IEEJ: May 2003

April 10, 2003
380th Regular Meeting for Briefing Research Reports

Evaluation of the New Electricity Industry System- Centered on a Comparison with the European and American Systems -Junichi Ogasawara
Senior Economist, Electric Power Group, First Research Department
The Institute of Energy Economics, Japan
Research Objective
On February 18 of this year, a “Desirable Future Framework for the Electricity
Industry System (draft)” (“Report”) covering a new framework for the electricity
industry was agreed to at the 14th Electricity Industry Committee, and a report was
submitted to the Minister of the Economy, Trade and Industry. Then, in March of thissame year, a draft amendment to the Electricity Utility Industry Law based on this
proposal was introduced to the National Assembly.
The debates on this present system reform concern the realization of a system
intended to reconcile issues of public interest with the dual objectives of (1) rectificationof relatively high electricity charges compared with other countries, and (2) the
designing of a system that compares favorably internationally. Then, an attempt will bemade to evaluate how the framework of the new system indicated in this reportmeasures up to the above objectives, based on the current situation in the Europe andAmerica.
Main Conclusions
1. Though several issues still remain, this system reform should be able to assurea system that fosters wide-area competition, while maintaining stable supply,
and, as a Japanese type model, can be evaluated as having realized a first step
towards a framework for an electricity industry system that stands well up tocomparison internationally.
2. From the perspective of promotion of wide-area competition, it has been
decided to take the initiative over the United States and Europe, by“eliminating the rate pancaking problem,” the so-called addition oftransmission charges to straddled supply regions (abolishment of transfer
charges), which is expected to result in the realization of a “creation of asingle nationwide market.” As a result, consumer choices will be greatly
expanded and competition will evolve into a nationwide scale. Moreover, it
is anticipated that the establishment of Power Exchange will lead to theutilization of wide-ranging power sources and will also promote additional
competition.
3. On the other hand, from the perspective of assuring neutrality for thetransmission sector, it will be important (1) not to adopt structural regulations
intended to separate the generation sector and transmission sector of existing
General Power Utilities (GPUs), while emphasizing the assurance of the1

IEEJ: May 2003

neutrality of the transmission sector, and (2) to establish Neutral System
Organization (NSO) that draw up and monitor rules (facilities formation,system access, system operation and disclosure of information) for thetransmission sector, as new organizations. The NSO is, in addition, expected
to perform a variety of functions, including managing a system for making
public information on Available Transmission Capacity (ATC) on
interconnection lines, and providing a point for coordination related to theplanning for providing interconnection lines between areas, and should play animportant role in the maintaining of a stable supply on a nationwide scale.
4. An important issue will be the handling of the nuclear power, the conclusionsof which are to be forthcoming by the end of 2004. The outcome of thoseconclusions may also potentially have an impact on the present framework.
Over the long term, the coordination of the creation of a single nationwide
market with a network infrastructure that has been formed from a regional
perspective, will also be an issue. The formulation of the plan for a wide-area
network infrastructure and the bearing of the costs are to be coordinatedthrough the forum of the NSO, “which will provide the forum for thecoordination of the planning for the outfitting of the interconnection lines
between regions;” however, just how it will actually be coordinated will be anissue.
5. Though serious discussions on the future detailed system design are
anticipated, a number of points of contention remain to be studied. Three will
be particularly important: (1) the providing of a compensating mechanism inconjunction with the elimination of the rate pancaking problem,(2) the
governance of the NSO and the decision making process, and (3) participationof government offices in the Power Exchange and a supervisory system. A
function for reconciling opinions among the interested parties will of course beparticularly important for the NSO, and the creating of a framework for it will
be an issue. At the same time it will also be essential to train neutral
specialists capable of holding their own in specialized discussions.
Explanation
1. Current State of Progress in Deregulation
The deregulation of electric power in Japan has shown steady progress. The 1995
amendment to the Electricity Utility Industry Law introduced the IPP (independent
power producer), while the 1999 amendment to the Electricity Utility Industry Law
brought about retail market opening for special high voltage customers as of March
2000. Though the market share for new entrants (PPS; Power Producer and Supplier) in
January 2003 was a mere 0.87%, a lively competition has been realized primarily forbusiness in the major metropolitan areas. PPS power sources are expected to growsteadily over the medium and long term. The efficiency of the General Power Utilities(GPUs) should also progress and the benefits of deregulation will be passed on in theform of lower charges in regulated customers as well. Nevertheless, situations such as
the existence of transfer charges that were charged when GPUs supplied acrossstraddled supply regions left the impression that competition was restricted to withinregions.

