ECONOMICS: Indonesia's power sector
Far Eastern Economic Review
March 19, 1998

Energy:
 Act of Desperation:
 Indonesia's state-owned electricity monopoly exemplifies the country's
 problems-debt, inefficiency, cronyism; The utility's attempts to renege
 on contracts with foreign power suppliers are leading to a further loss
 of confidence
  * By Salil Tripathi and John McBeth in Jakarta
    1999 Words
03/19/98
p42    

We hereby notify you that in light of the current monetary crisis . .
. payment for purchase of geothermal steam and electric energy from
Gunung Salak geothermal power plant . . . will be in rupiah with an
exchange rate of $1=2,450 rupiah, which is the exchange rate used in the
1997/1998 state budget.
   Djiteng Marsudi
 President-Director, Perusahaan Listrik Negara

   Call it an electric shock. In mid-January, Indonesia's state-owned
electricity distributor, PLN, sent the above letter to power supplier PT
Unocal Geothermal of Indonesia, a subsidiary of America's Unocal. With
the rupiah's market rate at around 10,000 to the dollar, the letter
effectively said that PLN had decided to pay Unocal a mere quarter of
what it owed.
   Similar letters went to three other private power producers, as well
as to Arco Indonesia, a subsidiary of American firm Atlantic Richfield,
which supplies gas to an east Java power plant. The take-it-or-leave-it
missives shocked the industry. Fumes a Western energy analyst: "It's a
clear case of breach of contract."
   American direct investors are fuming for other reasons too. Some say
they will seek compensation if their projects are cancelled under
Indonesia's plan to "review" 15 infrastructure projects, as required by
the International Monetary Fund. That could open the way for action over
other alleged breaches of contract -- such as PLN's unilateral decision
to spread its currency losses.
   But PLN's president-director Djiteng Marsudi had little choice. He is
running a behemoth that's simply bleeding to death, a victim of the
haemorrhaging rupiah, arbitrary decision-making and political
interference. It's mired in billions of dollars of debt and its
distribution system is unravelling as a result.
   Of all the Indonesian companies that have gone bad along with the
rupiah, perhaps none is more critical to the nation's economic health
than PLN, one of its biggest state-run companies. For one, the
government has to service its 8 trillion rupiah in long-term debt, which
sucks money from other areas and widens the fiscal deficit. For another,
the erosion in its ability to distribute power efficiently could
undermine economic recovery. Finally, its attempt to renege on
contractual obligations will further convince foreign investors that
Indonesia is a bad bet.
   PLN was a problem-plagued utility long before the rupiah's fall. Like
most monopolies, it's inefficient and wasteful, and has been losing
money for most of the decade. This year it is projected to lose 1.31
trillion rupiah because of currency losses -- and subsidies to
consumers.
   Electricity supply in Indonesia is seen as a social service, not a
commercial venture. PLN sells electricity at less than what it costs to
produce or purchase. During the growth years, it simply amassed debt and
muddled along. Indeed, those were the years it laid ambitious plans for
expansion and privatization-plans it may well be regretting now.
   Privatization of the power industry began in earnest six years ago.
In those heady days, power companies and investment banks courted PLN
with impressive demand-and-supply projections, in line with the rosy
forecasts that the economy would grow 7% per year for the next 25 years.
Planners took seriously a 1992 World Bank estimate that 90% of urban
households and 67% of rural households had electricity or could afford
to buy it. Less than 50% of households had electricity in 1995,
portending a huge latent demand.
   Based on such figures, PLN set itself far-reaching targets: To
increase the electrification of all households to 60% by 1999; to almost
double the number of private customers to 25 million, and to more than
double sales between 1995 and 1999.
   Indonesia was estimated to need 12,000 megawatts of new power during
the current five-year plan (1994-99), with private power companies
expected to generate a quarter of that. This was a mouth-watering
prospect for foreign power producers whose home markets were stagnating.
Along with their predictions of galloping electricity demand, they
pitched the need for new, cleaner, more advanced power stations.
   Based on those projections, PLN signed many contracts and sanctioned
many projects -- more than what was needed in some parts of the country
even without an economic slowdown. With the economy now shrinking, the
average 15% annual growth in electricity demand is expected to slump to
zero. This means that the new power PLN has contracted for will far
exceed demand. For instance, if all the power projects planned in Java
go ahead they will add 5,000 megawatts, or 35%, to the Java-Bali grid's
current capacity by 2003.
   The potential oversupply is also due to a familiar factor in
Indonesia's troubles: First Family meddling. President Suharto's
children and friends forced PLN to sign contracts to purchase power that
won't be needed from plants in which they have an interest.
   A particularly egregious example was the $1.77 billion Tanjung Jati C
project in Java, backed by Suharto's eldest daughter, Siti Hardijanti
Rukmana (Tutut). Analysts view the station as unnecessary, and it has
since been postponed -- although industry sources say efforts are still
being made to revive it.
   In December, PLN head Djiteng complained to a parliamentary committee
about "constant interference" from "outsiders" who undermined his
authority and imposed expensive projects on the utility that it didn't
need and couldn't afford. It was an obvious reference to the Suharto
offspring and cronies.
   (Djiteng did not respond to REVIEW requests for an interview.)
   With the economy expected to shrink for at least two years, all that
political coercion and all those promising projections have come to
nought -- except to saddle PLN with a string of contracts committing it
to buy power even if there is no demand.
   PLN has power-purchase agreements with 26 private suppliers. Under
these "take-or-pay" agreements, the utility must pay for the power
