Taking advantage of Japan’s feed-in tariff regime

Author: | Published: 1 Mar 2013
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Junichi Ikeda of Nagashima Ohno & Tsunematsu discusses the promotion of renewable energy through Japan’s feed-in tariff regime

On July 1 2012, the Act on Special Measures Concerning Procurement of Renewable Electric Energy by Operators of Electric Utilities (Act on Special Measures), which establishes Japan's feed-in tariff (FIT) regime for the promotion of renewable energy, became effective. This new law made an immediate and substantial impact on the renewable energy sector in Japan. According to government reports, by the end of November 2012 more than 187,000 renewable energy generation facilities (mostly solar photovoltaic facilities) were certified by the Minister of Economy, Trade and Industry pursuant to the Act (certified facilities), and the aggregated amount of renewable energy produced (on an output basis) grew to more than 3,648,000 kW.

The FIT regime is not the first regime established in Japan to promote renewable energy and strengthen the country's energy independence. The Renewable Portfolio Standard (RPS) regime was introduced in 2003 by the Act on Special Measures Concerning New Energy Use by Operators of Electric Utilities (RPS Act). Under the RPS regime, electric utilities were required to use a certain amount of electricity generated from renewable energy generation facilities. The RPS Act was repealed on July 1 2012 by the implementation of the Act on Special Measures. In addition, a feed-in tariff regime for surplus electricity generated by solar PVs installed on residences was introduced in 2009 under the Act on Sophistication of Energy Supply Structure. The Act on Special Measures was enacted to further promote new investments in renewable energy projects and renewable energy.

Framework of the FIT regime

Under the FIT regime, utilities are required to purchase electricity generated by certified facilities at certain pre-determined fixed prices for certain fixed periods of time, and to allow certified facilities access to their grid connections, although the Act on Special Measures does allow for certain exceptions. The FIT regime contemplates that the excess cost incurred by utilities under this new arrangement will be recovered through surcharges assessed to consumers of electricity. The Act on Special Measures applies to solar, wind, hydro, geothermal and biomass generated electricity (renewable electricity).

Facility certification

In order for a renewable energy supplier to benefit from the FIT regime, its renewable energy generation facility must be certified by the Minister. A facility which has received such certification is defined under the Act on Special Measures as a certified facility and a renewable energy supplier which intends to supply the renewable electricity using a certified facility is defined as a specified supplier. Special purpose vehicles (SPVs) are eligible to become specified suppliers. While the specific criteria covering each type of renewable energy source are set out in ministerial ordinances, the following are key criteria applicable to all types of renewable energy sources:

  • The facility must have an appropriate system in place in Japan that enables facility inspections and maintenance for the duration of the purchase period, and facility repairs within three months of the event necessitating such repairs;
  • The facility must allow for measurements to be taken of the amounts of renewable electricity supplied to utilities; and
  • The installation and operational costs of the facility must be recorded.

If any of the aforesaid criteria fails to remain fulfilled, the Minister may elect to revoke the certification.

Purchase price and period

In general, initial investments in renewable energy projects are costly and investors must wait a substantial amount of time to recoup their investments through profits generated from such projects. Thus, without assurances regarding the level of achievable profits, investments in renewable energy projects would not likely increase. In this respect, in setting the purchase price, the Minister, who determines the purchase price and period in consultation with ministers of other governmental agencies and the Purchase Price Calculation Committee, an independent committee established by the Diet, must take into account, among other things, the appropriate level of profit for renewable energy suppliers. It should be noted that within the first three years of the enforcement of the Act on Special Measures, the Minister is required to give special consideration to the level of profit for specified suppliers in determining the purchase price in order to intensively promote the use of renewable electricity. For example, the purchase price for electricity generated from solar PV of 10kW or more for the 2012 fiscal year was ¥42.00 ($0.44) (with tax) and the purchase period was set at 20 years.

The Act provides that Minister is to determine the purchase price and period before the start of each fiscal year (April 1 of each year). Thus, it is important for investors to understand which purchase price (either the purchase price established for that particular fiscal year or to the year thereafter) is to apply to their projects in order to correctly anticipate the expected cash flow from such projects. The purchase price applicable to a particular project will be determined by the date the renewable energy generation facility is certified by the Minister, or the date of a utility's receipt of an offer from the renewable energy supplier to enter into a grid connection agreement (GCA), whichever is later.

Once the purchase price applicable to the specific project has been determined, it applies continuously throughout the purchase period even if the purchase price is subsequently changed by the Minister as a result of the annual re-evaluation. In exceptional cases, however, the Minister is able to change the purchase price during an unexpired purchase period if "significant changes in economic conditions" have occurred or are likely to occur. According to the Ministry of Economy, Trade and Industry (METI), however, this only applies in extremely exceptional cases such as when there is sharp inflation or deflation. It should be further noted that the purchase price continues to apply even if the initial power purchase agreement (PPA) has been terminated and the specified supplier enters into another PPA with a different utility, or ownership of the certified facility is transferred to a third party which then becomes the new specified supplier.

