Report and Recommendation of the President to the Board of Directors Proposed Loan and Administration of Loan and Grant Republic of Indonesia: ...

Report and Recommendation of the President
 to the Board of Directors

Sri Lanka
Project Number: 40061
February 2010

Proposed Loan and Administration of Loan and Grant
Republic of Indonesia: Java–Bali Electricity
Distribution Performance Improvement Project
                     (as of 13 January 2010)

              Currency Unit           –    rupiah (Rp)

                   Rp1.00         =       $.0001090156
                    $1.00         =       Rp9,173


  ADB          –      Asian Development Bank
  AFD          –      Agence Française de Développement
  ASEAN        –      Association of Southeast Asian Nations
  CDM          –      Clean Development Mechanism
  CER          –      certified emission reduction
  CFL          –      compact fluorescent lamp
  CMI          –      Carbon Market Initiative
  CO2          –      carbon dioxide
  DGEEU        –      Directorate General for Electricity and Energy Utilization
  EBITDA       –      earnings before interest, taxes, depreciation, and amortization
  EIRR         –      economic internal rate of return
  EURIBOR      –      Euro interbank offered rate
  FIRR         –      financial internal rate of return
  IEA          –      International Energy Agency
  IPP          –      independent power producer
  IRSDP        –      Infrastructure Reform Sector Development Program
  LED          –      light-emitting diode
  LIBOR        –      London interbank offered rate
  PLN          –      PT (Persero) Perusahaan Listrik Negara (State Electricity
  PSO          –      public service obligation
  SAIDI        –      system average interruption duration index
  SAIFI        –      system average interruption frequency index
  UNFCCC       –      United Nations Framework Convention on Climate Change
  WACC         –      weighted average cost of capital

                   WEIGHTS AND MEASURES

GWh (gigawatt-hour)           –           1,000 megawatt-hours
kilovolt-amperes              –           kVA
kW                            –           kilowatt
kWh (kilowatt-hour)           –           1,000 watt-hours
MVA                           –           megavolt-amperes
MW (megawatt)                 –           1,000 kilowatts
MWh (megawatt-hour)           –           1,000 kilowatt-hours
tCO2eq                        –           ton of CO2 equivalent

       (i)    The fiscal year (FY) of the Government and its agencies ends on 31 December.
       (ii)   In this report, "$" refers to US dollars.

 Vice-President       C. Lawrence Greenwood, Jr., Operations 2
 Director General     K. Senga, Southeast Asia Department (SERD)
 Director             A. Jude, Energy and Water Division, SERD

 Team leader          S. Hasnie, Principal Energy Specialist, SERD
 Team members         D. T. Bui, Economist, SERD
                      R. Butler, Social Development Specialist (Resettlement), SERD
                      R. Kausar, Infrastructure Specialist, SERD
                      M. Sultana, Senior Social Development Specialist, SERD
                      Y. Tsujiki, Financial Analysis Specialist, SERD
                      S. Tumiwa, Principal Planning and Coordination Specialist, Regional
                      and Sustainable Development Department
                      S. Zaidansyah, Counsel, Office of the General Counsel

In preparing any country program or strategy, financing any project, or by making any
designation of or reference to a particular territory or geographic area in this document, the
Asian Development Bank does not intend to make any judgments as to the legal or other status
of any territory or area.

