This is Tom Rowland's Reese and you're listening to Switched on the BNF podcast. Today we're discussing the Japanese power market, a market which, as one of our guests boldly claims, could be the most important power market in the world. Since the Fukushima disaster and its entire nuclear power fleet being shut down, the Japanese power market has continued to face our host of challenges, not only natural disasters, but the global energy crisis and more extreme periods of weather.
To many, this may seem unattractive or too challenging, and yet the world's third largest liberalized power market has been attracting more attention from foreign investors than ever. While Japanese power demand has been in decline in recent years, we are now seeing this trend reverse with new data centers and semiconductor manufacturing plants connecting to the grid. With these
comes the need for further power sources. Utility scale renewables such as wind and solar would be a natural fit for most in this situation, but as we are to discuss today, land constraints and local factors opposing their own set of challenges For these two to discuss, the Japanese power market further. Today, I'm joined by two of BNF's Global Power Market's Teamly it's Mariko O'Neil and Yumi Kim, to review findings from the report Japan Power Market Outlook
too H twenty twenty four Tailwinds Ahead. BNF clientsill be able to access this and other related research at BNF go on the Bloomberg terminal and at BNF dot com. Now, let's talk to Marico and Num about the Japanese power market. So I'm joined here today by Mariko. Mariko, thank you for joining.
Thanks for having me, and Yumi.
Thanks a lot for inviting me too.
So we're talking about the Japanese power market. First off, there's a lot of interest in it right now. It seems to be a hot topic, not just in Japan but around the power world. So why is it that everyone's talking about Japan right now?
Yeah, good question. So this might be controversial, but I think there's an argument to be made that the Japanese power market might be the biggest power market in the world never And we can get into sort of like all the parameters of whether it is or it isn't later, But in terms of why now, Japan has been slowly but surely liberalizing its power market over the past couple of decades, and its efforts really accelerated after twenty eleven and when they had to remove nuclear capacity from the
grid after Fukushima. So you could say that it was properly liberalized in twenty sixteen, and since then trading volumes have been climbing. And given that it's an island with no almost no natural resources and almost entirely dependent on fuel imports, there's been a lot of interest sort of across the commodities space on what's going on in the Japanese power system.
So, actually, I mean on this topic, you both spoke at a seminar that we held in our Tokyo office quite recently after releasing the Japan Power Market Outlook, and it was part of Japan Power Week, which I presume is like a bigger thing where everyone is coming in. So how much of the people in the room there would you say were people who do their business in Japan versus global companies.
Yeah, at the moment, it's quite a nice, almost straight down the middle, half and half split, i'd say, of market participants, with half of them being domestic Japanese players, and then the other half being from everywhere from Sydney to Singapore to Hamburg to Chicago. So that's been quite international.
One of the things about Japan having liberalized its power market more recently is that those who've been involved in the US or European power markets are looking at it and thinking, I can play the same game or a similar game to what I did in the US or in Europe in Japan.
So just before we started recording, I was talking about my cats. I adopted two kittens recently, and one of the things that my wife said, and she'd never had cats, was a surprise to her, is that if you didn't know cats, you'd think they're all the same, and when
you have them, you realize they have distinct personalities. So liberalized power markets, you know, and you mentioned that people who are familiar with liberalised power markets see japan'ze here is a power market that is becoming more like what I'm used to. But just like a cat, the Japanese power market must have its own personality. So what are the characteristics that define the Japanese power market as distinct from the others that we're used to.
One of the things might be like geography. So, as I mentioned, Japan is an island with no electrical interconnections to any other country, so in that sense, it's quite self contained. Those people who've been involved in Europe or the US, this might be a bit different to them,
where there's a bit of interconnection between different markets. Another thing is that it's sort of like a very long and thin island, you could say, so in terms of climate and weather, you have subarctic regions like hock Guido in the north, all the way down to subtropical regions like Qushu in the south, with really different climates throughout the year, which obviously affects electricity consumption or what I
guess we call power demand. And another thing actually that is a very particular quirk is that the grid is essentially split into two. So East Japan, which is composed of the region's hock Guide or Tohoko and Tokyo, is on fifty hertz, and then West Japan, composed of the six other power regions of Japan, is on sixty hurts, and there's very little transformer capacity between the two, which makes it sort of a tale of two cities.
