Deal with power producers

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.