By Gero Di Piazza
As Indonesia attempts to attract foreign investors, the country’s biggest state-owned utility is sending out the wrong signals by persuing legal action against IPPs.
Indonesia and its power industry have seen challenging times over the last eight years. The Asian financial crisis has hit the country hard and its power market has suffered the consequences.
The Java-Bali region of Indonesia was to be the set location for two geothermal plants before the court battles commenced.
The country has an installed electrical generating capacity estimated at 19.9 GW, with 82 per cent coming from thermal sources, 15 per cent from hydropower and three per cent from geothermal. Prior to the 1997 crisis, Indonesia made plans for a generation expansion project. The move was meant to draw in independent power producers (IPPs).
The plans set out the construction of around 15 projects. One of those involved was a power company that was set up in 1994, by US-based Caithness Energy and Florida Power and Light, called Karaha Bodas Company (KBC). In November 1994, KBC was set to operate two geothermal power plants on the Indonesian island of Java. KBC entered into a Joint Operating Contract (JOC) with Pertamina – Indonesia’s state-owned oil and gas giant, and a 30-year Energy Sales Contract (ESC) with Pertamina and Perusahaan Negra (PLN).
KBC got to work with the task in hand and carried out extensive research that accumulated some $100 million in project costs. But as the full force of the crisis settled, Indonesia’s plans to expand capacity had to be shelved in a cost cutting scheme. The financial strains on PLN and Pertamina were highlighted by the companies’ inability to pay for the power purchase agreements signed with IPPs. Both overestimation of demand and a decline in demand worsened the situation. PLN has an overcapacity of almost 50 per cent, which equalled some $5 billion in debt, and has since mounted up as the Rupiah declined in value.
The KBC project was delayed twice, first in September 1997 and again in 1998. After realizing the plans would not be rescheduled, KBC began to look for compensation for the capital spent on a survey of over 400 MW of geothermal energy reserves.
The JOC and ESC were core issues, which inevitably had to be settled through the first of many court battles. The first venue was Geneva at an international arbitral tribunal in Switzerland, under United Nations guidelines. On the day judgement was passed, September 30, 1999, the court ruled in KBC’s favour with a $261 million pay-off, which has since risen with interest at a rate of four per cent. Sadly, for KBC, the matter did not end there as Pertamina and PLN contested the figure, claiming it was marked up and should have been $32 million.
This argument did not hold water in the appeal process, which led Pertamina to annul the Swiss ruling and battle it out in four other countries – US, Canada, Hong Kong and Singapore, which, over time, all agreed that the Swiss ruling was just. The Indonesian companies had their assets frozen by international courts, but it did not deter them and led them to slug out a sixth court battle, this time in Indonesia, where a ruling in their favour was expected. Speaking about the Jakarta ruling before the result was announced on August 27, Jim Bishop, Vice President of Caithness Energy, joint parent company of KBC, said: “If it goes their way, they’re going to be sending a very large signal to the world that ‘we signed the New York Convention, we promised to abide by International Law, but when it comes down to it, we’re going to conduct things in our own court system and do things the way we want to.’ It seems as though their court system may not be as unbiased as it should be.”
But even though Petramina won on August 27, KBC should not have any problems in receiving its compensation award as frozen capital is held in a number US and foreign accounts. Also, the Hong Kong Court issued interim orders that gave KBC a beneficial interest in Pertamina-held shares in three Hong Kong companies: Tugu Insurance, Pertamina Energy Trading and Korea Indonesia Petroleum. The Canadian and Singapore courts have made similar rulings to freeze any assets Pertamina has in those jurisdictions.
Bishop argues, “We’ll take the payment from whatever source gets us our payment soonest. So if we need to take those shares and liquidate those companies, we will do that. To date, they just flat-out refuse to pay us the judgement, we’re going to have to get paid by whatever means we can.” The frozen cash cannot be transferred to KBC accounts because Pertamina claims the money is not theirs to give away, notes Bishop, adding: “They are trying to make the argument that it’s not their money and that’s what’s being appealed in various courts. They are claiming it is Indonesia’s [the state] money.”
Naturally, the Indonesian companies have also appealed against having their capital frozen. In June 2002, the US court of appeals upheld a freeze on approximately $275 million of over $520 million frozen in trust accounts in the name of Pertamina. In doing so, the court denied a motion by the government of Indonesia, which had argued for the release of 95 per cent of the frozen funds.
After all the issues that have been heard and re-heard in various international courts of law, the two-year wrangle continues and there seems to be no let up by Pertamina and the Government of Indonesia, even though the matter is far beyond validation or negotiation.
The government is now seeking loans from various financial institutions to install new power plants and transmission lines across the country to meet the growing power needs. Capacity addition of around 18 000 MW is projected in ten years, which requires a total investment of $11 billion by 2005. But while these court battles endure, Indonesia will be trapped in a Catch-22 scenario.
The preparations of trying to lure foreign investors to a country with healthy energy reserves, will be counterbalanced by the dispute. Foreign companies that have considered investing in Asia may well do so, but in less complicated zones such as China. Bishop regrets ever doing business in Indonesia and vows never to negotiate in the country again. “We would never see Indonesia again! I can’t imagine any condition that would attract us back into that country. There are many other better places in Asia to do business. They are just being hard-headed. You need a firm foundation of law for international business and you need the sanctity of contracts and our experience tells us that it does not exist there at this point.”
Financially, this is not the only concern that Indonesia has come across. Rating agency Standard and Poor’s had to downgrade Indonesia’s debt rating from CCC+/Negative to Selective Default (SD) after the country began negotiations to restructure its Paris Club debt. Paris Club is set up by Standard and Poor’s to assist emerging market countries in times of financial stress by facilitating the restructuring of sovereign debt owed to participating governments, explains Takahira Ogawa, a utility analyst at Standard and Poor’s.
Over the years, the country initially owed $350 million to a syndicate of 70 banks along with several other separate loans involving numerous governments being owed billions of dollars. Due to the government’s incapabilities to see off the loans, it has been downgraded to SD three times in three years following the imposition of ‘comparability of treatment’ under Paris Club rules, says Ogawa.
His colleague Erly Witoyo, based in Singapore, said: “In some way, the high risk in the country gives investors the opportunity to earn high returns. However, this is not always the case. For instance, in the electricity industry, unless the government is able to pay more than ¢5/kWh for electricity, it is unlikely that investors will rush in to build more plants. The highest PPA currently averages ¢4.93/kWh.For investors, itmakes more sense to invest in countries such as Thailand, where investment risk is lower.”
Bishop agrees: “This would scare anybody who has assets in Indonesia or is thinking about investing in Indonesia. The more their government supports this, the less credibility they are going to have in world markets. It seems as though they think they can bury their heads in the sand believing they can get away from this liability.”
Nonetheless, it is easy to see what would initially attract foreign companies to the country, the potential and energy reserves has never been in doubt. According to government data, around 40 per cent of the world’s geothermal resources is located in Indonesia, which could produce
20 000 MW. Also PLN, for example, had a total generating capacity (including IPPs) of around 24 039 MW last year and demand is expected to increase by 3.4 per cent per annum. The Indonesian government is in the process of passing through laws to aid the legal clarity of geothermal plant implementation. One company taking advantage of this is Sumitomo Corp, which was one of a host of companies that had its plans to construct a 1200 MW thermal power plant delayed. The Tanjung Jati B, is located on the central part of the Island of Java.