Commentary | 04 October 2017

Indonesia's electricity play imperils national economic goals

'The generation plan could unnerve investors and leave private operators on hook for state equity.' Originally published in the Nikkei Asian Review.

'The generation plan could unnerve investors and leave private operators on hook for state equity.' Originally published in the Nikkei Asian Review.

By 2030 the countries of the Association of Southeast Asian Nations will collectively represent the world's fourth-largest economy. The region's links to other major economic powers -- China, India, Japan and the U.S. -- mean it will become increasingly pivotal for the fortunes of global growth. Inseparable from this outlook, however, is its vast need for energy. Even as economies become less energy intensive, Southeast Asian demand for energy will increase by more than 80% from now through 2040, according to the International Energy Agency.

Nowhere is this challenge more acute than in Indonesia, ASEAN's largest economy. Indonesia has made recent progress on electrification (up from 85% in 2014 to 93% in 2017), but per capita electricity consumption trails well behind regional peers Vietnam (almost two times higher), Thailand (four times higher), and Malaysia (five times higher). This burdens households and businesses alike, and the scarcity of electricity, especially beyond population-rich Java, also undercuts efforts to foster downstream industries.

As a result, Indonesian President Joko Widodo made the sector one of his top priorities, launching in 2015 a four-year plan to add 35,000 megawatts of new generation capacity. The plan envisioned a large role for private investment, with 25,000MW slated for independent power producers and the remaining 10,000MW for Perusahaan Listrik Negara, Indonesia's state-owned power company. PLN projects that $80 billion of a total $110 billion in investment needed for power plants during 2016-2025 will come from the private sector.

Moving goalposts

Unfortunately, an emerging plan to increase PLN's participation in private power plants threatens these targets. According to a May 2017 letter circulated to PLN's subsidiaries, and presentations to power plant developers, PLN's subsidiaries will take a minimum 30% ownership stake in all independent power producers' projects. This rises to 51% for projects that are not large-scale or lack technical challenges. It is not clear how such projects are defined. Most concerning, some independent developers have been told not only that PLN is seeking majority control of the equity in their projects, but that they should assist with its financial responsibilities in terms of funding the equity.

If implemented, this would represent nationalization of large portions of private investors' projects, and the equity grab would effectively obliterate any incentive for commercial investment in power plant development in Indonesia. Some developers have already negotiated their tariffs and are waiting only on power purchase agreements, the final step before projects are shovel-ready. In these cases, many millions of dollars have been spent studying feasibility, engineering, design and environmental impact.

It is also concerning because of Indonesia's pressing need for private investment in electricity. Improving the investment climate is among Widodo's core themes, and when overseas he continually emphasizes how Indonesia is "open for business." At home, he upbraids ministers for scaring investors, dispatches them to negotiate directly with skeptical investors, and features rolling "deregulation packages" as a key economic benchmark.

PLN occupies a privileged position because of its monopoly on electricity's transmission and distribution to households. Its subsidiaries also develop and operate power plants. Although not the regulator, PLN is the most important stakeholder for independent producers, virtually all of which must sell their electricity to the company. Even if a producer wishes to sell directly to a private end user, such as an industrial estate, PLN must waive its right to supply the power.

Planning, tariff negotiation and the eventual signing of a power purchase agreement all happen with PLN, and the company has for many years been the industry's main repository of technical and professional capacity. Policy is the notional domain of the energy ministry, but PLN's corporate stance on an issue, such as tariff levels or its energy mix, is often most decisive in terms of outcomes in the market.

This unusual blend of market power and commercial interest gets to the heart of this case. Independent producers must be incorporated into PLN's medium-term plan, but in practice they have developed without intervention from, or partnership with, a state entity. Now, however, some developers have been told that PLN will join as an equity partner, and that it will expect them to assist PLN with its financial responsibilities, either by paying for or arranging for financing for the state-owned company's stake. This comes after tariff negotiations have already effectively locked in financial fundamentals for private operators. A disinterested observer might conclude that PLN is using its market position to expand its corporate balance sheet at the expense of private investors.

It is not known whether this will apply to all independent projects. Some are reportedly exempt, and in the past PLN subsidiaries have participated in such projects as co-investors. Other developers have simply been told that a PLN subsidiary needs to own 51% of the project, but have not been asked for financial assistance. Structures supposedly would be fashioned to leave developers, which would be 49% minority owners, in control of procurement and operational decisions.

Developers -- not to mention their lawyers and bankers -- would presumably be wary of such agreements; as incidents in other sectors have shown, Indonesia's company law rarely recognizes such agreements, and in the event of a dispute almost unassailable control is vested with the 51% owner. Divergent views on the use of state-owned contractors or the awarding of operations and management contracts are but two of many potential flashpoints.

Either way, requiring independent producers to give up large equity stakes -- especially amid uncertainty about how they will be financed -- would probably wreck even the most attractive projects. For even a medium-sized power plant this means an equity contribution of $50 million to $75 million. Taking over such a position, even if fully paid up, shortly before a project receives a power purchase agreement and thus becomes bankable, represents a dramatic increase in its net present value, and a transfer of value from private to state-owned enterprise. PLN, which has taken over and canceled projects already incorporated into its own planning, may use these onerous terms to snuff out unneeded independent producers amid concerns about excess power capacity in Java.

Debt burden

Such a policy should also be evaluated in the context of an unusual warningfrom the Indonesian finance minister about the sustainability of PLN's debt burden. The ministry has already appealed to creditors for waivers on some PLN repayments, which will increase in coming years. Such considerations would also explain PLN's efforts to engineer an expansion of its asset base without taking on further debt.

Beneath the surface lies a tussle among some of the president's close economic advisers about the government's emphasis on state-owned enterprises as tools of development. It also touches the "super holding" strategy of creating large, asset-laden SOEs to boost their leverage and access to credit for infrastructure development. The insistence on 51% stakes -- and at pricing seemingly below market value -- echoes the approach to resource investors such as Freeport-McMoRan, the world's second-largest publicly traded copper company, which agreed to sell 51% of Grasberg, the world's second-largest copper mine, to the Indonesian government but is now confronted with an offer well below market value for the shares.

That such a disruption of investor certainty is occurring in the investment-hungry electricity sector, which is also a presidential priority, is perhaps a graver concern. These new guidelines also damage all investors -- foreign and domestic alike. Many independent producers are wholly domestically-owned, and even capital and technology intensive projects usually feature substantial domestic ownership, often from a major conglomerate. Investment climate issues sometimes have a limited domestic constituency because of a belief that foreign investors are the prime beneficiaries of transparency and certainty. This is not the case, based on what is known about this initiative.

Hopefully, as in the past, Widodo's genuine concern for Indonesia's investment climate will prompt him to intervene against this risky initiative. He should recognize the unfair threat to private investors seeking reasonable returns for developing power plants. Unfortunately, the initiative -- including its use of market power to aggrandize SOE balance sheets and the emphasis on majority control -- is also consistent with his administration's broader approach to economic policy. One document explained that the initiative will "capitalize on market goodwill" to build the balance sheets of PLN subsidiaries without growing its debt. Should it continue, that goodwill might evaporate rather quickly.