Japan's long-term decarbonised power auction: Bankability analysis for LNG projects

With the 4th Round framework for Japan’s Long-Term Decarbonised Power Source Auction (“LTDA”) now finalised and registration deadlines approaching in October 2026, developers and financiers exploring the applicability of the LTDA to LNG-fired thermal power projects should take careful note of several key bankability issues. This article identifies the principal risk areas and structural features of the latest auction framework that will shape project finance structuring decisions.

Executive summary

On September 2, 2026, the Organization for Cross-regional Coordination of Transmission Operators (“OCCTO”) published the finalised Tender Guidelines and Capacity Procurement Contract Terms (the “Terms”) for the 4th Round of the LTDA. The auction targets 6 million kW of LNG-Only Thermal Power (“LNG-Only Thermal”) capacity, with the Supply Start Deadline extended from 8 years (in the 2nd/3rd Rounds) to 11 years. A significant structural development is the establishment of a Fixed Clawback framework for Other-Market Revenues, which allows operators to elect a fixed annual clawback amount in lieu of a performance-based calculation; however, the specific amount remains to be determined, leaving the project finance base case unresolved. Additionally, the Decarbonisation Roadmap compliance obligation (requiring commencement of decarbonisation measures within 10 years of supply start) continues to present a material contract termination risk under the Terms, with such termination events outside the scope of the Force Majeure provisions. With business entity registration opening on October 13, 2026, and lender letters of interest required at the power source information registration stage (October 19–23, 2026), project sponsors and lenders must act promptly to meet these deadlines.

1. Overview of the 4th Round Auction Framework

The solicited capacity for LNG-Only Thermal under the 4th Round is 6 million kW. The upper price limit is JPY 92,068/kW/year where development of an LNG receiving terminal is required, and JPY 65,284/kW/year where such development is not required (Tender Guidelines, Chapter 3, Section 2(1)(b) and Section (6)). The contract price for each awarded power source equals the respective bid price under the Multi-Price Auction format (Tender Guidelines, Chapter 6, Section 2).

Notably, the Supply Start Deadline has been extended from 8 years (applicable in the 2nd and 3rd Rounds) to 11 years from the 4th Round onward (7 years where environmental impact assessments under applicable statutes or local ordinances have been completed or are not required) (Article 13(ii) of the Terms; cf. 8 years for the 2nd and 3rd Rounds). This extension was introduced in response to the capacity constraints of plant manufacturers (Tender Guidelines Public Comment Opinion No. 51; Terms Public Comment Opinion No. 6), and represents a favourable development from the perspective of construction period risk.

2. Revenue risk: fixed vs. performance-based clawback of Other-Market Revenues

(a) Status of deliberations

The framework for a dual-track clawback system for LNG-Only Thermal has been finalised, under which operators may choose between (i) Performance-Based Clawback, which returns approximately 90% of Other-Market Revenues (“Other-Market Revenues”), and (ii) Fixed Clawback (Article 28 of the Terms; Tender Guidelines, Chapter 4, Section 3(7), Note 9).

The expression “approximately 90%” used in the Tender Guidelines is shorthand. The actual clawback rates are set in three tiers of 95%, 90%, and 85%, depending on the level of Other-Market Revenues (Article 28, Paragraph 1, Items (i) through (iii) of the Terms). For base-case modelling purposes, note that the effective clawback rate fluctuates depending on which tier the Other-Market Revenues fall into relative to the Cost of Capital embedded in the bid price. Further, the election between the Performance-Based Clawback and the Fixed Clawback must be made not at the time of bidding, but at the commencement of the supply provision year (Tender Guidelines, Chapter 4, Section 3(7), Note 9).

Critically, as stated in the study group materials, “the specific amount (JPY 8,000/kW) has been deleted in order to continue deliberations on the clawback level and its methodology.” In the finalised Tender Guidelines and Article 28 of the Terms, the figure has been replaced with the abstract expression Clawback Level Amount (yen/kW/year), with the statement that “deliberations will continue at the national advisory council (Electricity Stable Supply Working Group), and the results will be reflected in these Terms.”

In the public comment process (Tender Guidelines Opinion No. 52), the opinion that “annual ex-post re-selection should be permitted” was raised. OCCTO responded that “the purpose is to promote LNG long-term contracts, and annual opportunistic selection is not contemplated.”

