Deal with power producers

The government's success in lowering the price that the state electricity company PT PLN is paying and will pay to 20 independent power producers (IPPs) will go a long way in reducing the company's financial burden and, at the same time, spur power investments while averting a looming electricity crisis.

In a more positive impact on the investment climate, the successful renegotiations of the contracts with IPPs will send a strong signal to investors that the government will, in good times or bad, honor the sanctity of contracts.

The encouraging development seems to have been prompted by the realization on the part of both parties that it would have been better, more civil and less costly to renegotiate the prices of the contracts than resorting to messy, time-consuming and costly lawsuits.

The IPPs' willingness to renegotiate also implied their acknowledgement that the contracts, which were foisted on PLN in the early 1990s without competitive bids, were commercially unfeasible as the punitively high prices had been dictated by the contractors associated with Soeharto's family members and cronies. After all, corruption, collusion and nepotism had then been the main hallmarks of major business deals between the government and private investors.

The contract's revision that reduced PLN's procurement prices to below 5 U.S. cents per kWh from a range of 6 cents to 8 cents as stipulated in the original contracts will not only save the company billions of dollars.

Even more important is the positive impact the contract amendments will have on the efforts the government and PLN are undertaking to raise public understanding and support for a sizable increase in electricity rates.

Both the government and the House of Representatives have agreed that the price of electricity will have to increase 6 percent quarterly between 2003 and 2005 to bring it on par with PLN's production cost of 7 cents/kWh.

The electricity rate increase is necessary for sustainable production and to encourage conservation. Power generation costs in rupiah terms have risen steeply, not largely because of the gross inefficiency of PLN, but mainly as a result of the more than 70 percent depreciation of the local currency to the American dollar as 85 percent of its cost components are based on foreign exchange.

The public would understandably never accept any power rate increase, however economically imperative it might be, if they knew that PLN paid IPPs highly punitive prices. Just witness how strong public opposition was to the power price increase that was announced simultaneously with rises in telephone and fuel prices early this month. The tough measures have subsequently been corrected.

Since the exorbitantly high prices, which embodied corrupt and collusive practices and cost markups, have been reduced by and large to international generation costs, the environment for gradually phasing out government electricity subsidies will become more conducive.

The new agreements will jump start the construction of many IPP power plant projects, which have been stalled since the onset of the economic crisis in late 1997. This means that at least 8,000 megawatts in additional power generation capacity will come on stream within the next two to four years.

This additional capacity will avert a power crisis that PLN had predicted to hit within the next two to three years as the demand for electricity has been rising steadily along with the economic recovery. In fact, the threat of a looming power crisis has been cited by most foreign investors as one of the main barriers challenging new investment ventures in the country.

Another great benefit of the IPP power plant projects is that none of them will rely on oil. Most will be fired by coal and geothermal steam, thereby diversifying our source of commercial energy away from the present heavy dependence on hydrocarbon.

Certainly the contract amendments will help restore investor confidence in the country at a time when PLN, overburdened with mountains of debts caused partly by the rupiah's meltdown, simply does not have enough resources to expand its transmission and distribution networks, let alone construct new generation stations.

The future outlook of private investment in electricity is foreseen to be much brighter, especially after last September's enactment of the Electricity Law, which will gradually abolish PLN's monopoly of power generation, transmission and distribution to mid and large-scale users.