Indonesia announces new geothermal law and tariff regime

Speed read
In 2014, Indonesia has made important reforms to its geothermal electricity generation regulatory regime, specifically in relation to (1) licensing, (2) permitting in conservation forests, (3) tariffs payable for electricity and geothermal steam, (4) transmission line construction risk, and (5) government support for geothermal electricity generation projects. It is hoped that these changes will go some way towards accelerating investment in the geothermal sector and unlocking Indonesia?s abundant geothermal resources.

Overview
Despite electricity shortages, continued strong growth in electricity demand and an urgent need to reduce dependence on fossil fuels and cut fuel subsidies, Indonesia has struggled to exploit its abundant geothermal energy reserves, having achieved installed electricity generation capacity of only 2,500 MWs (from potential total reserve of 22,140 MWs).

Many in the industry blame a regulatory regime that has failed to attract IPP developers and their financial backers. Investors have been put off by a complex and uncertain licensing regime, overly restrictive prohibitions on the exploitation of geothermal resources in conservation forests, an uncertain and uneconomic tariff environment and an inefficient allocation of transmission line construction risk.

In response, legislators and regulators have recently issued (1) Minister of Energy and Mineral Resources (MEMR) Regulation No. 17 of 2014, dated 3 June 2014 (MEMR Regulation 17), (2) Minister of Finance (MOF) Regulation No. 173/PMK.011/2014, dated 22 August 2014 (MOF Regulation 173), and (3) Republic of Indonesia Law No. 21, dated 26 August 2014, (the New Geothermal Law). Together, these new laws and regulations have introduced important changes to the rules governing geothermal electricity generation by independent power producers (IPP) in Indonesia, including with respect to:

1. licensing;
2. permitting in conservation forests;
3. tariffs payable for electricity and geothermal steam;
4. transmission line construction risk; and
5. government support for geothermal electricity generation projects.

Licensing
The New Geothermal Law replaces Law No. 27 of 2003 and Government Regulation No. 59 of 2007 (the Revoked Geothermal Laws) and seeks to improve the regulatory environment for geothermal electricity generation by (1) centralising the licensing authority in the MEMR, and (2) removing obstacles to geothermal electricity generation activities in conservation forests.

Direct Utilisation vs Indirect Utilisation
Like the Revoked Geothermal Laws, the New Geothermal Law draws a distinction between Direct Utilisation (Pemanfaatan Langsung) (including tourism, agribusiness, industrial uses and other direct uses of geothermal resources) and Indirect Utilisation (Pemanfaatan Tidak Langsung) (limited to electricity generation) of geothermal resources. The New Geothermal Law now limits the authority to organise and manage Indirect Utilisation of geothermal resources to the MEMR (the authority was previously shared with provincial and regional governments). Provincial and regional governments do, however, continue to share with the MEMR the authority to organise and manage Direct Utilisation of geothermal resources located within their respective jurisdictions.

IPP developers should also note that regional governments are entitled to receive a fee from geothermal projects located on Working Areas within their jurisdiction, to be calculated as a percentage of gross revenue and to commence from the commercial operation date of the first generating unit. The mechanism for calculating the fee and the procedures for its collection have both been left for further elaboration pursuant to a future Government Regulation.

By centralising the authority to organise and manage geothermal electricity generation activities in the MEMR in the manner described above, it is hoped that a more uniform and streamlined licensing regime will emerge in practise, giving greater certainty to IPP developers and their financiers.

Working Areas
Consistent with the general shift towards greater centralisation, the New Geothermal Law also grants the right to determine and auction Work Areas (Wilayah Kerja) for Indirect Utilisation of geothermal resources to the MEMR exclusively, even though regional and provincial governments may still participate in the conduct of a Preliminary Survey for the purpose of defining a Work Area.

Whereas the Revoked Geothermal Laws limited a Work Area to 200,000 hectares, the New Geothermal Law states that a Work Area may be determined and granted based on the nature of the geothermal energy reserve in the relevant area. This is a significant improvement, as it removes an arbitrary limit on the size of a Work Areas and allows a Work Area to be determined on the basis of the actual nature of the geothermal reserve and in consideration of economic factors relevant to the development of the geothermal reserve.

New Geothermal Licence
Under the New Geothermal Law, an IPP developer must first obtain a Geothermal Licence (Izin Panas Bumi) from the MEMR before undertaking any exploration, exploitation or utilisation activities within any Work Area it has been awarded. A Geothermal Licence is issued to the IPP developer by the MEMR based on a Work Area and is valid for an initial 37-year period, but can be extended by additional 20-year periods. The initial 37-year period is comprised of a five year (extendible to up to a seven year) exploration period and a 30-year exploitation and utilisation period. Under the Revoked Geothermal Law, the same period was comprised of a three year exploration period (extendible to up to five years), a two year feasibility period and a 30-year exploitation period.

