Despite a significant renewable energy potential, Indonesia currently only produces six percent of its electricity from renewable energy. The Indonesian government is targeting increasing this to 23 percent by 2025. Many view this as ambitious given the pace at which renewable energy projects have been developed in Indonesia in recent years.
The Indonesian government tried to stimulate investment in renewable energy through higher feed in tariffs in 2014. While this may have made Indonesian renewable energy projects a more attractive financial proposition for developers, it also gave rise to disagreements between PT PLN (Persero) (PLN) (Indonesia’s state-owned sole offtaker) and other stakeholders on certain projects on the basis that prices were too high. By the end of 2016, the Indonesian government’s attitude to renewable energy generation shifted, with new Indonesian energy minister Ignasius Jonan indicating that there was a need to further reform the renewables sector, with a particular focus on reducing feed in tariffs, as it was considered too high compared to the tariffs charged by thermal power plants.
To that effect, the Ministry of Energy and Mineral Resources (MEMR) promulgated Regulation 12 of 2017 (“Regulation 12”) on January 30, 2017. Regulation 12 applies to a broad range of renewable energy sources, including solar, wind, hydro, biomass, biogas, municipal waste and geothermal. In respect of each of these renewable energy sources, Regulation 12 imposes: (a) new lower maximum feed in tariffs; and (b) new contracting regimes.
Mr. Jonan has stated that his reforms are intended to encourage investment into the renewable energy sector to help Indonesia reach its 2025 targets. However, many commentators have been critical of these reforms and believe that they may hinder, rather than stimulate, further investment into renewable energy.
Regulation 12 applies to all renewable projects in Indonesia involving the abovementioned renewable energy sources. There are several exceptions to this including (among others) projects which have signed a power purchase agreement (PPA) with PLN as at the date of the regulation and geothermal projects that have been awarded to a developer.
One of Mr. Jonan’s aims when reforming renewable energy tariffs was to make these more competitive against energy generated from fossil fuels. This is clearly reflected in Regulation 12, which benchmarks all renewable energy tariffs against the “Generating BPP,” being the average cost of generating electricity in a local area during the previous year.
As a result, renewable energy tariffs—depending on their location and on the renewable energy source—need to be either lower or equal to the Generating BPP for the relevant area. In respect of all renewable energy sources other than geothermal and urban waste, the maximum permissible tariff is 85 percent of the Generating BPP for the area where the project is to be located (if that area is one where the Generating BPP is above the national average), or the Generating BPP for the area where the project is to be located (if the Generating BPP for that area is less or equal to the national average). Geothermal and urban waste projects have the maximum tariff set at the Generating BPP for projects in areas where the Generating BPP is above the national average. The tariff is subject to negotiation in other areas (including for projects in Sumatra, Java and Bali). The Generating BPP for each area for the period between April 1, 2017 – March 31, 2018 were published by MEMR on March 27, 2017.
If the intention is to require renewable energy projects to have competitive tariffs, benchmarking renewable energy tariffs to the average electricity price in a particular area has—at first glance—an attractive economic logic to it. However, it raises a number of issues.
First, is the average cost of producing electricity in a particular area an appropriate proxy for the cost of producing electricity from renewable energy sources? Most of the power in Indonesia is generated from thermal—and particularly coal-fired—power plants. Not only are these different technologies, but they also have different tariff structures to renewable energy tariffs. For instance, they tend to allow a pass-through of fuel supply costs, which may be affected by changing commodity prices. PLN PPA tariffs also sometimes vary over time (e.g., with capacity charges reducing in later years), meaning that looking at a tariff level for one year may not be representative of the average tariff over the life of a project.
Second, the cost of electricity in Indonesia varies significantly between its regions, tending to be lower in more developed Sumatra, Java and Bali and higher in other areas (which also tend to have lower electrification rates). Linking renewable electricity tariffs to the average local price may lead developers to focus on introducing renewable energy projects in less developed areas—although this may itself come at a higher cost due to the more limited existing infrastructure and grid connectivity.
Third, the Regulation did not clarify certain key aspects of the tariff structure, such as whether it would be US dollar-based (as has been the case for feed in tariffs to date) or rupiah-based. The Generating BPPs published for 2017 – 2018 express the Generating BPP both in rupiahs and US dollars using the average rupiah/US dollar exchange rate for 2016. Having a US dollar Generating BPP is helpful. However, it is not clear whether the PPAs will refer to the US dollar or rupiah value.
Some commentators criticize this approach, noting that it reflects the one taken in respect of geothermal tariffs under Regulation 14/2008, which was reformed shortly after coming into force to allow for the direct negotiation of geothermal tariffs.
Broadly speaking, Regulation 12 introduces two new contracting regimes, one for solar and wind projects, and another (subject to certain variations) for other renewable energy sources. Regulation 12 contemplates the development of a standard set of procurement documents and a standard form PPA for each renewable energy source.
With respect to the form of PPA, based on our experience with PLN to date, we would expect it to broadly follow the terms and risk allocation of precedent PPAs which have been successfully financed, subject to adjustments to reflect the specificities of the relevant renewable energy source.
Solar and wind projects will be subject to a tender process based on the capacity that is stated as available in PLN’s electricity supply business plan. Each tender package must offer at least 15MW installed capacity and may allow for different locations. This is a departure from the current contracting regime, which is based on a direct negotiation (for wind projects) and the allocation of a capacity quota against a fixed tariff to prequalified developers (for solar projects).
It is unclear whether the price will be the sole criterion for the award of projects to developers. Based on the terms of Regulation 12, it would appear that the bidder offering the lowest price would be awarded the project.
Projects using other renewable energy sources are subject to either a “reference price” or a direct selection mechanism. There are slight differences between the various renewable energy sources as to which method is used. Hydropower projects seem to allow for both options in all cases, while biomass and biogas projects contemplate a “reference price” mechanism if the project is below 10MW and direct selection if the project is above 10MW, and urban waste and geothermal projects contemplate reference price at all times.
It is not clear from Regulation 12 how the reference price selection mechanism would work, including whether it would be initiated by the developer (as per the direct selection mechanism—see below) or PLN. As this concerns the direct selection mechanism, we assume that this would be similar to the mechanism that has been used in the context of several renewable energy sources so far (such as wind projects), whereby the developer will submit a proposal for a project to PLN for consideration and PLN may, if it considers the project to be eligible for direct selection, propose the direct selection of the project to MEMR.
In the context of hydropower projects, Regulation 12 does not explain in what circumstances a reference price would be used and when a direct selection would be used.
Regulation 12 is a significant departure from the regime previously applicable to renewable energy projects. MEMR’s objective of making renewable power tariffs more competitive comes across very clearly in the regulation by benchmarking renewable power tariffs against the average cost of power production in a particular area. Some of the new contracting regimes proposed by MEMR are still unclear. We would expect these will be clarified once the forms of procurement documentation and PPAs are published. While the reduction in renewable tariffs will hopefully encourage PLN to pursue the development of renewable energy projects, whether this new regime will translate into a surge of new renewable energy projects remains to be seen.