LOAN AND PROJECT SUMMARY                                               i
I.     THE PROPOSAL                                                    1
       A.   Performance Indicators and Analysis                        1
       B.   Analysis of Key Problems and Opportunities                 2
III.   THE PROPOSED PROJECT                                            8
       A.   Impact and Outcome                                         8
       B.   Outputs                                                    9
       C.   Investments                                               10
       D.   Special Features                                          12
       E.   Project Investment Plan                                   13
       F.   Financing Plan                                            13
       G.   Implementation Arrangements                               14
       A.   Financial Analysis                                        18
       B.   Economic Analysis                                         18
       C.   Environmental Benefits and Social Safeguards              18
       D.   Sustainability                                            19
       E.   Risks                                                     19
V.     ASSURANCES                                                     19
VI.    RECOMMENDATION                                                 21
1.   Design and Monitoring Framework                                  22
2.   Climate Change and Indonesia                                     24
3.   Power Sector Analysis                                            26
4.   Analysis of Tariffs, Subsidies, and Sector Road Map              30
5.   Development Coordination                                         35
6.   Detailed Cost Estimates                                          38
7.   Implementation Schedule                                          39
8.   Procurement Plan                                                 40
9.   Outline Terms of Reference for Consultants                       46
10.  Financial Performance and Projections of PLN                     48
11.  Financial Analysis                                               52
12.  Economic Analysis                                                55
13.  Summary Poverty Reduction and Social Strategy                    60
SUPPLEMENTARY APPENDIXES (available on request)
A.   Diagnostic Study of the Indonesian Power Sector
B.   Strategic Road Map of the Indonesian Power Sector
C.   Technical Assessment of the PT Perusahaan Listrik Negara's Distribution Network
D.   Methodology for Benefit Assessment of Energy Efficiency in Distribution
E.   Indonesian Power Distribution Development Strategy
F.   Concept Paper for Energy Efficient Lighting Pilot
G.   Preliminary Clean Development Mechanism Assessment Report

Borrower              Republic of Indonesia

Classification        Targeting classification: General intervention
                      Sector (subsector): Energy (energy efficiency and conservation)
                      Themes (subthemes): Economic growth (promoting economic
                      efficiency and enabling business environment), environmental
                      sustainability (eco-efficiency), capacity development
                      Climate change: The Project contributes to climate change
                      Location impact: Rural (medium), urban (low), national (medium)

                      Partnership: Agence Française de Développement (AFD)

Environment           Category C: The environmental implications were reviewed and
Assessment            no adverse impacts were identified.

Project Description   The Project will reduce the overall carbon dioxide (CO2) emissions
                      of Indonesia's power sector and contribute to the global effort of
                      mitigating the impact of climate change. This will be achieved by
                      saving energy, increasing capacity, deferring distribution capacity
                      expansion by distribution network rehabilitation, and reducing
                      peak demand from use of efficient lighting by residential

                      The efficient lighting program will pilot the use of 500,000 compact
                      fluorescent lamps (CFLs) and light-emitting diodes (LEDs) in
                      selected isolated and islands grids.

Rationale             Indonesia ranks among the top 20 polluters in the world. The
                      country's CO2 emissions per capita have grown significantly since
                      the 1980s, a large part of which is from the burning of oil.
                      Emissions will get worse in the short term, as the Government
                      plans to rapidly expand the use of coal for power generation to
                      reduce its reliance on imported oil.

                      The Government's energy conservation and energy efficiency
                      initiatives will offset part of these emissions, and these efforts
                      need to be part of mainstream planning to have larger impact. PT
                      (Persero) Perusahaan Listrik Negara (State Electricity Corporation
                      [PLN]), the state-owned power utility, has invested in energy
                      efficiency projects for its power distribution, which has reduced
                      overall distribution losses and CO2 emissions. To maintain the
                      momentum, PLN has an ambitious plan to invest about $1.2 billion
                      in distribution between 2010 and 2014. A large part of this plan
                      will be financed by internal resources, and loans from bilateral and
                      multilateral partners.

                          The Asian Development Bank (ADB) will engage with PLN in its
                          overall energy efficiency improvement initiative, with the proposed
                          small Project covering the entire Java–Bali network with
                          cofinancing from the Agence Française de Développement (AFD).
                          The proposed project components could be implemented within 2
                          years. If the proposed Project and the partnership in financing is
                          successful, ADB will scale up this operation with a sector project
                          (using a multitranche financing facility) and support part of PLN's
                          financing needs for the energy efficiency strategy.