According to a public notice issued by the Minister, a purchase period commences on the date when electricity generated from the renewable energy facility is first supplied to the utility pursuant to the applicable PPA.

Foreign investment

Except for the general requirements under the Foreign Exchange and Foreign Trade Act, there are no legal restrictions on foreign investments in relation to renewable energy projects in Japan.

Implementation of a renewable energy project

The key steps for implementing a project under the FIT regime include, among others: (i) planning (for example, determining the specifications of the facility, determining the investment structure, selecting a project site, and conducting preliminary consultations in regards to the grid connection); (ii) obtaining necessary approvals; (iii) negotiating and executing project-related agreements; (iv) fundraising; (v) constructing the facility; and (vi) commencing operations of the certified facility.

A SPV can serve as a specified supplier that owns and operates a certified facility. One of the most commonly used investment structures in Japan is referred to as the GK-TK structure. Under this structure, a Japanese limited liability company (godo kaisha) is first established to serve as the TK operator (eigyosha) under a tokumei kumiai agreement (TK Agreement) and the owner of the certified facility. Tokumei kumiai investments are then made with the GK as the TK operator, with respect to the TK operator's business pursuant to the TK Agreement, and those investments serve substantially as the equity needed for the project. If an equity investment was instead to be made by way of a subscription of common shares in a Japanese stock company (kabushiki kaisha) which owned the certified facility, the investor would be subject to double taxation (both at the corporate level and investor/shareholder level). Under the GK-TK structure, however, taxable amounts at the corporate level are reduced, and profits gained and losses incurred by the GK as the TK operator are distributed to the tokumei kumiai investors.

Under legislation that created a special tax treatment intended to promote investments in environmental related fields in Japan, certain solar PV and wind-power generation facilities which qualify as certified facilities are eligible for immediate depreciation of the entire acquisition price of such facilities subject to certain restrictions prescribed under the applicable tax law. (The applicable facilities must be acquired between May 29 2012 and March 31 2013 and must be in operation within one year of their respective acquisition date. According to an outline of the proposed tax system revisions for the 2013 fiscal year, this special tax treatment is expected to be extended for two additional years.) Although detailed tax structuring is indispensable and any tax treatment would also be subject to fulfillment of certain other requirements, it became possible for a tokumei kumiai investor to take advantage of this immediate depreciation benefit at the investor level taxation, through the use of the GK-TK structure.

There are three options available under Japanese law to secure a site for a project: (i) acquiring ownership of the site, (ii) acquiring surface rights to the site (chijo-ken), and (iii) acquiring a leasehold right to use the site (chinshaku-ken).

Although acquisition of a site is the most assured legal means to secure a site, doing so will increase the initial investment cost. In addition, if the investment is made through a GK-TK structure, a certain regulatory issue in respect of the Real Estate Specified Joint Enterprise Act may arise when disposing of the project site and distributing the profits therefrom to the tokumei kumiai investors at the exit phase. Thus, to elude this issue, investors frequently opt to instead acquire a land use right (a surface right or land leasehold right) for their project. In Japan, land owners are often reluctant to create surface rights over their properties and thus this option may not be possible. Also, a leasehold right may not be suitable since the duration of any such leasehold right may not legally be allowed to exceed 20 years, and the duration of a renewable energy project such as solar PV will likely exceed 20 years taking into account the time required to construct the certified facility. Although the possibility exists that it may be viewed as an improper circumvention of the regulation limiting lease terms to 20 years, one possible idea to address this issue would be to enter into two separate land lease agreements: a short-term land lease agreement for the duration of the construction period, and a long-term land lease agreement for the duration of operation of the project (in the case of a solar PV, 20 years).

Further, if the owner of a project site transfers its ownership interest in such site to a third party, the leasehold right held by the specified supplier may not be asserted against this third party unless such specified supplier's leasehold right has been perfected. In order to perfect a leasehold right, registration thereof must be completed. Therefore, when negotiating the terms and conditions of a land lease agreement with the owner of the site, the land owner's consent to the registration of the SPV's leasehold right should be required as a covenant to such agreement.

In order to benefit from the FIT regime, the renewable energy facility must be certified by the Minister. The certification can be obtained before commencement of the construction of the certified facility. The processing of applying for certification will likely take approximately one month to complete with the exception of biomass facilities which will likely take about two months to complete.

Although the applicable regulations and permits may differ depending on the location of the project site or the size of the facility, other laws that may apply to the project include the Electricity Business Act, the Agricultural Land Act and the Building Standards Act. In addition to conducting a legal due diligence to identify the applicable approvals/permits related to the project, it is advisable that a preliminary consultation with the applicable local government agency be conducted at the planning stage.

In the case of a renewable energy generation facility with a certain output capacity, a utility will typically need to conduct a technical analysis regarding the grid connection. In such cases, a preliminary consultation with the utility to address the grid connection is necessary. It normally takes about three months to complete this process. In order to make an offer to enter into the PPA and GCA, this process must be completed. It should be noted, however, that completion of this process is not a prerequisite for a Certification.

