Report No. PID9910
Project Name                     Indonesia-Energy Project
Region                           East Asia and Pacific Region
Sector                           Electric Power & Other Energy Adjustment
Project ID                       IDPE63913
Borrower(s)                      GOI W/PARTIAL ONLENDING TO PLN & PGN
Implementing Agency
Address MOF, MEMR, MIGAS(PERTAMINA),
DGEED, PLN AND PGN
Ministry of Finance (MOF)
Environment Category             A
Date PID Prepared                November 17, 2000
Projected Appraisal Date         July 9, 2001
Projected Board Date             November 20, 2001
1. Country and Sector Background
An underlying analysis of the main sector issues has been carried out in
the context of two major sector studies financed by the Bank's own
resources: one for the oil and gas (hydrocarbon) sector (which was
completed in June 2000 under report number 20512-IND); and one for the
electricity sector, which culminated in the Bank, ADB and USAID-supported
launch of the Government's Power Sector Restructuring Policy in August
1998. The key issues are as follows.(i) Substantial subsidies for
petroleum products and electricity. The energy sector presents one of the
biggest challenges to the ability of Indonesia's Government to maintain
fiscal sustainability, and consequently, macroeconomics stability. This
is because the pricing structure of petroleum products and electricity is
significantly distorted, at both the absolute, and relative (see v)
levels. The domestic price for a composite barrel (of five major products
representing over 97 percent of domestic fuel consumption) was roughly 43
percent of the international price in December 1999 (the amount of subsidy
varies depending on the crude oil price and exchange rate). The
Government's subsidies for petroleum products (estimated at US$4.9 billion
in 1999) are huge by any measure, representing about 5 percent of GDP in
1999, or over 25t of the Government's routine expenditures. The loss in
economic efficiency resulting from these subsidies is estimated at about
US$780 million. If the subsidies are not removed, the amount that the
Government would have to provide between now and the end of 2005 would be
about US$24 billion. Furthermore, the subsidies provided to the fuels used
for electricity generation mean that the costs faced by the power sector
are understated (hence distorting sectoral investment and operating
decisions). Even more significant than this indirect subsidy is the direct
subsidy provided to the power sector (estimated at US$1 billion in 1999)
to meet PLN's cash flow requirements. As a result of the depreciation of
the Rupiah, PLN (the State electricity corporation) sells electricity at
the equivalent of US3.0-US3.4c per kWh, while it purchases fuel, as well
as electricity from independent power producers (see iv), in foreign
currency. Consequently PLN's average costs per kWh are about twice as
high as its average sale price.As part of the above-referenced sector



work, the Bank has already proposed a program for the gradual removal of
the fuel subsidies (Annex 4), taking into account the relative distortion
of prices, as well as the impact of the program on the poor and on the
cost of living. Although price increases will have substantial fiscal
benefits, they will also have potentially adverse macroeconomics and
social impacts. Consequently, immediate increases to market levels are
seen as being unrealistic. Rather, fuel prices should gradually move to
market levels over the medium term (i.e., five years), with the eventual
goal being full price liberalization. Further, after each major increase,
prices need to be periodically adjusted, under an appropriately designed
formula (already provided to the Government), to reflect market
conditions, and be prorated even while prices are still subsidized.Under
the Bank's Second Policy Reform Support Loan (April 26, 1999), the
Government made a commitment to implementing plans for the phased removal
of both fuel and power subsidies, while protecting the poor and other
targeted groups. However, several attempts by the Government during 1998
to mid-2000 to increase the prices of petroleum products (other than
aviation fuels), met with strong public resistance. The Government thus
deferred a fuel price hike several times, and eventually in September
2000, raised the prices of the five major products by an average of 12%.
