TOCOM Electricity Futures Market: 2022 Review

After having being authorized by the Ministry of Economy, Trade and Industry (METI), TOCOM’s Electricity Futures market has, as of April 4, 2022, had its market status converted from a “trial listing” to a “permanent listing”, just two and a half years after its launch in September 2019. During that period, TOCOM has amended various trading rules, including the abolition of price limits, the expansion of Dynamic Circuit Breakers, and modifying the margin system to better cope with the risks of sudden fluctuations in power prices, following the extreme rise in the spot electricity market prices in the Electric Power Exchange experienced in January 2021, which was caused by tight supply and demand. As the market is now permanent, TOCOM aims to further increase the convenience for market users, and to further develop the market from a mid to long-term perspective.

Japan’s annual power consumption is about 987 TWh, making it the fourth largest market in the world, and it is said to be the largest of the world when considering that Japan is a liberalized single market. The liberalization of power markets in Japan started in 1995, and since then the liberalization has proceeded in stages. When the electricity retail market was fully liberalized in April 2016, newly established power retail companies entered the business.

In the meantime, TOCOM launched its electricity futures markets in September 2019. As most of the power retail companies that newly entered the market relied on the power wholesale market (Japan Electric Power Exchange (JEPX)) for procurement, the importance of JEPX has only increased and the need to hedge price volatility risk rose. As a result, the power retail companies started to participate in the TOCOM electricity futures markets, as did foreign power traders.

The annual trading volume of TOCOM electricity futures in 2021 was about 27,000 contracts (a 180% increase over 2020) or over 300 million kWh (also a 180% increase over 2020), which is the equivalent to 23.65 billion Yen (or a 400% increase from 2020) in nominal value.

The number of market participants, which started with a mere 13 corporations, expanded to 144 (as of March 2022), an 11-fold increase since market inception, and the major power companies have also started to participate in the market. It is worth noting that foreign energy traders’ participation is increasing, and their monthly trading volume continues to grow, now representing around 15 to 20 % of all trades.

There are several drivers behind this market expansion.

Firstly, power companies have been highly motivated to hedge by using the TOCOM electricity futures market after experiencing the sharp spot price increase which occurred between the end of December 2020 and January 2021. The soaring prices made power companies acutely aware that electricity futures is a valid means with which to protect themselves from significant price swings in a liberalized electricity market environment.

Electricity futures trading is noted as a valid risk management tool within the 6th Strategic Energy Basic Plan which was issued and approved by the Cabinet in October 2021, as well as in the “Electricity Market Risk Management Guidelines (the guidelines to improve stable power supply service)“. Electricity futures are the first listed commodity futures product to be positioned as a policy tool by the government, which may have assisted in the early electricity futures’ permanent listing status.

Circumstances surrounding the electricity markets in Japan have changed dramatically over the past two and a half years. When futures trading started, electricity prices kept declining due to an inflow of renewable energy into the market, decline in electricity demand due to the spread of Covid-19, and the effects of lower fuel prices. However, the situation changed in December 2020. After the JEPX spot market chaos in January 2021, a combination of multiple factors pushed electricity prices up, and thus the circumstances surrounding electricity businesses, especially retail sellers, became increasingly difficult. Factors that contributed to this change include the European gas market chaos that arose in the fall of 2021, soaring fuel prices (e.g. crude oil, LNG and coal) following Russia’s invasion of Ukraine, and the depreciation of the Yen.

Under such an environment, TOCOM has implemented many measures to enhance market convenience, in order to contribute to power companies’ business stability through price discovery and risk hedging. One of the revisions TOCOM implemented, following requests from power companies, was the expansion of contract months to a continuous 24-month curve (up from 15), which was adopted in April 2022. Power companies had asked TOCOM to calculate/provide prices on an even longer forward curve to use as reference when they bid on the electricity spot market. Another reason was the need to be able to trade in contract months that include the next fiscal year period.

Other requests included enhancing the ease of off-floor transactions with greater transparency, increasing the number of market makers and implementing margin off-set between LNG and electricity futures. TOCOM believes that by enhancing the market convenience for users, this will help further develop the energy futures markets.

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