With regard to negotiation and execution of certain project-related agreements, the following points which pertain to the application of the Act on Special Measures should be considered when preparing project-related agreements.

Under the Act on Special Measures, utilities are obliged to enter into PPAs with specified suppliers and to purchase all renewable electricity at the applicable purchase price for the duration of the applicable purchase period, unless certain justifiable exceptions which are specifically provided under the ministerial ordinance, apply. These exceptions include, without limitation, cases where (a) entering into the PPA is likely to unreasonably impair the interest of the utilities, (b) the specified supplier rejects certain proposed provisions in the PPA , and (c) the specified supplier enters into a GCA with a utility that is different from the one with whom the specified supplier entered into the PPA, and (i) it is geographically impossible for the utility to access the electricity to be supplied by the specified supplier's facility, or (ii) the contents of the PPA conflict with the terms and conditions of the wheeling service provisions of the utility with whom the specified supplier entered into the GCA.

The specified supplier may wish to set out in the PPA that even if "significant changes in economic conditions" occur and the purchase price is amended by the Minister, the purchase price under such specified supplier's PPA will remain the same. Doing so would further stabilise the cash flow from the project. Inclusion of such provision in the PPA would, however, likely constitute legitimate grounds for a utility to reject a request to enter into such PPA.

Under the FIT regime, the PPA must confer exclusive jurisdiction over the disputes arising therefrom to the courts of Japan, the governing law of the PPA must be the law of Japan, and the PPA must be written in the Japanese language.

In an effort to address the possibility that utilities may insist on the use of their standard form PPAs which contain certain provisions that appear to conflict the spirit of the Act, METI published a model power purchase and grid connection agreement (Model Agreement). The Model Agreement was initially designed to be used when the following conditions are met: (i) the same utility enters into the PPA and the GCA; (ii) the type of certified facility is either a solar PV or a wind power facility generating 500 kW or more; (iii) the Model Agreement is to be executed before commencing construction of the certified facility; and (iv) acquisition and operational financing is to be acquired from a financial institution.

As METI pointed out, the Model Agreement is designed to be used not only when the specified supplier is a SPV but also when such specified supplier is an ordinary Japanese company. Thus, in raising funds by way of project financing using SPVs, the Model Agreement should be supplemented to include both non-petition and limited recourse clauses.

Specified suppliers are not obliged to use utilities' standard form PPAs, and instead, may ask the utility to enter into the Model Agreement.

As contemplated by the Model Agreement which contains provisions regarding access to a grid connection, a utility typically owns the grid connection through which it can access the renewable electricity. Thus, the PPA will normally contain provisions regarding the grid connection. Under the Act on Special Measures, a utility must grant the specified supplier access to its grid connection if so requested, unless certain justifiable exceptions apply. These exceptions include, without limitation, cases where the specified supplier will not bear certain costs necessary for establishing and maintaining the grid connection, the GCA contains false or illegal terms or conditions or the GCA obliges the utility to pay for damages incurred by the specified supplier even when such damages cannot be attributed to the utility, and the specified supplier does not agree to curtail its supply of electricity without compensation from the utility upon the occurrence of certain conditions such as when the supply of electricity from the utility to the public is likely to exceed demand despite implementation of certain countermeasures by such utility (provided that such curtailment without compensation must not exceed 30 days per year).

In the event the operator under an operation and maintenance (O&M) agreement becomes unable to provide operation and maintenance work for the specified supplier in relation to a certified facility due to bankruptcy or otherwise, and there is no other operator which can take over the former operator's obligations thereunder, there would arise a risk that the certification may be revoked by the Minister on the grounds that the appropriate domestic system that enables the specified supplier to monitor and maintain the certified facility would no longer exist. Thus, in the event the project sponsor will not be the operator under the O&M agreement, the financial status and creditworthiness of candidates to serve as the operator must be carefully evaluated before entering into the O&M agreement. Further, a back-up operator should be retained in preparation for the situation where appointed operator is no longer able to fulfill its obligations under the O&M agreement.

Junichi Ikeda

Nagashima Ohno & Tsunematsu

Kioicho Building, 3-12, Kioicho, Chiyoda-ku Tokyo 102-0094, Japan
T: +81-3-3288-7000
F: +81-3-5213-7800
E: info@noandt.com
W: www.noandt.com

Junichi Ikeda is a partner at Nagashima Ohno & Tsunematsu. He specialises in securitisation, structured finance, energy, and dispute resolutions with a focus on disputes arising from financial transactions. Before joining Nagashima Ohno & Tsunematsu, he was a judge at the Tokyo District Court and at other district and family courts in Japan, a Staff Attorney at the Civil Affairs Bureau of the General Secretariat of the Supreme Court of Japan, and the Deputy Director of Industrial Finance Division, Economic and Industrial Policy Bureau, Ministry of Economy, Trade, and Industry.

Ikeda received an LLB from Waseda University in 1993 and an LLM from Southern Methodist University School of Law in 2000.

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