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Figure 1

PPS market share tends

million kWh
200

Share
1.0%
0.87%

180

PPS Sales

160

0.9%
0.8%

PPS Share

140

0.7%

120

0.6%

100

0.5%

80

0.4%

60

0.3%

40

0.2%

20

0.1%
0.0%

0
00/4

00/7

00/10

01/1

01/4

01/7

01/10

02/1

02/4

02/7

02/10

03/1

Source: Prepared from the “Total Electrical Energy Demand Bulletin” of the
Resource Energy Agency
2. “Report” Outline
The outline of this “report”(“Desirable Future Framework for the Electricity Industry
System (draft)” ) may be summarized in the following five points.
(1) Elimination of the rate pancaking problem (= abolishment of transfer charges)
It has been decided to abolish the transfer charges that are charged whenever supply
areas are straddled, which have tended to obstruct competition between GPUs, the useof wide area supply capability and the expansion of customers choices. In response tothis, transmission charges will be integrated into the connection charges and a so-called
postage stamp system for each demand region will ensue. In conjunction with theabolishment of the transfer charges, measures for settlement between GPUs are to be
introduced and the reliable collection of costs is to be guarantied.
(2) Establishment of NSO and Power Exchange
Neutral System Organization (NSO) play an important role. In relation to theutilization of the network, that serves as a common infrastructure, they establish therules for (a) the formation of facilities (rules for the formulation of network facilities
plans), (b) system access, (generator side access rules and customer side access rules),(c) system operation and (rules for assuring sufficient capacities during system
operation, rules for formulating operating plans for network facilities, rules forload-dispatch instructions, and rules for interconnection line operation), and (d) the
disclosure of information, and they provide supervisory and dispute handling (mediation
and arbitration) services. In addition, they make public information on Available
Transmission Capacity (ATC) on interconnection lines, provide a point for coordinating
central electricity supply communication functions and the planning for providing ofinterconnection lines between areas, evaluate supply reliability, produce and publicize
various statistics and undertake investigation and research relating to bulk power
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systems.
Moreover, it has been decided to organize Power Exchange on a national scale madeup of day-ahead market and forward market, so as to promote the utilization ofgeneration facilities over a wide area. Assuring a certain transaction volume in theinitial stages of the founding of the exchange is an issue of concern. Nonetheless,though the GPUs will not be compulsorily required to provide their generation
production, they will initially contribute voluntarily to make public policies on power
supplies.
(3) Non-adoption of structural regulations, such as the separation of transmission sector
and generation sector (unbundling)
With the objective of maintaining supply reliability, considering the geographic andfacilities requirements peculiar to Japan, it was decided at this time not to impose
structural regulations, such as the separation of transmission sector and generation
sector (unbundling) on GPUs. Instead, three behaviors will be reliably guarantied: (a)the information firewall, (b) the prohibition of cross subsidering, and (c) the prohibitionof discriminatory treatment. This is to be done by guarantees provided under the laws
and by setting up an ex post facto government checking function.
(4) Phased retail market opening (schedule clarification)
A schedule has been made known indicating retail market opening for 500 kW andabove (about 40%) in 2004, for 50 kW and above (about 63%) in 2005 and the start ofdiscussions for full retail market opening from 2007. Rather then a sudden
deregulation, as has been seen in some foreign countries, it has been decided to adopt aphased approach while laying groundwork, such as the establishment of NSO andPower Exchange.
(5) (Positioning of nuclear power and coordination with the market)
It has been decided to proceed in the following manner. “A system will be set up to
analyze and evaluate factors, such as the cost structure encompassing the back-end
operations in general and the profitability of nuclear power generation as a whole.
Based on the results, arrangements will be made, for example as to the appropriate
apportionment of roles between the government and private sectors, and coordination
with the existing system. A study will then be made, including necessity as well, as tothe orientation for specific systems and measures, such as economic measures, with atarget of the year 2004.” This report is to be ‘finished,’ at the stage where this study iscompleted.
3. Situation in Europe and America(1) Situation in the United States
In July of 2002, the Federal Energy Regulatory Commission (FERC) of the UnitedStates made known the draft regulation for the Standard Market Design (SMD) andcalled for wide-reaching discussions. The SMD came about due to the fact that noprogress was being made on the establishment of an RTO (Regional Transmission
Organization) that had been sought in rule (Order 2000) for the establishment of an
RTO set forth by the FERC in 1999. In the background of the California Energy crisisand the Enron problem, however, a call arose for a wholesale power market design that