                          The Project’s objective is to reduce the peak load demand and
                          system losses by implementing distribution network rehabilitation
                          and an efficient lighting program that will also contribute towards
                          greenhouse gas reduction. Carbon credits will be sought following
                          the approved methodology of the Clean Development
                          Mechanism’s (CDM) executive board. This investment is in line
                          with ADB's commitment to clean energy and energy efficiency
                          across Asia.

                          About 200 megawatts (MW) equivalent in distribution system
                          capacity will be freed and about 400 gigawatt-hours (GWh) will be
                          saved annually through energy efficiency at a cost well below the
                          cost of developing equivalent new capacity. This will reduce the
                          emissions of Indonesia's power sector by about 330,000 tons (t)
                          each year.

Impact and Outcome        The impact of the proposed Project will be reduced CO2 emissions
                          by the power sector. The outcome of the Project is to contribute to
                          PLN's overall power distribution efficiency and quality of power

Project Investment Plan   The investment cost of the Project is estimated at $120.0 million,
                          including physical and price contingencies, interest and other
                          charges during implementation, and taxes and duties of $9.0

Financing Plan            A loan of $50,000,000 from the ordinary capital resources of ADB
                          will be provided to the Republic of Indonesia under ADB's London
                          interbank offered rate (LIBOR)-based lending facility. The loan will
                          have a 25-year term including a grace period of 5 years, an
                          interest rate determined in accordance with ADB's LIBOR-based
                          lending facility, a commitment charge of 0.15% per annum, and
                          such other terms and conditions set forth in the draft loan and
                          project agreements. AFD will cofinance the Project in the amount
                          of $50 million. The loan will have a 15-year term, including a grace
                          period of 5 years, and an interest rate in LIBOR equivalent to a
                          Euro Interbank Offered Rate (EURIBOR)-flat rate and such other
                          terms and conditions set forth in the draft loan agreement.

                           A cofinancing agreement will be entered into by ADB and AFD
                           under which the parties will jointly finance the investment costs.
                           ADB will administer the AFD loan including procurement,
                           recruitment of consultants, and disbursement, according to the
                           cofinancing agreement to be signed.

                           A grant from the Clean Energy Fund under the Clean Energy
                           Financing Partnership Facility will be provided to PLN in the
                           amount of $1.0 million equivalent to be administered by ADB.

                           PLN will finance $19.0 million of the Project costs, including all
                           local taxes and duties.

                                                       Financing Plan
                                                          ($ million)
                              Source                                    Total              %
                              Asian Development Bank                    50.0              41.67
                              AFD a                                     50.0              41.67
                              Multi-Donor Clean Energy Fund
                              under the Clean Energy Financing
                              Partnership Facility
                                                                          1.0               0.83
                              PT (Persero) Perusahaan Listrik
                              Negara                                     19.0              15.83
                                             Total                      120.0              100%
                                 Agence Francaise de Développement.
                                 Established by the governments of Australia, Norway, Spain, and
                               Sweden; and administered by ADB.
                               Source: Asian Development Bank estimates.

Allocation and Relending   Under a subsidiary loan agreement that will be on terms and
Terms                      conditions satisfactory to ADB and AFD, the Government will
                           relend to PLN the proceeds of the ADB and AFD loans.

Period of Utilization      November 2012

Estimated Project          May 2012
Completion Date

Implementation             PLN will be the executing agency and has overall responsibility for
Arrangements               the implementation of the Project. PLN will appoint the deputy
                           director for distribution and commercial for Java–Bali to supervise
                           the implementation of the Project. The deputy director for
                           distribution and commercial for Java–Bali will appoint a project
                           director who will be supported by qualified staff.

                           In each of the five participating regions, the existing technical staff
                           of PLN will implement the Project. The regional manager will
                           appoint a project manager who will be supported by several
                           technical staff. The project managers of each region will
                           coordinate the day-to-day activities through the project director in
                           PLN headquarters but will report to the regional general manager.

