IEEJ: January 2013 All Right Reserved
Special Bulletin
A Japanese Perspective on the International Energy Landscape (117)January 17, 2013

Significance of Competition Policy in Energy Market -- Its Bright and Dark Sides
Ken Koyama, PhD
Chief Economist, Managing Director
The Institute of Energy Economics, Japan
Institutional reforms of energy markets are one of the most important energy policy
challenges for any country whether it is a resource-rich country, an energy exporter, an energy
consumer or an energy importer. Since energy is an essential good for economic activity and civil
life and becomes a strategic good occasionally, energy market design or control coveringdevelopment, production, exports, imports, distribution, sales and other major energy segments arevery significant for governments or states.
Discussions on an electric market system reform in Japan are viewed as significant and are
attracting attention because energy market design as a policy challenge is important. Furthermore,
the reform has been considered in the context of a thorough energy policy revision based on theimpacts of the unprecedented March 2011 disaster including the devastating earthquake and tsunami,
and the Fukushima Daiichi nuclear power plant accident. Globally, energy markets are being
redesigned amid fundamental market and technological developments including (1) efforts to workout low-carbon energy mixes, (2) a rapid rise of renewable energy supported by policy measures, (3)the growing importance of electric grid and electricity supply/demand stabilization measures under
the increasing supply of intermittent renewable energy, and (4) energy supply/demand changes under
the ongoing shale revolution. We must pay attention to the global trend where many countries are
considering new energy market designs. Here, I would like to discuss what I see as key points for
new energy market designs from the macro energy policy viewpoint.
As discussed above, governments have routinely and commonly regulated, managed andintervened in energy markets in consideration of energy’s significance and strategic importance.
Representing such approach is a view that: “Energy is too important to be left for the market
mechanism (alone)”. I would like to reiterate that the basic view still exists to some extent. But theexpansion and development of energy markets, the technological developments and a rise in thenumber of market participants have led to a new trend where governments have believed that theintroduction of the market mechanism for energy through the adoption of competitive measures andthe elimination of various market regulations would be technically feasible and provide greater
economic benefits. The belief has spread. Since the early 1980s, the enhancement of free economy
management in the United Sates and the United Kingdom accelerated the deregulation of energy
markets and the introduction of competition. Such trend spread from the United States and Europe tothe rest of the world. In the 1990s when crude oil prices were stable at low levels, a growingly
influential view was that it would be most desirable to leave energy for the market mechanism asenergy is nothing but an ordinary commodity.
In fact, the introduction of the market mechanism for energy has brought about great
benefits including cost cuts through competition, the pursuit of greater efficiency, the invigoration ofmarkets and individual market players’ enhanced competitiveness, since energy is a good tradable inthe market. Deregulation and competition introduction policies have broken through structural
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problems in which rigid institutions, industrial systems and inefficiency are protected for seemingly
justifiable reasons including stable energy supply and environmental protection. They have served todrive a new market dynamism. This is a key aspect of the deregulation. In this sense, energy market
reforms and competition introduction have clear benefits and their appropriate promotion hasremained important. At the same time, however, energy market experiences have indicated thatcompetition introduction and deregulation are not necessarily a fix-all solution to all problems andthat their promotion could cause various difficulties.
First, an option that is the most economically efficient (for a short term) may be chosen
more easily in a competitive market as a matter of course, leading the market structure and supply
sources to be greatly biased towards one specific direction occasionally. Some excessive bias orconcentration could be coupled with market externality and other problems to cause new problems.
Before the first oil crisis, oil had globally been chosen as the most economically efficient energy
source, leading many countries to grow dependent on oil. Japan had increased its dependence on
Middle Eastern oil from the viewpoint of the best economic efficiency. This worked to make theimpact of the oil crisis very grave and drove Japan later to promote the diversification of oil supply
sources. Apart from energy, we still remember that heavy dependence on the cheapest rare earth
metals from China was a factor behind the rare earth supply reduction problem in 2010.
Second, there have been problems involving the best timing of competition introduction
and the overall environment at the time. One of the essential benefits of deregulation andcompetition introduction is greater efficiency or the reduction of surplus. This means that the benefit
works best when a relevant market has massive surplus. When the benefit works best, the surplus ina system can be reduced efficiently. Typically, companies have minimized their oil inventories in a“just-in-time inventory approach” for a liberalized oil market. But the improvement of efficiency
through competition, though reducing surplus, can make markets vulnerable to external shocks orfluctuations in some sense, bringing about problems with stable energy supply and a substantial
increase in price volatility. When competition is introduced into a market, it is important to decide
whether the market is characterized by the existence of large scale surplus that must be reduced. If
the decision is based on inaccurate judgment in this regard, the benefit may fail to work best, or evenaccelerating the destabilization of the market.
Third, deregulation and competition introduction work to essentially prevent surplus
from emerging or existing in a system as indicated above. This, coupled with the long lead time forenergy-related investment, may lead to make the promotion of energy investment difficult. Under thecircumstance, an option to be chosen for the diversification of energy sources or some otherdesirable policy goal may fail to be selected under the market mechanism alone. This problem’sdifficulty seems to have been indicated by the United Kingdom’s electricity market reform plan
where the government is considering introducing the so-called feed-in-tariff system with CDF, under
the recognition that the promotion of long-term investment in electricity sources, including that inrenewable energy and nuclear power generation, would be difficult under the market mechanism
alone. In this respect, I was very much impressed by an European energy expert who recently told
me that the United Kingdom was designing intervention-oriented system in the name of institutional
reforms under a competitive market. .
Endless discussions have been made on the bright and dark sides of and benefits and limitsof the market or competition mechanism in regard to not only the energy problem but also general
economic policies. A key point in considering the bright and dark sides is that we must understandthe present situation or conditions and find appropriate measures or policies to address the situation.
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In Japan, the government should consider its energy policy revision in view of global trends and thenation’s realities.

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