This increase, although less than that recommended by the Bank, was
nonetheless a positive step, particularly as the relative increases (see
v) were more or less in line with what the Bank had recommended. Several
attempts to increase the power tariff, as required under the
tranche-release conditions of ADB's Power Sector Program Loan were also
delayed, and only last April the Government was able to increase the
tariff by about 30% on average, which at today's exchange rate is the
equivalent of USc---per kWh.   (ii) Pertamina's dominant role and its
inefficiencies in both upstream and downstream hydrocarbon sector
operations. Another energy sector issue that has a substantial impact on
Indonesia's economy is the problematic role and functions of Pertamina
(the State oil, gas and geothermal agency). Key concerns are that: (a)
Pertamina's direct operation in the exploration and production of oil and
gas in its own concession areas is not efficient; (b) Pertamina acts as
the Government's sole agent in supervising the activities of the private
companies in the upstream oil and gas sector--thus creating an inherent
conflict of interest, since Pertamina competes with the companies it
supervises--and this supervisory role focuses more on control than on
gaining added value for the Government, consequently contributing to
delays and other inefficiencies; and (c) Pertamina enjoys a virtual
monopoly over a huge market in downstream activities, a role which is not
conducive to efficiency and reliability (with inefficiencies particularly
severe in the refining subsector).The Bank in the context of its sector
work has recommended that the Government carry out an assessment of the
alternatives for reforming Pertamina in a fundamental way, including: (a)
forming several full and legally binding subsidiaries, as well as
initiating a major divestiture and/or partial privatization program; (b)
removing the Foreign Contractors Coordinating and Management Body (BPPKA)
from Pertamina and locating it under MEMR (possibly within MIGAS), or as a
separate agency; (c) ensuring that Pertamina participates in upstream
activities on an equal basis with private companies; and (d) removing
Pertamina's monopoly status from downstream activities. With regard to
latter, given the size of Indonesia's domestic petroleum market, it can
attract international, regional and local investors if the right framework
is put in place to make competition realistic and vibrant (see
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viii).Although in the last two years a number of changes have been
introduced by the Government to gradually liberalize the sector, none have
been implemented yet. The Government has in theory opened the refinery
sector to private participation, liberalized the market for lubricants,
indicated its intention to separate off Pertamina's geothermal operations,
and lifted price controls on aviation fuels. However, in practice, there
has not been substantive progress in these areas, and some of these policy
initiatives are limited in the absence of fundamental changes to the legal
framework (e.g., the private sector can build refineries, but cannot
supply the major fuels to the domestic market--they can only sell these
products to Pertamina). In compliance with an IMF requirement, the
Government also appointed international auditors to conduct special audits
of Pertamina. (iii) Current structure of the power sector. Given PLN's
virtual insolvent state, its huge contractual obligations, its problematic
corporate structure and some of the sectoral issues, continuous operation
of PLN in its present form is untenable. Although a necessary step, a
major increase in tariffs (and/or direct financial support) by the
Government, is not in itself sufficient to ensure a sustainable long term
solution to the power sector's problems. On the one hand, the Government
faces an enormous fiscal burden from PLN (see i and iv), while on the
other hand, PLN's own freedom to respond to evolving needs and
circumstances is circumscribed by constraints imposed on it by the
Government. Consequently, Indonesia needs to move in the same direction
as many other countries that are transforming their electricity industries
by unbundling vertically-integrated utilities (like PLN), and by moving to
a competitive market-based industry structure governed by a independent
regulatory framework.The electricity system on Java-Bali is relatively
well-developed, and over the medium term can potentially be transformed
into a commercially viable and financially independent operation, which in
turn would allow the sale of PLN's Java-Bali assets. Operations would be
governed by an independent regulatory body, and not by direct Government
interference. However, operations outside Java are much less developed
and will require stronger Government support for the foreseeable future,
thus being more akin to the provision of a social service than the
undertaking of a commercial activity.Consequently, the Government's Power
Sector Restructuring Policy, launched in August 1998 (based on inputs from
the Bank, ADB and USAID), requires the unbundling of PLN geographically,
which will allow the distinct separation of PLN's potentially commercial
