Indonesia in jeopardy of facing severe power shortage

Indonesia in jeopardy of facing severe power shortage

By James Castle and Todd Callahan

JAKARTA (JP): Earlier this month the legislature agreed to
hike electricity rates an average of 17.5 percent effective July
1. The measure in large part is being taken to address the
government's ballooning budget deficit, which is feared could
exceed 6 percent of gross domestic product this year, by trimming
expensive subsidies on fuel and power that the country can ill
afford. The electricity subsidy situation is so badly out of
hand, that even with this increase, the subsidy for the fiscal
year will still be a whopping Rp 4.7 trillion.

Since the announcement was made on June 11, a chorus of
protest has appeared in the popular Indonesian press and several
industries have voiced their objection to the increase. Some
critics assert that the price increase of the state owned PLN
electricity firm will drive inflation perilously high and claim
the new tariff disproportionately raises the cost of service to
small residences (R-1), which is only one of 17 categories in the
company's complicated tariff structure.

In reality, the inflationary impact of such a small rate
adjustment should be small. According to one study, even if
electricity prices were doubled, the effect would be a 6.6
percent increase in the cost to manufacture most consumer
products. Therefore the fear this much smaller increase will send
inflation soaring seems overstated.

On the matter of small residential customers, the public's
concerns are readily understandable particularly in the current
environment in which so many Indonesians are struggling to make
ends meet. It is natural that no one wants to pay higher
electricity bills when conditions are already so hard.

Unfortunately, the price hike in this category, as a matter of
economic necessity, must occur because the vast majority of PLN's
approximately 28 million customers are concentrated in this
group. Without a cut in the huge subsidy currently spent in this
category, it would be virtually impossible to make any headway in
reducing burdensome subsidies, and until subsidies are eliminated
there will likely be no new money for investment in power
production or distribution.

With regard to industrial users, opposition has been vocal
because their tariff has been targeted by PLN for a substantial
increase. Organizations representing groups as varied as
textiles, exporters and small and medium sized enterprises (SMEs)
have argued that higher electricity rates, in tandem with more
expensive fuel prices, will drive many manufacturing businesses
to closure and contribute to more unemployment.

The truth is that subsidized utilities do help keep some
businesses open, but many more are simply receiving a free ride
and have been profiting from the government's subsidies for
years. This misapplication of subsidies is indefensible, and it
is time for the system to be phased out.

Notwithstanding the importance of trimming subsidies to ease
pressure on the budget, a more compelling reason to adjust
electricity rates is to ensure the continued operation and
provision of power by PLN.

Low, government-fixed electricity prices have left PLN in dire
financial health. Indeed, the single biggest contributor to the
company's problems has been the exchange rate of the rupiah
versus the US dollar. With revenue in rupiah, but much of their
debt, most of their maintenance costs, and payments to
independent power providers (IPPs) denominated in US dollars, the
utility's situation grows worse every time the rupiah heads
south. It is important to note that this is what has driven PLN
into loss positions since 1997, not the contract rates paid to
foreign IPPs, as commonly believed.

Since the economic crisis began in Indonesia, PLN has posted
losses of Rp 0.6 trillion in 1997, Rp 9.2 trillion in 1998, Rp
11.4 trillion in 1999, and a staggering Rp 23.4 trillion in 2000.
Conditions are currently so grave that in April the government
converted close to Rp30 trillion of PLN's debt into state equity
in a bid to save the utility from falling into bankruptcy.

Why is all of this important? Without a financially solvent
electric utility, Indonesia is in jeopardy of facing a severe
power shortage by 2003. This could result in blackouts in Jakarta
and elsewhere in the country. In fact, the warning signs are
already present. In some critical regions PLN cannot connect new
customers because it lacks the money to add more capacity.

Meanwhile, the Java-Bali grid was put on alert status earlier
this year and a reported 22 regions outside of Java face an
imbalance in their energy supply-demand outlook. In the newly
established province of Bangka-Belitung, the governor even
identified insufficient electricity supply as the region's
biggest problem. Bearing this out, according to a Bisnis
Indonesia interview with Hardiv Haris Situmeang, PLN's Director
of Planning, the state utility needs to immediately invest US$3.3
billion in new plant capacity and transmission lines to overcome
its problems.

Longer term, the amount of investment needed in new capacity
is even more daunting. According to an estimate from the ASEAN
Center for Energy, countries of the Association of Southeast
Asian Nations will require a minimum investment of US$69.5
billion between 2000 and 2010 to keep pace with electricity
demand. Thailand, Vietnam and Indonesia are forecast to need the
most capacity, each requiring in the neighborhood of US$20
billion.

PLN's president director, meanwhile, has put the required
investment figure for Indonesia at an even higher US$28 billion.
Admittedly, while no one can quantify definitively Indonesia's
long term electricity needs, it is clear that the increase in
demand will be massive.

Considering PLN's current state of affairs, neither the
utility nor the government have very many options. To stay ahead
of nationwide demand, which is now close to its pre-crisis level
of 12 percent per annum, the authorities must adopt a cohesive
energy policy that attracts new investment. At this juncture
there will need to be an emphasis on three important steps.

First, the planned 17.5 percent tariff increase on July 1 must
go ahead as scheduled. Subsequent increases must be made, in
phases, until PLN's domestic tariffs are high enough for it to
pay for its foreign currency costs. Aiming for a tariff
equivalent to US$0.07 per kilowatt hour (kWh) by 2005, as has
been reported in local newspapers, is a good goal.

At first glance, reaching such a rate might seem like a pipe
dream given the fact that PLN's current tariff for the whole
system, on a weighted average basis, is only about Rp 230 per
kWh. However, skeptics should remember that PLN's domestic
tariffs averaged US$0.07 per kWh before the Asian financial
crisis swept through the country.

Second, disputes must end between PLN and the IPPs, which have
built most of the country's new electricity capacity. Forget
about blame for a moment. "Fault" might be valuable as a
political commodity, but assigning it will not get Indonesia the
sorely needed foreign investment it wants. For the country to
move forward, PLN must negotiate deals that make sense for both
sides.

Related to this point, the government would be wise to come to
some understanding with OPIC, an arm of the U.S. government, over
a US$260 million claim resulting from an international
arbitration case which CalEnergy successfully brought against PLN
in 1999 for breach of contract. Until this matter is settled, big
IPPs and the financiers behind them will not be interested in
returning to Indonesia.

Finally, there must be continuity of policy across government
administrations to stimulate foreign interest in building more
power capacity. Perfection is not necessary, but the authorities
must get enough right so that investors feel assured their
contracts will be respected. More specifically, if security of
payment concerns diminish in an environment which delivers a fair
return, PLN will have all the investment it needs.

The writers are technical advisors at PT Jasawenang
Citrasempurna, a subsidiary of the Castle Group in Jakarta. James
Castle is also the President of the American Chamber of Commerce
in Indonesia.