(b) Risk description and impact on bankability

While the availability of the Fixed Clawback option has been confirmed, the specific amount remains to be determined. As a result, the net capacity revenue (i.e., the Capacity Procurement Contract Amount (“Contract Amount”) minus the Fixed Clawback amount) cannot be determined in the project finance base case, leaving the Debt Service Coverage Ratio (“DSCR”) assumptions unresolved.

Additionally, because the Fixed Clawback is not linked to actual market revenue performance, there is a risk that the Fixed Clawback obligation could arise even in scenarios where wholesale electricity sales revenues fall below LNG fuel costs (a so-called negative-spread scenario).

On this point, it is not entirely clear from the text of the Terms whether the condition in the main clause of Article 28, Paragraph 1 (limiting the clawback to cases where “Other-Market Revenues are positive” (the so-called zero-floor provision)) also applies to the proviso governing LNG-Only Thermal that has elected the Fixed Clawback. One reading is that the proviso merely substitutes the “calculation method” for the clawback amount, and that the triggering condition in the main clause (i.e., the zero-floor) continues to apply to the obligation to make a clawback payment. Under this interpretation, no Fixed Clawback payment would be required in negative-spread years. Alternatively, if the proviso is read as establishing the clawback amount independently of the main clause, the clawback obligation would persist even in negative-spread years, creating a downside risk structure that is worse than the Performance-Based Clawback.

Depending on which interpretation prevails, the question arises whether the clawback amount in negative-spread years constitutes a “claim” by OCCTO under Article 7, Paragraph 3 of the Terms (i.e., a cash outflow from the SPC). We recommend that a written inquiry be submitted to OCCTO before bidding, and that the response be documented.

On the other hand, when the Fixed Clawback is elected, the monitoring obligations and evidentiary submission requirements relating to bilateral contract discipline are exempt (Tender Guidelines, Chapter 7, Section 6(2)), which enhances the flexibility of market trading activities.

Conversely, if the Performance-Based Clawback is selected, note that where the obligations under the bilateral contract discipline are not satisfied, the Other-Market Revenues for LNG-Only Thermal will be deemed to be calculated based on the simple average of the applicable area price in the spot market (Article 28, Paragraph 1, Note 1 of the Terms). Sponsors and lenders should be aware of the risk associated with non-compliance.

(c) Mitigation / regulatory changes enhancing bankability

Compared to the prior framework, the very creation of the Fixed Clawback option represents a significant improvement in the predictability of net capacity revenue, which is a positive development for bankability. In addition, Article 28, Paragraph 4 of the Terms expressly provides for carry-forward of negative Other-Market Revenues to the following fiscal year, enabling partial recovery of negative-spread-year losses for operators that elect the Performance-Based Clawback. Furthermore, operators that elect the Fixed Clawback are permitted to re-select their clawback method after 9 years from the commencement of the Contract Period (“Contract Period”) (Tender Guidelines, Chapter 4, Section 3(7), Note 9). For lenders, this re-selection option may be leveraged in conjunction with refinancing opportunities.

The contract unit price is adjusted at the beginning of each fiscal year during the Contract Period for changes in price indices and interest rates (Appendix 1 to the Terms). The base Weighted Average Cost of Capital (“WACC”) used in Cost of Capital calculations has been raised to 5.5% for the 4th Round (from 5.0% for bid years 2023–2025), and interest rate fluctuations are included in the adjustment scope, which is a meaningful improvement for long-term project finance. However, the construction cost deflator used to adjust capital and Cost of Capital components is fixed at the ratio of “the year preceding the supply provision start year to the year preceding the bid year” (Terms Public Comment Response No. 28), and the same fixed value applies throughout the Contract Period. Post-operation CAPEX inflation is not continuously reflected; this should be noted in the financial model.

3. Decarbonisation obligation risk

(a) Status of deliberations

The obligation to comply with the Decarbonisation Roadmap (“Decarbonisation Roadmap”) is expressly set forth in Article 22(1) of the Terms, which requires the commencement of decarbonisation measures (including re-bidding in the LTDA for purposes of retrofit) within 10 years of the supply provision start date (Article 22, Note 2 of the Terms).

