Investments in Japan need to create value in the energy transition

Key points

• Japan plans to spend ¥10tn(US$64bn) a year to crowd in private investment and generate ¥370tn($2.4tn) in public and private capital by 2040.

• With 65% of capital deployed by major Japanese companies reportedly destroying value, then policymakers need to scrutinise government-backed projects more closely, argues ACCR’s Sam Hall.

• He warns that support for hydrogen injection, carbon capture and ammonia co-firing could prolong costly, high-emitting technologies instead of accelerating cleaner alternatives.

• Stronger disclosure rules and investor engagement could redirect funding towards technologies such as electric-arc-furnace steelmaking, battery storage and renewable power, he says.

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Japan has introduced a new growth strategy to increase public spending by ¥10tn (US$64bn) a year, with the intention of crowding in further private investment into the economy and generating at least ¥370tn ($2.4tn) in public and private investment by 2040.

But around 65% of capital deployed by Japan’s largest companies destroys value, Japan’s Ministry of Economy, Technology and Industry (METI) finds.

If Japan’s economy has been plagued by value destruction, as METI finds, then it’s squarely in the interests of policymakers and global investors to make sure this tidal wave of investment is fully harnessed and flows into technologies with the highest potential for decarbonisation, value creation, and future competitiveness.

Both METI and Japan’s financial regulator, the Financial Services Agency (FSA), have encouraged companies and investors to move away from the short-term, passive investment approaches born out of low-growth, deflationary economic conditions, and instead pursue bold, long-term growth investments.

Policymakers will likewise need to develop ways of assessing company investment plans to make sure public funding support goes to those with the most value-generating potential. Policy support also needs to be nimble enough to course-correct: technology and investment opportunities will continue to shift as the energy transition unfolds.

Investors – with their expertise in capital allocation and risk assessment – can play an important role in helping Japanese policymakers establish frameworks which enable robust assessment of investment plans and technology potential.

Investors can draw on their experience in evaluating company investment plans and strategy to engage in dialogue with policymakers about what new disclosure requirements and metrics might be best suited to assessing the growth prospects of company plans.

This need not be limited to long-dated investments and early-stage technologies.

For example, investors could engage policy makers (as well as companies) about what policy roadmaps and subsidies, green steel labelling, and public procurement will be needed to generate returns on the conversions of blast furnaces to lower-emission electric arc furnaces, which are due later this decade.

Transition finance in Japan is supporting ineffective, expensive technology

 

There are long-standing concerns over abatement backed by Japan’s growth strategy, such as hydrogen injection and CCS for steel blast furnaces, and ammonia co-firing for coal power plants. This is because both are highly expensive and have limited emissions-reduction potential compared with alternative technologies.

Japan is currently supporting extensive research and development by Japanese steelmakers into hydrogen injection and CCS technologies for reducing the heavy emissions of traditional blast furnaces. These technologies risk entrenching coal use by extending blast furnace life, but they also have limited abatement potential and are unlikely to be commercially competitive with greener steelmaking methods in future. Despite most major steelmakers outside Japan having shifted away from these technologies, they continue to attract a majority of steel sector R&D subsidies.

There is also concern about Japanese policymakers’ extensive support for technologies which attempt to bring down power plant emissions by burning ammonia alongside coal. The technology is widely viewed with scepticism by analysts, who note it is both expensive and inefficient. And indeed public funding for R&D into this technology was recently halved due to rising costs and technical delays. Yet the fuel remains part of Japan’s industrial strategy, unlike in neighbouring South Korea, whose government has abandoned it.

In both these cases, stronger investor scrutiny of value creation potential in government-backed investments could help identify commercial and technical risks earlier. It could also help redirect capital and policy support towards alternative technologies with greater long-term growth and decarbonisation potential, such as direct reduced iron (DRI) steelmaking, grid-scale battery storage and renewable power generation. These technologies already receive policy support, but a greater share of public and private investment could accelerate their deployment and improve long-term decarbonisation and growth outcomes.

Strong policy frameworks, alongside investor stewardship, can maximqise value from growth

 

METI and FSA encourage companies and institutional investors to engage in constructive dialogue with a particular focus on growth. This will come as good news to investors, who have often found it challenging to obtain useful disclosures in engagements with Japanese companies about their long-term plans. What long-term investors are looking for are credible scenarios, clear assumptions, and robust frameworks so they can guarantee that company growth plans are resilient, profitable, and future-proof.

METI does note that companies need to more explicitly demonstrate how their investments can create value. More specific guidance from METI and other policymakers would be powerful in setting expectations for how companies should do this. Clear, robust frameworks for assessing the value-accretion potential of investments that receive policy support will be of particular importance.

Dialogue with investors can help policymakers align these frameworks with international capital market expectations. This includes building on existing Sustainability Standard Board of Japan (SSBJ) disclosure requirements and GX transition planning to ensure more granular, growth-oriented assessment of investment plans and specific metrics needed to test technology potential and strategy at the sector level. In steelmaking, for instance, investors and policymakers would likely benefit from discussions about what green steel labelling, public procurement mechanisms and price premiums are required to generate acceptable returns on the conversion of blast furnaces to lower-emission electric arc furnaces later this decade.

The incoming wave of investment in Japan could end up washing away shareholder value, or it can direct capital flows towards the technologies that will win in the transition, rather than those that risk becoming uncompetitive. The prize is an energy transition that delivers not just lower emissions, but stronger companies, better returns, and a more competitive Japanese economy.

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