operations in Java-Bali from those operations still requiring direct
Government support over the longer term (outside Java-Bali). The Policy
envisages the creation of a Regional Electricity Company (REC) comprising
all of PLN's assets outside Java-Bali. Subsidies for electricity
development outside Java-Bali will be channeled through a Social
Electricity Development Fund (SEDF) until such time as those operations
become wholly (or partially) commercially viable and financially
independent. (However, any subsidies intended to directly support the
utilization of electricity or of other fuels by the poor, whether outside
Java-Bali or on Java-Bali, will be made explicit and transparent as a
distinctly separate line item in the Government's budget). Further, the
Policy requires that PLN's operations on Java-Bali be additionally
unbundled by function (i.e., generation, transmission and distribution),
to allow the transition to a competitive multi-buyer/multi-seller (MBMS)
market for operations on Java-Bali, over the medium term (i.e., five
years), and in preparation for privatization. As an interim step to full
competition, which requires a change in the current legislation, the
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Government proposes first establishing a Single Buyer market on
Java-Bali. Apart from enacting a new electricity law, another
pre-condition of eventually moving to the MBMS market is for the power
delivery system on Java-Bali to be sufficiently robust.The Government has
taken steps to implement this Power Sector Restructuring Policy, by
establishing, under the previous Government (Keppres 139/98), a
cross-Ministerial Steering Committee to oversee the corporate and
financial restructuring of PLN, as well as to rationalize the private
power program (see iv). In parallel, the Minister of Energy and Mineral
Resources has established a team to oversee the implementation of the
needed legal and regulatory reforms, including the drafting of a new
electricity law and implementing regulations. To support the
implementation of the Policy, the Bank and ADB have been focusing on
complementary areas of restructuring activities. ADB has already provided
a program loan (about US$400 million) to the Government to deal with
sectoral aspects of the restructuring such as development of legal and
regulatory framework and the creation of the Single Buyer and MBMS
markets. The Bank on the other hand has been focusing on the corporate
and financial restructuring of PLN, by helping the Government and PLN to
prepare the detailed design of the implementation plan, as well as by
financing the consultancy services required for the actual
implementation.(iv) Liabilities associated with Independent Power
Producers (IPPs). In addition to PLN's other problems, it faces huge
liabilities relating to independent power producers (IPPs). Although
Indonesia's IPP program was successful at attracting private capital into
the power sector, the contracts provided to the IPPs have resulted in huge
real and contingent liabilities for PLN and the Government, as well as
potentially excess generation capacity on Java-Bali. (Even before the
growth slowdown caused by the crisis, PLN faced the prospect of
substantial excess capacity on Java-Bali over the coming years). As a
result, the Government is faced with an additional risk factor from the
energy sector with regard to maintaining fiscal sustainability.
Furthermore, successful implementation of the Government's Power Sector
Restructuring Policy is also put at risk until this issue is resolved.The
Government signed 26, mainly unsolicited, IPP contracts, which if they
were all to be implemented would add about 11,000 MW to the country's
installed generation capacity at a total estimated cost of about US$18
billion, or about US$130 billion in "contractual obligation" costs over
the next 30 years. These contracts are in the main supported by a
Government Letter of Comfort provided by the Ministry of Finance (MOF),
and all capacity payments are payable in hard currency (mostly US
dollars). Out of this 11,000 MW capacity, about 3090 MW (2895 MW in
Java-Bali) have already been completed or are about to be completed
shortly. While the tariff varies for each, their average tariff is over
US6c per kWh. Since the crisis, PLN has been paying the
dollar-denominated invoices of the currently onstream IPPs as if the
exchange rate were still at pre-crisis levels, and the Government has
announced the postponement, review or cancellation of the planned IPPs.
Consequently, there have been several litigation cases, including a ruling
by international arbitration tribunal in favor of one of the IPPs.
Currently one or two interim agreements have been signed between the
Government and the IPPs, but a long term solution is not at hand yet.(v)
Distorted energy product pricing structure (especially for natural gas).
At the relative level, the disparity between prices of individual
petroleum products is large, as is the disparity between the prices of
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natural gas, electricity and substitutable fuels. Electricity prices are
further distorted by differences between consumer classes, and between
regions, due to the imposition of a Uniform National Tariff.
