INDONESIA RISING. Policy Priorities for 2010 and Beyond 53474 Energizing the Power Sector Key Messages A reliable, affordable and sustainable supply of electricity is essential for Indonesia to emerge as a large mid- income economic power in the next decade. The power sector is now at a critical juncture and facing considerable challenges: 1. Significant investments from both public and private sectors are required to sustain economic growth and increase access of the poor to electricity. 2. Low tariff levels undermine the public energy utility, Perusahaan Listrik Negara's (PLN) financial viability, stall much needed capacity expansion and lead to unsustainable government subsides. 3. Investment in key national power companies is hampered by the legal and regulatory uncertainty caused by the annulment of the 2002 Electricity Law. 4. High upfront costs and a lack of adequate incentives have impeded significant progress in the development of renewable energy resources, especially geothermal power. Key Action The government should: 1. Clarify the structure and regulatory framework of the electricity market. 2. Rationalize pricing and subsidy policies in order to encourage investment and ease the financial volatility of PLN. 3. Further support the development of geothermal and other renewable energy resources, and properly mitigate the negative environmental impacts of coal-based power generation. 4. Increase public investments in power sector infrastructure projects to sustain economic growth, increase access and create job opportunities during the current global financial crisis. Bank's large developing member countries in the region. Where Indonesia Stands Now The power sector has entered a critical period during which its ability to sustain economic growth faces significant Indonesia's power industry expanded rapidly between challenges. the early 1980s and late 1990s. Although significantly weakened by the Asian financial crisis, the power sector is gradually recovering. By the end of 2008, the total Large Investment Requirements installed generation capacity of the national power system reached around 30,000 MW, making it one of the largest Robust and sustained economic growth is driving the in the region. Given the size of its population however, demand for electricity to grow at an annual rate of over Indonesia's per capita electricity consumption and seven percent. Indonesia's power demand is projected to electrification ratios remain the lowest among the World grow between seven percent and nine percent annually 2 | INDONESIA RISING between 2009 and 2020. There is tremendous pressure on PLN's tariff level is still insufficient to cover the supply cost the sector to keep pace with economic growth because of for almost all customer categories, including those who the strong correlation between energy and GDP growth in are able to and should pay for electricity at cost-recovery Indonesia.1 levels. The government has consequently had to provide significant subsidies to maintain PLN's financial viability. Electrification rates remain low. Over 70 million2 people In addition, the structure of the current tariff system needs still do not have access to electricity. About 80 percent to be rationalized to reflect the economic cost structure of of those without power reside in rural areas, over half supply. of whom live outside of the dominant economic centers of Java and Bali. To reach the government's target of electrifying 90 percent of the population by 2020, PLN Regulatory and Institutional Barriers will need to connect roughly two million new subscribers The lack of certainty in the legal and regulatory annually, double the rate of the past few years. framework governing the electricity sector hampers private investment. Following the annulment of the 2002 Significant public- and private sector investment is Electricity Law, governance of the sector reverted to the needed to meet growing demand and improve access. 1985 Electricity Law that was designed for a vertically PLN's expansion plan between 2008 and 2018 requires integrated monopoly. Although the 2002 Electricity an estimated US$83.7 billion investment. Of this total, Law addressed the goals of the electricity reform agenda, some US$58.5 billion is expected to come to PLN from the Constitutional Court ruled the law violated the public sector financing. The balance of the funding will constitution. Few Independent Power Producers (IPPs) have to come from the private sector, both domestic and have emerged as a result of the uncertain legal and international. regulatory environment caused by the law's annulment. Considering the substantial need for new generation capacity, laws and regulations clarifying the structure and Financial Viability of PLN regulatory framework of the electricity market are critical. The current tariff level is insufficient to cover PLN's cost of supply, leading to unsustainable government The restructuring and institutional reform of PLN subsidies to support PLN. PLN's financial viability remains in flux, weakening the government's ability to has deteriorated significantly since the removal of fuel provide public financing for power sector development. subsidies in 2005, and the suspension of electricity price Although the government started to pursue the increases since 2004. Although the price of fossil fuels decentralization, unbundling, corporatization, and has dropped considerably from mid-2008's historic highs, restructuring of PLN as early as 1993, progress has been inconsistent and slow because of the Asian financial Figure 1: Estimate of PLN's Financing Requirement crisis and ongoing legal uncertainty. Given the current (excluding Independent Power Producers/IPPs) lack of private investors globally, effective institutional 8,000 restructuring is critical to the government's ability to finance and improve the efficiency of the power sector. Pembangkit Penyaluran Distribusi 6,000 Environmental Challenges In order to reduce its dependence on oil, the 4,000 Government of Indonesia wants to significantly increase the share of coal in the power generation fuel mix. According to PLN's long-term plan, the share of coal 2,000 will increase from around 35 percent today to roughly 70 percent by 2020. The magnitude of expansion raises concerns about the likely environmental impacts on heavily populated Java and Bali, and environmentally sensitive 2008 2010 2012 2014 2016 2018 areas in some outer islands. One consequence is that Source: PLN RUPTL, 2008 Indonesia's greenhouse gas emissions will continue to grow at a much faster pace than most of its neighbors. 