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.