have a fairly long-term outlook for the\nselling price of the electricity. However, it will be very difficult for an\nelectricity generating business to construct a new plant if that price is\nsimply fluctuating around the SRMC.<\/p>\n\n\n\n

What a Capacity Shortage will Bring About<\/strong><\/p>\n\n\n\n

A customer exodus\nfrom FGPCs occurred as a result of the deregulation of the electric power\nsystem. In addition, a situation is also arising where the price of electric\npower is falling due to the expansion of renewables and a decline in the demand\nfor electric power. This will result in a structure where it would be better\nfor electricity generating businesses that hold surplus power plants to cut\ncosts by shutting down or decommissioning high-cost power plants in order to\nimprove earnings.<\/p>\n\n\n\n

What will happen if\nthere are fewer power plants? For instance, at peak power demand or if power\nplants stop due to some kind of trouble, there is a high risk of blackouts\noccurring due to a power supply shortage. It is also thought that the price of\nelectricity could rise due to a decline in the amount of electricity that generating\nbusinesses want to sell on the wholesale electricity market.<\/p>\n\n\n\n

If the price of\nelectricity is high, it becomes possible to construct new power plants, but in\nthe case of the construction of, for example, coal-fired or LNG-fired power\nplants, a lead time of around ten years is necessary. The result of this could\nbe that in the case of thinking about power plant construction in the situation\nwhere the number of power plants has dwindled and the trend in the price of\nelectricity is to remain high, it is possible that this price trend will remain\nunchanged over a period of about ten years.<\/p>\n\n\n\n

Capacity Mechanism and the Capacity Market<\/strong><\/p>\n\n\n\n

Given the situation noted above, a variety of means of securing power\nplants has been introduced in countries where the deregulation of the\nelectrical power system is under way in order to ensure adequacy (adequate\ncapacity for a stable power supply). In Scandinavia and Germany, for instance,\npower facilities are first secured by competitive bid, and adequacy is ensured\nby means of a \u201cstrategic reserve capacity\u201d that will supply power by starting up\nthese facilities in times of emergency. Japan has adopted the capacity market and\nthis is set to begin transactions in 2020. It is basically the same as that introduced\nin the UK and by PJM, the USA\u2019s largest regional transmission organization (RTO\n\u2013 an organization which operates and manages the power grid over an extensive\nregion, and which is independent of power companies, etc.). <\/p>\n\n\n\n

The following is an\noverview of the capacity market that is to be introduced in Japan.<\/p>\n\n\n\n

1. What will be\nTransacted on the Capacity Market?<\/strong><\/p>\n\n\n\n

The capacity market will deal not in electricity as measured in kWh, but in\nelectricity generating capacity as measured by kW. For hydropower, thermal and\nnuclear power, total power generation minus power consumed inside the power\nplant, etc. is recognized as the capacity. For variable power supply facilities\nsuch as solar power or wind power, capacity is calculated as the average of the\nlowest five days of power generation output at a designated time of day during the\naverage of the maximum three days\u2019 demand in the last 20 years. (I.e. of the 60\ndata points \u2013 3 \u00d7 20 \u2013 representing the three days of maximum demand over the\npast 20 years, the average of the five lowest days of power generation output\nis taken as the generating capacity of the facility.)<\/p>\n\n\n\n

2. The Capacity Market\u2019s<\/strong> Buyer<\/strong>s, Sellers and Cost Burden<\/strong><\/p>\n\n\n\n

The capacity market\u2019s sellers are the\nelectricity generation businesses that own power plants. The types of power\nsupply facilities that can participate in the market are all facilities except\nthose that are receiving subsidies as feed-in tariff (FIT) facilities. Sellers\nare also able to either opt to participate or not for each power supply\nfacility. The buyer is the Organization for Cross-regional Coordination of\nTransmission Operators (OCCTO), which was established during\nthe reform of the electric power system. The purchasing costs are funded\naccording to rate of usage of each electric power retail business at the time\nof the annual peak capacity, power transmission and distribution businesses\nalso taking on a part of the burden. These costs will be charged to the final\nconsumer as electricity and wheeling charges. (Wheeling refers to the\ntransportation of electricity between different grid systems.)<\/p>\n\n\n\n

