Proceedings of the International Conference on Electrical Engineering and Informatics Institut Teknologi Bandung, Indonesia June 17-19, 2007

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Evaluation and Risk Assessment of Independent Power Producers in Indonesia

I Made Ro Sakya11*, Pieter Schavemaker2 , Lou van der Sluis2
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PT PLN (Persero) - Indonesia Delft University of Technology- Netherland

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Commitment for participation of private generation companies in Indonesia started in 1992 and was booming up to 1997. The private power plants started to operate in the system from 1998 on. Fast growing demand of electricity and limited capability of the company and government are the main reason of inviting private participation in the electricity sector. A mixture of government and private participation in providing the electricity need to be implemented to balance the supply and demand. Power generation investment is a large private infrastructure project and a long-term investment with a life cycle around 20 25 years. Private investors need attractive terms to make the project viable, on the other hand the electricity company can not and will not bear all the risk during the life cycle of private power plant. A PPA (Power Purchased Agreement) is created to materialize a win-win commercial cooperation between a private company and the electricity company. This paper will evaluate and analyse the existing IPP implementation in Indonesia, and discuss the risks and opportunities on the terms and agreement of the PPA. The discussion will focus mainly on the pricing structures. The paper will also propose terms and conditions that should be incorporated in future PPA

1. Introduction
Private participation in the generation of electricity, usually called Independent Power Producer (IPP), was a booming market in the 1990s. In 1997, private participation plummeted due to the financial crisis, and was followed by a decreasing trend up to the year 200311. Currently, the dominant sector in private participation is Telecommunication; the investments cover the cost without subsidization or concessions and have a low risk on political intervention 11. The power sector is much more sensitive to the public policy. Despite the fact that level of investment for the IPP is still lower than in 1997, many investor and government expect that IPP will continue to be one of the players in supplying the electricity demand. The risks of IPP are quite significant since the investment in the projects are large and the payback period cover a long periods of time; moreover most of the investment will be sunk cost. The projects are usually considered to be essential for the public utility and are provided monopolistically. Thus the services are highly politicized. This makes the investors vulnerable to opportunistic governments 8(Irwin, 1999). This paper will identify the risks of a power purchase agreement (PPA) by analyzing its payment structure. A PPA is a contract between utility company and an IPP. Furthermore, a better arrangement of payment structure will be discussed.

2. IPP in Indonesia
Based on the Electricity Law No. 15 1985, and accompanied by Presidential Decree No. 37 in 1992, private participation in the power sector in Indonesia started. The decree encouraged private participation in electricity generation, transmission and distribution. During 1990 1994, 27 power purchased agreements (PPA) were signed
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between PLN and Independent Private Producers (IPPs) (Sari, 2001). In term of capacity, most of the IPP are coal power plants (68%), followed by geothermal (17%), gas (8%), oil (5%) and hydro (2%). The PPA is a long-term contract with a 20 30 years term. In 1997, Indonesia had a financial crisis, and the Rupiah level depreciated 250% against the US$ in 1998. As the PPA is pegged to the US$, and the revenue of PLN is in Rupiah, the financial condition of PLN was not good. Moreover, the financial institution that usually supports PLN and the Indonesian Power sector withdrew from the power project in the country 13. As a reaction, the Government of Indonesia set up some policies in the power sector. It is stated in the Letter of Intent to the IMF in 1999 that the government will (i) establish the legal and regulatory framework to create a competitive electricity market; (ii) restructure the organization of PLN; (iii) adjust electricity tariffs; and (iv) rationalize power purchases from private sector power projects3. The government constituted a power purchase renegotiation team in 2000 by Presidential Decree No. 133/2000. In 2003, almost all of the IPPs have been renegotiated, and most of them have been in operation. In 2006, 30% of electricity energy in Indonesia was produced by IPP, so the roll of IPP in the electricity production can not be ignored. The growth of demand of electricity in Indonesia is expected around 8 % per year. The additional capacity needed to cope the demand is about 2000 4000 MW per year. The expected power balance up to the year 2015 is shown in the Table. 1. The total power plant capacity was 29.320 MW in 2006, and the peak load was 15.396 MW, resulting in a reserve margin of 39 %. To have a safe reserve margin, 27323 MW additional generation capacity/investment is needed up to the year 2015.

