Reform the Japanese power system. Nationalize Tepco.

The Japanese government recently announced a de facto nationalization of the Tokyo Electric Power Company (Tepco) to avert the prolonged insolvency expected to result from massive compensation claims, cleanup charges, and reactor-disposal costs related to the accident at the Fukushima Daiichi Nuclear Power Station. This conventional plan calls for Tepco to be kept viable — that is, not allowed to fail, at least for the time being — so it can be the primary vehicle for dealing with the aftermath of the disaster.

But not letting Tepco fail creates real moral hazard. The government is effectively telling the shareholders and bondholders of other electric utilities that there is no need to worry; investors will not be held responsible should a similar accident occur on their watch. The current financial arrangement also leaves in place the Tepco corporate culture that was responsible for the failures to prepare for and respond to the Fukushima Daiichi accident — even as the damaged and vulnerable spent fuel pool at Unit 4 presents the need for long-term crisis management.

To avoid placing an unnecessarily heavy burden on taxpayers, the government should be pursuing not this de facto nationalization, but an immediate, complete, de jure nationalization of Tepco. Promotion of nuclear energy has been a national policy in Japan. Full Tepco nationalization would allow the state to take direct responsibility for compensation, decontamination, reactor disposal, and crisis management at Fukushima Daiichi. Nationalization of the world’s largest private-sector power utility would also send the message that no Japanese utility is too big to fail, reinforcing an accountability and safety culture within other nuclear operators. Perhaps most important, nationalization would create the opportunity to liberalize the Japanese electricity market, reducing the power of regional utility monopolies and encouraging alternative energy producers.

Prompt nationalization. The Japanese government adopted the Act to Establish the Nuclear Damage Compensation Facilitation Corporation in July 2011; under the act, the government and other electric utilities provide Tepco with loans that allow it to meet compensation claims arising from the Fukushima disaster. The loans have no fixed maturity date, but are to be paid back by Tepco over the next several decades. So far, however, the government has not established any system for providing the trillions of yen that will be required to dispose of damaged reactors and decontaminate the environment. Also, in less than a year since the passage of the act, it has come to light that accident-related costs are so massive that even if Tepco were to sell all its assets, it would remain insolvent for decades to come. Pressed to keep Tepco from failing outright, the government had few options. Under a measure announced on May 10, it agreed to inject approximately ¥1 trillion ($12.5 billion) of capital into Tepco in exchange for majority voting rights in the company. Thus, in effect, Tepco will be nationalized in July.

But such an arrangement has many problems.

First, the reluctance to let Tepco fail presents a moral hazard that is especially dangerous because it involves the management of nuclear materials. With any electric utility, the shareholders — and, to a degree, the creditors as well — bear a responsibility for seeing that the company is managed in a way that ensures proper disaster-prevention measures are adopted. And there is an appropriate mechanism for apportioning blame in the aftermath of mismanagement: Managerial shirking on safety leads to a serious reversal (in this case, an accident); the company fails; and shareholders lose their entire investments. By not letting Tepco fail, the government is effectively encouraging the lax management of nuclear facilities. It is telling the shareholders and bondholders of other electric utilities that investors will not be held responsible should an accident occur on their watch.

Moral hazard aside, Tepco is unlikely to see much in the way of productivity improvements under current management. Even in good times, the corporate culture of Tepco was notoriously customer unfriendly, in large part because of its special status as a private firm that operated as a regional monopoly. As long as this monopoly remains in effect, Tepco has little incentive to reduce costs or improve management, but instead will charge higher rates when in financial difficulty. Indeed, on May 11 — the day after the government’s massive capital infusion — Tepco formally requested permission from the Minister of Economy, Trade and Industry to raise its residential and other regulated rates by an average of more than 10 percent.

If Tepco is kept afloat, the Japanese public will probably have decades of low productivity, little managerial reform, progressively higher electricity rates, and continual injections of public funds. In the end, the taxpayer and the consumer will still pick up the tab for the nuclear accident and subsequent cleanup, bearing a substantially heavier burden than if the government had just stepped in at the start and used tax money to clean up the mess.

Crisis management and clean-up after the Fukushima Daiichi accident have turned out to be tasks far beyond the capacity of Tepco, and perhaps any private firm, to handle. The spent fuel pool at Unit 4 remains a catastrophic threat. Although structurally reinforced, the building containing the spent fuel storage pool for Unit 4 remains fragile, and the pool is exposed to open air. Another earthquake, a tsunami, or a tornado (tornadoes recently caused severe damage in Tsukuba, an area near Fukushima prefecture) could devastate Unit 4, resulting in further releases of radiation. Relying on the firm that bungled the original accident response to properly handle long-term management of such a severe threat would be, simply and plainly, irresponsible.