Consequently, the pattern of consumption for energy products is severely
distorted, leading to a misallocation of producer and consumer
resources.One outcome of this distortion is that the growth of the
domestic gas industry has slowed down, whereas its expanded utilization
could bring about significant environmental and economic benefits. For
instance, the sale price of natural gas to the industrial and commercial
sectors is about ------times the subsidized price of high speed diesel oil
(Solar), its main competitor. Eliminating this subsidy from Solar would
have allowed gas to substitute for around US$----million of Solar during
1999. Further, the structure of gas prices is not economic: the selling
price of gas for some users is lower than its economic cost of supply, and
for others is just barely sufficient to cover the costs; whereas with
respect to its value to the economy, a substantial amount of economic
rents (to the Government) are forgone.However, as the table in Annex 4
shows, it is not a straightforward case of simply structuring the gas
pricing within an economic framework to reflect the economic cost and
value of gas. This is because of the distortions in the prices of other
petroleum products for which the gas could substitute. Thus, a rational
gas pricing strategy must be developed that will take into account these
relative distortions during the transition until the subsidies are
gradually removed.(vi) Constraints on the utilization of domestic gas and
on expanded private sector participation.   In recent years, Indonesia has
seen a decline in its net exportable oil, and hence in the associated
revenues, because its growing domestic needs for energy have not been met
by increased oil production or by substitutes. Development of the
domestic gas market would serve to free up additional oil for earning hard
currency, and also have significant environmental benefits. But such
development is constrained both by the current distortions in the prices
of petroleum products, discussed above (see v), and by the lack of an
integrated gas transmission and distribution infrastructure. However,
since the Government is unable to finance the required infrastructure
expansion, there is a particular need for private equity. Increased
private sector participation can be achieved in gas transmission through
the involvement of strategic investors, and in gas distribution by partial
privatization of PGN (the State gas corporation) through a minority
initial public offering (IPO).The Government issued a Policy of Natural
Gas Development in August 1997, outlining principles of: sector
unbundling; introduction and promotion of private sector involvement and
competition; deregulated pricing for non-residential consumers;
infrastructure and market development; and the eventual establishment of
an independent regulatory body. This policy was to be partially
implemented through a Keppres for Natural Gas Transmission and
Distribution, the latest draft being July 1998, which was also intended to
clarify the existing legislative framework and consequently the roles of
Pertamina and PGN in the domestic gas sector. However, this has been
superseded by the drafting of a new oil and gas law (see viii).(vii) Poor
urban air quality. The most serious cause of atmospheric pollution in
Jakarta is vehicle emissions resulting from the combustion of petroleum
products, with emissions from the industrial sector being the next most
significant contributor. Measures of the health damage caused by
different pollutants indicate that removal of lead from gasoline, a
reduction of the sulfur content in diesel oil, and substitution of oil by
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natural gas through the development of the domestic natural gas industry
(see v and vi), could result in substantial health savings. For instance,
if the leaded gasoline is phased out, it is estimated that there would be
a US$6 billion reduction in environmental damage currently resulting from
lead poisoning.Prior to the crisis, under the Government's Blue Sky
program, Pertamina had planned to rationalize petroleum product
specifications and to phase out leaded gasoline grades through various
options such as increasing imports of high octane unleaded gasoline,
blending oxygenates such as MTBE into the gasoline pool, and/or increasing
the refinery production of high octane blend stocks such as reformate and
FCC gasoline. And one of the commitments subscribed to by the Government
in its letter of understanding with the IMF is to proceed with plans for
the complete removal of lead from gasoline. However, financing either the
required refinery modifications, or additional imports of high octane
gasoline, has become difficult under the country's current economic
circumstance.(viii) Deficiencies in the legislative framework for both the
hydrocarbon and power sectors. A number of the above problems stem from,
or are reinforced by, the current legislative framework for the energy
sector. In the hydrocarbon sector, the existing laws and regulations
sanction Pertamina's and PGN's sectoral dominance and allow the Government
to interfere with the sector in ways that inhibit efficient sector
operation and private sector participation. The Bank had provided
significant inputs to the original draft oil and gas law during 1998.
