Western countries completed the separation of electric power generation and supply about 20 years ago, allowing for a significant accumulation of data and analysis results related to each country's experience. When the Japanese government's plan is examined based on these findings, we can see that there is cause for serious concern and that further reform is needed. In this paper, I would like to summarize the issues and make proposals based on two keywords, independence and comprehensiveness, which are important in the operation of public infrastructure (social infrastructure) such as the electric power grid.
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In Japan today, major power companies have regional monopolistic control over operation of electric power transmission systems and distribution networks including utility poles and power lines. For example, companies with regional monopolies are responsible for determining who can use power lines at certain times, what usage charges to impose, and where to install new power lines. However, since major power companies also have power generation and retail divisions, there are concerns that as a means of pursuing their own profit, these companies limit the use of transmission and distribution networks by new power generators and retailers, and set high usage fees for transmission and distribution networks.
In order to allay this concern, it is necessary to ensure the independence of system operation. The current government proposal to achieve this is called legal separation. A major power company will make its power transmission and distribution division a subsidiary, and its subsidiary will be under the umbrella of a holding company. The government says that it will then aim for the independence of the parent company and its subsidiary through monitoring and regulation.
However, in view of economic theory, the experiences of different countries, and scientific data analysis, the probability of securing independence using this method is extremely low.
First, the major power companies, which are for-profit companies, will pursue the interests of the holding company, and so there is no guarantee that the connection between a parent company and its subsidiaries will disappear. Second, government oversight and regulation are subject to the issue of "information asymmetry." The operation of a transmission and distribution network comes with detailed information that only the operator possesses. There is also incentive for for-profit companies not to reveal information to the government. It is difficult for a government without direct access to information to conduct proper oversight and regulation, and the more it tries to increase accuracy in oversight, the more tax money will be required.
For these reasons, legal separation has almost never been adopted in the West. The global mainstream method is to establish a public third-party organization as an independent system operator (ISO) and completely migrate the system operation of the transmission and distribution network. Major power companies no longer have organizations that operate the transmission and distribution networks, and the system operation is left to public organizations.
Another feature of the legal separation scheme is that ownership of the transmission and distribution network has the potential to remain with the major power companies. The UK carried out the strongest separation of electric power generation and supply, known as ownership separation, and took ownership of the transmission and distribution network from its major power companies. However, ownership separation can lead to lawsuits over property rights, and the financial damage to major power companies is also significant. Therefore, the prominent view is that the best method is to leave the ownership of the transmission and distribution networks with major power companies and move only their operation to an ISO.
Another important element of power grid operation is comprehensiveness. Under the government's plan, 10 power transmission and distribution companies would remain as subsidiaries of major power companies in each region even after legal separation. Internationally, however, the common view is that when operating a public network such as a power grid, wide-area operation is more desirable than small-area operation. In fact, system operation integration of power grids has progressed in Europe, North America, and South America.
In Japan, nationwide consolidation of the system operation of the electric power grid would have major benefits. First, in the event of a disaster such as the Great East Japan Earthquake or the Hokkaido Earthquake, transmitting electricity from areas with excesses to those with a shortage would be much more efficient. Second, power prices could be lowered by adopting a method called "wide-area merit order," which preferentially generates electricity starting from lowest-cost power plants nationwide.
Third, the operation of a nationwide power grid is key to the expansion of renewable energy. The weakness of renewable energy is its instability in terms of power generation, due to the fact that generation is affected by climatic conditions. Recent data analysis shows, however, that the variety of climatic conditions in Japan from region ot region has the potential to rectify instability in the amount of power generation.
For example, even if the wind is weak on the Pacific Ocean side or the sun is hidden by cloud, the wind may be blowing and the sun may be out on opposite coast of Japan. If the power grid were operated over a wide area, a fall in the amount of power generated in one region could be adjusted by electricity from another region. It is not sensible to have as many as 10 transmission and distribution companies for a country which is as geographically small as Japan.
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Considering the independence and comprehensiveness which have the potential to be secured as discussed above, it is desirable to establish a public ISO and operate a nationwide transmission and distribution network for Japan. This idea is recognized by experts and members of the government, and a wide-area power operation promotion organization was established in 2015 as the first stage of electric power system reform. For now, the core of the organization's operations is limited to a portion of the work of an ISO. The government should establish a public ISO as soon as possible and implement system operation of a truly national transmission and distribution network.
The government's proposal cited the case of France's adoption as a basis for advancing legal separation. In France, however, a single company that is effectively state-owned is responsible for the entire nation's electricity grid. Therefore, when the transmission and distribution division became a subsidiary through legal separation, one state-owned company came to operate the power grid for the entire country, which was in effect very similar to the establishment of a public ISO.
Opinions opposed to electric power system reform include the arguments that the separation of electric power generation and supply will result in a loss of stable supply, a decrease in investment in transmission equipment, and an increase in the cost of power generation. However, there is no scientific evidence to support these claims. As explained in my book The Power of Data Analysis, care is needed since many of these claims misinterpret correlation as causation. For example, some who argue against simple comparisons of areas that have and have not separated electric power generation and supply, but these do not show causality, as various differences between the areas, such as climate, power plant configuration, fuel costs, and environmental regulations are not taken into account.
So is there any evidence that validates causality for the effects of the separation of electric power generation and supply and of power system reform? Over the past 20 years, research has progressed in a field of economics, especially empirical studies, by making full use of various kinds of data analysis. For example, Nancy Rose, a professor at the Massachusetts Institute of Technology (MIT), and her colleagues, have shown that abolishing the power generation sector's full-cost principle and introducing free competition in wholesale market transactions after separating electric power generation and supply improves the production efficiency of power plants and lowers power generation costs.
Steve Cicala, an assistant professor at the University of Chicago, analyzed hourly power generation and cost data for power plants throughout the United States and showed that power transactions through the wholesale market after the separation of electric power generation and supply reduce production at high-cost power plants and increase production at low-cost power plants, which also lowers the cost of power generation throughout society. Both studies were published in the international journal "The American Economic Review" and contain analysis results that carefully validated causality.
Power system reform is a difficult political issue with major stakeholders which is why policy decisions should be made based on empirical evidence and the experience of other countries, and reforms that focus on the benefit to the entire nation should be pursued.
* Translated by RIETI.
March 9, 2020 Nihon Keizai Shimbun