Responsible Author. Email : imadero@pln-jawa-bali.co.id

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Table 1 Indonesia Power Balance 2007 2015 (RUPTL, 2006)

2007 Gen. Cap [MW] 2009 2011 45,494 31,776 8.5% 43% 2013 52,280 37,239 8.6% 40% 2015 59.200 43,694 8.7% 35%

31.877 38.169

Peak Load [MW] 22,970 27,136 Annual Growth [%] 7.8% 9.1% Res. Margin [%] 39% 41%

Total investment that is needed up to 2015 is 19.5 billion US$, Table 2 show more detail investment need in Indonesian power sector. Table 2 Power Sector Investment (RUPTL, 2006)
2007 Generation Transmission Distribution Total 1,046 705 627 2,378 2009 1,986 629 738 3,353 2011 3,614 696 827 5,137 2013 3,265 294 917 4,476 10^6 US$ 2015 2,750 431 1030 4,211

Building a new power plant is almost impossible without private participation since the available public funds are very limited. The private participation in the infrastructure is one alternative to fulfil the demand of electricity. To stimulate this, the government has to prudently create risksharing arrangements that attract investors but are beneficial to the government and users as well.

and Operation cost are responsibility of the operator; this is to maintain to performance of the plant. Risk of fuel supply and fuel price depends on the PPA. Basically fuel is treated as a pass through. To mitigate the operator risk the payment formula for the energy is indexed to the fuel price. The risk of fuel supply failure requires consistency between the provisions in the fuel supply agreement and the PPA.. Market risk consists of two kinds of risks, demand/ offtake risk and currency risk. A provision to guarantee the income stream to meet debt financing costs is one of the mitigations of demand risk. The demand risk is usually represented in the payment structure of the PPA. The utility shall take the minimum amount of the power produced by the operator, or pay the minimum amount. In this case, the demand risk is allocated to the utilities. Currency risk is usually represented in the payment structure of the PPA. Even if the payment is in local currency, it is indexed to the foreign currency where the project is financed (usually in US$). The financing of IPPs may involve foreign currency debts. Therefore a foreign exchange risk is present if the debt servicing (and other payment obligations under the project contracts) is in foreign currency but the payments to the IPP under the PPA are in local currency.. An alternative is partial adjustment of the tariff under the PPA within a specified band, so that the risk is partially passed through and shared by both the IPP and offtaker1.

4. PPA Price Structure

The price structure of a PPA mostly defines the risk allocation of the parties. In Indonesia, every PPA has a unique price structure, but mainly there are two price structures: 1. Power Contract with Fixed & Variable Charge 2. Energy Sales Contract with Energy Price & Take or Pay Clause

3. Risk Component of IPP

In a PPA contract, the risk will be exposed to the contract signees of the project: the IPP as an operator, the Government or Utilities as a host, and the customers or people that will consume the electricity. How the risk should be allocated depends on the conditions of the project, but a major principle is that the risk should be allocated to the party best able to manage it, or party that can influence the sensitivity of the value of project to the risk factor, or the most important is party that can absorb the risk at the lowest cost 8 Risk allocation depends on the type of risk involved such as political risk, construction risk, operating risk, fuel risk, and market risk 17. Construction risk is a risk that arises during the construction period of the project. This pertains to the physical building of the infrastructure. Political risk is related to the government and regulatory risk. The extreme political risk is expropriation of the IPP; when the government nationalizes the assets or reneges the contract. The regulatory risk is the risk of new rules and regulations and the risk that returns on investment are reduced by red tape and/or corruption 15 Operating risk is related to the performance and the cost of the power plant. This risk will be allocated to the operator of the IPP. Performance of the power plant depends on the availability of the power plant. The lower the availability of the plant, the less revenue the operator derives. Maintenance

4.1. Power Contract

A power contract with fixed and variable charge is implemented in PPAs that have no obligation to absorb a certain quantity of fuel as primary energy. This usually applies for steam coal power plants. The payment structure has four primary components. Two components have a fixed charged which depend on the availability of the plant, and two components have a variable charge, depend on the energy produced by the power plant. The fixed charged is consist of capacity cost recovery charge, and fixed operation and maintenance charge. The variable charges consist of energy charge and variable operation and maintenance recovery charge.

4.1.1 Capacity Component

The capacity component is a payment to ensure the income stream to meet debt financing costs for investments. This component is usually called Capital Cost Recovery Charge. The revenue stream will always continue as long as the power plant is available for the system, even if the power plant is not dispatched. The payment is indexed to US$, and depends on the availability of the power plant.

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4.1.2. Fixed O&M Component

The payment for fixed operation and maintenance, or fixed Operation & Maintenance (O&M) Cost, is to ensure the cost of regular maintenance to make the availability of the power plant as stipulated in the PPA. The cost includes the overhead cost of running the power plant (salary and facility). The payment will be indexed to foreign exchange and customer price index..