3. How Prices are\nDetermined<\/strong><\/p>\n\n\n\n

The purchase price is determined by competitive bid. OCCTO determines the\ncapacity necessary for the country as a whole for one year and four years\nfollowing the year in which transactions take place. Having done that, among\nothers, it sets a rough target price, Net-CONE \u2013 Net Cost of New Entry \u2013 the\nprice per kW to recover the investment cost for construction of a new power\nplant within a certain period of time minus revenue from the wholesale\nelectricity market. These conditions are then brought together to establish the\ndemand curve. The sellers, the\nelectricity generation businesses, then determine their bidding prices for each\npower supply facility and enter their bids. The contract price is defined as the\npoint where the accumulated bids intersect\nwith the demand curve (see figure).<\/p>\n\n\n\n

The initiation of\ntransactions for the capacity market currently under consideration is 2020, the\ntransactions being for 2024. The Net CONE price is considered to be a new\nLNG-fired power plant with a recovery time for investment of 40 years, this\nbeing 9,307 yen\/kW at present. If this were to be the contract price, then, as\nan example, the Tokai No.2 nuclear power plant at an installed capacity of 1056\nMW (net output) would receive around 9.8 billion yen from the capacity market.<\/p>\n\n\n\n

The required\ncapacity for the whole country is considered to be the annual peak power demand\nto which is added a reserve amount in preparation for power supply facility outages.\nThis value is predicted to be around 150 million kW (150,000 MW). While it would\ndepend on the contract price, if this is set at 9,307 yen\/kW, the scale of the\nmarket would reach 1.4 trillion yen (150 million kW \u00d7 9,307 yen). Dividing this\nfigure by the total for retailed electricity in 2017, 863.2 billion kWh, gives\na price per kWh of around 1.62 yen. Converting this to the monthly average\ndomestic power consumption of 400 to 500 kWh results in an increased burden on\na household of 648 to 810 yen\/month.<\/p>\n\n\n\n

Figure: Power Supply Procured by the Capacity Market (left) and Method of Determination\nof the Contract Price (right) <\/p>\n\n\n\n

\"\"<\/figure>\n\n\n\n

Many Issues<\/strong><\/p>\n\n\n\n

A careful check of the UK and US capacity markets reveals that existing\npower supply facilities make up the vast majority of the successful bids.  If we think about it, we can see that this is\nan obvious consequence of the bidding strategy of electricity generating\nbusinesses on the capacity market. <\/p>\n\n\n\n

Newly constructed\npower supply facilities will bid at a price where they can basically recover\ntheir invested funds (in most cases this will be the Net CONE price). In this\ncase, fixed costs are recovered on the capacity market and the recovery of\ngenerating costs and profit will be gained from the sale of electricity on the\nwholesale electricity market and elsewhere. At the same time, existing power\nsupply facilities that are already running will be operated whether there is a\ncapacity market or not. Because they do not care about the capacity price of\nsuccessful bids, they enter a bid of 0 yen. Further, it is the contract price\non the capacity market that is the deciding factor when considering whether to\ngenerate electricity or decommission an existing power supply facility. Because\nof this, generating businesses will bid the amount for the costs necessary to\nmaintain operation of a power plant minus<\/em> revenue to be gained on the\nwholesale electricity market and elsewhere. \n<\/p>\n\n\n\n

Thus, the system\ndesign of the capacity market lends strong support to the operation of existing\npower supply facilities, as far as possible, rather than to the construction of\nnew power plants. Rephrased, this means that however decrepit or however much\nCO2<\/sub> is emitted from a power plant, this is a market that promotes\nthe notion that it is beneficial to operate a plant provided the marginal cost\nis low. In fact, on the UK capacity market, nuclear power plants, coal-fired\nand LNG-fired power plants are successful bidders, while new-build power plants\nare unable to make successful bids.<\/p>\n\n\n\n

Moreover, with the\ncurrent capacity market system design, it is not really possible for variable\npower supply facilities such as solar and wind power to be counted on the\nmarket. On the other hand, just as an example, the Fifth Basic Energy Plan,\nrevised last year, states that renewables should \u201cbecome a main power supply\nsource.\u201d In addition, Japan is also attempting to achieve a non-fossil-fuel power\nsupply ratio of 44% by 2030. According to the Long-term Energy Demand Outlook,\nthe breakdown of this 44% is 20 to 22% nuclear power and 22 to 24% renewables,\nbut it is already clear at the present time that the target for nuclear power\nis unattainable. How are these targets to be made consistent with what is\nhappening on the capacity market?<\/p>\n\n\n\n

