10 minute read | October.04.2023
The Long-Term Decarbonization Auction (the LTDA) is set to be launched in FY2023. Amid massive installation of VREs such as solar and wind continues, the LTDA, a form of auction at the Capacity Market (yōryō shijō) conducted by the Organization for Cross-regional Coordination of Transmission Operators (OCCTO), is expected to promote investment in sources such as battery storage and hydrogen firing, which will provide flexibility to the grid while also reducing CO2 emissions in the energy sector. Successful bidders at the LTDA will enter into a Capacity Reserve Agreement (yōryō kakuho kēyaku); CRA) with OCCTO to provide capacity over a certain long-term period (20 years in principle), satisfying certain conditions in exchange for the Capacity Reserve Payment to cover the fixed costs. OCCTO published the Guidelines for the LTDA (the Auction Guidelines) and the Terms and Conditions of the Capacity Reserve Agreement (the T&Cs) on September 13, 2023 with respect to the first LTDA to be conducted in FY2023 (see here and here). Registration of operators is scheduled to begin on October 16, 2023, and preparations are underway for the first auction in January 2024.
In this Alert, we provide an overview of the LTDA and look at the future of renewable energy, battery storage, etc. in Japan.
The LTDA was established as part of the Capacity Market.
The Capacity Market, for which the first auction was held in FY2020, was established to promote investment in power resources to secure sufficient future electricity supply. After the liberalization of the electricity market, there were concerns that resources with relatively high marginal cost but necessary for a stable supply of electricity may exit the market with the decline of the energy (kWh value) market price due to the entry of renewable energy with zero marginal cost, resulting in insufficient supply over the medium to long term. The Capacity Market was established in response to these concerns as a mechanism to pay for the future provision of power supply capacity fulfilling certain standards.
In the auction of the Capacity Market (which continues to exist as the “Main Auction”), OCCTO, as the buyer of future capacity (kW value), solicits power sources four years prior to the actual delivery year, and participating power sources register and bid on their own unit price (yen/kW/year). Successful bidders conclude a CRA with OCCTO and receive Capacity Reserve Payment (the amount calculated by multiplying the unit price (kW/yen) by its adjusted capacity considering the nature of the power source (kW)) in exchange for the supply capacity (kW value) to be provided in the specified delivery year, which thus improves predictability when combined with revenue from selling energy (kWh value) obtained from retailers via bilateral wholesale agreement or the wholesale electricity market. The funds necessary for Capacity Reserve Payments are sourced from the Capacity Levies collected from retailers.
Under the CRA, the resource must fulfill certain requirements to be considered a provider of supply capacity and must pay a penalty upon failure to fulfill such requirements. If deemed necessary in light of changes in circumstances that occurred during the four-year period between the main auction and the actual supply, OCCTO may, in the year prior to the delivery, conduct an “Additional Auction” to solicit additional capacity providers or to solicit resources to release capacity secured in the Main Auction.
The government, as it aims to achieve carbon neutrality by 2050 and a 46% reduction in GHG emissions by 2030 compared to 2013 levels, decided to create the LTDA scheme, where the Capacity Reserve Payment will be paid over multiple years to resources with high effectiveness in decarbonization, out of the need for consideration in determining capacity providers on the basis of their contribution to the reduction of CO2 emissions, and the further enhancement in investment in energy resources.
Resources eligible to participate in the LTDA are broadly classified into two categories: “stable resources” and “variable resources” (see Auction Guidelines, pp. 11 et seq.). “Stable resources” include certain hydroelectric power sources, certain thermal power sources (co-firing of LNG and hydrogen of 10% or more on an energy basis or 100% hydrogen), nuclear power sources, geothermal power sources and certain biomass power sources with an interconnection point capacity of 100 MW or more, as well as pumped storage or battery storage (standalone projects) with the same of 10 MW or more. “Variable power sources” include certain hydroelectric, solar, onshore wind, and offshore wind power sources with interconnection point capacities of 100 MW or more. Those FIT/FIP-approved are not eligible to participate in the LTDA.
The total capacity solicited for the FY2023 LTDA is 4 GW. A cap on the total capacity is set for some technologies—the cap of 1 GW for the category of pumped and battery storage in total (see Auction Guidelines, p. 10).
