Summary and Implications
Back in January 2017, the Indonesian Ministry of Energy and Mineral Resources issued a new regulation to help standardise certain terms of Power Purchase Agreements entered into between state-owned utility PT PLN (Persero) and independent power producers. Regulation 10 marks an interesting time in the development of Indonesia’s IPP model. There are areas of interest and concern deriving from Regulation 10 which may impact upon a sponsor’s investment case. Each will need to be considered further, holistically, against the terms of the forthcoming Power Purchase Agreements (PPAs) to be issued by PT PLN.
What is the scope of Regulation 10 and its likely impact on bankability of PPAs negotiated with PT PLN? How can Regulation 10 be transposed into PPA terms?
Indonesia’s independent power projects
Indonesia plans ambitiously to increase its power generating capacity by up to circa 35,000 MWe by 2025. Whilst the archipelagic nature of the country presents transmission and distribution challenges, its energy mix is diversified. Furthermore future development strategies intend to move away from imported oil and re-focus on coal, gas and renewables. The Indonesian government is also considering nuclear new build as an option.
Whilst PLN will invest in a proportion of the infrastructure needed to meet the intended targets, energy infrastructure investment plans are predominantly based upon attracting private investment into the power sector via an IPP model. Investment is attracted using a project structure which operates limited recourse, project finance principles with PLN taking responsibility for electricity off-take via long term Power Purchase Agreements.
Whilst PPAs are negotiated individually with PLN, the principles associated with risk allocation have been relatively consistent and well understood by PLN and the market alike. From the projects which have come to market over recent years, PLN and the Indonesian government have become well adept at negotiating PPAs considered bankable by various international sponsors, international financial institutions and multilaterals.
Overview of the PLN PPA model
PLN has been quite successful in developing a PPA model which has attracted private investment. The PLN PPA is complex and evolves from project to project, as opposed to being standard form.
The availability principle is something which pervades the PLN PPA – i.e. where the plant is available to generate, PLN will be liable to pay the generator for such availability. Whilst risk allocation across the terms of the PPA is something which is negotiated, risk is generally allocated to the party best placed to manage it. On the basis of PLN’s considerable role in Indonesia’s energy sector and that it is a state-owned utility, invariably it is well placed to manage a wide range of risks which sit outside the IPP’s mandate of generating and making power available for dispatch to PLN.
What Power projects does Regulation 10 Apply to?
Regulation 10 applies to all types of power projects except:
Regulation 10 is drafted on the basis of establishing key principles. These principles will then be transposed into the terms of subsequent PPAs issued by PLN. This is important as it means that the full impact of Regulation 10 cannot be fully understood until PLN fully transpose these terms into their standard PPAs.
Does it apply to current projects?
Regulation 10 does not apply to existing PPAs or projects in procurement which are sufficiently advanced so as to have received a letter of intent from the procuring body.
Although it does apply to projects in procurement stage which have not yet reached bid closing.
The current PLN PPA model for dispatchable projects is based on an availability model with a capacity charge designed to cover debt service, equity returns and fixed O&M. This capacity charge is accompanied by an “energy charge” designed to cover variable O&M costs associated with an actual dispatch of power to PLN.
Regulation 10 states that PLN is required to take and pay for electricity for “a period of time”; which should be agreed between the parties. The regulation also mentions considering the period of repayment to the IPP’s lenders. As a principle, this could be interpreted in various ways:
The narrow approach would hinder sponsors’ ability to achieve an optimal cost of capital on a project by project basis and, in turn, an optimal tariff price. It is likely the drafting of the standard PPA to allow for a “take or pay” term to be set against a pre-agreed period determined at tender stage (which ought to correlate with a project’s economic model generally, as opposed to narrowly focusing on debt repayment).
Sponsors and lenders will be interested in how this aspect of Regulation 10 is interpreted in subsequent standard PPAs as they structure their financing plans and economic models.
Regulation 10 states that all projects to which it applies must be undertaken on a BOOT basis, with a maximum 30 year term. Coal to power projects in the region have so far typically been subject to a relatively similar concession period and so this stipulation is fairly unremarkable. However, geothermal and hydro power projects in the region are not always restricted in time by transfer provisions.
Some sponsors may be concerned by this BOOT stipulation as it may limit the attractiveness of an investment case if the sponsor was interested in potential upside above and beyond the initial base case. However, the benefit of the BOOT model is that it provides certainty of term and certainty of transfer of liability. Sponsors interested in projects to which Regulation 10 applies will need to make investment decisions on the basis of a pre-agreed BOOT timeframe.
Force Majeure Issues – further push of the envelope?
Regulation 10 suggests that PLN will be excused (presumably from an obligation to make capacity payments as has been the case) if a force majeure event occurs and affects the PLN grid. This shifts risk allocation in PLN’s favour and potentially leaves sponsors assuming risk for events over which they have no control. If this is the case, then it shifts the risk allocation methodology currently deployed by PLN and may present a bankability concern for sponsors and lenders.
Regulation 10 states that where a natural force majeure event occurs, the PPA’s term of will be extended. This is unlikely in itself to be a panacea to the risk that this force majeure risk sharing approach has to a sponsor’s revenues and outgoings such as repayment of interest and principal which will not benefit from similar force majeure provisions under market standard loan agreements – therefore the obligation to continue servicing debt will continue, despite the fact that PLN is excused from making capacity payments to the IPP.
It has been suggested publicly that the MEMR does not intend Regulation 10 to fundamentally shift the risk allocation adopted in current form PPAs. However, the drafting of Regulation 10 is such that it could be interpreted to fundamentally alter the force majeure risk allocation so it places a greater burden on the developer.
With that in mind, key points to look at in future PPAs:
Political risk and change in law – how are sponsors and Lenders affected?
PPAs with a state-owned utility usually follow the principle of the state-owned utility protecting the generator from unforeseeable acts and omissions of the state, in a broad sense. The protections, whether classed as a political force majeure event or a change in law, would normally be triggered by:
In the context of political risk or change in law, this will normally be remedied via an uplift in the electricity tariff or if this is not feasible, a triggering of the “put or call” option in favour of the IPP and its sponsors.
Regulation 10 refers to changes in laws and seems to suggest a risk sharing between PLN and the IPP for such events. However what is unclear is the effect Regulation 10 will have on existing political force majeure provisions in the PLN PPA.
If read narrowly, it could suggest that only change in law risk (to the exclusion of government action or inaction risk) would be covered in the PLN PPA in the future, and even in such an event, there would need to be some risk sharing between the parties. If this is the intention, then this would be a fundamental bankability concern.
On the other hand, there is still room to adopt a wider interpretation as the consequences of other political force majeure events (e.g. government action or inaction) may still be provided for and agreed between the parties.
Restriction on transfer of shares
Regulation 10 stipulates that a sponsor cannot transfer shares before the achievement of commercial operations date – save in the case of transfer to an affiliate which is over 90% owned. However the drafting of Regulation 10, leaves unclear whether the original sponsors are permitted to make share transfers to one another prior to commercial operations date. Further, after commercial operations date, PLN’s consent is required before a transfer can occur.
By international standards, neither of these provisions is unusual. (For certain projects it would in fact be usual for share transfer restrictions to continue to apply for the first few years of operations). PLN and the Indonesian government will be keen to ensure that a sponsor’s shareholder make-up remains consistent with that which existed at procurement stage – at least until the construction works are properly complete and the plant is operational.
These provisions will also often be stipulated by lenders and whilst sponsors need to be aware of this issue as a restriction on their long-term strategies, this is not an issue which impacts fundamentally upon the bankability of a PPA.