Competitive market benefits power consumers

Competitive market benefits power consumers

David O'Brien, Jakarta

An article in this newspaper on Aug. 23, 2004 reported the
doubts that consumer protection activists have for reform of the
Indonesian power sector. There are some issues worthy of
discussion to balance the argument from the dogmatism of "status
quo good, change and competition bad".

It seems there is a lack of appreciation that the system
remains close to crisis and the status quo will not stop the
lights going out. It is when the lights are out and the factories
are shut that consumers really start to hurt.

Electricity demand continues to grow at double the rate of GDP
growth. There has been little new capacity added since the crisis
and reserve margins are thinning in the face of this growth and
reliability issues associated with ageing plant.

There is a pressing need for a solution to ensure that
Indonesia's emergence from crisis is not forestalled due to lack
of electricity supply.

The financial health of PLN will not allow it to exist as is.
Tariffs have been frozen this year at a rate that equates to
nearly US$0.07 at an exchange rate of Rp 8,500 to a dollar. At a
current rate of 9,200 this has already declined to below $0.065.
This is all occurring in an environment of rising global interest
rates adding to cash flow pressures.

This $0.07 level is widely promoted as the "natural price
level" for Indonesia, being the pre crisis price. It needs to be
appreciated that pre crisis PLN enjoyed subsidized fuel prices
for fuel (80 percent of costs) that allowed for a profit to be
generated, albeit never at a reasonable rate of return.

The system currently remains highly dependent upon oil due to
historical subsidies and its associated distorting effect upon
fuel choice decisions. Little development of gas for domestic use
occurred when oil was priced artificially low. As a result the
system is reliant to a large extent on oil at its current record
prices. The second most popular fuel is coal. Coal is now also
enjoying a record run, being well up from its historical average
price of around $25/tonne to $60/tonne. It will take several
years of new gas development to allow for a more balanced
portfolio of generation.

In this environment there is not the capacity for self funded
expansion by PLN as it continues to plug gaps as best it can and
fight for survival. The current capital requirements for the
electricity network over the next decade are estimated at up to
Rp 180 trillion . With the state budget already burdened with
debt repayments and ongoing retail fuel subsidies there is
limited capacity to meet these needs.

The article stated that "as private companies control
different parts of the business, it (free market competition)
will make the supply chain longer and in turn push prices higher
for consumers". The article went on to attribute a 40 percent
price rise for consumers as a result. Though surprised at such an
assertion I was not at the forum last weekend to see the
financial projections that support it. Previous projections that
I have been associated with anticipate an increase of less than
half this level to strengthen the industry and allow greater
development to benefit consumers.

The proposed law foresees little change to the supply chain.
Transmission and distribution are to remain in state owned hands
as monopoly assets and generation and retail will be subject to
competition. All of this only applies in areas that meet the set
of seven criteria set forth for there to be competition. These
criteria exist to ensure that any competition initiated will
benefit consumers.

One of the criteria to be met before adoption of competition
is that these business units have a greater level of commercial
and legal autonomy. This will allow greater clarity of transfer
pricing at arms length and comparisons of operating costs of
different business units. With the entire supply chain presently
under the single ownership of PLN, there is limited disclosure of
supply chain effectiveness.

The Java/Bali/Madura (JBM) system and that of Batam are the
only regions that are forecast to meet the criteria for
competition in the foreseeable future. It is planned that Batam,
given its size, will serve as a testing ground prior to adoption
in JBM.

It should be noted that JBM accounts for 80 percent of demand
for the whole of Indonesia and is the area which will support the
balance of the country through providing community service
obligation funds. These funds will make the delivery of
electricity at reasonable prices to the less economic regions
possible. In this manner consumers in less developed regions can
be served with affordable electricity.

The JBM system already has autonomous business units split
along the lines described above. In fact there are five
distribution/retail companies, a transmission company and two
generation companies.

The law foresees competition initially at the generation
level. This is the largest component of the cost base for the
final consumer. I am yet to see an increase in competition lead
to increased prices and reduced services levels. Look at the
results in the telecommunications sector in Indonesia with only
limited competition introduced.

Nengah Sudja describes how in a free market, where demand
exceeds supply, prices will rise to a higher level before
reaching equilibrium. The form of market for Indonesia is yet to
be defined. It is still unclear from the law if a totally
uncapped pool market is proposed or there will be some form of
single buyer or something in between.

The fact is that in a growing market a free pool is not
desirable and there will be some form of cap or a single buyer
setting a cap price. Both are acceptable forms of market so long
as investors are aware of the rules and can price this
appropriately in assessing their investment.

It is most unlikely that consumers will be immediately subject
to market forces. Most countries use a system of bilateral
contracts that protect consumers that are not seen as benefiting
from competition initially. The competition is likely to occur at
the level of large commercial/industrial users. This leads to
consumer benefits again as more competitive prices, innovation
and improved reliability of supply will support greater growth of
the economy.

It is also proposed in the Law that an independent regulatory
body be established to oversee the controlling entity and balance
the needs of investors and consumers. Such a body is now proposed
to be implemented in the electricity industry by the end of this
year.

The development of a strong and healthy electricity industry
serves to raise living standards for the entire nation. There
will be Universal Service Obligations to be imposed upon
infrastructure providers so as less profitable areas are
developed. Greater clarity of costs and tariffs is a key to
ensuring that this activity takes place in the most economically
efficient manner to benefit all. The step by step approach to
competition being undertaken seems to be designed with the
consumer very much in mind.

The writer is a Technical Advisor at CSA Strategic Advisory.
CSA helps businesses through a combination of "soft" behavioral
and "hard" financial advice.