You could say, Yeah, I'd also like to add that the fuels market in Japan is quite unique because, as Marco said, Japan is quite important dependent. It doesn't have a lot of natural resources within that country. So when we look at the normal power mix in Japan, there's almost a fifty to fifty split between call and gas, and within those fuel technologies, there's quite complicated contract structure
compared to markets like Europe and US. So that's another feature in Japan that's quite unique to the market.
We're going to talk about that, that sort of the complexities of the spot versus contract markets, because I think that is something to understand the Japanese paner market you have to really understand as much as the power dynamics. But just generally on this point around fuels all being imported, does that translate to relatively expensive power in Japan, then, I'd.
Say so to a certain extent. In Japan because as we highlighted, it has to import almost all of its fuel. That's particularly true for gas because gas prices tend to be more expensive than cool So unlike US, where it has a huge capacity of domestic gas procurement, like Japan has to really quite a lot on the spot procurement and also the long term contracts from other countries like Middle East and also US, so all of that costs is translated into higher power prices in Japan.
So we have an island kind of divided into sort of two islands. We could say a fifty hertz and a sixty hertz island. Could we just explain quickly for listeners, why are there two different grids with different frequencies?
They have a different frequency when it comes to grid because Japan's powermark used to be dominated by nine incombine utilities, so they used to have control over generation, transmission and operation and also the retail side. So because it was basically a monopoly of those nine incombineutilities, they had very little incentive to cooperate with each other because they kept
control over specific power regions. But because Japan now faced the regulation of the power markets, now obviously they have to cooperate more. But unfortunately, because of this historical legacy of incombine utilities, the greed system is not as holistic as we want to be.
So we have this thin island with very diverse weather, not a lot of its own natural resources, and relatively expensive imported fuel, and then we know that if those are the equations you're dealing with, maybe a logical thing would be nuclear. And obviously nuclear has had a rollercoaster of a story in Japan. Could you tell us where we are right now? Give it maybe a little bit of a background into the history of it, but could you tell us what the current dynamic sell when it relates to nuclear.
Yeah, so funny that you asked this bit. So in twenty eleven, after the Mount Dan up for Kushuma, Japan turned off all of its nuclear reactors for power generation, so it went from having significant chunk of power generation being nucleared to none and thankfully, actually there were limited blackouts because they had pretty strong contingency plans for other sources of power. But it has meant that obviously they've substituted a lot of nuclear generation with gas and coal generation.
And since twenty eleven there's been a big effort to restart some of the reactors. So they want to basically check all of the nuclear reactors to make sure they're safe to operate and in the event of anything like an earthquake or another tsunami, there is a sufficient backup plan in place to ensure everyone's safety, and they've restarted a handful, particularly in West Japan, so I think nuclear generation last year was just shy of ten percent of
power generation in Japan. However, they have set quite ambitious targets for restarting the nuclear fleet, So because of its role as sort of cheap, marginal cost and low carbon source of power generation, Japan wants to have twenty to twenty two percent of its power generation coming from nuclear
by twenty thirty. However, the process of restarting the reactors has been really slow and riddled with delays, and actually the first nuclear reactor in East Japan has restarted since twenty eleven, so if you think about that, that's taken
over thirteen years to restart that reactor. And based on our recent analysis, actually even if Japan were to restart all of the reactors that have applied to its Nuclear Regulation Authority for approval to restart, it still wouldn't hit this twenty thirty target of having over a fifth of its power generation coming from nuclear. So it is kind of stuck in a tricky position because obviously, even if the government would like to emphasize nuclear as a source
of clean and low cost power generation. It's extremely politically contentious, and there's very little control of an independent regulator deciding whether or not a reactor is safe to restart. So that's sort of the whole pickle with nuclear power.