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would include a highly reliably transmission sector which led to the setting out of the
SMD. The Standard Market Design is similar in nature to the PJM ISO1 system of theNortheastern region. Its major characteristics are that it requires the establishment of a
day-ahead energy market and a real-time market, and that it adopts a ‘locational
marginal pricing (LMP)’ system as its price determination system. In the Westernregion, however, hydroelectric power has a relative high weighting, and given the lackof familiarity with the LMP system, its implementation will likely be delayed.
On the other hand, a completely different deregulation system has been adopted in
Texas where the jurisdiction of the FERC does not reach, which has drawn attention due
to the uniform results it has shown. Its prime characteristic is that unlike the SMD and
PJM systems, it adopts a quite decentralized system operation method, which, forexample, does not impose an obligation on market participants to assure scheduling andancillary services.
Figure 2

Situation with respect to RTO applications and their establishment

ISO New England
RTO West

Midwest ISO

New York ISO

TRANSLink
PJM Interconnection
PSCo(TRANSLink West)
California ISO

SPP

TVA

Grid South

Weat Connect
SETrans
ERCOT ISO
GridFlorida

Source: Prepared from the FERC, ”Regional Transmission Organization Activities”
home page.
(2) Situation in Europe
In Europe, the movement aiming at a unified ‘internal electricity market’ is gaining
momentum, as the next step following the 1996 EU Order. Interested parties havebeen gathering periodically at the scene of the Florence Regulatory Forum to study
matters related to international power trade within the EU region. Uniform progress has
been achieved in the aspects of unification of the transmission charges relating tointernational power trade, reduction of the level of charges and congestion management
for interconnection lines.
1

This is an organization that independently operates a system from market participants straddling the sates ofPennsylvania, Maryland and Virginia through Power Exchange of day-ahead market and real-time market.

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Meanwhile, important matters concerning domestic system were decided at the stageof political agreements of the related Cabinet Council in November 2002. Morespecifically, within the scope of retail market opening it was decided to open the
non-residential sectors by July 2004, with full opening to be implemented by July 2007.
In addition, management unbundling or legal unbundling was to be required for thetransmission sector and distribution sector. (Other conditions are also pending withregard to the distribution sector.)
4. “Report” Evaluation(1) Evaluation and issues concerning the elimination of the rate pancaking problem
The abolishment of transfer charges and the establishment of a wholesale Power
Exchange have made evident the new orientation from regional markets towards thecreation of a single nationwide market. Though the U.S. and Europe have made aparticular effort to “eliminate the rate pancaking problem,” Japan has merited attention
as a vanguard example for achieving its elimination.
However, as a pending condition, “They will seek to use the abolishment of transfer
charges to resolve the questions of recovery of costs, settlements between regions, andlocation in remote areas and will watch how the situation progresses following theabolishment, and if major problems arise, they will immediately reassess theabolishment.” Nonetheless, the orientation towards the creation of a single nationwide
market that has been expressed lately is unlikely to change.
Since linked equipment between companies is weak in terms of physical infrastructure,
and a long-term build-up will be required, the structuring of a mechanism “to provide
compensation commensurate with the abolished transfer charges” will be indispensable.
It is assumed that measures for settlements between companies are now being
introduced and the secure recovery of costs will be guaranteed; however, a debate is
now being called for in the United States and Europe on how the compensation money
will be calculated, and adequate study will be required.
(2) Evaluation and issues concerning the establishment of NSO(a) Governance
As mentioned previously, NSO have been set up to handle such problems as theformation and usage of various networks and they play an important role in themaintenance of a stable supply on a nationwide scale. Consequently, the governanceand decision-making procedures at NSO have a marked affect on the operation of theelectricity market.
There are no examples of the same sorts of institutions having
been established in Europe or America, and it is a system unique to Japan.
They are made up of “Board” and ad special committees established within the NSO
as well as the representatives of the interested parties, and inevitably the ‘scope of theinterested parties,’ the ‘distribution ratio of seats,’ and the ‘ selection’ have a significant
impact on the decision making process.
In Europe and America as well, the means of participation of interested parties inorganizations requiring neutrality vary and it is dangerous to think that a framework,
once determined, will be the ultimate outcome. Originally, in the United States as well,in many instances ISO Boards were made up of the representatives of the interested

