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.