5.1.2. Fuel Risk Assessment

There are two kinds of fuel risk in the PPA, the fuel supply risk and the fuel price risk. The fuel supply risk is allocated to the operator, and is stipulated in the PPA. In the energy sales contract type, a failure in fuel supply will decrease the take-or-pay obligation. Fuel price risk is allocated to the utility. A pass-through mechanism is used in this arrangement. To mitigate this risk, the fuel supply contract between the operator and the fuel supplier has to be approved by the utility.

4.1.3

Energy Charge

The energy charge is for the payment of the energy that is produced by the IPP. The energy payment reflects the cost of fuel supply to produce electricity. Basically, PPA is a pass-through provision to mitigate fuel price risk from the operator, so that the risk will be borne by the utilities.

5.1.3 Market Risk Assessment

Existing PPA allocate market risk to the utilities the demand risk is reflected in the capacity charge recovery in the power contract and the take-or-pay provision in energy sales contract. To mitigate this risk, the utility must prudently forecast the demand of electricity before the PPA is signed. The currency risk is reflected by the US$-indexed and inflation-indexed formula. This is incurred in the capacity charge rate and maintenance charge. Thus, the risk allocation is for the utility. Reason for this condition is that the financing of IPPs may involve foreign currency debt. Quite some literature focussed on this currency risk, especially the exchange risk 16, 5, 12, 8. Basically, the exchange risk should not fully allocate to the host or utility which at the end is the government. The exchange risk should be share among government, investor and customer. The government bears the exchange risk because of their control over exchange and interest rate as well as inflation rate. Investor can control the way the fund is raised and managed, where as customers control the demand.

4.1.4. O&M Variable Charge

The payment for the variable O&M charge is to recover the cost of O&M that varies with the production of electricity.

4.1.5. Other Payment

Other supplemental payments are can cover startup costs and emergency output payments. This cost will be paid if the condition is demanded by the utilities.

4.2. Energy Sales Contract

The energy sales contract is meant for IPPs with a take-or-pay fuel supply contract. This usually applies for geothermal or natural gas power plants. The contract usually has back-to-back with the fuel supply contract. This means that take-or-pay provision of energy is linked to the terms of fuel supply contract. The payment structures are simpler than in the power contract. The payments consist only of an energy payment, with a take-or-pay provision. Capacity and maintenance cost is covered by the energy payment. A take-or-pay clause is an obligation for the buyer to take a certain amount of the energy, and there is a minimum payment for every period of the settlement. Geothermal powerplant usually have a 90 100% take-or-pay provision, while Natural gas usually has a 60 75% take-or-pay provision.

6. Future PPA
Despite the difficulties faced by the investor and government to implement IPP contracts, the IPP will not vanish from the development of infrastructure; it is expected that IPP will continue to be one of important pillar of infrastructure investment17. There is a need for private participation because the government faces budgetary constraints and unavailability of public funds to finance the infrastructure. The full benefit of private infrastructure will depend on how the risks are allocated. Recent trends suggest that private sponsors put more emphasis on risk mitigation strategies than before. It is the responsibility of policymakers to ensure that the investment climate promotes risk-sharing arrangements that attract private operators but benefiting governments, taxpayers, and users as well. Woodhouse (2005) study pointed out a trend that new IPPs are smaller size than in the market of 1990, and the enterprise that build the IPP consist of regional investors. The conditions in Indonesia are in line with Woodhouse results: most of the new IPP are smaller and come from the regional investors . This condition creates some opportunity to arrange a new risk-sharing that makes the PPA more sustainable. The literature on risk mitigation of the IPP contract is impressive and is the most extensive on the exchange risk and demand risk that are usually allocated to the government. Obviously, almost all of these literatures suggest that the most

5. Risk Assessment
The price structure in the existing PPAs in Indonesia represents operating risk, market risk and fuel risk.

5.1.1 Operating Risk Assessment

Operating risk is usually allocated to the operator, and is reflected in the capacity recovery charge and fixed O&M recovery charge. The fixed revenue of the operator will be directly influenced by the performance of the powerplant. Optimal availability of the power plant will ensure the revenue stream to compensate the debt financing cost. The cost of O&M is allocated to the operator; the worse the O&M carried out, the worse the performance of the power plant. The operator should optimise the cost of O&M so that it is not higher than the O&M payment minus the overhead of the company.

