Opinion: Recent developments in government guarantee in the Indonesian power sector

Overview
The Minister of Finance regulation on Government guarantee for the second phase of the Government's fast track programme in the power sector has recently been replaced by a new regulation. The form of guarantee in the new regulation has been significantly changed towards ensuring the bankability of the power projects.

Background
In the first half of 2011, the Government issued the Minister of Finance (the Minister)'s Regulation No. 77/PMK.01/2011 (MR77) as an implementing rule of Presidential Regulation No. 4 of 2010 for issuance of Government guarantee (Guarantee) for the second phase of the fast track programs in power sector. Just as the market is trying to grasp the issues on effectiveness and the bankability of the Guarantee under MR77, the Minister revoked and replaced MR77 by Minister's Regulation No. 139/PMK.011/2011 on Procedures for Granting of Guarantee for Business Viability of PT Perusahaan Listrik Negara (Persero) for Construction of Power Generation using Renewable Energy, Coal and Gas Undertaken Through Cooperation with Independent Power Producers (MR139). MR139 took effect on 22 August 2011.

Key Changes in MR139
The Government's motivation in issuing MR139 was to address the issue of bankability of power projects. With that in mind, MR139 entirely changes the implementation of the Guarantee as previously set out under MR77. MR139 substitutes the previous version with a Guarantee (and risk coverage) more favourable to the Independent Power Producers (IPPs) and in a form more typically expected for infrastructure projects.

The key changes of implementation of the Guarantee in MR139 are set out below:

1. The Guarantee is now issued directly in favour of and to the relevant IPP, rather than to PLN.

Now that the IPP is the recipient of the Guarantee, the IPP will have a direct recourse to the Government under the Guarantee and it may assign its rights under the Guarantee in favour of lenders.

Notwithstanding that, it is questionable whether the Minister will agree to waive in the Guarantee certain rights of a guarantor generally that are provided by the Indonesian Civil Code, such as the right to demand that the IPP seeks to sell the assets of PLN before enforcing the Guarantee and the subrogation rights of the Minister which if exercised may trigger competing claims between the IPP (or its lenders) and the Minister against PLN. In order to ensure that the Guarantee can be immediately enforceable upon payment default of PLN, waiver of such rights are necessary. The Guarantee in the first phase of the fast track program did not contain such waiver, thus, it will depend on the negotiation between the IPP and the Minister.

2. The Guarantee applies to the risk of PLN being unable (for whatever reason) to discharge its payment obligations to the IPP in respect of purchase of electricity under a power purchase agreement (PPA), rather than only the risk of inability to pay caused by a Government act or decision.

This means that the Guarantee now covers any payment default by PLN, including non-payment under certain reliefs to which the IPP is entitled under the PPA, e.g., deemed dispatch, price adjustment, etc. This is certainly a very positive sign of the Government willingness to guarantee PLN's credit risk.

Nevertheless, it should be noted that it is only the ability to pay for the purchase of electricity that is guaranteed. Risks which are not related to payment or non-credit risks (such as risks of Government actions or decisions (e.g., failure to obtain permits from the Government, change of law, etc) or non-performance by PLN of its non-monetary obligations under the PPA) would not be underwritten by the Government.

While some commentators have criticised this, it should be understood that the PPA already has a mechanism for dealing with non-credit risks under which the IPP will be entitled to some reliefs, e.g., deemed commissioning, deemed dispatch, price adjustment, milestone adjustment, termination and buy-out, etc. The Guarantee is intended to ensure the continued operations of IPPs and the endurance of contractual arrangements, inter alia in order to secure ongoing supply of electricity to meet Indonesia 's needs. Thus viewed, the limitation on the Guarantee is not unusual and indeed has been a feature of previous Guarantees.

3. The Guarantee covers any non-payment risk that occurs during part of or all of the commercial operation phase of the project, starting from the commercial operation date (as stipulated in the PPA) (COD) to either the expiry of the PPA or a shorter period as determined by the Minister (i.e., before the PPA expires).

MR139 does not specify the circumstances under which the Minister will issue a Guarantee with a shorter validity period than the term of the PPA. Obviously, a limited term Guarantee is not something that the market expect to see. This is a critical issue which will determine the effectiveness of the Guarantee under MR139.

Further, under the PPA there may be electricity distributed by the IPP to PLN in a pre-COD phase for which PLN has to pay but the Guarantee excludes non-payment by PLN in this phase.

4. The Minister imposes a restriction on timeframe by which the guaranteed power projects must achieve a financial close - defined as signing of the project financing documents by the IPP with its lenders and disbursement of the loan thereunder:
(a) For non-geothermal projects, the financial close must be achieved within 12 months from the issuance of the Guarantee.
(b) For geothermal projects, the financial close must be achieved within 48 months from issuance of the Guarantee.

The Minister will terminate the Guarantee in the event of failure to comply with the above timeframe.

It accordingly appears that the demonstrable commitment of the IPP and lenders in financing the project is required by the Government in return for its giving of the Guarantee.

The Guarantee applies for any qualified power project that has been procured by PLN in the second phase of the fast track programme, regardless of whether the procurement was before or after the issuance of MR139. Accordingly, all power projects in the second phase may benefit from the Guarantee.

Conclusion
Save for a potential uncertainty on the term of the Guarantee, MR139 clearly implements the Guarantee more progressively in order to improve the bankability of power projects ? adopting an approach that is similar to the pre-1997 Asian crisis type of guarantee. MR139 sets a new milestone in the Indonesian power sector and is expected to be a positive driver in the market.

MR139 also reflects an important flexibility in the development of the Indonesian regulatory framework in general: while evolutions in Regulations can create uncertainty, the Government in adopting this new Regulation has demonstrated a willingness and ability to listen to the demands of the market and where necessary to adjust its regulations accordingly.

If you have any questions on the issues raised above, please contact:

Daniel Ginting (Daniel.Ginting@allenovery.com)
Partner, Jakarta (+62 21 2995 1701)

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

Cindy Riswantyo (Cindy.Riswantyo@allenovery.com)
Associate, Jakarta (+62 21 2995 1705. (ends)