This version did not pass, and in any case was substantially modified, to
its detriment, at the final stages. The Bank then recommended that the
draft law be revised to more closely provide the framework for a
competitively-based, market-oriented sector operation, involving less
Government interference, and consistent with international industry best
practice. However, the draft oil and gas law so far has still not been
enacted. In addition, the associated regulations (based on detailed input
provided by the Bank), have been reviewed by MIGAS, but are still
pending.In the power sector, the competitively-based market operation
envisaged for the sector under the Government's Restructuring Policy
requires a new legal and regulatory framework. A new electricity law has
been drafted, although not yet submitted to Parliament, and as part of the
technical assistance associated with ADB's program loan, support will be
provided for the development of an autonomous regulatory body with the
capability to regulate the power sector.(ix) Institutional requirements
for capacity building. All energy sector entities require capacity
building to some extent, particularly given the new challenges which they
will face during the transition to a more liberalized and market-oriented
sector. In particular, the Government requires help to improve public
acceptance of the need for fuel and power price rises. There are also a
number of other specialized needs for capacity building. For instance,
the current Minister of Energy and Mining Resources has expressed interest
in establishing a National Energy Policy Office, and has indicated that
external support would be required. Further, energy planning/forecasting
functions and capabilities are currently spread among many Government
agencies, and there are a number of weaknesses in the current approach to
developing a cohesive overall energy plan, and supply and demand
projections. Also, the draft oil and gas law requires many of Pertamina's
roles to be transferred to another agency, in which case such an agency
may require significant capacity building to be able to supervise and
regulate PSCs, and DGEED needs to be strengthened to deal with new issues
arising as a result of the restructuring of the power sector.
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Consequently, sector institutions should be strengthened across the board,
particularly where regulatory responsibilities are increased as a result
of the reforms.
2. Objectives
The objective of the Indonesia Energy Sector Project is to reduce the
fiscal burden, and consequently the macroeconomics risks, of the energy
sector on the Indonesian economy, while reducing the sector's adverse
impact on the environment.This objective will be achieved under the
Project through supporting the Government in its efforts to: n gradually
phase out subsidies for fuel, by requiring the adoption of an automatic
mechanism for the periodic adjustment of fuel prices, by developing
effective mechanisms for delivering any targeted subsidies to the poor,
and by augmenting the Government's ability to improve public acceptance of
the need for fuel price increases and changes;n lay the foundation for a
commercially viable, financially independent, and operationally secure and
efficient power sector on Java-Bali, as well as allow the introduction of
a Java-Bali competitive electricity market, by supporting the
implementation of the corporate and financial restructuring of PLN, and by
debottlenecking the Java-Bali power delivery system;f manage the subsidies
for power development outside Java, by requiring the establishment of a
Social Electricity Development Fund (SEDF);ft rationalize the energy
product pricing structure (during the period until prices are fully
deregulated), by developing, and requiring the implementation of, a
rational gas pricing policy;n promote the development of the domestic
natural gas industry, in order to free up additional oil for export, by
assessing how the gas sector can be restructured and attract increased
private sector participation, and by expanding the gas distribution
infrastructure on West Java;n increase the domestic use of cleaner fuels,
by prioritizing options to phase out lead from gasoline, (as well as
through the achievement of the above actions to implement a rational gas
pricing policy and expand the gas distribution infrastructure);ft improve
capabilities for implementing sector reforms and planning for sector
development, by strengthening the institutional capacity of the Ministry
of Energy and Mineral Resources (MEMR), the Directorate General of Oil and
Gas (MIGAS), and the Directorate General of Electricity and Energy
Development (DGEED).
3. Rationale for Bank's Involvement
n The past policy dialogue has provided critical support for mapping the
reforms needed in the both the gas and, to a larger extent, power
sectors. However, despite the above-mentioned commitments by the
Government, ongoing Bank involvement is required to ensure implementation
of the proposed reforms. For instance, the Government has indicated in
its Statement of Development Policy (under the Second Policy Reform
Support Loan) that it is looking to the World Bank to take the lead role
in providing guidance and support for PLN's corporate and financial
restructuring, and to the ADB to take the lead on the related legal and
regulatory reforms. Without Bank involvement, it is clear that the
desired reforms will not occur, and that the complementary areas addressed
by ADB will hence also not be successful.n The Bank has worldwide
experience in both hydrocarbon and power sector reform, and it is in a
unique position to play a catalytic role in helping Indonesia in the
design and implementation of the needed reforms.n The project component
relating to the domestic gas sector builds on a solid record of two
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successful prior projects with PGN.n The market-sounding of international
gas utilities to determine private sector interest in the downstream gas
business in Indonesia has revealed a strong private sector preference for
the financial participation of the Bank in the sector, in order to reduce
the potential investors' perception of political risks.
