IEEFA Update: Indonesia’s Electric Company Gets Its Bond Deal Done, But Investor Risk Remains

How Much Will the Government Be Willing to Subsidize PLN?

Last week was good to PLN, Indonesia’s state owner power company. Despite chaotic emerging bond markets, which had punished the rupiah and pushed yields on Indonesian bonds higher, PLN was able to paddle safely to shore with a successful US$2 billion bond issue.

Flexibility was the key to getting the financing done. With guidance from Indonesia’s well-respected Ministry of Finance, PLN managers were smart to opt for a refinancing strategy that markets could support as opposed to a new financing effort that would have drawn attention to PLN’s poor planning disciplines and stretched fundamentals (see our previous recent research along these lines, earlier this month and in April).

In the end, PLN raised U$1 billion in 10-year bonds at an estimated yield of 5.5% and $1 billion in 30-year bonds at an estimated yield of 6.1%. Most of the total—$1.7 billion—will be used to fund a tender offer for three bonds with coupons ranging from 7.8 to 8 %, two of which were due to be refinanced in the next two years.

This arrangement means PLN’s stretched debt-service ratios will get a much-needed break and the company will have less explaining to do next year as other Asian issuers swarm debt markets in what is expected to be a very busy year for refinancing.

It was not all warm hugs for PLN, however. No government likes to see debt-hungry state-owned enterprises that rely on the sovereign’s credit-worthiness become a potential drag on a country’s funding profile. That would be playing with fire in Indonesia, a sovereign issuer that only just recovered its investment-grade credit rating in 2017. It is important now for investors to keep a careful eye on how PLN’s debt is priced relative to its sovereign debt. Here there is room for caution. Commenting on the bond issue, IFR noted that PLN’s new bonds were priced “around 100bp wide of the sovereign, a big difference from last year’s issue when its spread over the sovereign was 38bp and 54bp for 10- and 30-year bonds.”

NOW THAT PLN HAS GOTTEN THROUGH THIS FUNDING EXERCISE UNSCATHED, the next round of questions about financial risks associated with PLN’s fossil fuel-heavy strategy will likely focus on the how much the Ministry of Finance will be willing to subsidize PLN to cover its 2018 operating losses. Our numbers indicate that the subsidy required by PLN to just report flat earnings versus 2017 would be IDR 58.7 trillion (US$4.2 billion), marking a 28.5% increase over 2017, and our figures may prove too conservative in light of upward pressure on oil and coal prices.

This issue is clearly weighing on Indonesia’s Minister of Finance Sri Mulyani Indrawati. Just last week, the minister noted that a careful review of Pertamina’s and PLN’s finances will need to be conducted before subsidy decisions are finalized as part of the 2018 budget and in light of the recent sharp increases in oil and diesel prices.

Reducing energy subsidies has been crucial to maintaining global bond investors’ positive perceptions of Indonesia’s economic outlook. Pertamina, Indonesia’s national oil company, is now a net oil importer, exposing both PLN and the public to global oil price pressures. For the Ministry of Finance, it will be a question of which company—PLN or Pertamina—can bear the most financial pressure.

The largest member of the Association of Southeast Asian Nations continues to lag global trends in power production.

Higher oil and coal prices will almost certainly require higher government subsidies this year because PLN’s tariffs are frozen for ratepayers through 2019—a politically sensitive policy intended to blunt the impact of sharply higher costs in an election year. PLN does not provide enough disclosure on its fuel costs to support accurate estimates of how much the government may need to increase the 2018 subsidy to cover actual increases in 2018 fuel costs.

Moreover, efforts to cap potential coal price increases will hold some of the damage in check for PLN. IEEFA’s 2018 forecast assumes a 10% fuel cost increase only—a figure that now seems unrealistic. If that were number were to go 20%, which is possible, we believe the required subsidy could rise to IDR 70.5 trillion ($5 billion), resulting in a 54% subsidy increase over 2017. This is not something that the Ministry of Finance will want to have to face without a new plan for mitigating further fuel price increases if energy volatility continues through 2019.

Any subsidy uncertainty will complicate PLN’s efforts to tap the bond markets later in the year to cover its heavy expected capital spending program.

IN IEEFA’S RECENT SCENARIO ANALYSIS OF PLN’S SPENDING PLANS, we highlighted the many risks associated with PLN’s scheme with independent power producers for further buildout of coal-fired generation. Higher fuel prices inevitably amplify all of these risks.

And even though Indonesia has significant domestic coal reserves, the politics associated with coal in Indonesia mean that global oil and coal price trends translate into inflation risks for reluctant ratepayers and taxpayers at every turn. The economic burden of accepting energy price risk as a determinant of Indonesia’s growth trajectory will become harder to understand as Indonesia’s peers turn away from coal-fired power. Not only do other countries have the potential to lock in more flexible and low-cost renewable power infrastructure, their economies will become increasingly insulated from exactly the type of energy price shock that the Indonesian Ministry of Finance is now left to manage.

While congratulations are in order for PLN having navigated this refinancing, all the many contradictions in Indonesia’s power development scenarios could mean the glow will not last long.

While PLN was getting its debt refinancing across the line, Huadian Bukit Asam Power was reported to have won financing from China Export Import Bank to finance Sumsel 8, a US$1.6 billion, 1,240-megawatt (MW) mine-mouth coal-fired power plant scheduled to come online in 2022 in southern Sumatra. This is exactly the type of project that threatens to add even more pressure to PLN’s financials.

Meanwhile, the Asian Development Bank (ADB) has recently announced a partnership with Vena Energy, Asia’s largest independent renewable energy company, to finance 42 MW of solar photovoltaic generation and 72 MW of wind power for PLN. Even the normally restrained ADB couldn’t help sounding triumphant.

“By supporting a sector-changing financing for renewable energy, with an innovative portfolio approach, ADB and Vena Energy have been able to add over 114 MW of clean energy to Indonesia’s electricity grid, while helping reduce the country’s dependence on fossil fuels and promoting renewable energy development,” said Jackie Surtani, ADB’s infrastructure finance division director for Southeast Asia, East Asia, and the Pacific.

This renewables project is certainly good news for Indonesia and PLN. That said, the scale of agreed-upon coal projects with old technology dwarfs that of innovative renewables initiatives in PLN’s development plan. It is unfortunately a plan so far out of balance that there is little hope that Indonesia’s ratepayers can be protected from the type of economic risk that nearly cost PLN its chance to refinance last week.

Melissa Brown is an IEEFA energy finance consultant.

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