Guarantees for gas contract payments needed

Guarantees for gas contract payments needed

Todd Callahan, PT Jasa Cita, Jakarta

Edimon Ginting's article in this newspaper titled Domestic gas
should be used to fuel Indonesia's future (Oct. 2) hit the nail
on the head. There is no doubt that development of domestic
natural gas to satisfy Indonesia's burgeoning energy needs will
benefit the country.

Increasing domestic gas consumption will result in investments
and drive the local economy, reduce fuel-bill and operational
costs by hundreds of millions of dollars per annum, conserve
foreign exchange through reduced oil imports and have a positive
impact on the environment because gas is an exceedingly clean
fuel.

Regrettably, the enormous savings that would accrue to the
nation by switching to gas are, at the moment, just talk because
government linked companies are unwilling to provide the
contractual assurances that gas producers require. Specifically,
state owned companies like PLN are indisposed to provide the
payment guarantees that are a precondition to completing more gas
sales agreements.

Last July, for example, billions of dollars of heads of
agreements (HOA) pacts were announced in Bali involving a number
of gas producers and consumers, among others the state electric
utility (PLN), the state gas company (PGN), and the state
fertilizer producer (PKG).

The HOA pacts essentially covered supply volumes and prices.
However, many points in the agreements still require negotiation.
Ultimately, gas sales agreements must be signed that formalize
important matters such as supply arrangements, payment terms and
other contractual details.

The main bone of contention before any gas sales agreements
can be completed is payment guarantees. As a matter of prudence,
gas producers require assurances in the form of Standby Letters
of Credit (SBLC) that take effect if a buyer fails to pay. On the
other side of the table, large domestic gas consumers consider
them burdensome and unnecessary.

On a recent television talk show, PLN President Director Eddie
Widiono lamented demands for payment guarantees like SBLC's,
facilities that are somewhat difficult for PLN to obtain because
of bank lending limits in Indonesia.

Without ignoring the basis for establishing these bank lending
limits, the arguments of producers for SBLC's and other payment
assurances need to be appreciated. In general, payment guarantees
are necessary because in most cases gas is a single-buyer
commodity in Indonesia.

It cannot be freely traded because the pipeline distribution
infrastructure does not yet exist. Thus, once a gas field is
developed, the developer is at the mercy of the buyer. There are
no alternative customers. In this context, a producer's request
for a one-year SBLC is not unreasonable.

Furthermore, it should be recognized that payment guarantees
are not the same thing as investment guarantees. Investment risks
are the responsibility of producers and, when determining a
project's feasibility, they would have carefully considered "risk
and return" factors when negotiating a final gas price.

In the end analysis, SBLC's are nothing more than an attempt
to safeguard long-term agreements that exist between buyers and
sellers. In the Indonesian case, investment will not materialize
unless producers can acquire irrevocable guarantees that gas
purchasers will meet their payment obligations.

In determining these guarantees, consideration is given to the
financial condition of the buyer, the payment history of the
buyer, the political and business conditions associated with the
buyer's country, as well as other factors. In general, the credit
rating of the buyer and country of domicile are used to assess
the risk associated with specific projects and transactions.

Indonesia's rating, for example, was recently upgraded by
Standard & Poor's (S&P) from B minus to B. In general, S&P's
assessment is that Indonesia is able to meet its obligations, but
adverse economic, financial or business developments still pose a
threat to its capacity to honor its obligations. Despite the
recent improvement, the S&P rating is not investment grade. In
non-diplomatic language, Indonesia's rating is still less than
desirable.

In PLN's case, the national credit rating agency, Pefindo, has
assigned a credit rating two levels below S&P's country rating
for Indonesia. In Pefindo's words, although there have been
improvements in PLN's financial condition, the company does not
yet boast an economic tariff level and it is unlikely to have one
until 2005.

Additionally, PLN must make regular debt payments and
therefore is unable to satisfy the growing demand for power. In
other words, there is some perceived risk about PLN's capacity to
meet its payment and other obligations.

In view of these realities, it is sensible for producers
making large investments to demand contractual guarantees that
insure buyers will satisfy their payment obligations. This logic
is equally applicable to industries such as oil, mining, power
generation and others investment-intensive sectors. This is
business: adequate safeguards and payment guarantees must exist
before agreements can be activated.

In summary, policy makers must realize that development of the
domestic gas sector requires huge investment. SBLC's not only
ensure payment to producers, but they ensure that the development
of the sector will take place. The provision of payment
guarantees will foster investment in new gas fields that fuel
economic and more efficient power generation. Since no economy
can grow without sufficient electricity, this will exert a
positive impact on overall growth.

The solution is simple. State owned companies like PLN must
obtain the necessary credit facilities from state-owned banks and
Bank Indonesia's governor and other top government officials must
give the matter greater priority. However, even if legal lending
limits pinch PLN's credit access, the firm can, albeit difficult,
still provide the necessary payment guarantees. Cut the Gordian
knot, issue the SBLC's and put the country on a path to greater
gas utilization.

The writer is a policy observer and works as a senior
technical advisor at PT Jasa Cita, a Jakarta-based business
consultancy.