Contracting for Geothermal in Japan

Abstract

Although Japan has the third largest deposit of geothermal energy in the world, its total installed generation capacity remains paltry. In part, development has been stymied by contractual problems involving promissory credibility. By the common law of property, hot springs hotels in many areas can potentially shut down geothermal projects. Geothermal developers would make the projects worth the hotels' while if they could, but cannot credibly assure them that they (the developers) will compensate them for any damages ex post. Conversely, by the basic logic of collective action, hot springs hotels cannot credibly promise to negotiate in good faith. Because each hot springs owner may potentially have a right to enjoin the entire geothermal project, the developer faces sequential negotiations, each of them a bilateral monopoly -- and no one owner can credibly promise that all subsequent owners will negotiate in good faith.

These problems are not necessarily insolvable. And the few geothermal plants that exist are disproportionately those where the hotels and developers created ways to solve these twin contractual problems. Some geothermal developers overcame their credibility problem by piping hot water to the hotels directly. Some hotels overcame their collective action problem by negotiating through their trade association or town government.

Keywords: Geothermal, renewable energy, property right

JEL Classification: K11, Q2, Q4