The New Geothermal Law also stipulates that an IPP developer must obtain relevant environmental permits before commencing any drilling during the exploration period. All relevant environmental permits must also be obtained, and a feasibility study must have been submitted and approved by the MEMR, before any exploitation and utilisation activities are undertaken.

The New Geothermal Law also sets out a number of new obligations that the holder of a Geothermal Licence must abide by, including (1) conducting exploration, exploitation and utilisation activities in accordance with technical guidelines, (2) submitting long-term exploration and exploitation and utilisation plans, which include work plans and budgets that are consistent with the magnitude of the geothermal energy reserve, and (3) keeping good faith books and records that reflect actual business activity.

The Geothermal Licence (Izin Panas Bumi) issued under the New Geothermal Law replaces the Geothermal Mining Licence (Izin Usaha Pertambangan Panas Bumi), previously issued under the Revoked Geothermal Laws. Under transitional provisions included in the New Geothermal Law, an Existing Geothermal Mining Licences may be converted into a new Geothermal Licence, provided exploration activities have been commenced before 31 December 2014.

Indirect Utilisation in Conservation Forests
Recasting the ?Geothermal Mining Licence? (under the Revoked Geothermal Laws) as a ?Geothermal Licence? (under the New Geothermal Law) is designed to make it clear that the Indirect Utilisation of geothermal reserves does not constitute a mining activity, thereby making it possible to undertake geothermal electricity generation activities in certain conservation forests where mining activities are currently prohibited.

Republic of Indonesia Law No. 41 of 1999 on Forestry (the Forestry Law) permits mining activities in production forests and protected forests (subject to a borrow-to-use permit), but does not permit mining activities in conservation forests. Activities that are permitted in conservation forests (comprising both natural reserve forests and nature preserve forests) are governed by Republic of Indonesia Law No. 5 of 1990 on Conservation of Biological Resources and Government Regulation No. 28 of 2011 on Management of Natural Reserve Areas and Natural Preserve Areas (together the Conservation Laws). The Conservation Laws specifically permit the harvesting of thermal energy, including geothermal energy, in certain natural reserve areas (game reserves) and all natural preserve areas (national parks, forest parks and natural tourism parks).

The conduct of geothermal electricity generation activities in a production forest or a protected forest will continue to require a ?borrow-to-use permit?. In conservation forests, where such activities are now permitted, a ?forestry utilisation permit? will be required. Removing the prohibition on geothermal electricity generation activities in conservation forests in this manner should help to kick-start the development of geothermal reserves that are located in such areas.

Tariffs
An uneconomic tariff structure and general uncertainty in the tariff determination environment for geothermal electricity generation projects in Indonesia has also discouraged investment in the sector. MEMR Regulation 17 represents the government?s latest attempt to address these concerns. Following tariffs based upon voltage and capacity, location, PLN?s cost of electricity procurement and a uniform tariff applicable to all geothermal projects in Indonesia, MEMR Regulation 17 returns to a tariff ceiling determined by reference to location, but this time based on an escalating tariff scale through to expected commercial operation, as follows:

Commercial Operation Date	Ceiling Price (US$/kWh)
	Region I	Region II	Region III
2015	0.118	0.170	0.254
2016	0.122	0.176	0.258
2017	0.126	0.182	0.262
2018?????	0.130	0.188	0.266
2019	0.134	0.194	0.270
2020	0.138	0.200	0.274
2021	0.142	0.206	0.278
2022	0.146	0.213	0.283
2023	0.150	0.219	0.287
2024	0.155	0.226	0.292
2025	0.159	0.233	0.295
Region I	Sumatera, Java and Bali
Region II	Sulawesi, Nusa Tenggara Barat, Nusa Tenggara Timur, Halmahera, Maluku, Irian Jaya and Kalimantan
Region III	Isolated areas within Region I and Region II that are dependent on fuel-based power plants

MEME Regulation 17 provides that IPP developers must bid an electricity tariff (not in excess of the tariff ceilings referred to above) during the old Geothermal Mining Licence bidding process. It remains to be seen if this will automatically apply to the new Geothermal Licence regime under the New Geothermal Law (although we assume this is the intention).