In the public comment process (Terms Opinion No. 16), the request was made that Economic Penalties (“Economic Penalties”) should be waived where the preconditions of the Decarbonisation Roadmap become unattainable for reasons not attributable to the operator. In response, OCCTO stated that Economic Penalties may not be applied where the matter is recognised as an objection under the applicable Requirements provision or as a Force Majeure (“Force Majeure”) event under Article 29, Paragraph 1 of the Terms.

However, these are discretionary remedies at best (the responses state that Economic Penalties “may not apply in some cases”) and do not guarantee an exemption.

(b) Risk description and impact on bankability

Where it becomes clear that an operator has “failed to pursue the implementation of the Roadmap without reasonable grounds,” this constitutes a contract termination event under Article 33, Paragraph 3, Item (i) of the Terms (Article 24(1) is to the same effect). The regulatory structure does not permit LNG-Only Thermal to receive capacity revenues for the full 20-year period; decarbonisation measures must be commenced within 10 years of the supply provision start date. Where the contemplated measure is fuel conversion to hydrogen or ammonia, the current uncertainty surrounding the hydrogen/ammonia supply chain, pricing, and technology renders the need for, scale of, and funding for additional investment in the second half of the project finance loan period inherently uncertain (the same applies to retrofits for CCS-equipped thermal power).

A critical observation is that the Force Majeure special provision under Article 29, Paragraph 1 of the Terms is expressed as applying “notwithstanding Articles 12 through 24,” meaning that contract termination under Article 33 falls outside its scope. Accordingly, even where Economic Penalties under Article 24 are waived due to Force Majeure, it is textually difficult to conclude that the contract termination risk under Article 33(3)(i) is similarly shielded. OCCTO’s response to the public comment (Terms Opinion No. 16) addressed only Economic Penalties and does not constitute a safeguard against termination risk.

That said, the clawback penalty for contract termination (i.e., the Economic Penalty calculated as total disbursements to date and defined under the second sentence of Article 33, Paragraph 4 of the Terms) applies only to termination under Paragraphs (1) and (2), and does not extend to termination under Paragraph (3). This limitation is favourable from a lender’s perspective.

From the 4th Round, the maximum Contract Period for LNG-Only Thermal has been expressly set at 30 years (Tender Guidelines, Chapter 3, Section (2)). However, since the 10-year trigger for commencement of decarbonisation measures remains unchanged, the constraints on project finance tenor design remain the same.

(c) Mitigation / regulatory changes enhancing bankability

Under the current framework, a pathway exists for LNG-Only Thermal to re-bid in the LTDA for purposes of decarbonisation retrofit, thereby securing capacity revenues for the additional investment (Tender Guidelines, Chapter 7, Section 2(2)). While contract termination for Roadmap non-compliance is limited to cases where the operator has “failed to pursue implementation without reasonable grounds” (Article 33(3)(i) of the Terms), ambiguity remains in the interpretation and application of this standard, necessitating contractual protections in the financing documentation.

Potential structuring measures include: (i) a soft mini-perm structure with accelerating cash sweep ratios in the second half of the loan period (around the 10th year, when the decarbonisation obligation is triggered); (ii) mandatory prepayment events triggered by OCCTO rectification notices regarding the Roadmap or by non-award in a re-bidding process; and (iii) setting the re-bidding obligation as a covenant, with the possibility of mandatory prepayment or refinancing pre-agreed in the financing documentation based on the re-bidding outcome (award or non-award). At the due diligence stage, it would also be useful to analyse the scope of the “reasonable grounds” defence.

Schedule and practical considerations

The key dates for the 4th Round (Tender Guidelines, Chapter 3, Section 1) are as follows:

• Business entity information registration: October 13–16, 2026
• Power source information registration: October 19–23, 2026

At the power source information registration stage, applicants are required to submit (i) a grid connection review response and (ii) Appendix 1 to the business plan (Form 2), being the “Funding Plan”. Where project finance is utilised, the attachments to Appendix 1 must include documentary evidence of the financial institution’s project finance lending track record as well as a letter of interest or commitment letter. Accordingly, the lender mandate process and issuance of the letter of interest must be planned on a timeline working backwards from mid-October 2026.

Author: Kentaro Okamoto, Counsel.