Jakarta partners Benny Bernarto and Nadia Soraya give a detailed overview of project finance and infrastructure in Indonesia.
Reproduced with permission from Law Business Research Ltd. This article was first published in Getting the Deal Through: Market Intelligence (Volume 3, Issue 1) – Project Finance, (published in April 2016; Panel Leaders: Phillip Fletcher and Aled Davies, Milbank, Tweed, Hadley & McCloy LLP) For further information please visit www.gettingthedealthrough.com.
An interview with Benny Bernarto and Nadia Soraya
Benny Bernarto is a corporate and commercial lawyer based in Norton Rose Fulbright's Jakarta office. His practice focuses on general corporate work; energy and natural resources; infrastructure; mergers and acquisitions; and foreign investment, including the healthcare sector.
Benny has extensive experience in infrastructure and power projects and the associated project financing: among others, the 670MW coal-fired power plant in Banten, West Java and the Sarulla geothermal power project, which was awarded Indonesian Energy Deal of the Year 2014 by Asian Legal Business. He has been recognised by Asialaw Profiles as a Recommended Individual (2014), and by IFLR1000 as a Rising Star and Leading Lawyer (2012–2013).
Nadia Soraya is a banking and finance lawyer based in Norton Rose Fulbright's Jakarta office. Her main industry sectors are energy, infrastructure and financial institutions.
Nadia handles a wide range of finance and corporate transactions including project finance; general banking and finance; and mergers and acquisitions. She has particular expertise in the power and natural resources sectors, where she has advised on a number of significant project financings. She works for large banks and in the oil and gas, power and mining industries.
GTDT: What have been the trends over the past year or so in terms of deal activity in the project finance sector in your jurisdiction?
Benny Bernarto & Nadia Soraya: As South East Asia's largest economy and a vast equatorial archipelago of 17,000 islands extending 5,150km (3,200 miles) east to west, between the Indian and Pacific Oceans in South East Asia, with a population of approximately 200 million people, Indonesia is in great need of expediting the development of its infrastructure. Reliable power, water supplies, roads, seaports and airports are a priority for the Indonesian government. Although these infrastructures are basic, they are critical to supporting the economy of Indonesia.
In 2015, the government allocated 290 trillion rupiah (approximately US$220 billion) for infrastructure development, primarily to support the development and construction of, among other things, 2,650km of road, 1,000km of freeways, 2,159km of railways, 24 new seaports, expansion of 59 existing seaports, and 15 new airports.
Back in 2014, the government also announced its five-year plan to build a 35,000MW power plant, to be completed by 2019. This programme received a mixed reaction from the public and from players in the electricity industry, considering the number of challenges that would be faced in particular by PT PLN (Persero), the state utility company, as the primary off-taker of electricity in Indonesia, and also by independent power producers in developing and implementing power projects. Power projects, in particular those that have been and are to be developed by independent power producer companies, have mostly attracted investors and lenders in the project finance sector. Independent power producer projects such as Paiton, Cirebon, Sarulla and Banten are just a few examples of power projects in Indonesia where development was financed by way of project financing. Tanjung Jati B is the first power project financed by way of a finance lease.
With the exception of Sarulla, which is a geothermal power plant, the other power plants mentioned above are large coal-fired power plants, each having capacity of not less than 600MW (the Paiton power plants complex, for example, has a maximum generating capacity of around 4,000MW).
Project financing in Indonesia, however, is still a developing market. This is particularly true because only recently have key infrastructure projects other than in the power industry been open for private investment. In the past, the development of key infrastructure projects was still pretty much owned or controlled by the government through the relevant state-owned enterprises, and their development was mostly funded by state funds, the situation of which has limited the ability of other infrastructure projects in Indonesia to adopt a project finance scheme.
It is, however, unfortunate that government programmes to develop key infrastructure projects have been hindered by long delays caused by various issues such as the procurement process, which causes deficiencies in government-allocated infrastructure budget spending and difficulties in completing the land acquisition process. There have also been other external factors affecting the development of projects, such as the regional economic slowdown and the drop in oil and commodities prices.