That's really interesting, And I would have just thought that in this scenario that the natural next question would be why aren't we seeing a huge increase in the buildout of renewables, whether it's wind or solar. Seems like a market primed for that, But they're not. I mean, I don't know what the numbers are. Am I right in saying they're not actually a huge part of the film mix?
Yeah, you're right that for solar and wind products, it's taking quite a bit of time in Japan to be developed, and that's because of relatively high cost of development compared to other countries. And the main reason is that Japan there's quite a lot of mountains, so it's really difficult to build large scale solar products, for example, within its land and that's why it's been pretty expensive to generate
from renewable sources. And that provides a reason why Japan's government wants source focus on nuclear products by restarting them, because it's less expensive compared to building new large scale
solar and wind products in Japan. But even with those slower build out of solar and wind products in Japan, we're starting to see quite a lot of latility when it comes to power price dynamics because there's still quite a bit of solar products coming in in certain regions like qu in the down South, and that's causing some interesting power price dynamics, like we're seeing much lower prices during the midday when more solar products tends to generate electricity together.
And I mean your point around the sort of the geography is taken, you know, the mountainous aspects, are we seeing significant uptake of rooftop solar.
There's quite a lot of share of roof puff solar because of the same issue that we highlighted earlier, because of a lot of mountains hindering large scale utility solar. So we're seeing a lot of top solar products being built on top of residential properties, and that tends to take up a lot of share in Japan's solar product capacity.
Got it.
So if we're thinking solar in Japan, probably our starting point is rooftop solar, right interesting, and then we alluded to it earlier, but the sort of the situation when it comes to fuel is a little bit complicated. And this is a market dynamic that is maybe I'd be wrong set it's unique to Japan, but it's not something you see in every market, and you do see it in Japan. I know, you me, You've spent a lot
of time trying to figure this out. But when we're thinking about power market dynamics, obviously a thing we always think about is what is the fuel price? And in a lot of markets as easy, you know, because whether it's gas or coal, there's pretty liquid market with prices that are constantly reported, and so it's very easy to sort of relate what's going on power markets to that. It's not quite so simple in Japan. So can you just explain a little bit why it's not quite so simple?
Sure?
I do think that the fuel's market and Japan is very unique, and sometimes it can be causing a lot of headache to the traders. It is quite complicated, and
that's because it has made two ways of procurement. And first of all, the fuels can come from a spot market or the currently traded market where utilities can buy fuels on the spot or relatively for a short shorter period of time, and then there's another procurement method for long term contracts and for Japan's gas market, oftentimes those long term contracts are indexed to oil prices like Brent, and those deals can last up to almost fifteen to
twenty years. When I started covering this sector, it didn't seem very obvious why long term contract guess would be indexed to oil, and that seemed very random to me. And actually there's quite a bit of long history behind this because the utility started indexing long term contract to oil back in eighties and nineties and that's when Japanese
utility started inputting gas to using the power sector. And back then is used oil indexes to price that because they are more familiar with the oil pricing and that could give more stability in terms.
Of price outlook.
So fast forward, even today, a lot of the procurement are still based on this kind of long term contract gas prices index to oil and it can take up around almost ninety percent of Japan's gas procurement currently. Even for coal, it does have a quite complicated structure. It both has spot and contract market to it, But for coal it's less complicated because contract coal prices are index to spot core prices, so it's easier compared to gas market in Japan.
I remember you were telling me the other day that the rules have changed recently about when say, if you're a gas generator you're placing your bids in the power market, what you should treat as your underlying fuel price. So what are those rule changes and what led to those rule changes happening?