regardless of whether it takes up the supply. What's worse, its
contractual obligations are indexed in dollars, while its tariff rate is
fixed in rupiah: PLN has contracted to buy power at between 5.74 and
8.50 cents per kilowatt-hour, compared with its current selling price of
200 rupiah (1.7 cents) per kilowatt-hour. These obligations, among
others, bring the utility's estimated liabilities over the next 15 years
to $43 billion.
   With the rupiah's value down 80% against the dollar, there's no way
PLN can come up with the money. Recently, it even failed to meet payment
schedules for gas supplied to its Gresik plant in east Java, forcing the
supplier, Arco, to exercise standby letters of credit with two state
banks. (Letters of credit included in the gas contracts require local
banks to make payments on behalf of PLN.)
   PLN is seeking a way out by paying its power suppliers at the
pre-crisis exchange rate. Djiteng has also said that the utility can
only buy 30% of the capacity of new private power plants, instead of the
80% stipulated in the contracts.
   For PLN, these are acts of desperation. It can't go for the obvious
solution -- a huge tariff hike -- for fear of triggering more riots.
Coming on top of fuel prices set to rise in April, an increase in the
electricity price would be sure to spark more popular anger. "You need a
multiple to tackle the problem," notes one Jakarta-based analyst, "but
you only need a fraction of that multiple to cause a lot of unrest."
   Yet what PLN is doing -- backing out of contractual obligations -- is
causing plenty of unrest among the foreign investors who have pumped
millions of dollars into power projects. Some American investors may be
getting ready to sue.
   CalEnergy Corp., whose power projects have been "reviewed," is
claiming compensation from the Overseas Private Insurance Corp., the
U.S. government's private-sector insurance arm. CalEnergy purchased
political-risk insurance from OPIC in 1996 for its $265 million equity
investment in two geothermal plants. OPIC has warned that if it pays the
claim, it will seek compensation from Indonesia. Under a 1967
investment-protection treaty, Indonesia must compensate the U.S.
government for payment of such claims proven valid by binding
arbitration.
   The warning from OPIC puts PLN in a dilemma: If it approves
American-invested projects, it risks antagonizing the IMF; if it cancels
them, it may have to pay substantial compensation. Cancellation could
lead to a slew of breach-of-contract claims in Indonesia, where OPIC is
insuring 10 projects.
   Among them are the giant Paiton I and II stations owned by a
consortium led by Edison Mission Energy of California. When the
1,250-megawatt stations in east Java come on stream between the end of
this year and 2000, the Java-Bali grid stands to be 60% oversupplied.
But PLN is contracted to buy power from Paiton I at 8.53 cents per
kilowatt hour for the first six years of its 30-year contract. Sources
close to the consortium say PLN may be forced to shut down some of its
diesel-powered units to accommodate the new station.
   PLN's situation is desperate on other fronts as well. Many of its own
plants are 1960s-vintage and use gas-guzzling technology, but it has no
money to upgrade them. As scarce dollars are devoted to importing vital
spare parts, plant maintenance is likely to suffer, threatening more
breakdowns. In some areas, up to 20% of electricity transmitted is lost
from ageing transmission lines. Regions under-supplied with power can't
tap from regions with an oversupply for lack of grid connections.
   Thanks to haphazard planning, PLN's two new gas-fired stations in
east and central Java can only be run on liquid fuels: In east Java, no
gas pipeline was built; in central Java, there was never any natural gas
available in the first place. The power supply in parts of Sumatra is
reaching critically low levels, yet a gas-fired plant in south Sumatra,
involving Coastal Energy of the U.S., has been put on hold as one of the
15 projects being reviewed. Without it, south Sumatra faces power
outages this year. Meanwhile, drought increases the likelihood of
blackouts in regions like west Java, where hydroelectric dams account
for 30% of installed capacity.
   The Ministry of Finance has sent private power companies a letter
saying that it will "cause PLN to discharge its obligations" but doesn't
say how. So that's small comfort. Indonesia's power-privatization
programme is in a shambles, and the loss of confidence by investors may
kill it.
   In recognition of the seriousness of the situation, Suharto has
quietly formed a blue-ribbon committee to look into PLN's problems. It's
headed by Rahardi Ramelan, vice-chairman of the National Development
Planning Agency. He's a close associate of Research and Technology
Minister B.J. Habibie, Suharto's choice for vice-president. The
committee's main task will be to sort out what projects are needed over
the near and long term and how to go about restructuring the utility.
   To he PLN out, and salvage their projects, most foreign investors
appear willing to discuss compromise solutions. "Companies will
privately be willing to discuss the issue with PLN, but PLN needs to
know it cannot unilaterally set terms," notes a Western diplomat in
Jakarta. El Paso Energy International and Australia's Energy Equity
Corp., for example, are discussing new terms of payment with PLN over
their Sengkang gas-fired station in south Sulawesi.
   Some foreign companies are looking for a quid pro quo from PLN. "If
these guys want to play games with the current agreements, then they're
going to have to give something back," says a senior Western energy
executive in Jakarta. "That might mean giving the current players
exclusive rights to tender for any new projects over the next 10 years.
It wouldn't make them happy, but it would be something."
   What makes many foreign investors unhappy is the prospect of PLN's
resolve crumbling under pressure from the Suharto family to go ahead
with nonviable projects at the expense of needed ones. A former PLN
adviser sees some hope in the newly formed presidential committee to
overhaul PLN, but as he points out: "Indonesia should be judged by
whether the political will exists to listen to and accept professional
advice."
   That may turn out to be the hardest part of all. Ask the IMF.