In the first place,\nthe vast majority of the power plants are owned by the FGPCs. These power\nplants, having a high public nature, were sited, constructed and operated under\nthe Fully Distributed Cost (FDC) Method; i.e. the citizens of the country bore\nthe various costs involved through public utility charges. Just because these\npower supply facilities have been deregulated, does that mean the FGPCs can do\nwhat they like with them?<\/p>\n\n\n\n

It is pointed out\nas a reason for the introduction of the capacity market that, if the wholesale\nelectricity market price converges on the SRMC, there will occur risks such as\na) the possibility that initial investments cannot be recovered, b) power\nsupply shortages resulting in the wholesale electricity market price trending\nto high levels over considerable periods of time, and c) price spikes (sudden\nextreme rises in price). However, despite there being sufficient capacity actually\navailable, the wholesale electricity market price rose sharply in the winter\nand summer of 2018. This was partly the result of unplanned outages due to\naccidents, but another important factor was the shortage of power supply\ncapability due to restrictions on the amounts of electricity generated over and\nabove that necessary to fulfill demands on companies because of FGPC fuel\nconstraints (suppression of fuel consumption). <\/p>\n\n\n\n

Summary<\/strong><\/p>\n\n\n\n

The Ministry of Economy, Trade and Industry and OCCTO are claiming that the\ncapacity market is price neutral. When electricity is transacted only on the\nwholesale electricity market, in the case of capacity shortages there is the\npossibility of sharp price rises and the continuation of high price levels, but\nthese situations can be avoided by securing capacity through the capacity\nmarket. However, there are also risks involved in the introduction of a mammoth\nofficial market such as the capacity market. This kind of market is prone to\nregulatory blunders, and with the current market design it is mainly decrepit\nand dangerous nuclear power plants along with CO2<\/sub>-belching coal-fired\npower plants for which the capacity price will be recognized. It may also be\nthat this market will make it difficult to construct new power stations.<\/p>\n\n\n\n

We are now living in a transition period to a new electric power system marked by the introduction of large volumes of renewables, demand reduction and the shutdown of nuclear power plants. The introduction of a system, the capacity market, that gives strong incentives in the direction of locking in the status quo will lead to an obstruction of reforms. One reason for Germany adopting a \u201cstrategic reserve capacity\u201d rather than a capacity market can be found here. Moreover, Japan constructed its electric power system on the exceptional recognition of regional monopoly to power companies in respect of the public nature of electricity and by placing the financial burden on the citizens of the country. It is important that policies to secure capacity be considered with these factors in mind.<\/p>\n\n\n\n

Even if the\ncapacity market is introduced, there are some approaches that need to be considered.\nExamples are that power supply facilities constructed under the FDC Method and\nfor which investment has to some extent been recovered should be put to the\nmaximum effective use (excepting nuclear power plants), and that the capability\nfor predicting required capacity should be raised by encouraging the changeover\nof generations of power supply facilities by mandating decommissioning after a\ncertain number of years. <\/p>\n\n\n\n

The securing of\ncapacity is necessary, but not at the expense of introducing a system that\nlocks in the status quo for the foreseeable future. The introduction of the\ncapacity market, even if it should go ahead, requires a fair system and full\nunderstanding by the citizens of the country. A more careful and\nwell-thought-out consideration of the issues involved is demanded.<\/p>\n","protected":false},"excerpt":{"rendered":"

By Matsukubo Hajime (CNIC) The reform of the Japanese electric power system, including the deregulation of electric power retailing and the separation of power generation and transmission, occasioned the creation of several new markets....<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[90],"tags":[],"class_list":["post-4435","post","type-post","status-publish","format-standard","hentry","category-economics-of-nuclear-power"],"acf":[],"_links":{"self":[{"href":"https:\/\/cnic.jp\/english\/index.php?rest_route=\/wp\/v2\/posts\/4435","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/cnic.jp\/english\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/cnic.jp\/english\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/cnic.jp\/english\/index.php?rest_route=\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/cnic.jp\/english\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=4435"}],"version-history":[{"count":3,"href":"https:\/\/cnic.jp\/english\/index.php?rest_route=\/wp\/v2\/posts\/4435\/revisions"}],"predecessor-version":[{"id":4474,"href":"https:\/\/cnic.jp\/english\/index.php?rest_route=\/wp\/v2\/posts\/4435\/revisions\/4474"}],"wp:attachment":[{"href":"https:\/\/cnic.jp\/english\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=4435"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/cnic.jp\/english\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=4435"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/cnic.jp\/english\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=4435"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}