Japan: Large-scale battery storage opportunities in an evolving market

These have come from a mix of major Japanese industry players, including electric utilities and large corporates, and international players like technology providers Tesla, LS Electric and Sungrow, and developers such as Eku Energy and Gurin Energy.   

The current boom in announced projects and business partnerships in Japan’s energy storage market has taken time to materialise, but as Ali Karimian, market optimisation director at energy trading platform provider GridBeyond, said recently, Japan represents a “fresh, unsaturated market.” 

Speaking after Ireland-headquartered GridBeyond won its first asset optimisation deal in Japan, Karimian said that the recently developed market does not yet have a big field of competitors vying for revenues. Ancillary services revenues available for battery energy storage system (BESS) assets have been much higher in recent months than in other markets where GridBeyond is active, such as the UK and US, which are seeing saturation and intense competition.

Hirofumi Sho, head of investment and origination for Japan at Eku Energy, began looking into battery storage business models around five years ago at Macquarie’s Green Investment Group, which launched the developer from its London offices.

Sho says the Japanese market was unfamiliar with battery storage at the time. The industry’s role was mainly to lobby for market access and recognition of the value of BESS for the grid while considering how the battery market could get started.

The first big change came when a partial revision to the Electricity Business Act legislation in May 2022 created a category of power generation business to which large-scale battery systems could be included.

The second big step was the launch of two nationwide subsidy schemes designed to promote the use of energy storage. One was launched by the national government’s Ministry of Trade, Economy and Industry (METI), and the other by the Tokyo Metropolitan Government.

Sho’s colleague, Eku Energy Japan managing director Kentaro Ono, explains that the METI subsidy covers up to 30% of the Capex cost for large-scale BESS. The Tokyo Metropolitan Government scheme, meanwhile, is for projects both in and outside the Tokyo area and covers up to 50% of the Capex. Both schemes help to improve the economics of financial return on investment, Ono says.  

While these steps progressed at the top level, Hirofumi Sho says the industry was also becoming more familiar with battery storage and how it works.

The Japanese government introduced a new capacity market mechanism, the Long Term Decarbonisation Power Source Auction (LTDA), which then gave developers, including Eku—a winner in the most recent LTDA round—a fixed 20-year revenue stream to which a business case could be attached.

“Revenues are becoming increasingly stabilised for developers, which I think represents the journey of the Japanese market so far,” Sho says.

The LTDA has been a big boost for the market, but it is also important to note that, as with maturing markets such as the UK, developers and investors can ‘stack’ revenues from their assets.

The LTDA’s launch was followed by the opening of energy trading opportunities in the balancing market and wholesale market to BESS assets and, in April 2024, the opening of day-ahead and week-ahead ancillary services markets.   

‘Market design for energy storage in Japan not yet fixed in place’

However, though it has come a long way, based on the still-evolving nature of the regulatory framework and market design, BloombergNEF (BNEF) energy storage analyst for Japan, Umer Saddiq, sounds a note of caution.

Saddiq says that despite the growth of opportunities, the Japanese battery storage market remains volatile compared with more established markets.

Policy and market design changes occur roughly every six months, impacting everything from battery-specific regulations to power and ancillary services markets. According to the analyst, some developers are finding that this makes it difficult to understand what changes might come next.

For example, while the first rounds of the LTDA included two duration categories for batteries and pumped hydro energy storage of 3-6-hour duration and 6-hour+ bids, a recent METI committee has proposed that future rounds may seek only long-duration energy storage (LDES) of 6-hour duration or longer.

“From a developer angle, they would want to see policy continuity, or if there is a change of policy, they would want to have a head start of maybe a year. So, while there are multiple revenue streams available, one of the challenges in the market is that it’s very hard to understand when the policy change will be coming in,” Saddiq says.

In terms of market design, proposals have been made to combine some of the ancillary services markets and trading markets, including the delta-kilowatt market (balancing capacity) and kilowatt-hour market (balancing power).

