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.