Executing Agency           PT (Persero) Perusahaan Listrik Negara (State Electricity
                           Corporation or PLN)

Procurement            The Government requested, and ADB management approved, (i)
                       advance action for procurement of goods and related services,
                       and (ii) retroactive financing for goods and related services. The
                       advance action will cover tendering and bid evaluation up to the
                       stage of ADB’s approval of PLN's recommendation for award of
                       contract before the effective date of the loan agreement. The
                       retroactive financing for goods will cover the 12 months prior to
                       the date of the loan agreement with a ceiling of $5 million, or 10%
                       of the ADB loan amount. The Government was advised that ADB
                       approval of advance contracting and retroactive financing does
                       not commit ADB to approve the proposed loan and that ADB
                       financing will be dependent upon the Government's compliance
                       with all aspects of ADB's procedural requirements, including
                       compliance with the relevant provisions of the loan agreement and
                       ADB's guidelines.

                       All procurement to be financed under the ADB and AFD loans
                       and CEF Grant will be carried out in accordance with ADB’s
                       Procurement Guidelines (2007, as amended from time to time),
                       and the procurement plan prepared and agreed upon between the
                       Government and ADB. Ten contract packages will be procured
                       under the Project through either international competitive bidding
                       or national competitive bidding. Equipment for the pilot project for
                       efficient lighting will be procured though limited international

Consulting Services    Consultants will be selected and engaged under the Project in
                       accordance with ADB’s Guidelines on the Use of Consultants
                       (2007, as amended from time to time). An international consulting
                       firm will be engaged to manage implementation of the Project.
                       The firm will deliver 105 person-months of consulting services (15
                       person-months of international and 90 person-months of national
                       consulting) following ADB’s quality- and cost-based selection
                       method and using full technical proposal. Individual consultants
                       will deliver 18 person-months of consulting services (6 person-
                       months of international and 12 person-months of national
                       consulting) for implementation of the pilot project for efficient

Project Benefits and   The Project will reduce the power sector's CO2 emissions by
Beneficiaries          330,000 t per year. It will also support registration of the proposed
                       Project with the regulatory authorities to capture the value of the
                       avoided emissions as cash flows under the CDM. The value of the
                       avoided CO2 emissions will be around $3.5 million each year.

                       The proposed Project will improve the efficiency of power
                       distribution in all of its five regions on the islands of Java and Bali.
                       PLN will save energy by reducing its distribution losses and at the
                       same time improve power supply voltage to its feeders in west,
                       central, and east Java.

                        Overall, about 400 GWh of electricity will be saved annually—
                        about 100 GWh in Jakarta, 40 GWh in central Java, 50 GWh in
                        west Java, 180 GWh in east Java, and 30 GWh in Bali. The value
                        of the 400 GWh of saved power (assuming a marginal cost of
                        $0.15 per kilowatt-hour) is about $60 million each year.

                        About 200 MW of equivalent distribution system capacity will be
                        freed and, using the saved energy, PLN will be able to connect
                        about 1.2 million additional customers to the Java–Bali network.

Risks and Assumptions   This Project involves no new technology and PLN has all the
                        necessary skills to design and implement the project components,
                        hence risks related to design and implementation are low.
                        Shortage of power generation in the system is another risk, as
                        distribution investment alone will not improve power supply
                        reliability and quality unless there is sufficient power to distribute.
                        However, PLN's efforts in mobilizing financing from both internal
                        and external resources is showing results as about 2,500 MW of
                        additional generation capacity in Java will be commissioned
                        between 2010 and 2012.

                        PLN has also identified a range of specific risks: (i) stronger
                        growth in electricity demand, resulting in overuse of existing
                        equipment (reducing its lifespan); (ii) a worsening financial
                        situation, if revenues are lower than expected because of delays
                        in the payment of subsidies by the Government; and (iii)
                        insufficient investment from independent power producers (IPPs)
                        delaying the much-needed investments in generation. PLN has
                        developed a range of mitigation measures to address these risks,
                        such as (i) planned investments to rehabilitate and optimize the
                        distribution network to reduce overloading and promote demand-
                        side management to reduce demand, (ii) arrangements to raise
                        capital from the domestic market and through borrowings (bilateral
                        and multilateral lenders) so that investments can be implemented
                        in a timely manner, and (iii) introduction of higher tariffs and terms
                        to secure primary energy requirements through long-term
                        contracts, etc.

