Electricity Power Mix in 2030: Excessive conservation would be an undue burden on consumers

Faculty Fellow, RIETI

Are Japanese consumers, who are already being forced to pay more than twice what their American counterparts pay for electricity, ready to accept a further electricity rate increase? Following the Fukushima nuclear power disaster, Japan increased the use of fossil fuel sharply to make up for the shuttered nuclear power plants. As a result, its reliance on fossil fuel has reached 88% and electricity prices have risen by 35% compared to the pre-crisis level. The Ministry of Economy, Trade and Industry (METI) established a subcommittee under the Advisory Committee for Natural Resources and Energy to develop a long-term outlook for energy supply and demand in Japan and consider the nation's electricity power mix in 2030. Some people might expect that the long-term energy supply and demand outlook naturally will take into account a degree of suppression of rising electricity prices. However, projections made by the government in the past assumed a sharp rise in electricity prices in the coming years. In 2012, the Energy and Environment Council under the then government led by the Democratic Party of Japan (DPJ) proposed a set of options for energy and environmental scenarios, all of which with the assumption of electricity prices increasing by 60% to more than 100% by 2030. Why are electricity prices expected to rise so sharply?

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This is usually attributed to an expected increase in the share of renewable energy sources. However, greater energy conservation will have a larger impact. Energy conservation (power saving) and the rise of electricity prices are the two sides of the same coin. Energy conservation is achieved, in large part, by introducing energy-saving technologies in the form of capital accumulation. As they reach the end of their respective useful lives, new energy-saving technologies are gradually incorporated into the economic system without significant additional costs. In order to accelerate the introduction of energy-saving technologies in the market economy, there must be a sufficient increase in electricity prices as a background factor so that the purchase of such technologies would be a rational investment opportunity for companies and households. In other words, if the level of future electricity prices is set as a target, the realizable level of energy savings is determined automatically.

To date, the government has promoted the deployment of energy-saving technologies by means of subsidies and direct regulatory restrictions instead of transferring the cost to consumers in the form of higher electricity bills. However, the cost of energy conservation, though hidden by a cheap trick of government policy, ultimately rests on the shoulders of consumers or the general public. Japanese companies that have been forced to bear the cost of energy conservation would lose their competitiveness in international markets as their overall production costs are bound to increase. In the household sector, investments in education and health would be impeded.

As a general tendency, the relative prices of capital goods are on a decline. Thus, even if electricity prices are to remain stable in the future, energy-saving technologies will be introduced over time even in the market economy. A slight front-loading effect is all that can be gained from the government measures designed to promote energy conservation. On the other hand, irrational choices in making investment decisions would undermine the growth potential of the national economy, regardless of who is ultimately to bear the resulting costs.

For more than 20 years, the government has strived to inflate the quantitative effect of energy conservation by disregarding the costs involved. However, an overestimate of the effect of energy conservation would result in an underestimate of electricity demand in the future. It would also make the volume of carbon dioxide (CO2) emissions look smaller and the share of renewable energy sources in the electricity power mix larger, respectively, than they are in fact. As such, overestimating the effect of energy conservation is a forbidden fruit as a means to bring actual results closer to ideal policy goals.

The figure below shows the trajectories of actual and projected electricity demand in Japan and the United States for the period 1995-2030. We can see that the effect of energy conservation is overestimated in Japan following a modest decrease in actual demand, with the trajectory of projected electricity demand heading downward as if taking over the brief downward trend in actual demand. An overestimate of the effect of energy conservation made by the past government tends to induce an overestimate by a future government as the incumbent government avoids exceeding the predecessor's projections for future electricity demand in making its own projections. Ironically, projections that had been made in such a manner turned out to be fairly close to the actual demand in recent years, during which production activity has been severely affected in the aftermath of the global financial crisis and the March 2011 earthquake.

Figure: Actual and Projected Electricity Demand in Japan and the United States
Figure: Actual and Projected Electricity Demand in Japan and the United States
Sources: Ministry of Economy, Trade and Industry (METI) and U.S. Energy Information Administration (EIA)

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Based on this approximation between the projected and actual electricity demand, the effect of energy conservation efforts over the years through 2030 is estimated to be very large even under the assumption that the economy will grow at 1.7% per year, a fairly strong pace for Japan. In reality, however, the electricity demand decrease not attributable to the contraction of production in the aftermath of the earthquake is due, in large part, to the front-loaded implementation of energy conservation measures. Therefore, the remaining effect of energy conservation as of 2030 will be very limited.

In contrast, projections for future electricity demand in the United States are rational. Projections based on the reference case scenario serve as forecasts. Although U.S. demand for electricity dropped significantly in 2009 and has been relatively subdued since, it is projected that the growth rate will return to the level prior to 2009. Even under the scenario assuming the implementation of best available energy conservation technologies, electricity demand is projected to increase.