The new tariff structure attempts to address a longstanding IPP developer concern that PLN has, in general, refused to entertain any tariff escalation for inflation, prior to the commercial operation of a project, under its model geothermal power purchase agreement (Model PPA). This has been a difficult risk for geothermal IPP developers to assume (given the long lead time for geothermal projects). The issue has also been compounded by the fact that under the old Geothermal Mining Licence regime a number of Geothermal Mining Licences were awarded to bidders who explicitly bid on the basis of a pre-commercial operation escalated tariff, a position that PLN refused to entertain at the time those IPP developers came to negotiate the Model PPA. MEMR Regulation 17 makes it clear that there shall be no pre-commercial operation escalation other than the escalation built into the tariff ceiling, as illustrated in the table above. While this is an improvement, it still means that any inflation risk arising from delay in achieving commercial operation continues to be borne by IPP developers. Furthermore, it is not clear on the face of MEMR Regulation 17, how the relevant commercial operation date will be determined for the purpose of determining the applicable tariff ceiling (although we expect this to be either the commercial operation date required in the Geothermal Licence request for proposals issued by the MEMR in relation to a Work Area or the commercial operation date bid by IPP developers in response to such a request for proposals).

MEMR Regulation 17 also allows for price adjustment for existing geothermal projects, increased capacity and extension projects, subject to the approval of the MEMR and compliance with certain conditions. For projects that have identified the winning bidders, but that were still at the licensing phase when MEMR Regulation 17 was issued, the following transitional provisions apply in respect of their ability to adjust the tender price.

Tender	Geothermal Mining Licence (IUP) awarded	MEMR Assignment Letter issued to PLN	Electricity Business Licence (IUPTL) obtained	Model PPA signed	Transitional provisions
COMPLETE	?X	X	X	X	If items marked ?X? are obtained by 31 December 2014, price may be adjusted after exploration and feasibility study completed.
COMPLETE	?COMPLETE	X	X	X	If items marked ?X? are obtained by 31 October 2014, price may be adjusted after exploration and feasibility study completed.
COMPLETE	?COMPLETE	COMPLETE	X	X	If items marked ?X? are obtained by 31 August 2014, price may be adjusted after exploration and feasibility study completed.
COMPLETE	?COMPLETE	COMPLETE	COMPLETE (but tariff still being negotiated)	X	If items marked ?X? are obtained by 30 September 2014, price may be adjusted after exploration and feasibility study completed.

Transmission Line Construction Risk
Another issue addressed by MEMR Regulation 17 is the allocation of transmission line construction risk to PLN or IPP developers. Historically, PLN has insisted (in its model geothermal PPA) that IPP developers assume this risk. In response, IPP developers have long argued that PLN (not the IPP developer) is best placed to manage and mitigate this risk (especially land acquisition risk).

Geothermal IPP developers have also successfully insisted that the cost of any transmission line construction obligations should be passed through to PLN via a cost recovery mechanism. Accordingly, it is the Indonesian consumer who ultimately bears the cost for transmission line construction (either, directly, as a consumer or, indirectly, as a taxpayer). It is in the best interest of consumers that this risk be allocated to the party that can manage it in the most efficient manner.

MEMR Regulation 17 makes it clear that PLN shall, henceforth, bear the obligation for transmission line construction. MEMR Regulation 17 also states that any tariff determined in accordance with MEMR Regulation 17 is exclusive of cost recovery for any transmission line construction costs borne by an IPP developer. So, does PLN intend to pass transmission line construction costs to IPP developers (i.e. will the next model geothermal PPA includes a cost recovery mechanism for transmission line construction costs)? This would be an unusual result where transmission construction is undertaken by PLN and would likely be difficult for many IPP developers and their financiers to accept. We will have to wait and see what the next model geothermal PPA contains before this issue is finally put to rest.

Government Support
MOF Regulation No. 173 replaces Minister of Finance Regulation No. 225/PMK.011/2013. Noteworthy for geothermal IPP developers is the fact that a Business Viability Guarantee Letter issued in relation to a geothermal project shall remain valid provided financial close occurs within 48 months of the Business Viability Guarantee Letter being issued (rather than 12 months, as is the case for non-geothermal power projects).

The Path Ahead
These changes are broadly considered to be steps in a positive direction and do go some way to answering a range of longstanding concerns that have been widely held in the Indonesian geothermal industry. If implemented constructively, these changes should pave the way for greater success by Indonesia in achieving its goal of productively harnessing its abundant geothermal resources.

Contact information

Daniel Ginting
+62 21 2995 1701
Partner, Jakarta
daniel.ginting@allenovery.com

Andrew Digges
+62 21 2995 1721
Foreign Legal Consultant, Jakarta
andrew.digges@allenovery.com

Michael Tardif
+62 21 2995 1702
Foreign Legal Consultant, Jakarta
michael.tardif@allenovery.com

Tarsis Halintar
+62 21 2995 1717
Senior Associate, Jakarta
tarsis.halintar@allenovery.com