The Japanese government should not inject additional funds to keep Tepco afloat but instead deal with the aftermath of the accident directly. In line with that decision, the government should allow Tepco to fail, nationalize what remains, and reconstruct it into a responsible and responsive utility.

Nationalize Tepco, liberalize the electric market. Tepco sold 2.8 billion kilowatt-hours of electricity in its fiscal 2009, making it the world’s largest private-sector power company. The nationalization of such a large player would provide a great opportunity to speed liberalization of the Japanese electricity market. For this liberalization to work, Tepco’s generation and transmission businesses would need to be split, and contractual arrangements between power suppliers and power users have to be reformed, introducing what is known as a “real-time balancing” pricing system.

The Japanese power industry is currently organized in a system that centers on vertical integration, beginning with power generation and extending through transmission to retailing. There are 10 electric utilities in Japan, each with its own regional monopoly. A 1995 revision to the Electricity Business Act touched off a round of deregulation of that monopolistic system, but the established power companies retained near-monopolies in their generation and retailing businesses, and they discouraged new market entrants with high prices and penalties for supply and demand variations.

Japanese economist Tatsuo Hatta has proposed that the current method of regulating electric supply and demand, which is controlled by the regional monopolies, be replaced with real-time balancing, a system that requires all electricity generating plants and large electrical users to inform a command center of their next-day schedules of electricity production and use. Actual volumes of electricity production and use may vary from the schedule; the command center balances these volume gaps every 10 minutes, buying excess electricity from generating plants and users who consume less than planned and selling to users who need more. Price would change in accordance with the real-time supply-demand balance. In this way, producers have an incentive to add capacity to accommodate demand peaks, and users have an incentive to save energy.

Even beyond a real-time system for balancing short-term electricity supply and demand, a number of obstacles must be cleared to complete liberalization of Japan’s electricity market. First, renewable energy sources need to be linked to the power grid. Toward this end, it is necessary to establish a highly sophisticated supply–demand system that incorporates techniques for regulating and storing power generated by alternative methods. Also, there is the issue of assuring long-term supply stability by balancing investments in power generation and power transmission. But Japanese companies have made real progress in the development of smart meters, smart grids, and other elements with which to establish systems that can regulate, store and guide investment in energy alternatives.

And any system that encourages alternative energy production in Japan will require a reform of current monopolistic system. The full nationalization of Tepco could serve as a starting point for that reform.

Reform the market and clean up the mess. Nationalize. A smooth and full Tepco nationalization would improve the response to the Fukushima accident and liberalize the Japanese electricity market simultaneously. The government would take responsibility for — and bear the costs of — Fukushima-related compensation, decontamination, and reactor disposal. Tepco, meanwhile, would go out of business in steps, beginning by splitting its nuclear facilities from other power generation facilities. The government would take over the nuclear facilities and make them part of a national nuclear power company, and Tepco would sell its other facilities, using the proceeds to pay down its debts. Tepco’s transmission network, including command centers, would be nationalized and then, upon introduction of real-time balancing, reconfigured as a foundation upon which to build a new power supply and demand system. As these efforts proceed, deregulatory initiatives could open the transmission network to other power producers and thereby support the development of renewable energy throughout the country.

The accident at the Fukushima Daiichi Nuclear Power Station — and the subsequent, nagging risk of national power shortages — revealed the significant vulnerability of power generation based solely on large centralized facilities such as nuclear power plants. Electricity is the indispensable basis of a modern society. Ensuring its stable supply is the mission of the power industry as a whole, with the government assuming the primary responsibility for fostering an open and fair competitive market for electricity.

The Japanese government needs to create a vision for a new energy reality that incorporates energy conservation and a decentralized, distributed power-generation system that includes many energy sources, including renewables. But the government needs to do more than create such a vision; it must also take the initiative to realize that vision. The full nationalization of Tepco is the best way to assure safety, enforce accountability, and change the Japanese power -generation industry in a fundamental way.

Editor’s note: Yoichi Funabashi and Kay Kitazawa co-authored “Fukushima in review: A complex disaster, a disastrous response” featured in the March/April 2012 issue of the Bulletin.