Indonesia issues sovereign guarantees for power projects

Despite the adoption of a new electricity law in 2009 liberating the Indonesian electricity market, most electricity generated in Indonesia is sold to PLN, the state-owned utility, under 25 or 30-year power purchase agreements (PPAs).

One of the challenging dynamics of the Indonesian electricity market is the fact that PLN sells electricity to consumers at less than PLN’s cost of generation and the tariff payable to independent power producers (IPPs).

The Indonesian Government compensates PLN for the difference between the cost of generation and the retail tariff by way of a subsidy known as the Public Service Obligation (PSO).

The issue of PLN’s creditworthiness and the commitment to pay the PSO has been critical for IPPs seeking project financing. Traditionally, the essential mitigant to PLN’s credit risk has been the Indonesian sovereign guarantee.

In August 2011 the Indonesian Government passed Ministerial Regulation No. 139 of 2011 on Procedures for the Granting of Business Viability Guarantee of PLN for Development of Power Plants using Renewable Energy, Coal and Gas Conducted Through Cooperation with Independent Power Producers (Regulation 139).

Regulation 139 caused ripples of concern amongst the IPP industry because it suggested that the sovereign guarantee issued to IPPs for PLN’s payment obligations under PPAs would be reduced.

In particular, it appeared that termination payments under PPAs would no longer be covered. Without cover for termination payments, most international lenders and export credit agencies previously active in Indonesia were unwilling to lend without sponsor support for this risk or a stable investment grade rating for Indonesia.

Sponsors unwilling or unable to provide support were faced with the prospect of shorter tenor, higher cost lending from regional banks. As a result there were few bids for projects tendered by PLN in late 2011 including Banten, Riau and Kalsel 1.

However, recent events bode well for Indonesian power projects. Fitch and Moody’s upgraded Indonesia’s sovereign credit rating to investment grade in December 2011 and January 2012 respectively. Once lenders become satisfied that Indonesia’s investment grade rating can be sustained, the issue of PLN’s creditworthiness becomes much less significant.

In the last few weeks Indonesia’s Ministry of Finance issued sovereign guarantees covering PLN’s payment obligations under PPAs for two geothermal projects at Rajabasa and Muara Laboh. These are the first business viability guarantees to be issued under Regulation No. 139.

A third guarantee is likely to be issued soon for a hydro project under the second Fast Track programme, which is seeking financial close in the near future.

Despite initial fears, the Ministry of Finance is willing to guarantee PPA termination payments. On the negative side, however, the guarantee does not provide blanket coverage of PLN’s obligations under the PPA.

On the contrary, only specific post - commercial operation date payment obligations are covered. It is likely that the guarantee will cover the tenor of the financing, but will not necessarily cover the remaining period of the PPA.

The issue of the first business viability guarantees by the Ministry of Finance and the new investment grade rating ought to provide the industry with cause for optimism.

However, readers should note that the business viability guarantee is only available for Fast Track II projects. Several projects outside of the Fast Track II programme are being tendered without the benefit of a guarantee.

The first of these projects, Banten, a 660 MW coal-fired project, is moving into the financing phase this year. This will be an interesting test for the financing market and may establish a new model for financings in Indonesia.

Laurie Pearson, Of Counsel, Norton Rose (Asia) LLP. Laurie is a member of Norton Rose’s projects and energy group based in Singapore.