Guarantees for gas contract payments needed<\/p>\n
Todd Callahan, PT Jasa Cita, Jakarta<\/p>\n
Edimon Ginting's article in this newspaper titled Domestic gas
\nshould be used to fuel Indonesia's future (Oct. 2) hit the nail
\non the head. There is no doubt that development of domestic
\nnatural gas to satisfy Indonesia's burgeoning energy needs will
\nbenefit the country.<\/p>\n
Increasing domestic gas consumption will result in investments
\nand drive the local economy, reduce fuel-bill and operational
\ncosts by hundreds of millions of dollars per annum, conserve
\nforeign exchange through reduced oil imports and have a positive
\nimpact on the environment because gas is an exceedingly clean
\nfuel.<\/p>\n
Regrettably, the enormous savings that would accrue to the
\nnation by switching to gas are, at the moment, just talk because
\ngovernment linked companies are unwilling to provide the
\ncontractual assurances that gas producers require. Specifically,
\nstate owned companies like PLN are indisposed to provide the
\npayment guarantees that are a precondition to completing more gas
\nsales agreements.<\/p>\n
Last July, for example, billions of dollars of heads of
\nagreements (HOA) pacts were announced in Bali involving a number
\nof gas producers and consumers, among others the state electric
\nutility (PLN), the state gas company (PGN), and the state
\nfertilizer producer (PKG).<\/p>\n
The HOA pacts essentially covered supply volumes and prices.
\nHowever, many points in the agreements still require negotiation.
\nUltimately, gas sales agreements must be signed that formalize
\nimportant matters such as supply arrangements, payment terms and
\nother contractual details.<\/p>\n
The main bone of contention before any gas sales agreements
\ncan be completed is payment guarantees. As a matter of prudence,
\ngas producers require assurances in the form of Standby Letters
\nof Credit (SBLC) that take effect if a buyer fails to pay. On the
\nother side of the table, large domestic gas consumers consider
\nthem burdensome and unnecessary.<\/p>\n
On a recent television talk show, PLN President Director Eddie
\nWidiono lamented demands for payment guarantees like SBLC's,
\nfacilities that are somewhat difficult for PLN to obtain because
\nof bank lending limits in Indonesia.<\/p>\n
Without ignoring the basis for establishing these bank lending
\nlimits, the arguments of producers for SBLC's and other payment
\nassurances need to be appreciated. In general, payment guarantees
\nare necessary because in most cases gas is a single-buyer
\ncommodity in Indonesia.<\/p>\n
It cannot be freely traded because the pipeline distribution
\ninfrastructure does not yet exist. Thus, once a gas field is
\ndeveloped, the developer is at the mercy of the buyer. There are
\nno alternative customers. In this context, a producer's request
\nfor a one-year SBLC is not unreasonable.<\/p>\n
Furthermore, it should be recognized that payment guarantees
\nare not the same thing as investment guarantees. Investment risks
\nare the responsibility of producers and, when determining a
\nproject's feasibility, they would have carefully considered "risk
\nand return" factors when negotiating a final gas price.<\/p>\n
In the end analysis, SBLC's are nothing more than an attempt
\nto safeguard long-term agreements that exist between buyers and
\nsellers. In the Indonesian case, investment will not materialize
\nunless producers can acquire irrevocable guarantees that gas
\npurchasers will meet their payment obligations.<\/p>\n
In determining these guarantees, consideration is given to the
\nfinancial condition of the buyer, the payment history of the
\nbuyer, the political and business conditions associated with the
\nbuyer's country, as well as other factors. In general, the credit
\nrating of the buyer and country of domicile are used to assess
\nthe risk associated with specific projects and transactions.<\/p>\n
Indonesia's rating, for example, was recently upgraded by
\nStandard & Poor's (S&P) from B minus to B. In general, S&P's
\nassessment is that Indonesia is able to meet its obligations, but
\nadverse economic, financial or business developments still pose a
\nthreat to its capacity to honor its obligations. Despite the
\nrecent improvement, the S&P rating is not investment grade. In
\nnon-diplomatic language, Indonesia's rating is still less than
\ndesirable.<\/p>\n
In PLN's case, the national credit rating agency, Pefindo, has
\nassigned a credit rating two levels below S&P's country rating
\nfor Indonesia. In Pefindo's words, although there have been
\nimprovements in PLN's financial condition, the company does not
\nyet boast an economic tariff level and it is unlikely to have one
\nuntil 2005.<\/p>\n
Additionally, PLN must make regular debt payments and
\ntherefore is unable to satisfy the growing demand for power. In
\nother words, there is some perceived risk about PLN's capacity to
\nmeet its payment and other obligations.<\/p>\n
In view of these realities, it is sensible for producers
\nmaking large investments to demand contractual guarantees that
\ninsure buyers will satisfy their payment obligations. This logic
\nis equally applicable to industries such as oil, mining, power
\ngeneration and others investment-intensive sectors. This is
\nbusiness: adequate safeguards and payment guarantees must exist
\nbefore agreements can be activated.<\/p>\n
In summary, policy makers must realize that development of the
\ndomestic gas sector requires huge investment. SBLC's not only
\nensure payment to producers, but they ensure that the development
\nof the sector will take place. The provision of payment
\nguarantees will foster investment in new gas fields that fuel
\neconomic and more efficient power generation. Since no economy
\ncan grow without sufficient electricity, this will exert a
\npositive impact on overall growth.<\/p>\n
The solution is simple. State owned companies like PLN must
\nobtain the necessary credit facilities from state-owned banks and
\nBank Indonesia's governor and other top government officials must
\ngive the matter greater priority. However, even if legal lending
\nlimits pinch PLN's credit access, the firm can, albeit difficult,
\nstill provide the necessary payment guarantees. Cut the Gordian
\nknot, issue the SBLC's and put the country on a path to greater
\ngas utilization.<\/p>\n
The writer is a policy observer and works as a senior
\ntechnical advisor at PT Jasa Cita, a Jakarta-based business
\nconsultancy.<\/p>",
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