Indonesian geothermal IPPs: Full steam ahead?

Andrew Digges - Allen & Overy

The Indonesian Ministry of Energy and Mineral Resources (MEMR) estimates that power generation requirements in the country will increase from 36,000 MW in 2009 to 187,000 MW in 2027. Last year, in an effort to keep pace with growing demand, the Government of Indonesia announced a second programme for the accelerated development of an additional 10,000 MW of electric power generating capacity in Indonesia by 2014 (viz. "Second fast track program"). The Government is seeking greater private sector involvement in the Second fast track program than seen with the first. Given declining levels of oil production in Indonesia, which is now a net importer of oil, focus for the Second fast track program is coal and gas-fired generating facilities and also renewable, predominantly geothermal, resources-based generation. Located along the subduction zones between the Eurasian and Indo-Australian tectonic plates, the country has an abundance of both seismic activity and reserves of geothermal energy. The country is estimated to have 27,000 MW of geothermal generating potential. Until November 2009, total installed geothermal generating capacity was 1,179 MW [1].

Second fast track program

On January 8, 2010, Presidential Regulation No. 4/2010 came into force. It appoints Indonesian state owned electricity generation company, PT Perusahaan Listrik Negara (Persero) (PLN), to accelerate the development of power plants utilising renewable energy, coal and natural gas (and supporting transmission facilities), by itself and through cooperation with independent power producers (IPPs) from whom PLN will purchase electricity. The regulation also stipulates that: the capacity and location of the power plants will be regulated by the MEMR; the Government shall guarantee the business feasibility of PLN in accordance with prevailing laws and under provisions to be regulated by the Ministry of Finance. Investors looking to invest in power projects in Indonesia under the Second fast track program will be keenly awaiting the release of such MoF regulations; and

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power plants will benefit from Ministry of Finance regulated import duty exemptions and other facilities. On January 27, 2010, Ministerial Regulation No. 2/2010 of the MEMR set out details of the location and capacity of each power plant to be implemented under Presidential Regulation No. 4/2010. The table below summarises the overall capacity planned to be developed by 2014, broken down by energy source and by type of implementation (by PLN or in cooperation with an IPP).

Of the 10,147 MW of new capacity planned [2], geothermal generating capacity makes up the largest share with 3,977 MW (39% of the total), 78% of which is intended to be implemented by IPPs. Most notably, geothermal generating capacity makes up a remarkable 61.5% of all generating capacity to be implemented by IPPs under the Second fast track program.

Geothermal regulations
Private sector geothermal power projects are subject to regulations relating to the process of obtaining rights to exploit geothermal resources as well as regulations that impact on IPP power projects generally. From 1991, development of geothermal projects in Indonesia was governed by Presidential Decrees No. 45/1991, 49/1991 and 23/1992. The business structure was based around allocation of geothermal business working areas or Wilayah Kerja Pengusahaan (WKP) to PT Pertamina Geothermal Energy or PGE, a subsidiary of PT

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Pertamina (Persero) for development. Private sector involvement would typically involve a joint operating contract with PGE in relation to exploitation of geothermal resources and an energy sales contract with PLN. The regulatory environment relating to Indonesian geothermal power projects has undergone substantial development in recent times, particularly the past 12 months. A significant portion of Indonesian geothermal electricity generating capacity expected to be developed in the next few years will come under the pre-existing WKP structure (such as the Sarulla project and expansions at Wayang Windu). Nevertheless, the remainder of this article focuses on the impact of the new regulatory environment that is developing and its impact on future geothermal projects, including those under the Second fast track program, and particularly those being developed by IPPs. Some of the key regulations relevant to future private sector geothermal power projects are: Law No. 27/2003 on Geothermal mining - regulates the geothermal mining authority, operational and business activities, use of land, granting geothermal permits known as an Izin Usaha Pertambangan Panas Bumi or "IUP", and state income and supervision. Government Regulation 59/2007 on Geothermal business activities preliminary surveys. Ministry of Finance Regulation No. 177/PMK.011/2007 on Exemption of custom duty on importation of goods for upstream exploration business activities of oil, gas and geothermal. Ministry of Finance Regulation No. 242/PMK.011/2008 on VAT on the import of goods for exploration business activities of oil, gas and geothermal. MEMR Regulation No. 11/2008 on Procedures for determination of geothermal working areas. MEMR Regulation No. 2/2009 on Guidelines for geothermal surveillance duties procedure for tendering preliminary geothermal survey assignments to the private sector. MEMR Regulation No. 5/2009 on Guidelines for electricity purchasing price by PLN from cooperation and other business entities - which sets out a process for establishing tariffs. MEMR Regulation No. 11/2009 on Guidelines for implementation of geothermal business activities regulating the working area tender process, tender guarantee and performance bond. Law No. 30/2009 on Electricity - the "New Electricity Law". MEMR Regulation No. 32/2009 on Benchmark price for the purchase of electricity by PLN from geothermal power plants. Ministry of Finance Regulation No. 24/PMK.011/2010 on tax concessions for renewable energy projects (tax reduced by 5% for 6 years, lower tax rate on dividend payments for overseas investors, projects exempt from VAT and import duties for equipment). - relating to