Sure, so when it comes to power prices, you can imagine that that's determined why utilities bidding into the wholesale power market. And that's the biggest driver for that is the marginal cost of generation or the fuel procurement costs for these utilities. And as I just explained, because there's a huge component of long term contract gas prices in gas procurement, you two ties used to calculate those beasts
almost based on their long term contract gas prices. And then like in the recent few years, there has been more volatility in the spot gas market, and then the utilities realized that they could resell the cargoes that they procure from the long term contract market to the spot gas market when there's such an opportunity, and then that caused a huge spike in the power market because utwoties were more incentivized to sell gas rather than to use
it to burn gas at their gas generation fleet. So then Japanese government decided to revise the guideline in terms of how the utilities calculate those bidding costs. And nowadays, after twenty twenty and twenty one, now the youtuities tend to reflect more spot gas prices in their beating costs, and to a certain extent that has raised the power prices in Japan. But also for you tities, now they don't have to resolve gas in the spot market when there's such a spike in the gas prices.
This is interesting if we take a step back, what you've just described to me in totality seems like an example of a market going from this very regulated world of you know, regulated monopolies, bilateral contracts doing what is need to sort of keep the lights on, and then
trying to transition towards a very liquid, liberalized market. And it seems like this sort of thing are kind of some of the I don't know whether you would want to call it growing pains that you hit along the way where suddenly there are things happening that seem very contradictory and complexity because you're going from one system that's very simple to another system that's very simple. But in
the middle of that transition you have complexity. And that seems to me part of what's going on here in Japan right now. What makes it an interesting market is that it's not fully there yet in terms of being a liberalized power market.
I think I think you're right, it's sort of a long road. And I would say, given sort of some of the geographic constraints that we've discussed, energy cost and energy security is obviously a big concern for regulators, and I think it makes them quite risk averse to move too quickly. Obviously, like the electricity grid is such a complicated thing, and you know, finding yourself at any moment a little bit short of power can really lead to disaster.
And so, you know, I mentioned that it has been liberalizing for several decades, and we sort of assume that the reforms will, you know, continue.
So, speaking of being worried about keeping the lights on, everywhere in the world, when we talk about power, there is always a question about Ai data centers, And I know this is something that you looked at in the recent Japan power market outlook. So we've talked about this really tight power market, you know, particularly with the historical retirements of nuclear and then it being very load to bring them back, and then on top of that, users to say, oh, there's a new source of demand in
the form of data centers. Is that a going to be a major part of this story in Japan?
Yeah, So I guess that there are a couple of components to this query about the recent boom in AI technologies. The main one is around data centers and basically the build out of these data centers that are really energy intensive, and to what extent is that going to strain the grid.
Having looked at basically what's in the pipeline in Japan, it looks like most of the data centers that will be coming online in the next couple of years will be in areas that already have really high power demand, so very populous areas like Tokyo and Orsaka, which is in the Kansai area. And there's a question, I guess, when you're looking a little bit further out as to
whether that will continue to be the trend. So having demand concentrated in certain areas is not ideal for Japan because, for example, the less populous areas of how I Do and Qsu have a lot of renewable generation. There's a lot of power supply there, but not a lot of demand.
And then you know, when you get into Orsaka, Tokyo, you have a lot of power demand but not so much power supply, let alone clean power supply and new AI technologies like training large language models, doesn't have as much of a need to be close to the end user so close to big cities. So that's sort of an open question, I guess as we look a little
bit longer term. But the other facet of it in Japan is that the government has big ambitions to make Japan a bit of a powerhouse in terms of the supply chain and in particular for semiconductor manufacturing, so it has quite generous subsidies for companies looking to open semiconductor
fabs or fabrication plants we call them. And the tricky thing with those, I guess, is that a lot of these technology companies, be it for the data centers or the semiconductor manufacturing, have quite ambitious climate targets as well, even though their processes really require around the clock power. And so this is kind of something that has also been reopened the nuclear question in Japan because obviously wind and solar is intermittent and only generates power when the
sun is shining or the wind is blowing. But there are lots of market entrants, particularly given recent geopolitical risks, that are looking to open facilities in Japan that need to consume a lot of power out of twenty four to seven around the clock basis, while also meeting company wide targets to have that be carbon free. And so there's been a lot of attention on nuclear as that
low carbon, around the clock source of power. But also the government I suppose, has been trying to promote some of these facilities to be in those areas like cock Guide or Qushu that have a lot of renewable power. Water is also an important question. So yeah, those are some of I guess the variables at play when it comes to AI. But in the sort of like next couple of years, we looked at the data centers that will probably come online, and I think in terms of prices,
it won't really do that much. There's not a huge amount I think in the pipeline, and some of us scenarios are seeing like a plus minus one percent I think change in power prices over the coming couple of years. So yeah, I wouldn't I wouldn't get too over excited about it in the near term, but there are a bit more uncertainties when we look further into the future.