In response to this and in an effort to expedite development, since September 2015 the Indonesian government has unveiled 11 economic stimulus packages. These packages aim to boost economic growth in Indonesia through deregulation, tax incentives and by making room for foreign investment. In particular, these packages should be useful in supporting and realising the government's intention to develop infrastructure projects including the development of 35,000MW power plant capacity within five years, mentioned above.
GTDT: In terms of project finance transactions, which industry sectors have been the most active and what have been the most significant deals to close in your jurisdiction?
BB & NS: In Indonesia, the infrastructure sector (the power sector in particular) is the industry that has been the most active in project finance transactions in Indonesia for the last 20 years. One of the primary goals of the government over the last 10–15 years has been to boost and expedite the development of infrastructure.
The previous administration launched the Master Plan for the Acceleration and Expansion of Indonesia's Economic Development (MP3EI), with the intention of attracting more investment and transforming Indonesia into one of the 10 major economies in 2025. From a regulatory perspective, this is also shown by the issuance in 2005 of a regulation on public-private partnerships: Presidential Regulation No. 67/2005 (which was replaced by a new regulation issued in 2015) and various PPP projects announced and tendered out by the government during the last 10 years. Still in the electricity sector, in 2006, the administration announced stage one of a fast-track programme followed by a second programme in early 2010 whereby each programme aimed to accelerate the development of 10,000MW power plant capacity.
"One of the primary goals of the government over the last 10–15 years has been to boost and expedite the development of infrastructure."
Unfortunately, to date, most of the projects declared under the PPP scheme and the fast-track programme have been postponed, delayed or converted to pure government infrastructure projects. There have been various obstacles hindering the Indonesian government from tendering out and therefore initiating projects, and preventing investors from completing or even participating in infrastructure projects.
With the current government administration's emphasis on
infrastructure development, the issuance of PPP regulations in 2015
was a key infrastructure reform intended to correct the earlier
paralysis and therefore expedite the development of infrastructure
projects by adopting a more effective and efficient approach.
Despite all of the challenges, at least two large power projects managed to achieve financial close during 2013 and 2014: the 670MW Banten coal-fired power plant and the 330MW Sarulla geothermal power plant. The significance of the Banten power plant is that it is the first independent power project in Indonesia financed in the international debt markets without government support.
While the Sarulla geothermal power plant is, to date, the largest geothermal power plant in Indonesia, it is no surprise that the roll-out of the 35,000MW plan is making the power sector the most active industry in the development of infrastructure projects, resulting in future power sector project financing transactions being even more active than at present. For the most part, this is driven by the fact that project finance schemes have been used in the early generation of power projects developed by independent power producers, such as the Paiton project, which created a precedent for future projects developed by the private sector.
GTDT: Which project sponsors have been most active in driving activity? Which banks have been most active in providing debt finance?
BB & NS: In terms of project sponsors, project finance transactions in Indonesia have mainly been dominated by international developers, including those from Japan and South Korea. To name a couple, Sumitomo and Marubeni are two of the most active international project sponsors with existing projects already in operation and expansion in progress.
As for domestic sponsors, Medco, through PT Medco Energi International and PT Medco Power Indonesia, has been active in developing power projects in Indonesia, most recently with its involvement in Sarulla. PT Medco Energi International is a member of Sarulla Operations Ltd, being the operator of the Sarulla power plant. Sarulla Operations Ltd consists of Japan-based Itochu, Kyushu Electric, US based Ormat Technologies and PT Medco Energi International. The US$1.17 billion project is probably the first renewable project financed under limited recourse project finance to have closed, which took more than 15 years. The financing agreements were signed with the Japan Bank for International Cooperation (JBIC) and the Asian Development Bank (ADB), serving as the lead structuring banks, and six commercial banks.
Export credit agencies dominate the debt financing market for sponsors and project companies. The extensive involvement of export credit agencies in the project financing market in Indonesia is not surprising for various reasons, including the inevitable necessity for the offshore supply of large equipment required for the development of the projects, as local suppliers are still unable to provide the required large equipment.