1 Elasticity of electricity sales growth to GDP growth was on average greater than 1.5 in the past 15 years 2 World Bank," Electricity for All", 2006. Policy Priorities for 2010 and Beyond | 3 Indonesia's renewable energy resources are still Optimize the fuel mix and protect the environment. largely unexploited or underdeveloped, despite their The government should prioritize and promote the high potential as clean, indigenous energy resources. development of Indonesia's abundant renewable energy Indonesia has very rich renewable energy resources, resources, especially geothermal, and ensure the sustainable especially geothermal, hydropower and biomass. Major development of fossil fuel power generation. efforts to scale up renewable energy development that began in the 1990s have been impeded by the high upfront A systematic government intervention is needed capital cost of technology, the lack of incentives and to integrate various initiatives and focus efforts on regulatory certainty, and the relatively weak institutional enabling greater development of renewable energy capacity of major national institutions resources. Immediate actions need to be taken to (i) formulate pricing, fiscal and other incentives to encourage greater investments; (ii) reduce the barriers faced by embedded power producers, especially from How Indonesia Can Rise Further the renewable energy sector, who wish to sell electricity to the grid; (iii) increase the sector's credibility by Clarify the structure and regulatory framework of the establishing clear and transparent processes including electricity market to restore confidence in the sector. the institutional arrangements for offering renewable Clear policies and predictability in the legal and regulatory opportunities for investors; (iv) enhance the domestic framework are necessary to the sustainable development capability to develop and operate renewable power of the power sector. In this regard, it is essential to fill the generation facilities; and (vi) enhance the financial legal void caused by the annulment of the 2002 Electricity viability of renewable energy development projects Law with a new electricity law and the corresponding through carbon trading and other low-carbon financing implementation regulations. The new law and mechanisms. implementation regulation should define the structure of It is important to ensure that the environmental the power market, and roles of the central and sub-national impacts of expanded coal-fired power plants are governments, PLN, and the private sector in the market. thoroughly assessed and mitigation measures are implemented in accordance with environmental laws Rationalize pricing and subsidy policies in order to and regulations. In Java-Bali and other large power encourage investment and ease the financial volatility grids, clean coal technologies should be progressively of PLN. The current electricity tariff and subsidy policy promoted whenever they are feasible and economically require urgent review: the government should rapidly justified. In small power grids, wherever feasible, large, formulate a new tariff system based as closely as possible modern power generation technologies should be on the costs of meeting electricity demand in order to adopted for coal-fired power plants. promote economic efficiency. Proper regionalization of the tariff system may benefit the development of the Increase public financing in power infrastructure. The geographically diversified power sector. This tariff system recent downturn in global credit markets has reduced should also meet the sector's financial and social objectives the availability of short- and medium-term funding. (e.g. subsidizing poor consumers) in accordance with Globally, project developers are experiencing a withdrawal sound practices and specific government mandates. of potential investors and commercial lenders, and face higher funding costs. Governments are increasingly being Further build up the institutional capacity of large called upon for capital infusions or credit support to cover national power companies. International experience funding requirements. An estimated US$4.4 billion is suggests that the strong institutional capacity and efficient needed to fund public power projects in Indonesia in operations of key national power companies are essential 2009/10, of which only US$3.1 billion was secured by for power sectors in developing countries to supply the end of 2008.3 The US$1.3 billion shortfall is likely reliable and affordable electricity for social and economic to considerably hamper growth in the power sector. It is development. The objective of capacity building over the essential that the government step in to finance the gaps. next few years should be to strengthen PLN's ability to run an efficient commercial power company. Capacity building should focus on "fundamental" issues facing commercial power companies, such as corporate planning, financial management, infrastructure project construction management, and operational management. 3 Estimated by the World Bank team 4 | INDONESIA RISING How The World Bank Can Help In the next few years, the World Bank's power sector strategy will follow three major themes: Financing public sector power infrastructure projects to sustain economic growth and increase electricity access to the poor. The World Bank's investment lending support will focus on infrastructure projects where public financing is justified, such as pumped storage hydropower projects, renewable energy investments, and power transmission and distribution projects. Reforming the tariff and subsidy system, and improving the efficiency of the national power companies. In line with a primary government strategic priority, the World Bank will help the government and PLN fully review existing pricing and subsidy policies for the long-term sustainable development of the power sector. In addition, technical assistance will be provided to key national power companies for capacity building and efficiency improvements. Moving the sector towards an environmentally friendly and low-carbon development path. This strategy will be implemented through lending, carbon finance and technical assistance operations with major power sector institutions such as PLN, the Pertamina Geothermal Company (PGE), and the Ministry of Energy and Mineral Resources. The World Bank Office Jakarta for more information, please contact: Indonesia Stock Exchange Building Tower 2, 12th floor Mr. Leiping Wang Jl. Jenderal Sudirman Kav. 52-53, Jakarta 12190, Indonesia Senior Energy Specialist ph. + 62 21 5299 3000 | fax. + 62 21 5299 3111 lwang3@worldbank.org http://www.worldbank.org/id Investing in Indonesia's Institutiond for Inclusive and Sustainable Development