What is expected of a demand outlook is to present a highly realistic scenario to help companies develop medium- to long-term business plans. Estimates that are not underpinned by an economic rationale are nothing but a distraction.

Suppose that electricity supply plans are made based on an outlook that underestimates future demand, and that actual demand exceeds the assumed maximum demand. When we look at one side of the coin (volume), Japan will have to impose use restrictions or blackouts to suppress electricity demand. Otherwise, it will have to increase electricity supply from aged thermal power plants and purchase carbon allowances from overseas to offset the resulting increase in CO2 emissions. Meanwhile, on the flip side of the coin (prices), my estimates show that electricity prices would have to be doubled in order to induce a significant reduction in demand. Given that, and based on the Japanese and U.S. outlooks for the supply and demand of electricity, prices for electricity and carbon emissions in Japan will be five times as expensive as those in the United States in 2030. This is not compatible with economic growth.

The fear of a doubling of electricity prices is not a work of imagination. In European countries, which are leading the way in the liberalization of the energy sector, electricity prices have doubled across the board since the beginning of this century. In the case of Italy, electricity prices began to climb when the European Union (EU)'s first directive on the liberalization of the electricity market was transposed into national law in 1999. By 2013, electricity prices tripled or increased by 2.3 fold in real prices deflated by the consumer price index.

Prior to the sharp increase in electricity prices, the growth rates of industries and the degree of their dependence on electricity, measured as a share of electricity costs in total production costs, were almost uncorrelated. However, today, we find a strong negative correlation between the two. Certain industries--such as those manufacturing ceramics, clay and stone products, rubber products, and pulp and paper products--are apparently lagging behind, with their growth rates underperforming the national average by three to four percentage points.

This indicates that a doubling of electricity prices has the potential to dramatically change the industrial structure of an economy through the substitution of domestic goods with imported goods and the offshoring of production. High electricity prices have driven many multinational companies to move their manufacturing bases to China, which relies on coal-fired thermal power generation for nearly 80% of electricity supply, and the United States, which maintains relatively stable electricity prices without imposing excessive requirements for use of renewable energy sources.

Since the beginning of the 21st century, Italy's economic growth rate has been close to zero, the lowest among advanced economies. The contraction of production resulting from a surge in electricity prices can be taken as a factor depressing the annual rate of economic growth by 0.15 percentage points, according to an estimate based on certain assumptions. If we apply this to an outlook for the Japanese economy, the expected increase in electricity prices would depress Japan's gross domestic product (GDP) in 2030 by about 2.2% than would otherwise be the case, losing nearly 100 trillion yen of national income by the time. Japan must not fall into the same rut as Italy.

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Even disregarding grid reinforcement costs incurred in association with the integration of unreliable renewable energy sources into the power distribution network, renewable energy business is not economically viable. Without government subsidies, all but a handful of renewable energy-based power suppliers would not survive. Renewable energy surcharges, which are levied on electricity bills to help finance purchases of renewable energy-based electricity under the feed-in tariff (FIT) system, are expected to total more than one trillion yen in FY2015. Meanwhile, expectations for positive economic spillovers from emerging renewable energy business--which had been expressed by some people--failed miserably. Prior to the launch of the FIT system, imports accounted for approximately 30% of solar cells sold in Japan. Upon its introduction, the share of imports climbed to nearly 80%. Import prices of solar cells, which had been falling by approximately 20% every year, turned upward (even when denominated in a foreign currency) in early 2013, following the introduction of the FIT system. As such, the introduction of the FIT system gave a little breathing room to Chinese exporters, relieving them from cut throat competition.

Fixed purchase prices for electricity under the FIT system not only impede competition among renewable electricity suppliers but also serve as a gravitational force to keep electricity prices from falling. In order to curtail rising prices, the government must expedite efforts to work out a strategy for exiting the FIT system as quickly as possible. Meanwhile, as a realistic way to move forward, the target level for renewable energy sources should be kept to around 20% of the electricity power mix and this should be pursued as a medium- to long-term goal.

A projection of the future electricity power mix could serve as a guiding light to show the way and break the ongoing energy policy impasse. Nuclear power generation still has an important role to play as a base-load power source that can consistently meet demand in a way compatible with the three goals of energy security, low carbon emissions, and economic growth. Replacing aging nuclear power plants with new ones is a possible future option for improving safety and efficiency. The target share of nuclear power generation should be set to 20% or above. How to satisfy the remaining demand is essentially up to the choice of private-sector companies between coal and natural gas. Maintaining the shares of nuclear power and renewable electricity at their respective appropriate levels is instrumental to alleviating the risk of rising prices resulting from the planned liberalization of the electricity market.

>> Original text in Japanese

* Translated by RIETI.

March 19, 2015 Nihon Keizai Shimbun

April 30, 2015

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