In addition, the competitive pricing offered by export credit agencies and multilateral lending agencies have, to our understanding, been attractive to sponsors, although the requirements applied by these agencies may have been more stringent than those of the commercial banks.
JBIC, Korea Eximbank (KEXIM), ADB and the International Finance Cooperation (IFC) are some of the most active export credit agencies and multilateral lending agencies providing debt financing services. The involvement of export credit agencies in a project is also determined by the identity of the primary project sponsor or sponsors. In the case of the US$730 million financing for the Banten plant, the project is owned by PT Lestari Banten Energi, a subsidiary of the Malaysian Genting group. The lenders for the project are Malayan Banking Berhad, Exim Bank of Malaysia, CIMB Bank, Citibank and RHB Bank.
GTDT: What are the biggest challenges that your clients face when implementing projects in your jurisdiction?
BB & NS: Challenges vary from client to client, both when participating in a government procurement for projects and in implementing the project once awarded.
That being said, there is a general perception that land acquisition, coupled with the deficiency in or absence of a regulatory framework surrounding the development of infrastructure projects, are the biggest challenges faced when participating, initiating and implementing projects in Indonesia.
However, clients should also carefully consider certain other factors when planning and implementing projects. Mechanisms and procedures for tendering; procurement procedures; finalising contractual arrangements; coordination; and interactions between various authorities including ministries, agencies and central, provincial and regional governments whose roles in the development of infrastructure have been growing since decentralisation in 2001, all need to be refined to improve implementation of these infrastructure projects.
Public consultation also plays an important role in project development, and this is recognised by the government as shown by its inclusion in the relevant public-private partnership regulation, although it has only been briefly contemplated. More detailed provisions need to be set out in various implementing regulations to ensure that public consultation takes into account the general public's opinion on an infrastructure project.
A poorly conducted (or absence of) public consultation process before the implementation of the project will result in dissatisfaction of parties participating in and surrounding the projects, and would likely lead to public protests and demonstrations against the projects as well as the possibility of a land dispute initiated in the project location (regardless that the land procurement is conducted by the government).
The Central Java 2 x 1,000MW coal-fired power plant project (Batang Power Plant) is an example of a PPP project that has been delayed substantially due to environmental and land acquisition issues.
The PPP regulation requires financial close to be completed within 12 months after the execution of the PPP agreement. This will require additional effort by the government in simplifying the process to obtain licences and permits required for PPP projects. For example, currently a power plant project requires no less than 50 licences from various authorities, including the central and regional government, depending on the location of the project.
It is estimated that the project company will have to spend no less than 900 days to process and obtain those licences, not only because the licences must be processed and obtained from various authorities but also because certain licences can only be applied for after the issuance of other licences.
GTDT: Are there any proposed legal or regulatory changes that may give rise to new opportunities in project development and finance? Do you believe these changes will open the market up to a broader range of participants?
BB & NS: Since September 2015, the Indonesian government has introduced 11 economic stimulus packages. These packages aim to boost economic growth in Indonesia through deregulation, tax incentives and by opening space in foreign investment. The latest economic stimulus package (ie, the 11th package) focuses on curtailing Indonesia's logistics costs, reducing dwelling time at Indonesian harbours and improving the investment climate of Indonesia.
The realisation and implementation of these stimulus packages will require the government to issue a number of more detailed laws and regulations that will also bridge the deficiencies in or lack of infrastructure regulatory framework. A specific regulation addressing licensing issues surrounding infrastructure in the power sector has also been issued recently. Among other things, it aims to simplify the number of licences that will need to be obtained and also the procedures involved in issuing the licences. Foreign investment in Indonesia is conducted under the auspices of the Capital Investment Coordinating Board, and that authority is working to halve the number of licences and permits required and to expedite the processing time to 256 days (approximately 10 months).
Provided that the regulations required to implement the economic stimulus packages can all be issued in a timely manner consistent with the announced stimulus packages, they are expected to boost project finance activity in various sectors. Indeed, although still at an early stage, we have seen some positive activity in the tendering process of power projects in the first quarter of 2016.
