By James Topham and Aaron Sheldrick
TOKYO (Reuters) - After the Fukushima disaster crippled Japan's nuclear energy sector three years ago, the government pledged the biggest shake up in the history of the fragmented electricity industry to boost competition and contain a surge in power prices.
But a first crucial phase of Prime Minister Shinzo Abe's plan - to set up a national grid company to allow new suppliers to sell electricity to the residential sector - has been watered down so much that even people directly involved in creating or running the body say it will not have enough power to succeed.
The original government aim was to set up a company that could guarantee equal access to all participants.
But plans to give the nationwide grid management body more control over the system of distribution and transmission lines were scaled back, amid lobbying from Japan's power utilities.
The main remit of the grid company, which is scheduled to start operations next April, has been restricted to ensuring reliability of supply in emergencies.
The body's lack of power means the new company will be unable to force the country's 10 regional monopolies, which control generation and distribution within their regions, to boost interconnections to establish a true national grid.
This will hold up a second phase of reforms, the opening up of the 7.5 trillion yen ($68 billion) residential and small business market from March 2016, the centerpiece of the plan to boost competition, lower power prices and cut energy imports.
Hiroshi Takahashi, who sat on a government panel on the reforms, said he was "relatively pessimistic" about the grid company because he felt it would be unable to stand up to the utilities, which have powerful backers in government.
"It has not been given enough power, and ... overall energy policy has not been decided," said Takahashi of the Fujitsu Research Institute.
The structural problems of the power grid were highlighted by the 2011 tsunami and nuclear shutdown, which left some regions with power shortages despite ample supplies elsewhere.
The government says the reforms are on track and it is committed to reducing the cost of electricity as much as possible.
Japan is the only country in the world with two electricity frequencies and needs transformers to switch power between east and west. Only 1.2 gigawatt can be transferred, about the capacity of one large nuclear reactor, and current plans are to increase this only by an extra 0.9 GW at a cost of 190 billion yen ($1.7 billion), according to a trade ministry official.
The grid company's incoming president Yoshitsugu Kanemoto does not pull his punches about the challenges he faces.
"The organization does not have the full power to make and implement plans," said Kanemoto, currently a professor at the National Graduate Institute for Policy Studies.
An official at the Ministry of Economy, Trade and Industry, which is implementing the reforms, says it has included people from outside the power monopolies in the new grid organization to loosen the utilities grip on the market.
HUNDREDS OF FIRMS REGISTERED
The shortcomings in setting up a national grid will make it harder to open up the power market to full competition, say officials at companies looking to enter the industry, while grid limitations could restrict the ability of independent power sellers to help drive down prices.
Independent power sellers, which often offer lower rates and consumer friendly plans, have been limited to 4 percent of the market by what they say are onerous operational restrictions.
The lure of selling directly to the retail market spurred more than 300 companies including Panasonic Corp and Nissan Motor Corp to register with the government to sell power independently since the Fukushima disaster.
They plan to either build their own generation plants or buy off others and act solely as retailers.
Tokyo Gas Co Ltd, for example, Japan's biggest city gas supplier, aims to grab a 10 percent share of the retail power market in the Tokyo metropolitan area by 2020, doubling its power generation capacity to 3,000 megawatts. The company already supplies power to larger customers after an earlier phase of liberalization.
The final stage of the reforms involves splitting up the generation and transmission units under holding companies but utilities won't be forced to shed operations under the current plans, creating further doubts about the scope of changes.
"If it's a functional unbundling and the monopolies still own their own regions, there's no strong incentive to unify the frequency zones," said Nobuo Tanaka, the former head of the International Energy Agency.
Adding to the grid body's difficulties, is the uncertainty over when and how many of Japan's 48 nuclear power plants will be restarted after the post-Fukushima shutdown.
"The timing for nuclear restarts is cloaked in uncertainty and that naturally makes it difficult to anticipate and calculate use of the transmission network," said Junichi Ogasawara of the Institute of Energy Economics, Japan, adding this would hinder talks about new investments in the network.
To overcome the hurdles of transferring electricity across regions, western Japan-based Kansai Electric Power Co is planning a power plant in eastern Japan.
But some industry officials say competition would be confined to within the current structure and the new body should aim to create a market that allows for real-time power trading.
"With a system like that, we could sell even more electricity," said an official in charge of selling power at a big Japanese corporation.
(1 US dollar = 109.5300 Japanese yen)
(Editing by Richard Pullin and Ed Davies)