|    10 February 2021

Indonesia’s shift to renewables is likely to accelerate in 2021

Renewable energy investors we speak to in Indonesia tend to put considerable emphasis on the targets the government set at the 2015 Paris agreement. Specifically, this is the ambition to achieve a contribution of 23% to the overall energy mix from renewable energy sources by 2025. Given we are currently only at 12%, the more optimistic investors we speak to remain excited by the prospects for growth within the sector, even if the target is achieved later than hoped.

Afterall, the global average renewable contribution is now close to 30% and ASEAN neighbours such as Vietnam and the Philippines have long since shifted towards renewable sources. Notwithstanding this, it isn’t quite so simple in Indonesia. Significant fossil fuel reserves, unfavourable regulation, and a lack of available debt funding sources are just a few of the problems developers face. Here, we attempt to provide some numerical details quantifying the potential size of the opportunity, as well as pinpointing where bottlenecks exist from an execution perspective, as well as areas of potential interest for investors.
Several Factors have delayed the shift to renewables

We believe the shift has been hampered by a number of factors, that can ultimately be grouped into three main problems – 1) an existing abundance of coal and gas. 2) A complex policy environment with unfavourable pricing and 3) a relative unavailability of credit from the domestic banking system. We explore each obstacle in more detail below.

Fossil Fuel Reserves - Moving away from Coal and Gas isn’t easy when you have significant and inexpensive reserves. Of the approximately 70,000 MW of electricity produced annually, 55% is powered by Coal – equivalent to around 110million tons of consumption, suggesting the country has almost 240 years of reserves.

Despite being heavy users of coal, domestic consumption accounts for only 20% of total production. Indonesia has a surplus of 400million tons per year which is exported primarily to China and India, making coal even cheaper from a scale perspective within the national energy mix based purely on economics. Gas reserves in Indonesia are also abundant. Gas represents around 27% of the national energy mix, equivalent to 1,500,000mmcf, yet like Coal, Gas is a major export for the country (exports are over 1,700,000mmcf per year) meaning scale benefits have pushed down the local cost of production.

Policy and Regulation: The Constitutional court ruled in 2003 that electricity must be managed by the government through either state-owned enterprises or public-private partnerships. This means that very few independent power companies can sell electricity directly to consumers; instead, they must sell their electricity to PLN first. PLN is quite independent of the Ministry of Energy and Mining (where initiatives are often supportive for renewable projects), and is more focused on cost management. If Fossil fuels are inexpensive, the propensity for PLN to switch is low. Furthermore, the price of coal in particular has been kept even lower than market prices would dictate. The government issued price caps in 2018 and 2019 stating local mines couldn’t charge any more than $70 per tonne. This is a direct saving to PLN and an understandable reaction by the government after a period of rising coal prices. However, a key unintended consequence of the policy was that by subsidizing the electricity sector, the government was artificially decreasing the average generation cost of coal-fired electricity, putting renewables at an unfair disadvantage.

Further to this, the tariff levels payable to grid-connected renewable projects are capped at a ‘maximum’ of 85-100% of the prevailing tariffs in the region – a far cry from the premiums typically paid in other countries given the lack of negative externalities associated with renewables. Furthermore, the definition of a ‘maximum tariff’ means that PLN, as the off-taker, has a certain degree of freedom to negotiate these tariffs case by case, making the pricing process opaque and the resulting PPA prices difficult to estimate beforehand by developers, hampering investment appraisal.

Another policy broadly unfavoured by investors is the requirement for private developers to transfer their projects to PLN at the end of the agreement period. The Build, Own, Operate, and Transfer (BOOT) scheme in the ESDM Minister Regulation Number 50 of 2017 made the projects less attractive to investments and most certainly had an impact on local bank willingness to issue credit terms. (luckily recent policy is more favourable as we discuss later).

So in Indonesia, a PPA is by no means a guarantee of project commencement. Of the 70 PPAs issued in 2017, 8 projects were completely terminated due to cash flow, 24 are still awaiting financial close, meaning banks have yet to commit, and a further 22 remain in the construction phase where the risk of banks pulling funds ( particularly for smaller developers) remains very high.

Credit availability (or a lack thereof): Investors familiar with Indonesia know that the banking sector from a profitability perspective is arguably the most attractive of any country in the region. Unfortunately this profitability comes at the expense of loan growth. The general appetite for risk has remained low since the 1997 crisis and shows no signs of abating. For larger developers, this is less of an impediment as they are typically able to provide sufficient collateral, but typically with a charge of at least 12% interest per year. For smaller companies – such as those that typically embark upon mini-hydro projects, the unavailability of bank credit simply means they can’t move forward. This presents a major hurdle to the country’s shift towards renewable power. For renewable energy to reach 23% of mix by 2025, total investment of circa US$150 billion is needed. The state simply can’t afford such an investment, meaning the private sector must engage, but how can this occur without banking sector participation? Surely smaller developers have only one choice, and that is to seek overseas investment partners.