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parties; however, they have shifted to independent persons2, for example without market
participant and pecuniary related interests. (In Europe it is often the case thattransmission companies are made countrywide monopolies and thus similar problems
are not encountered.)
It is particularly important to establish a way for interested parties to participate(Board and special committees) and at the same time, how the respective groups ofinterested parties will form arguments is also an important consideration. What isrequired is an organization for shaping an agreement among the respective the PPS,
self-producers and wholesale electric utilities. Over the medium and long term, an
important issue will be the training of independent specialists capable of holding theirown in specialized discussions.
(b) Guaranty of legal force
The regulations providing for the presently established NSO are set up to guaranty
their observation by a ‘system of self-regulation’ framework, in which the market
participant himself observes the rules agreed upon.
In both Europe and America, there has been a diversification of the participants in theelectricity industry, and the assurance of legal force for the rules relating to reliability
standards is a major issue. At present, all their various countries have adopted a‘system of self-regulation.’ (The enactment of a law to legally guaranty legal force iscurrently under deliberation in the United States.)
It is essential to the process of enactment of rules to be observed by market
participants under the ‘system of self-regulation’ that the view of each interested party
be expressed and that a thorough debate be conducted. Consequently, the governance of
the NSO is also important from the perspective of the legal force for the rules to be
formulated by the NSO.
(3) Evaluation and issues concerning Power Exchange(a) The proper approach to public participation
The Power Exchange decided by this present establishment may be expected tocontribute significantly to the ‘creation of a single nationwide market’ through theutilization of a wide-ranging generation facilities.
It has been agreed that the Power Exchange will be established as a purely ‘private
exchange’ and that its neutrality will be secured though the organizational configurationof “an intermediate corporation”. However, considering that establishment of multiple
exchanges is unrealistic and the scale of the PPS market share is small, theestablishment of multiple exchanges is not feasible. Consequently, this Power
Exchange will need to have a fixed public character, and it may be desirable for theorganizational and operating rules of the exchange to be determined through a public
discussion forum to a certain degree. Up to what stage of the outline of at least theorganization configuration and the operation rules would it be necessary to holddiscussions in a public forum?
(b) Nature of the power provided and supervisory system
In a market it is desirable that transactions be done freely and forcing transactions for2 This indicates persons without interests such as market participant and pecuniary type interests, and who havespecialized knowledge required for ISO operation.

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the concerned buying and the selling could distort the formation of the market.
Moreover, there is concern that market power will be employed when transaction
volume is low and thus the possibility remains that no valid price index will be formed.
Hence, at present there is no compulsory obligation on the GPUs to provide power, but
the GPUs were supposed to make known their thinking as to the power that would
initially be provided by them voluntarily. An operation that does not distort the tradingor prices in the market is necessary for this initial voluntary supply. Thus, normal
operation of the market and the achievement of a supervisory structure become issues ofconcern where there is little participation from public institutions. Under suchconditions, an emphasis should be placed on a system that executes the supervision andreporting within the exchange; however, there is room for study in the future, including
finding the best approach for public participation.
(4) Problems of retail market opening and unbundling of generation sector andtransmission sector(a) Scope of retail market opening
There are various examples in the different countries and regions of Europe andAmerica. There are, for example, those that have made full retail market opening at
once, and those that are expanding the scope of retail market opening in phases,
commensurate with the actual state of competition.
Viewed from the examples of such foreign countries, there is concern that an easy
expansion of the scope of retail market opening, while competitive conditions are still
not right, may cause competitive harm to small users, such as the home sector. It could
thus be said a sound approach would be to make the present decisions on the expansionof the scope of retail market opening in a phased manner, commensurate with theestablishment of NSO and Power Exchange and the progressive development ofcompetition.
(b) Non-adoption of structural regulations such as the separation of generation sector
and transmission sector (unbundling)
A variety of methods have been adopted in Europe and America (ownership
unbundling, legal unbundling, management unbundling, etc.), aimed at increasing theindependence of the transmission sector from other business activates. With the
exception of Japan, there are few countries that have continued with an integrated
system even following deregulation.
Nevertheless, structural regulations (unbundling), such as the separation of generation
sector and transmission sector at existing GPUs, were not adopted. This can be said tobe an appropriate choice from the viewpoint of stable supply, as these GPUs were
expected to assume almost the entire supply of electricity of regions where they
continued to maintain regulated areas. The key to the handling of the structural
regulations will be how the concept of ‘supply obligation’ deteriorates along with fullderegulation.
5. Summary and Outlook for the Future(1) Medium-term issues(a) Outline
A study is planned by a detailed working group, in anticipation of the National

