Strategic Procurement in Japan: Managing Risk Beyond the Basics

Following our latest blog on Japan, where we outlined the complexity of Japan's electricity market and the opportunities available to large energy buyers, we now turn to a topic that demands closer attention: risk management.

As we highlighted previously, retail prices were stable in the years after deregulation in 2016, but the global energy crisis of 2021–2022 (see wholesale prices below) revealed how exposed Japan was – and still is – to international commodity price shocks. Electricity prices have eased since then, but turbulent world politics and Japan's reliance on imported fuels continue to create material risks for energy consumers. In this environment, effective risk management has become a crucial part of every company's long-term energy strategy.

Understanding where risk originates is the first step to managing it. In Japan, costs are shaped not only by retail contract design but also by the global, regulatory and operational systems beneath them.

This blog explores two key risks in Japan's electricity costs and the risk management options available for large energy buyers:

• Fuel market risk represents the foundation layer. Japan's dependence on imported LNG (37% of generation) and coal (31% of generation) creates direct exposure to global commodity shocks. The 2022 energy crisis demonstrated this vulnerability when LNG import prices surged 300% year-over-year, flowing through to retail bills via Fuel Cost Adjustment (FCA) mechanisms.
• Market price risk emerges through JEPX wholesale market volatility, where prices can spike during supply-demand imbalances. The Japan Electric Power Exchange handled 267.7 TWh in FY2023, approximately 40% of total generation.

Fuel risk management: Beyond basic FCA understanding

Fuel volatility is the foundation of electricity costs in Japan. Because the country relies so heavily on imported LNG and coal, global events quickly find their way into local bills – either via retail prices, JEPX spot prices or the Fuel Cost Adjustment (FCA) (燃料費調整, nenryōhi chōsei), which uses a moving average of past fuel import prices. This creates a lag of two to five months, meaning today's shocks often appear later in invoices.

Source: Shulman Advisory

This lag phenomenon is common during energy market deregulation as countries transition away from oil-indexed gas contracts. Europe experienced a similar price lag until local gas indices were established.

Japan's recent experience demonstrates the impact: from 2021 to 2023, FCA increases caught many buyers by surprise. For a typical 30 GWh industrial consumer, FCA costs surged from representing a minor percentage of monthly bills to consuming 35% of total energy expenses at the peak in early 2023.

How the FCA works

The basic FCA formula: FCA = (Average Fuel Cost - Base Fuel Cost) × Unit Adjustment Rate

Regional utilities use different fuel weightings based on their generation portfolios. Tokyo Electric Power Company (TEPCO, shown above) relies heavily on LNG, creating high natural gas exposure, while utilities in coal-dependent regions like Kyushu face different volatility patterns. After the 2021–2022 crisis, most utilities removed or raised FCA caps, leaving buyers with unlimited fuel cost exposure.

Managing FCA exposure

Although FCA pass-through has stabilized with commodity prices, the energy crisis showed the importance of evaluating contract exposure to FCA and mitigating it. Two primary approaches reduce exposure to FCA volatility:

Contract structure optimization: Blend fixed-price contracts (with FCA) and market-linked agreements (without fuel linkage) to balance stability and opportunity.

Financial hedging: Use oil futures to hedge LNG exposure, since Japanese LNG contracts typically price at 10–15% of Japan Crude Cocktail (JCC) oil benchmark.

JEPX and managing market price risk

Industrial consumers in Japan face three primary procurement channels, each with distinct risk profiles:

• Bilateral Contracts (Physical) – Customizable long-term agreements offering price certainty but with counterparty risk and limited liquidity. These work well when customization is essential or when both parties seek long-term stability.
• JEPX day-ahead (spot) and Intraday Markets – Highly liquid physical delivery markets used for immediate needs and balancing. The day-ahead market is the largest trading venue in Japan (267.7 TWh in FY2023), while the intraday market serves as a final adjustment up to one hour before delivery.
• Futures Markets (Financial Settlement) – Cash-settled instruments on EEX, TOCOM, or NYMEX offering long-term hedging from weeks to years. Liquidity remains relatively low but is increasing (EEX grew from 18.3 TWh in 2023 to 72.9 TWh in 2024). These instruments eliminate counterparty credit risk through clearing houses.

Market-linked contract evaluation

Market-linked contracts are gaining popularity among industrial companies, but buyers must understand their true risk profile. These agreements typically price energy at JEPX plus a fixed margin, appearing to eliminate fuel exposure. In reality, JEPX prices remain heavily influenced by fossil fuel generation costs.

The result? Market-linked contracts can amplify rather than reduce volatility. During the 2021–2022 crisis, some market-linked agreements produced higher costs than traditional fixed-price-with-FCA contracts because JEPX price spikes exceeded fuel cost increases.

Advanced price risk protection mechanisms

Corporate buyers are increasingly demanding sophisticated risk mitigation tools, driving innovation in contract structures. Suppliers, including generators, aggregators, and retailers, are responding with three emerging solutions that address JEPX volatility concerns:

• FIP (Feed-in Premium) enhanced structures leverage Japan's Feed-in Premium scheme to reduce market price exposure. Under FIP, renewable generators receive a premium above wholesale prices, creating more stable revenue streams that suppliers can pass through to corporate buyers via improved contract terms.
• Split supply frameworks allow buyers to maintain two contracts: one delivering electricity under JEPX-linked pricing, while the other uses a fixed-price structure. Buyers get direct exposure to wholesale market dynamics while maintaining contractual flexibility.
• Fixed-price virtual PPAs represent the most sophisticated solution, combining renewable energy certificates with contract-for-difference (CfD) mechanisms that eliminate market price risk. These structures fix the electricity price regardless of JEPX volatility while supporting renewable development. More on this topic in an upcoming blog.