Policy reform – long awaited but gradually occurring

With the above mentioned bottle necks well known by the Jokowi government, policy reform has gradually been introduced to alleviate the pressures felt by smaller renewable energy developers. Earlier this year the Government issued Ministerial Regulation No. 4/2020 to jumpstart stalled renewable energy projects. The regulation draft seeks to remove the compulsory Build-Own-Operate-Transfer (BOOT) scheme long seen as a disincentive for renewable energy investment into smaller projects, and should make PPAs more bankable. Yet, the full presidential decree is expected to go a few steps further.

The new rules are expected to include simpler pricing, including a feed-in tariff system, which means IPPs won't have to negotiate pricing with the sole off-taker PLN. The government could even ‘pay the gap’ between pricing and PLN's basic cost of electricity supply. At the end of October 2020, Energy and Mineral Resources Ministry (ESDM) electricity director general Rida Mulyana, said “Before the end of the year, we will have a presidential regulation on the EBT (renewable power) tariff, improving the economics for developers so that investors will be increasingly interested in developing EBT in Indonesia. The ESDM director then went onto say that for small projects of up to 5MW, one of the regulation’s pricing mechanisms would be a fixed feed-in tariff for mini power plants, helping to ensure predictable financial returns for investors. At the time of writing this report it is December 28th 2020 – although no formal announcements have been made yet, expectations remain high for Q12021.

Potential areas of opportunity

Key considerations for investors are project type (solar, Hydro, WtE, or Wind), project stage (FS, DPT, PPA, COD) and project location as opportunities vary significantly from island to island. What is, in our opinion, quite clear is that Indonesia’s ‘top down’ renewable energy potential is arguably one of the worlds most under-utilised. Reports from the Asia development Bank indicates over 400GW of potential capacity from renewable sources but only around 2.5 per cent had been utilised so far.

Project ‘type’ of best potential: To achieve the goal of 23% by 2025, a substantial increase will be required from each energy type, but the benefit will be born more by some types than others. According to the table below (issued by the Ministry of Energy and Mining), the biggest increase in capacity will be from Solar and Hydro, with both adding between 5-6GW in the next 4 years. Solar tends to attract most attention from investors – advancements in solar technology over the last 5 years have seen remarkable efficiency gains alongside a continued fall in unit costs. From an investment perspective, upfront investment costs of around $1m-1.5m per MW make it the cheapest form of energy and therefore the least risky. However, local developers are at a significant disadvantage in the solar market. The recent announcement of Abu Dhabi’s Masdar 144M floating solar project came with bad news for local solar names – the tariff was under $0.055cents. Local developers that typically operate projects under 10MW will be unable to compete at such price levels. Wind is also not expected to be a major contributor at a national level, with opportunities isolated to southern Sulawesi, Kalimantan and Nusa Tengarra.

Hydro is certainly an interesting project type in Indonesia. It is projected to increase from an already high base of committed energy, but it must be noted that many of those committed projects have stalled. In terms of energy producing assets only around 10GW comes from Hydro in 2020. In our opinion Hydro remains the most viable energy source accessible to investors, and within Hydro we specifically favour ‘run-of-river’ Hydro.

The country has 483 major rivers, is mountainous in many regions and is blessed with two different wet seasons, meaning hydrology data is extremely supportive for run-of-river Hydroelectricity production. Run-of-river is typically used for smaller Hydro plants of up to 100MW but usually between 5-50 MW. The benefits of run-of-river are that it is relatively inexpensive to build at around $2/kw and is significantly less environmentally hazardous relative to larger dam based Hydro plants. The two disadvantages most frequently associated with run-of river are inconsistent flow and availability of sites. In Indonesia both of these disadvantages are inapplicable.

Furthermore, the mini Hydro space is overwhelmingly occupied by local business owners. This is viewed favourably by policy makers as there is a desire to support local content and local entrepreneurship. Unfortunately the technical expertise of these business is not always up to international standards, with company balance sheets almost always lacking the necessary cash to fund a high quality consultant for feasibility studies or to qualify for local bank project finance. Without local bank participation, these projects are individually too small for foreign policy bank finance, which helps to explain why so many projects get to PPA but don’t commence operations.

Project ‘Stage’ of best potential: We typically categorise projects into 5 different stages – 1) Pre-Feasibility studies, 2) Post feasibility studies, 3) DPT, 4) PPA awarded – no Financial close, 5) PPA awarded, Operations commenced.