So beyond the next two years, we don't think it's going to make too much of a difference. But beyond that, there's a lot of you know, it starts getting into scenarios, you know, rather than as actually be able to say, because like what you've just described, there is quite a lot of different dynamic questions that, like, you know, and that kind of leads you back to geopolitical considerations, which are obviously extremely difficult to predict.
Yeah.
Interesting, I suppose it sort of leads me to this question, which I have asked before and I'm going to ask it again. It seems like Japan is not privileged when it comes to the energy transition. The geography. It means
it's not that easy to build renewables there. It doesn't have its own domestic sources of fuel, nuclear has a problematic history in Japan, and you know there are efforts to try and address that and still make the best of nuclear, but not just from an energy transition point of view, but just from an energy strategy point of view.
What options does Japan have given all of this? There doesn't seem to be an easy option for Japan. So am I wrong?
There is there an easy option? And if there isn't an easy option, what do you think the strategy should be? So really put you on the spot here. Obviously, you know, hopefully the Japanese government is listening intently.
Were like, you, me and Mariko, what's the answer?
I think, honestly, it might take a sort of reframing maybe. I think, you know, you mentioned earlier about when you know kats you kind of realize how different niache Cat is and so like in that vein, I think maybe some of the frameworks that we use to think about de carbonization solutions that optimize for things like costs in other countries are maybe we have to think about them a little bit differently when it seems like every option is a little bit tricky, and this difficulty has led
the government to somewhat unconventional places. So, for example, one of the things that is being promoted at the moment is sort of co firing of coal with hydrogen or ammonia, which, on balance, we think, based on the actual abatement possibilities of those technologies as well as the cost, doesn't really make sense, and it doesn't really help on the sort of energy security or import dependence side of things either.
But I think, like taking a step back, even before decarbonization really became a priority, I guess things were never really easy for Japan. It's always had sort of the fault lines being a risk for nuclear, and it never had coal or gas, so it was paying a higher price for a lot of things than some of its neighbors. So I think rather than having that be a reason to give up on things like renewables, it might be more of a reason to double down on some of those things that look difficult.
Right. It's it's because I mean we were speaking earlier about how I used to think that Japanese people, you know, in my ownivity, this is like a decade of Japanese people just inherently more energy efficient. Well, in reality, it's like you're in an island that has an expensive electricity.
By necessity, you have to use energy in a more mindful way.
So is what you're saying there that in all of these things, whether it's nuclear, renewables, fossil fuels, it has to be just done in an extremely smart and targeted way, and we may see certain innovations on, you know, making more out of what Japan has.
Exactly. Yeah, I mean, at least that's sort of what I think.
I think you Tommy, you raised a really good point about Japan facing challenges when it comes to cheap energy, clean energy, but also security of electricity. And for Japan, as you mentioned, because it's an island nation, it faces
a particularly difficult challenge around energy security. And that's why in the historical period, Japan's Energy Ministry or the METI try to prioritize energy security, and I guess that's why we're hearing less exciting news when it comes to renewables, and they've been I guess somewhat cautious around nuclear restarts
as well. But even though we're not very positive about Japan's ammonia co firing strategy and a lot of different renewable strategy that the government has, I think it still opens up a debate in terms of what can Japan do to decarbonize its energy on top of providing secure electricity. So I think there's kind of discussions around nuclear restarts, ammonia co firing, and also auctions for different kind of renewables.