Companies considering market-linked contracts should implement a cap on market-linked exposure and maintain a fixed price or hedging contract for the remainder.

Futures market development: Building sophisticated hedging strategies

Market share (EEX vs TOCOM) Source: EEX Japan Power 5th Anniversary event presentation

Futures in Japan work on a cash-settled basis, similar to how they operate in India. They settle against the average wholesale price for the month and cash out based on the difference between the hedged price and the wholesale price. More details can be found in our blog on India's electricity futures market.

Source: Shulman Advisory

The futures price curve above demonstrates lower volatility than spot markets because monthly delivery contracts average out daily fluctuations. This makes futures particularly valuable for budget planning and hedge accounting purposes.

Current market limitations require strategic adaptation

• Futures volumes represent only 7% of spot market activity (versus 300–500% in mature European markets)
• Trading concentrates in Tokyo baseload (71% of volume) with limited product diversity
• Seasonal patterns favour January–May trading due to fiscal year hedging cycles

Real-world hedging impact: A practical example

A Japanese industrial consumer recently implemented partial financial hedging to reduce market price exposure. This mid-sized manufacturer with 2,000 MWh monthly consumption (approximately 2.78 MW average demand) decided to hedge a 1 MW block – around 36% of their monthly electricity exposure (720 hours per month in a 30-day month) – using EEX monthly futures contracts.

The hedging strategy was straightforward: hedge 1 MW on a CfD that pays the difference between a fixed strike price and the monthly average JEPX settlement price. This creates a synthetic fixed price for the hedged portion while leaving the remainder exposed to spot market movements.

The results show both the protection and opportunity cost of hedging:

Low-price scenario

With a CfD strike price of 12 Yen/kWh versus an actual JEPX monthly average of 14.59 Yen/kWh, the CfD paid out 1.87 million Yen to the buyer. This effectively reduced their electricity costs by locking in power below the realized market average. The financial settlement compensated for the higher spot prices they paid on their underlying supply contract.

High-price scenario

With a CfD strike price of 16 Yen/kWh versus an actual JEPX monthly average of 14.59 Yen/kWh, the buyer paid 1.01 million Yen to the counterparty. This represented the cost of hedging when markets moved favourably. While they benefited from lower spot prices on their physical supply, the CfD required payment because the strike price exceeded the settlement reference.

What this means for your procurement strategy

CfD structures provide pure price risk management without affecting physical supply arrangements. This consumer maintained their existing supply contract while adding a financial overlay that modified their effective price exposure for ~36% of consumption.

Cash-settled hedges separate price hedging from physical supply. Buyers can maintain operational flexibility with their electricity supplier while implementing sophisticated financial risk management strategies. The two-way settlement ensures protection during high-price periods, though buyers pay for that protection when markets are favourable.

Conclusion: The new procurement imperative

Japan's electricity market evolution demands sophisticated risk management that goes far beyond traditional contract negotiations or simply rolling over fixed-price contracts with the regional utility (EPCO). The 2021–2022 crisis showed that companies treating energy procurement as simple cost minimization can face significant financial exposure during market stress.

The opportunity is substantial. Companies implementing proper risk management and hedging strategies, such as combining fuel risk management, futures hedging, and advanced contract structures like CfDs, can reduce cost volatility by 40–60% while maintaining competitive pricing. Those continuing with basic fixed-price approaches will likely face increasing costs as retailers build larger risk premiums into their offers to compensate for their own growing exposures.

Companies that act now by building internal capabilities, diversifying contract portfolios, and establishing hedging relationships with retailers or brokers will be positioned to capitalize on Japan's evolving energy landscape. Those who delay risk being caught unprepared by the next market disruption, facing both higher costs and limited options when volatility returns.

In our next analysis, we'll examine how Japan's accelerating energy transition is creating new opportunities in renewable procurement and how businesses can align risk management strategies with sustainability objectives while navigating an increasingly complex regulatory environment.

For those interested in exploring how these insights apply to your specific situation, contact us to discuss your energy procurement challenges.

This article was written with valuable input from Shulman Advisory, who provided their expert review and feedback.

Shulman Advisory is a leading consultancy helping foreign companies and stakeholders succeed in the Japanese energy market. With nearly 20 years of experience, Dan Shulman leads a bilingual team combining deep policy and regulatory expertise with hands-on operational knowledge to guide clients through Japan’s complex and evolving power market.

"Our services include market and regulatory research, entry strategy and support, energy procurement approaches, and tailored tools such as forecasting and site mapping.

It has been our pleasure to collaborate with our partners at E&C Consultants on this article. Recent years have seen growing demand for procurement optimization and wholesale price forecasting, and we are proud to have supported major energy users, from hyper-scale data centers to manufacturers, in meeting these challenges." 

Find out more about our partnership with Shulman Advisory in our news release.

All figures included in this blog, unless expressly stated, have been created by E&C Consultants.