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Assembly passing the draft amendment to the Electricity Utility Industry Law. The
points discussed in this report may be issues that have a significant bearing on theelectricity market over the medium and long term, and thus need to be studied in depth.
The positioning of nuclear power and coordination with the market is to be studied by
the end of 2004. In particular, it is anticipated that discussions to be held on the
problem of nuclear power will include the appropriate direction for back-end
responsibility, given that its potential affect on the present framework is undeniable.
Discussions on full retail market opening from 2007 are slated to begin over the
medium term; however, as the concept of supply obligation is likely to deteriorate
substantially, and there are also many aspects that cannot be ascertained on theextension line of the future framework of the electricity industry, thorough study will be
required.
(b) Positioning of nuclear power and coordination with the market
It has been decided to proceed in the following manner. “A system will be set up to
analyze and evaluate factors such as the cost structure encompassing the back-end
operations in general and the profitability of nuclear power generation as a whole.
Based on the results, arrangements will be made, for example as to the appropriate
apportionment of roles between the government and private sectors, and coordination
with the existing system. A study will then be made on the orientation and necessityof specific systems and measures, such as economic measures, with the year 2004 set as
the target.”Amidst growing importance of energy security and global environmental problems,
there is a demand for the steady promotion of nuclear power generation, which plays animportant role in Japan’s energy policy. Thorough discussion will be required as to how
these nuclear power policies will be positioned within the deregulation system and how
the of roles of the government and private sectors are to be apportioned. How theyturn out could also affect the framework of the present system; hence it will benecessary to keep a careful watch on direction of these talks.
(2) Long-term issues
Though the present concept of the ‘creation of a single nationwide market’ will beworked out over the long-term, this will, however, leave open the issue on how to assure
the formation of a network infrastructure suited to it.
In the United States the development of large scale RTOs has resulted in a shifting of
the burden of the cost for wide area networks from individuals to the general market,
which has in turn moved it in the direction of finding an answer the problem of the costburden. Moreover, it is likely that an effort will be made to promote a wide-area
electricity market through the formulation of RTO-wide regional transmission facilities
plans.
By comparison, Europe has decided to unify the fees for power transactions withinregions with equivalent charges for export and will adjust the differences with the costs
for relay through a compensating mechanism. It would, however, be difficult to say thateach country has been provided with an incentive for building interconnection facilities.
Accordingly, it is thought that an effort will be made by the regulatory agencies of eachcountry to assure the necessary network infrastructure by pushing for a reinforcement ofinterconnection facilities at the stage of plan approval for investment in ‘monopolistic

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transmission companies.’
It has been decided to introduce measures for settlement between companies in
conjunction with the abolishment of the transfer charges, and it is likely that thecollection of the costs for linked equipment will be guarantied. Nevertheless, it isquestionable whether adequate incentive has been assured for building up theinterconnection facilities for the creation of a single nationwide market by the existingGPUs. In regard to this problem, it has been decided to “provide a point for
coordinating the planning for the providing of interconnection lines between supply
areas” at the NSO, and indeed at this juncture as well, there will be a problem ofreaching a consensus at the NSO.
Contact: ieej-info@tky.ieej.or.jp10