Time sensitive investors hope to participate after the PPA has been awarded (stages 4 & 5). At this stage, investors are able to undertake a quantifiable investment appraisal given a full understanding of tariff levels, PPA term length and transferability at the end of the contract. Solar PV projects are often in high demand, and so investors must typically participate pre-PPA. Hydro on the other-hand has a large number of projects that have achieved a PPA but have failed to complete financial closing. Logically, investors should first review these assets as in our experiences some are highly investible, but many have not received funding for good reason.

Immediately prior to the PPA stage is the DPT stage, which in our opinion represents arguably the most interesting entry point into the market. DPT projects have gone through all the necessary local permits and PLN requirements prior to formally submitting for a PPA – effectively this is a pre-clearance that the developer meets the standards of the PLN. Within this category there are many economically viable projects looking for investors, and in addition to this, these projects will benefit from the eagerly awaited policy reform that we are told to expect, meaning tariff levels and project bankability could be better than many existing projects that have PPA. The downside of this stage is that the projects are not immediately ready to commence construction.

Prior to DPT is the feasibility study stage. For larger projects (30MW and higher), the FS stage is usually when investors become interested as the engineering preparation can be significantly more complex. An earlier involvement means the investor is able to better influence the critical planning, as well as building a substantial equity position at a lower price. All of this comes at the cost of time, as usually it will take at least 6 months to complete the FS and a further 6-12months to get the PPA.

Project ‘location’ of best potential: Whilst the overall country’s electricity needs are predicted to grow by around 7% every year until 2027, it is important to note that some regions will grow significantly faster than this. Somewhere between 10 and 20 million Indonesians still do not have access to electricity. For example, only 60% of people in East Nusa Tenggara have electricity, while in Papua the rate is under 60%. In many areas, power is also not available 24 hours a day, and is instead only accessible for a few hours at night. With this in mind, the potential for renewable energy to quickly electrify the unelectrified is undeniable. Understanding the preferences of PLN and MEMR are essential when selecting a project location, and rural electrification is certainly a top priority of the government. In addition to this, more populated islands such as Java have already benefitted from investment programs over the last few years, and so the risk of oversupply there is greater, and for investors that take a longer term view the moving of the capital city from Jakarta to Kalimantan will undoubtedly have implications for renewable infrastructure.

Finally, the location of the natural resource is obviously a key consideration for the location of the project! North and South Sumatra have some of the fastest flowing untapped Hydro reserves, and large parts of the island are still under 90% electrified – PLN has identified Sumatra as one of the best Hydro opportunities in the whole country, alongside Kalimantan. From the perspective of Solar, the whole archipelago is blessed with year round sunshine, but finding land suitable is a challenge – it’s either rainforest or is too close to residential areas. Obviously opportunities do exist in solar but its highly competitive and getting land permits are very complicated, which is why the recent 140MW Abu Dhabi (Mascar) project is a floating system. Wind also, as mentioned before, is isolated to East Nusa Tengarra and Kalimantan.

The positive economic effect of renewable energy in Indonesia

With demand for energy set to increase at a rapid pace in some regions, allowing renewable energy to provide for this would be good not only for Indonesia’s greenhouse gas emission reduction targets but also for overall economic growth via a surge in inbound investment, helping to support employment as well as the overall trade balance.

According to IRENA (2017), doubling the share of renewable energy in the energy mix from 2015 to 2030 could increase Indonesia’s gross domestic product by up to 1.3% in 2030 compared with baseline, mainly as a result of higher overall levels of investment in the energy sector, at the same time the trade balance could improve by up to1.6%, which should go some way to supporting a stable Indonesian Rupiah. The number of renewable energy- related jobs in Indonesia could also increase to 1.3 million, compared with about 100,000 in 2015.

With these benefits becoming more clear, it seems the government is coming to realise the importance of an effective regulatory and policy environment. All eyes are now on the presidential decree!

Investment Conclusions:

If the government achieves its target, it will need to be via Policy reform. IF they successfully reform policy, 20GW of new renewable energy capacity will need to come online in the next 4 years, of which at least 6GW will need to come from Hydro – a market less competitive for investors to access relative to Solar. The number of smaller local developers looking for capital within mini-hydro remains high, providing investors with the greatest opportunity set. Furthermore, these projects are ‘run-of-river’, an often less complicated and inexpensive project to execute with competent planning and sufficient funds. With this in mind, as we currently await policy reform, the vast majority of good opportunities, in our opinion, sit within the DPT stage, although there remains a small number of interesting projects with PPA for time sensitive investors. One technicality for consideration is that all projects under 10MW have foreign ownership capped at 49%. A 49% stake is insufficient reward for a foreign business that ultimately pays the bulk of costs. However, IndoInvestors has multiple solutions that allow foreign businesses to own a substantial majority stake in projects under 10MW, including our own local investment vehicle. Please contact us for further details at