“From an investor perspective, or a lender’s perspective, there are a lot of things to consider. The market design has not yet been fixed in place, compared to other markets,” Saddiq says.

“Many market players are still figuring out what business models they want to do,” says Isshu Kikuma, a global energy storage analyst at BNEF.

“LTDA is one option which has a long-term contract, which is nice, but some market players are only looking into the merchant opportunities, looking for the price upside. Some players are also interested in somewhere in between, which is tolling [agreements].”

LTDA: 20-year capacity payments, 10% merchant upside

The 26 BESS and two pumped hydro projects that won 20-year fixed-revenue capacity contracts in the 2024 LTDA hosted by the national association of grid operators, OCCTO, were announced in late April.

A total 1.3GW of 3-hour to 6-hour duration BESS, one 47MW BESS of 6-hour specific duration and two PHES projects adding up to 180MW were selected, including Eku Energy’s 150MW/600MWh Eshi project in Okayama prefecture, the company’s second project in Japan.

LTDA is an attractive mechanism for developers and their investors, given the long-term contracted capacity payments with a highly creditworthy offtaker, but there are strings attached.

“In the LTDA design, you have to return 90% of your profits from other markets, like ancillary services or power market arbitrage, back to OCCTO, because you are getting these capacity payments,” Umer Saddiq says.

“Almost all the revenue is already decided when you get that project awarded in the auction. It might be good for some of the project developers, because they want that kind of long-term certainty of 20 years’ capacity payments, but it also caps the revenue that you can practically get from anywhere else.”

So, although battery storage revenues can be stacked from multiple streams in Japan, for the winners of the low-carbon capacity market auctions, only 10% of their revenues can come from the merchant model.

Kikuma says that the LTDA capacity payments remunerate at a high enough level that for many developers, it doesn’t matter how much they could make from other sources, while the 10% merchant upside is small by proportion but not negligible.

“It’s relatively easier to finance [LTDA projects] for the banks as well, because there is that certainty of long-term payments,” Saddiq says.

“If you go for a full merchant model without LTDA, because there is a lot of policy risk in the market, things are changing: ancillary services market design, and then the instantaneous power market design as well, there’s a lot of uncertainty as to how the market will behave in the future.”

The BNEF Japan analyst says that, for now, developers are mostly opting either to apply for METI or Tokyo Metropolitan Government subsidies or participate in the LTDA. BNEF has only seen a limited number of cases where full merchant BESS projects have secured project financing.

For Eku Energy, the LTDA is important to the business model of its Japanese projects but the developer, perhaps best known for projects in the UK and Australia, sees three pathways to commercialisation for large-scale batteries in Japan.

The company secured a 20-year tolling agreement for its first Japan project, the 30MW/120MWh Hirohara BESS. Now under construction on the southern island of Kyushu, Eku claimed its tolling agreement with utility Tokyo Gas was a first of its kind for the Japanese market that helped it to close financing in the summer of 2024.

“In the historical context of Japan’s battery storage journey, the LTDA is another breakthrough for developers to secure a long-term contract, which is one of the attractive revenue streams,” Hirofumi Sho says.

“Some developers may only rely on this, but we do not. We are diversified, and we want to have diversified revenue stacks through the portfolio. However, having certainty of a long-term investment is still helping this market grow or change to a new stage.”

Kentaro Ono says that Hirohara BESS’ tolling deal and the Eshi project’s LTDA contract are two of three commercialisation pathways Eku Energy sees potential for in Japan.

The third is a full merchant model. Ono says the developer wants to hold a diversified portfolio representing different risk and reward appetites for investment.

That said, the Eku managing director says the merchant model is an opportunity for the future rather than today. Perhaps echoing the BNEF analysts’ view on the market uncertainty a little, Ono says it is not yet clear when that will be, but it will likely be in the next few years.

…to be continued.