4. Description
Although the Project is a primarily a sector adjustment operation, the
inclusion of physical investment and technical assistance components in
addition to the budgetary support component with its associated policy
conditions, mean that it is in effect a hybrid operation. Project
components will be scoped in more detail during project preparation.
However, at this stage, the following components are envisaged.(1)
Budgetary Support. The Project will include a relatively large budgetary
support component to be released in two tranches. Policy conditions
required for first tranche release will relate to: (i) the adoption by the
Government of an automatic mechanism for the periodic adjustment of fuel
prices; and (ii) the completion of a set of milestones for the initial
stages of PLN's corporate and financial restructuring. The appointment of
consultants for components (2), (4) and (5) below, as well as the
establishment of an adequately staffed Project Implementation Unit (PIU),
will also be first tranche release conditions. Policy conditions required
for second tranche release will relate to: (i) the completion of a second
set of milestones relating to PLN's restructuring, with particular focus
on cash flow management, financial restructuring and the initial operation
of the Single Buyer market; (ii) the establishment of the Social
Electricity Development Fund by the Ministry of Finance; and (iii) the
implementation by the Government of appropriate changes in gas prices,
relative to other fuels, as determined by the Study performed under
component (4) below.(2) Fuel Subsidy Removal Support. The Project will
include a technical assistance component to the Ministry of Energy and
Mineral Resources (MEMR) that will (a) develop effective mechanisms for
delivering any targeted subsidies to the poor, with regard to their use of
energy, and (b) augment the Government's ability to improve public
acceptance of the need for fuel price increases and changes.(3) PLN
Information Technology and System Delivery. The Project will include two
investment subcomponents to PLN. The first subcomponent will include
financing toward the management and financial information systems required
to establish separate transmission, generation and distribution successor
companies on Java-Bali which can be made commercially viable and
operationally efficient. The development of a masterplan for PLN's
information technology requirements will be undertaken as part of the
technical assistance for the corporate and financial restructuring of PLN
(provided under the Bank's Second Power Transmission and Distribution
project), and this masterplan will identify the specific hardware and
software requirements to be financed by the Project. The second
subcomponent will include transmission, subtransmission, SCADA and any
other related investments required on Java-Bali to (a) reduce system
delivery constraints, (b) improve the reliability and quality of supply,
and (c) allow the day-to-day operation of the Single Buyer, and
subsequently MBMS, markets. Since the likely cost of these investments
will be substantial, the Bank will be seeking co-financing assistance from
possibly JBIC for this subcomponent.(4) Gas Pricing. The Project will
include a technical assistance component to MIGAS for a short Study to
develop a rational natural gas pricing strategy. The Study's findings and
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recommendations will be used to develop the policy condition on gas
pricing for second tranche release of the budgetary support component.(5)
Gas Sector Restructuring and Private Participation. The Project will
include a technical assistance component to PGN for (a) investigating
options for restructuring, unbundling and decentralizing PGN's operations,
particularly with a view to separating its transmission and distribution
operations, (b) to assist PGN prepare for an IPO, and (c) to seek out a
strategic partner for PGN's transmission operations.(6) Gas Distribution.
The Project will include an investment component to PGN to expand its gas
distribution network in West Java. Prior to the crisis, the Bank had been
helping PGN to prepare the West Java Gas Distribution project, and had
intended to provide financial support to this project through a proposed
loan of US$100 million. The objective of that project was to support the
Government's policy of fuel diversification, via expansion of Indonesia's
domestic natural gas distribution network, given the economic and
environmental benefits of substitution by gas. This objective still
remains valid, although in light of the current economic situation, the
scope of the physical component, which was to supply natural gas to all
industrial and commercial consumers from Cilegon in the west of West Java
to Purwakarta in the east, may have to be reviewed. Since it is likely
that the Bank's proposed financial contribution will not be sufficient, it
is intended that the balance will be co-financed by JBIC. Furthermore,
since the major source of gas supply for the new distribution network is
expected to come from South Sumatra, PGN is planning to construct a
transmission line to transport gas from South Sumatra to West Java using
(concessionary) financing from JBIC.(7) Phasing Out Leaded Gasoline. The
Project will include a technical assistance component to MIGAS in order to
extend the analysis of issues and options for phasing out leaded gasoline
and for improving fuel specifications that will be carried out under a
PHRD grant as part of project preparation. The nature of the technical
assistance will depend on the recommendations of the PHRD-funded study.(8)
Capacity Building for MEMR, MIGAS and DGEED. The Project will include a
technical assistance component to MEMR, MIGAS and DGEED to improve energy
planning, forecasting and policy implementation capabilities, to review
the taxation of energy products, and to assist MIGAS in successfully
dealing with many of Pertamina's roles, should this be required.