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A substantial proportion of these have only relatively recently come into effect and have not been tested. Furthermore, some (including the New Electricity Law) still require further implementing regulations to come into effect.

Tender process
Geothermal mining areas are to be designated by the MEMR under regulation No. 11/2008 as "Working Areas". IUPs are granted for Working Areas under Law No. 27/2003. An IUP can be held by an Indonesian entity with foreign or Indonesian ownership. With foreign ownership, the Indonesian company should be a foreign investment company (a "PMA"), subject to limits prescribed on foreign investment under the Negative List Regulation No. 77/2007. There is no limit for geothermal business activities specifically prescribed, but the limit on electricity business activities, including power generation, is 95% foreign ownership. The power to grant an IUP is vested in regency or municipal authorities (local regents and mayors), provincial authorities (provincial governors) and national authorities (MEMR) depending upon the jurisdictional coverage of the relevant Working Area. Under an IUP, exploration permits have a maximum term of 5 years, a feasibility study permit has a term of 2 years and a production permit has a term of 30 years. An IUP for each Working Area is offered by the respective authority to business entities through an open tender process administered by a tender committee established for that Working Area. Bids are subject to a two stage process of evaluation: meeting certain administrative, technical and financial requirements, including

submitting evidence of capital injection for a tender guarantee from a local bank of at least 2.5% of the total cost of the first year of exploration and a performance guarantee for an amount of US$10 million in a government bank; and evaluation based on the lowest electricity price and the financial capability of the bidder. An IUP holder wishing to generate geothermal power is also required to obtain, under the New Electricity Law, a power supply business license known as an Ijin Usaha Penyediaan Tenaga Listrik or "IUPTL" from the Directorate General of Electricity and Energy Utilisation, prior to commencing its mining activities at the exploitation stage.

Geothermal electricity tariff

A long standing issue for private investment in geothermal power projects in Indonesia has been the high capital cost of producing geothermal power combined with the low tariff PLN is willing, or able, to pay. The price PLN is able to charge consumers for electricity is regulated to low levels. The types of tariff that might be seen as sufficient to attract private investors into geothermal generation would leave PLN operating at a substantial negative margin. There have been reports that PLN might be permitted to increase its sales prices by 5-8% to provide greater financial flexibility, combined with a new subsidy scheme to protect low-