As quoted in the Jakarta Post, earlier this year, President Joko 'Jokowi' Widodo has reiterated his commitment to building infrastructure on the outskirts of developed areas and in villages outside Java, allocating 313.5 trillion rupiah of the 2016 state budget to promote equitable development, especially in remote and border areas. On more than one occasion, the president has reiterated the importance of infrastructure development such as dams, reservoirs and ports to increase the competitiveness of national products.
The prevailing public-private partnership regulation provides a more expansive list of infrastructure in comparison to the previous regulation, which was more limited to the 'common' infrastructure such as transport, water resources, irrigation, oil and gas, electricity (including geothermal), telecommunication and waste management. The list has been extended to include, among other things, energy conservation; renewable energy (not limited to geothermal); education, sports and art facilities; tourism; correctional facilities; healthcare; and housing.
Further regulations are necessary to implement these additional infrastructure projects, and we expect the government to issue them in the near future.
GTDT: What trends you have been seeing in terms of range of project participants? What factors have influenced negotiations on commercial terms and risk-allocation? Are there any particularly innovative features?
BB & NS: With IPP projects being one of the most active sectors for project finance, export credit agencies and multilateral lending agencies play a major role in financing them. As described above, the active involvement of export credit agencies is not surprising as historically local suppliers have been unable to provide large equipment for projects. As in the past most large equipment, in particular long lead items, were only available through export, it is natural that export credit agencies have taken a major role in the financing of infrastructure projects.
For example, for the 330MW Sarulla geothermal power project, which reached financial close in 2014, financing agreements were signed with JBIC and ADB, who served as the lead structuring banks, and six commercial banks, as well as ADB in its capacity as implementing entity of the Clean Technology Fund and the Canadian Climate Fund. The project obtained construction and term loans under a limited recourse financing package of direct loans from JBIC and ADB, as well as loans from the commercial banks backed by political risk guarantees from JBIC.
To our knowledge, other sources of finance such as capital markets, insurance companies and pension fund investors have yet to be introduced in the Indonesian market to finance an infrastructure project. Project finance structures still follow the basic project finance concept with (limited) recourse to the project sponsors and heavy reliance on sponsor support.
We have not seen a project where lenders have agreed to no recourse to the project sponsors. The negotiations on commercial terms and risk allocation are partially driven and influenced by the good relationship between sponsors and lenders, and on whether the project is entitled to any form of fiscal support from the government, such as viability gap funding or a government guarantee.
GTDT: What are the major changes in activity levels or new trends you anticipate over the next year or so?
BB & NS: The Indonesian government has earmarked 313.5 trillion rupiah for infrastructure development in the 2016 state budget – the highest budget ever allocated to the country's infrastructure development (compared to 290 trillion rupiah in the 2015 state budget). This accounts for around 15 per cent of the total state budget. The government's infrastructure budget has risen sharply in recent years, being a positive indication of the government's intention to improve infrastructure facilities. The increase in infrastructure has been made possible by additional fiscal space created by the diversion of energy subsidies to capital expenditures.
The government was troubled by the lack of infrastructure spending by the relevant ministries. To our understanding, this lack of spending was primarily caused by bureaucratic red tape and a lack of policy coordination during the first half of 2015. Nevertheless, infrastructure spending grew during the second half of 2015 with the implementation of the economic stimulus packages and the issuance of various regulations to support those packages, which, among other things, aimed to ease the tender process for key infrastructure projects and speed up land clearance, so there is room for optimism.
The government issued Islamic bonds (sukuk) in 2016 to help finance next year's infrastructure projects. They will also seek foreign loans and inject capital into state-owned companies to fund the projects. Projects that had been tendered out and then postponed are now back in play. The current administration aims to reactivate various projects that were postponed, including toll road projects such as the Trans-Sumatera Highway (a US$23 billion highway to connect the northern and southern ends of Sumatera).
Overall, while we have seen clear signs of improvement, other factors such as the slowdown in China's economy and plunges in oil and commodity prices could play important roles in determining the degree of success of Indonesia's current infrastructure programme.