RIETI Report December 2004

Electricity Market Reform: Current State and Remaining Challenges
<RIETI Special Interview> TSURUTA Toshimasa

This month's featured article

Electricity Market Reform: Current State and Remaining Challenges
<RIETI Special Interview> TSURUTA Toshimasa

TSURUTA ToshimasaProfessor Emeritus, Senshu University

Greetings from RIETI

Recently the problem of performance-enhancing drugs has shaken professional sports in the United States. Fans wonder whether their heroes' achievements are due to superior ability and effort or chemical help. Everyone wants competition in the sporting arena, but for such competition to be meaningful it must be governed by clear and fair rules. Likewise, economic liberalization seeks to inject a healthy dose of competition into traditionally monopolistic markets and, as with sports, has been the subject of controversy. In this issue, we examine Japan's plans to liberalize its electricity market.

RIETI held a Policy Symposium entitled "Electricity Market Reform: Current State and Remaining Challenges" on December 15, in which participants assessed the current state of electricity market reforms in the United States and Europe, and discussed key issues for Japan in designing institutional mechanisms for electricity market liberalization. Before the symposium, RIETI Report spoke with one of the discussants, Toshimasa Tsuruta, to learn about the challenges and future goals of Japan's electricity market policy. Tsuruta is professor emeritus at Senshu University and serves on a governmental panel on electricity liberalization.

RIETI Special Interview

RIETI Report: With progress made on the partial liberalization of electricity retail market, Japan is set to begin deliberations on complete liberalization in April 2007. What changes we should expect and what challenges lie ahead?

Tsuruta: Before liberalization, electricity prices in Japan were far higher than those in other industrialized countries and this was cited as a major reason behind Japan's high cost structure. In order to eliminate this high-cost structure and improve the international competitiveness of the Japanese economy as a whole, it was imperative to reduce the cost of electricity by promoting the liberalization and enhancing competition in the electricity market. Also, the comparatively high price of electricity in Japan indicated the presence of institutionalized inefficiencies in the electric power industry. In order to develop the Japanese economy, it is essential to make the industry more efficient by promoting competition and eliminating such inefficiencies.

With each major utility company holding a regional monopoly, Japanese electricity users have been unable to choose their supplier. The presence of a monopoly is, without question, against the principles of a market economy. Essential facilities, such as electricity transmission and distribution lines, however, should be defined as social infrastructure subject to government regulation. With respect to the electricity market, the government should invite new players in under certain rules to facilitate fair and orderly competition, while promoting the formation of wide-area distribution networks. At the same time, it is desirable in light of market principles to remove barriers to entry and to introduce free competition in the power generation and retail sectors.

The institutionalization of inefficiency and presence of monopolies also involve a number of problems in the structure of individual companies. A series of scandals involving major companies points to a number of deficiencies in the governance of these companies. This means that corporate philosophy, ethics and management policy - indispensable factors for a company, as a public organ, remain an ongoing concern - have been absent. It is hoped that good companies with governance suitable to the 21st century will emerge through the process of liberalization.

RIETI Report: How do you assess electricity market reform in the U.S. and Europe? What lessons can Japan learn form their experience?

Tsuruta: Electricity supply mechanisms are not necessarily identical in every country. In fact, utility industries vary widely from one country to another, reflecting the various circumstances under which they were formulated. For instance, British utilities remained under government control for many years, whereas there are a number of small operators in the U.S. and Germany. Japan's system splits the national market (except for Okinawa prefecture) into nine service areas, with each served exclusively by a regional electric power company. This system is unique; no other country has such a regional monopoly system. By the same token, the development of electricity distribution networks is unique to each country. Japan is exceptional in that electricity transmission lines connecting different service areas are quite limited in capacity. Also Japan is probably the only country where the 50 hertz and 60 hertz systems co-exist. Therefore, in liberalizing the electricity market, Japan should focus on its own circumstances rather than trying to emulate the liberalization initiatives of other countries too closely.

A key lesson learned from the experiences of other countries is that Japan must not allow the occurrence of a power crisis or a major power blackout such as those seen recently in California and the northeastern U.S. The implication is that any liberalization or reform steps should be implemented gradually while ensuring institutional consistency. Meanwhile, Japan has much to learn from other countries with respect to the mechanisms of wholesale electricity trading and the roles of a neutral supervising body, both of which will be introduced in fiscal 2005. Through this learning process, Japan can and should seek to stimulate electricity trading. Japan's liberalization efforts have just begun and it has yet to construct a basic institutional mechanism for a liberalized market. In this regard, the experience of other countries can serve as a useful reference.

RIETI Report: Although Japan's high electricity costs are blamed for hampering Japanese companies' international competitiveness, it is also true that Japan's electricity services are world-class in terms of quality. Some question whether the ongoing liberalization initiatives will successfully bring competition to a long-monopolized market; others fear that liberalization will harm the quality of electricity supply services. How can Japan create a system that ensures sound supply while facilitating competition? What is the best way to liberalize the Japanese electricity market?

Tsuruta: The idea that competition leads to the deterioration of quality does not make any sense to me. Japanese automakers have been exposed to fierce competition both inside and outside Japan. Has this resulted in the deterioration of the quality of automobiles produced by these companies? Not at all. They have strived to improve the quality of their products to win consumers' confidence. In the case of electricity, liberalization will bring interregional competition, including among the major electric power companies, whereby various companies will use transmission lines simultaneously. Under such competitive conditions, maintaining high quality services is an absolute requirement.

The formation of wide-area networks will surely raise the possibility that damage caused by a single accident may spread over a larger area. At the same time, however, the formation of wide-area networks will facilitate a stable supply of electricity under ordinary circumstances. Therefore, to take advantage of such wide-area networks while minimizing risks, it is necessary to establish proper rules for the use of distribution networks and to implement an appropriate surveillance system, thereby ensuring that each player follows the rules. What is most important, however, is for the major electric power companies to exercise due diligence in managing the transmission networks.

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For your reference:
Hot Issues "energy"
http://www.rieti.go.jp/en/special/hot-issues/categories/energy.html

Program for the RIETI Symposium "Electricity Market Reform: Current State and Remaining Challenges," click here.

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