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important thing that is needed to improving the PPA is the government policy for ensuring the convertibility of foreign exchange, prudent macroeconomic management and sharing information about its policy intentions. A local currency debt could be an alternative to mitigate the foreign exchange risk. A trade-off usually exists among local currency interest rate and the foreign currency exchange risk. A mixture between foreign and local currency is possible, since the local capital market will not have enough liquidity to finance the whole project, but gradual development must be encouraged. There are some reasons, why the investors should share in the exchange risks. First, the government guarantees may encourage investors to take a fund resource with a high exposure to exchange and interest risk5, second the government may already be exposed to the risk associated with exchanged rate and interest rate shocks, and third the exchange rate guarantees may discourage the government to depreciate the domestic currency following a terms of trade shocks. The investors might have more incentives to manage the exchange rate risk, for example by hedging the risk to third party16. Currency risk is also related to the inflation rate, the payment for O&M in the PPA is indexed to both inflation and exchange rate. If a projects revenue is indexed to local inflation, over the medium to long term the effects of foreign exchange risk should be neutral12,6. The O&M charge contains both the local inflation rate and exchange rate index. Since the payments are in local currency, it seems logical to replace the foreign exchange index by the inflation index. This holds for all payment parameters. With a link to local inflation rate, sudden currency crises will not tend to cause extreme fluctuation that can trigger worse political risk.

References
1. APEC, Manual of Best Practice Principles for Independent Power Producers. 1997. 2. Estache, A. and M.E. Pinglo, Are Returns To Private Infrastructure In Developing Countries Consistent With Risks Since The Asian Crisis?, World Bank Policy Research Paper, 2004. No. 3373.Washington. 3. GOI-Gov.of.Indonesia, Letter of Intent. 1999. 4. GOI-Gov.of.Indonesia, RUPTL 2006 - 2015 (Statement of Power System Provision Planning in Indonesia 2006 - 2015). 2006, Dep. ESDM (Ministry of Energy and Natural Resources) Indonesia. 5. Gray, P. and T. Irwin, Allocating Exchange Risk in Private Infrastructure Contracts. Viewpoint, 2003. XXX. 6. Gray, P. and T. Irwin, Exchange Rate Risk - Reveiwing the Record for Private Infrastructure Contracts. Public Policy for Private Sector, 2003. 7. Irwin, T. Public Risk in Private Infrastructure. in Realizing Potential for Profitable Investment in Afrika. 2006. Tunis: IMF. 8. Irwin, T., et al., Managing Government Exposure to Private Infrastructure Risks. The World Bank Research Observer, 1999. 14(2): p. 229-245. 9. Izaguirre, A.K., Private Participation in the Electricity Sector - Recent Trends. Private Sector, 1998(154). 10. Izaguirre, A.K., Private Power Projects -Annual Investment Flows Grew by 44 Percent in 2003. Private Sector, 2004(281). 11. Kerf, M. and A.K. Izaguirre, Revival of private participation in developing country infrastructure. GRID LINES, 2007. 16(Jan 2007 12. Matsukawa, T., R. Sheppard, and J. Wright, Foreign Exchange Risk Mitigation for Power and Water Projects in Developing Countries. Energy and Mining Sector Board Discussion Paper, 2003(Paper No. 9). 13. Peter Pintz, D. and D. Andreas Korn, Development of a Competitive Electricity Market in Indonesia. Energy Studies Review, 2005. 13(2). 14. Sari, A.P. and F. Seymour, Indonesia - Electricity Reform Under Economic Crisis, in Power Politics - Equity and Environment in Electricity Reform, N.K. Dubash, Editor. 2002, World Resources Institute: Washington. p. 75-95. 15. Schiffer, M. and B. Weder, Catastrophic Political Risk versus Creeping Expropriation: What determines Private Infrastructure Investment in Less Developed Countries ,1999, World Bank. 16. Thobani, M., Private Infrastructure, Public Risk. Finance & Development, 1999. 36(1). 17. Woodhouse, E.J., A Political Economy of International Infrastructure Contracting: Lessons from the IPP Experience. 2005, Stanford.

7. Conclusion.
The paper has described private participation in power sector with a focus on Indonesia. In the future, this participation in the form of IPP needs to be continued. A better risk-sharing arrangement between the host, which at the end is the governments, and the operator, which is the investor, must be a win-win contract. Under the current PPA, the operator will bear the construction and operation risk, and the host will bear the market and demand risk. Political and regulation risk will be borne by both parties. Political risk is an intangible risk: better regulation and more transparent economic policy is a must to encourage the private participation in the power sector. The paper proposes three improvements on the current PPA: 1. Mixture of local and foreign financing 2. Sharing of the foreign exchange risk between the host and the operator 3. Substitution of the exchange risk by inflation rate.

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