In the LTDA, as in the Main Auction, successful bidders will execute a CRA with OCCTO and receive Capacity Reserve Payment from OCCTO for its supply capacity (kW value) and are subject to certain requirements and penalties for failure to fulfill such requirements. Differences compared with the Main Auction are as follows.
First, while successful bidders in the Main Auction will receive payment only for a single fiscal year, successful bidders in the LTDA will be entitled to receive Capacity Reserve Payments for multiple fiscal years (in principle, for the period of 20 years; such period for which the resources are to provide capacity and are entitled to Capacity Reserve Payments, are called the Applicable Period). The amount of the Capacity Reserve Payment granted during the Applicable Period will be adjusted by Consumer Price Index (CPI) (T&Cs, Art. 6).
Second, the method of determining the contract price differs. In the Main Auction, the contract price is determined based on the demand curve determined by OCCTO and uniform price is applicable to all successful bidders in principle (uniform price auction), but the contract price for successful bidders in the LTDA will be their bid price (pay-as-bid auction). Although there are certain adjustments (see T&Cs, Art. 6), the annual amount of the Capacity Reserve Payment is basically determined by multiplying the contract unit price (yen/kW) by the contracted capacity (kW). Capacity is calculated by multiplying a certain adjustment factor set by technology type (a lower value is used for VREs such as solar and wind), by the facility capacity.
Third, capacity providers selected through the LTDA must return “revenues from other markets.” That is, as the LTDA is intended to promote investment by ensuring predictability of return on the fixed cost portion, the LTDA scheme is designed to only cover such fixed cost portion. The bid price is therefore to be calculated based on the expected fixed costs, and the costs that are allowed to be factored into the bid price are restricted in accordance with the “LTDA Guidelines” issued by the Agency for Natural Resources and Energy (July 11, 2023; see here)(see Auction Guidelines, pp. 26 and 27), and are subject to monitoring by the Electricity and Gas Market Surveillance Commission (the bidding price is also subject to the cap set for each category of technology by OCCTO). A certain portion of the “other market revenues” (revenues earned outside of the LTDA through the wholesale market or through bilateral wholesale agreements) earned during the Applicable Period are to be paid or “returned” to OCCTO: in the case that (i) revenues (the Capacity Reserve Payment and “other market revenues”) exceed (ii) costs (fixed and variable costs), the portion equivalent to approximately 90% of such excess must be “returned.”
Fourth, like in the Main Auction the resources are to satisfy certain requirements but there are also some requirements peculiar to the LTDA. For example, the period for which the Capacity Reserve Payments are paid will be reduced if supply is not commenced after the “capacity provision commencement deadline,” which is the last day of the fiscal year that includes the day five years from the execution of the CRA (three years if the national/local EIA has been completed), in the case of solar; the last day of the fiscal year that includes the day eight years out (four years if the national/local EIA has been completed) in the case of wind, and the last day of the fiscal year that includes the day four years out in the case of battery storage (T&Cs, Arts. 13 and 15). In addition, economic penalties will be imposed in accordance with a certain formula (T&Cs, Art. 21) if the annual capacity factor falls below the set rates of 18.3% for solar and 28.0% for onshore wind (T&Cs, Art. 19).
You need to give due consideration to how the new scheme works including the economic penalties when deciding whether to participate in the LTDA. That said, the LTDA attracts considerable attention from the market in how the scheme could be used for battery storage and other projects that are expected to expand rapidly in the years to come.
After a decade of deregulations in the electricity industry and the introduction of renewable energy, Japan is now at a turning point where various new systems are being put into place. The first LTDA will be conducted in FY2023 and all categories of transactions in the Reserve Market (in which TDSOs (transmission and distribution system operators) procure balancing reserve) will begin in full force in FY2024. Subsidies have been instituted to support the introduction of standalone battery storage and hydrogen production, system reforms are being discussed to allow battery storage attached to FIP renewable projects to charge from the grid (not possible under the current law), and various other measures are being taken to promote further introduction of renewable energy while maintaining a stable supply of electricity. These and other measures should be closely monitored to ensure an appropriate and transparent environment for business and investment.
Orrick advised Pattern Energy Group LP on the sale of Green Power Investment Corporation (GPI) to NTT Anode Energy Corporation and JERA Co., Inc., which closed in August 2023 (see here). Prior to the sale, we had advised GPI on a continuing basis since its incorporation and have been involved in almost all of its development projects.
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