It is a step towards right direction for Japan to so we start decarbonizing its power sector.
Can I just add something which is also on the like the points that Ami mentioned, but also on making the most of what it has And this obviously could open up a whole new episode on grids, But one of the ways it can do that is also like
around transmission capacity. And I know we haven't really gone into it in much length today, but there's quite limited transmission capacity at the moment in Japan, again for the historical legacy reasons that you me mentioned where regional state owned utilities didn't really have much incentive to cooperate historically. But one of the things that could really help, I suppose,
into getting more bang for your book. We're already seeing solar curtailment or like solar power not being used in places like Yushu where there's not much power demand, but having really really good grid infrastructure could be one of the things that helps.
And I suppose, you know, going back to the original point, because in a way, it sounds like I've kind of spun a little bit of a downer here. You know, Japan has so many challenges when it comes to energy, and when we started with, Japan is the most exciting market power market in the world right now. So how do we reconcile the two? And I suppose to this point around being smart and making the right decisions, is this liberalization of the power market which is also bringing
in a lot of foreign players. You know, it's kind of like maybe bringing the best of the world to Japan in terms of intelligence. Do you see that these things you've just described, that this liberalization of the market is a necessary step to enable all of that to happen.
It's a really interesting question, and at the moment, I'm sort of of the opinion that liberalization of the market is not the end goal or necessarily the only solution to enable a lot of these changes to happen, but it might be a necessary intermediate step.
Coming from Korea, which is completely unliberalized market, I think there's a real value to liberalizing the market and bringing more participants, because like in countries like Japan, where there's in company utilities whose powers are so strong, we can't really imagine a lot of innovations to happen if they have a lot of generation assets. So I think when it comes to energy, we do require some type of regulations and so we still need some support from the
government to decobronize and also by security. But it's a good opportunity for Japan to face liberalization and let the participants figure out what's best for them.
It's a really interesting point comparing Japan and Korea.
Are there other countries in Asia that are starting to pursue the path of the Japan is pursuing right now? And is Japan in the region the sort of the leader on that front.
I'd say Japan and Australia are the leaders in terms of liberalized power market. Government is pursuing that direction, and there's also financial products like the futures market that brings different competitors. I'd say my next pick might be China. And now when it comes to China, it's it used to be a very unliberalized market with long term contracts instead of the wholesale power market. But Chinese government is really pursuing to move towards liberalized direction and it's opening
up wholesale markets in certain provinces. So I think in Kina there are on conversations starting to open in terms of what can the government and the participants do. And interestingly, when we attended the Japan Power Week a few months ago, we did see some Chinese participants coming for our events, So I think that really highlights the interests from Chinese market as well, and.
I think Southeast Asia as well.
This is something that's spoken about, but I think, you know, we spoke about Japan has is going on this long process of going from very regulated to very much more deregulated, and you encounter these bumps along the road, like the ones that you'd described earlier, Umi, and it sounds like, if you're wanting to understand that some of the challenges that other markets in Asia might be facing on going on that same journey, maybe Japan is a couple of
steps ahead. And that's also what makes Japan an exciting and interesting market because it's it's sort of maybe leading the way for the region.
Is that a fair statement.
Yeah, I think so. I think Japan would have a lot of trials and errors, which is going to be really tough for Japan, Japan's harmarket and also for US was analyzing the market. But then it's going to be a really good learning experience for Japan, but also other countries in APEG that faces liberalization.
Yeah, I think so. One of my favorite and now almost trite subtitles to use when I'm writing about Japan is liberalization and transition, and that I think what's been really interesting in Japan and that lot a lot of other countries will be watching closely, is the fact that they really are liberalizing their power market very much at the same time as they're trying to decognize it.
Got it, Mariko, thanks for joining us today.
Thanks so much for having me, and.
Youu me, thanks for joining us today.
Thank you so much for having me too.
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