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income consumers. Further, the Government has recently announced plans to raise the basic power rate by up to 15 per cent in July 2010, to apply only to higher capacity users. The plan is expected to be submitted to the House of Representatives within April 2010. Such price rises can be highly politically sensitive and this increase has not yet been implemented. Capital costs for geothermal power projects are as much as 2 or 3 times the cost, per MW, of fossil fuel generation. Geothermal generation, however, has relatively low operating costs. The costs of servicing interest and principal repayments for the debt required to fund the relatively high capital costs becomes a major expense that the price received per kWh of geothermal electricity must cover. Therefore, a longer tenor of debt can substantially lower the tariff required to cover debt service (plus operating expenses and an acceptable return). However, since the global financial crisis, typical tenors for international project debt have been substantially reduced, adding further upward pressure on the size of the tariff required to make a project bankable. The New Electricity Law provides a greater role for regional and local governments in setting tariffs, although it is expected that the central government will retain primary control over electricity resources. A framework for assessing electricity prices tendered in, for example, an IUP bid process is set out in MEMR Regulation No. 5/2009. The electricity price quoted is one of the key selection criteria in the tender process. MEMR Regulation No. 32/2009, which became effective on 4 December 2009, has provided some encouraging guidance by setting a maximum benchmark price of 9.70 US cents per kWh for the purchase by PLN of geothermal electricity. Until recently, typical tariffs agreed by PLN were less than half that figure. It remains to be seen what actual, agreed tariffs will emerge from this relatively new regulatory framework. At present, there appears to be a notable disconnect between those involved in establishing electricity pricing from geothermal projects through the tender process and the entity that will be expected to pay those prices (PLN). A standard pro-forma power purchase agreement (PPA) is intended to form part of the tender package for IUPs. However, the pro-forma PPA is yet to be finalised. Therefore, bids in the meantime need to be made without knowing final details of dispatch locations, quantities and timing, nor the balance of risk allocation and damages for non-compliance. Bids therefore remain conditional on further negotiation of the relevant PPA. The MEMR, with World Bank support, has commissioned a study on the design of geothermal project investment structures and on developing a pricing policy that provides sufficient economic incentives for developers in the geothermal sector. Results and recommendations from the study are not expected until 2011. This might yet lead to a further restructuring of the geothermal power project tender process.

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Conclusions
The scale of the current plans to increase the capacity of geothermal power generation in Indonesia is unprecedented. A majority portion of that capacity is intended to be developed by the private sector. The Government is reported to be pla nning to offer 37 geothermal power projects, with a total capacity of 3,977 MW, at the fourth World Geothermal Congress in Bali to be held on 25-30 April 2010. The MEMR is hoping that the congress will be attended by 2,500 delegates from 80 countries. We have seen evidence that international power utilities are exploring opportunities to become involved in the geothermal sector in Indonesia, not least to appease new corporate policies that seek to demonstrate a serious commitment to green energy. We expect such players might seek to gain a foothold by teaming up with local companies with existing geothermal mining rights and geothermal expertise, bringing generating technology and access to development capital to the project. However, a number of regulations that will impact on private sector geothermal power projects are new and remain untested. The development of IPP projects through the decentralised structure for geothermal mining tender processes remains relatively new. Other regulations remain to be released. While a ceiling price of 9.7cent/kWh will give some encouragement to investors, the outcome of future auction scenarios, and the position PLN will take on tariff discussions, remain to be seen. In order to achieve its stated objective to install substantial amounts of new, privately funded geothermal generating capacity by 2014, the Government and MEMR will need to waste no time in finalising, and providing certainty, about the regulatory framework that will apply, and also give the market confidence that tariff auctions and PPA negotiations will result in an economic outcome that attracts the required private (including international) investment. Andrew Digges is a banking and project finance consultant at Allen & Overy with ten years of experience at the firm. He advises on project and structured finance transactions in the power, oil & gas, petrochemicals, transport, infrastructure and mining sectors. During his time in Asia, Digges worked on project finance transactions in Brazil, China, India, Indonesia, Korea, Laos, Malaysia, Mexico, Saudi Arabia, Singapore, Thailand and Vietnam. In addition to his finance document experience, Digges specialises in construction and other project documents on PF transactions including construction, operation and maintenance, feedstock/fuel supply, offtake and concession agreements. He also has experience in acquisition, structured/leveraged financing and future trade receivables-backed securitisation. NOTES: [1] "Geothermal Development in Indonesia", (November 2009) By Sugiharto Harsoprayitno, Director of Geothermal Enterprise Supervision and Groundwater Management, Directorate

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General of Mineral, Coal and Geothermal, Ministry of Energy and Mineral Resources, presented at APEC Energy Working Group meetings, Bali, Indonesia. [2] The author notes that the proposed 2000 MW coal-fired power plant at Pemalang, Central Java, released for tender in February 2010, is not listed in the MEMR regulation No. 2/2010. This is understood to be because the Government is implementing this particular project in accordance with the "PPP law" (Presidential regulation No. 67/2005 - framework for public private partnerships in infrastructure projects).

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