(1) Budgetary Support
Physical Investments
(2) PLN information technology and system delivery
(3) PGN gas distribution
Technical Assistance
(4) Fuel subsidy removal support
(5) Gas pricing
(6) Gas sector restructuring
(7) Phasing out leaded gasoline
(8) Capacity Building
5. Financing
Total ( US$m)
GOVERNMENT               310
IBRD                     420
IDA                       --
Total Project Cost       730
6. Implementation
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n Implementation period: 4 years.n Executing agencies: (i) Ministry of
Finance for the budgetary support component and also for setting up the
Social Electricity Development Fund; (ii) PLN for its corporate and
financial restructuring as well as for the power sector investment
components; (iii) PGN for the gas distribution investment component and
the associated TA on restructuring and private sector participation; (iv)
MEMR for implementing fuel and power price changes and adjustment
mechanism, as well as for the TAs on fuel subsidy removal support and for
its capacity building; (v) MIGAS for the TA on gas pricing, for the TA on
capacity building and for the TA on phasing out leaded fuels (possibly in
coordination with Pertamina); and (vi) DGEED for its capacity building
TA.n Onlending: The Government will onlend to PLN and PGN the funds
associated with PLN's investment and the gas distribution components.
This will be done under Subsidiary Loan Agreements, which would pass on
all costs and risks, including foreign exchange risk, incurred by the
Government to PLN and PGN.n Monitoring and evaluation arrangements: The
Bank will closely supervise progress with policy reforms and with project
implementation progress by (a) the establishment of a cross-Ministry
Project Implementation Unit (PIU) as a condition of loan effectiveness
(i.e., first tranche release condition), (b) the establishment and
monitoring of appropriate monitoring and evaluation indicators, (c)
reviewing quarterly project progress reports from the PIU and all
executing agencies, and (d) undertaking regular field missions.n
Disbursement and auditing arrangements: With the exception of the
budgetary support component, separate project accounts will be maintained
by each of the executing agencies concerned and independently audited by
an auditor satisfactory to the Bank. In addition, PLN and PGN would be
responsible for submitting to the Bank each year its audited corporate
accounts. PLN has been audited by a private auditor (Has Tuanakotta &
Mustofa/Deloitte Touche Tohmatsu) while PGN has been audited by the State
auditor (Financial and Development Supervisory Board). However, in both
instances, accounting standards have been based on those generally
accepted in Indonesia. In the event local accounting standards differ
from international accounting standards (IAS) in selected accounting
treatments, agreement would be sought for the disclosure of the impact of
applying IAS on the company's financial position. In addition, as part of
the preparation for partial privatization of PGN, agreement would be
sought for PGN to be audited by a private auditor acceptable to the Bank.
7. Sustainability
The sustainability of the project is dependent on the mitigation of the
critical risks below, in particular on minimizing the public reaction to
the removal of subsidies for petroleum products and electricity, since a
strongly negative reaction might detrimentally impact the stability of the
political environment.
8. Lessons learned from past operations in the country/sector
It should be pointed out that lessons learned with respect to past
experience in Indonesia were gained under an environment characterized by
sustained rapid growth and social stability. The situation is now very
different and there is no reason to assume that past lessons will
necessarily be relevant in the current environment. Nonetheless, the
following lessons learned and how the project design will deal with them,
are quite relevant. Hybrid Operations and General Project Design n The
advantage of a hybrid operation is the potential for increased leverage on
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policy reforms. However, cross conditionalities between policy outcomes
and investment components need to be carefully designed. The Project has
clear linkages between policy reform outcomes and investment components
(see B.3 and D.l).n Complications may occur if there is large co-financing
without clearly defined investment components. The Project's investment
components, including those being co-financed, will be well
prepared/appraised, as if this were a standard sector investment loan.n
The speed and size of reforms are to take account of the social and
political conditions in the country. A hybrid operation (or APL) will
provide an appropriate time frame for the Project (see D.1), and
components are specifically included to mitigate the social impact of
reforms (see C1.2).n Government has in the past shown flexibility in
accepting tough policy conditions, but less commitment to their
implementation . The Project design will front-load the conditionalities,
and in the process will ensure that some key actions will take place prior
to the Board presentation. n Technical assistance needs to focus on
organization rather than just on studies or planning. The Project's TA
activities will be linked to institutional development and organizational
restructuring, instead of simply being isolated individual studies.
Appropriate arrangements will be made to ensure follow up actions on the
recommendations, in some cases through tranche conditions.Power Sectorn
The timetable for unbundling large power utilities needs to be realistic,
taking into account various social and political considerations. Project
implementation extends over a longer period than a typical sector
adjustment operation.n Rural electrification programs must be financially
sustainable. The Project requires the establishment of a Social
Electricity Fund.Gas Sectorn The pricing of natural gas and the corporate
structure of PGN also need to be addressed in order to accelerate the
development of the domestic gas industry. The objectives of the previous
gas distribution projects in Indonesia were to expand the physical network
and enhance efficiency and financial position of the gas distribution
company. The Project addresses the sectoral issues as well, such as gas
pricing, the restructuring of PGN and the increased participation of the
private sector, and the Government's statement of gas sector policy marks
a turning point in this regard.n International experience in the gas
sector shows that private participation in the sector is often enhanced
through establishing a competitive gas market including getting gas to
consumers at competitive prices. The pricing reforms under the Project
will encourage the evolution of a competitive gas market. General and
Project Implementationn Financial covenants need to be relevant and
achievable. For instance, a rate of return on revalued assets covenant
to measure financial performance is not appropriate for a company like PLN
with a very large and lumpy investment program, and in the process of
unbundling. This, and particularly the financial and corporate
restructuring of PLN, will be reflected in the formulation of project
covenants.          n Appropriate performance indicators (especially
outcome or impact indicators to measure the performance of PLN and PGN)
and monitoring are essential. These will be developed during project
preparation.n Attention needs to be given to accurate cost estimates and
on application of contingencies, as well as to availability of counterpart
fundings. Cost estimates (especially those for physical investments) will
be based on the latest market prices and future development trends, and
firm commitment will be sought from PLN and PGN on availability of
counterpart fundings.n Problems arising from dealing with affected people
during implementation.    Affected people will be involved from the early
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stages of project preparation and throughout implementation, to gain and
maintain their support.
9. Program of Targeted Intervention (PTI)     N
10. Environment Aspects (including any public consultation)
Issues        Environmental issues are associated with both the
adjustment and investment components of the Project. A key objective of
the Project is to reduce the impact of the energy sector's impact on the
environment, particularly in regard to improving urban air quality (and
reducing greenhouse gas emissions). This is to be achieved through
supporting the Government in its efforts to increase the domestic use of
cleaner fuels, by prioritizing options to phase out lead from gasoline, as
well as by promoting the development of the domestic natural gas
industry. These outcomes are supported by policy conditions associated
with the adjustment component, as well as by the investment component for
gas distribution.There are, however, potentially adverse impacts
associated with phasing out leaded gasoline, such as the potentially high
benzene and aromatic content of unleaded fuel if specifications are not
comprehensively monitored. There may be other positive and negative
benefits associated with the policy reforms supported by the Project, and
these will be assessed further during project preparation.
11. Contact Point:
Task Manager
M. Farhandi
The World Bank
1818 H Street, NW
Washington D.C. 20433
Telephone: 202-458-0478
Fax: 202-522-1648
12. For information on other project related documents contact:
The InfoShop
The World Bank
1818 H Street, NW
Washington, D.C. 20433
Telephone: (202) 458-5454
Fax:        (202) 522-1500
Web: http:// www.worldbank.org/infoshop
Note: This is information on an evolving project. Certain components may
not be necessarily included in the final project.
This PID was processed by the InfoShop during the week ending February 2, 2001.
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