1.      I submit for your approval the following report and recommendation on (i) a proposed
loan to the Republic of Indonesia, (ii) proposed administration of a loan to be provided by
Agence Française de Développement (AFD) to the Republic of Indonesia, and (iii) proposed
administration of a grant to be provided by the Clean Energy Fund under the Clean Energy
Financing Partnership Facility to PT (Persero) Perusahaan Listrik Negara, for the Java–Bali
Electricity Distribution Performance Improvement Project. The design and monitoring framework
is in Appendix 1.


2.      Indonesia ranks among the top 20 polluters in the world. The country's carbon dioxide
(CO2) emissions per capita have grown significantly since the 1980s, a large part of which is
due to the burning of oil. As a strategy to reduce its reliance on imported oil, the Government
plans to rapidly expand the use of coal for power generation, which will increase CO2 emissions
from the power sector. At the same time, the Government has taken initiatives to implement
energy conservation and energy efficiency policies to reduce emissions. PT (Persero)
Perusahaan Listrik Negara (State Electricity Corporation [PLN]), the state-owned power utility,
has invested in energy efficiency projects for power distribution, which has reduced overall
distribution losses and CO2 emissions. PLN has an ambitious plan to invest about $1.2 billion in
the distribution sector between 2010 and 2014 to further reduce distribution losses and CO2
emissions. A large part of this plan will be financed by loans from bilateral and multilateral

3.       The Asian Development Bank (ADB) will engage with PLN in its energy efficiency
improvement initiative, with the proposed small Project covering the entire Java–Bali network
with cofinancing from AFD. If the proposed Project and the partnership in financing are
successful, ADB will scale up this operation with a sector project (using a multitranche financing
facility) and support PLN's financing needs for pursuing its energy efficiency strategy. This
investment will supplement ADB ongoing policy work in the power sector, and will reduce
energy sector emission by reducing distribution losses, promoting energy efficient lighting
alternatives to customers, and making customers aware of energy efficiency measures.

A.         Performance Indicators and Analysis

4.       Geographically Indonesia is unique with its huge number of islands and vast coastlines.
About 65% of the population of Java island lives in coastal regions, and they are therefore
vulnerable to the effects of sea-level rise. Indonesian islands are vulnerable to earthquakes and
high waves because of their geographic location—between two shelves of the Asian landmass
and the combined Australian and New Guinean landmass. Indonesia's forest areas are also
prone to natural disasters, and events such as volcanic and tectonic earthquakes and tsunamis
are fairly common. In addition, the islands are subject to extreme weather events, such as long
dry seasons and floods. According to the International Disaster Database (2007), 1 the 10
biggest natural disasters in Indonesia in the last 100 years took place after 1990, and most of
these disasters were weather-related: flood, drought, forest fire, and increase of endemic
diseases. The Government estimates that the economic losses from the 10 biggest disasters to
be about $26 billion, of which around 70% is climate related.

    Centre for Research on the Epidemiology of Disasters (CRED). 2007. The International Disaster Database.

5.      As Indonesia is vulnerable to the threat of climate change, the Government plans to
reduce greenhouse gas emissions from the energy sector, and from land use, land-use change,
and forestry. Indonesia ratified the United Nations Framework Convention on Climate Change
through Act No.6 in 1994, and ratified the Kyoto Protocol through Act No. 17 in 2004. It also
plans to invest in carbon sequestration activities. The Government plans to work with its bilateral
and multilateral partners to tackle the threat of climate change.

6.      According to the World Resource Institute's publication2 in 2007, Indonesia’s emissions
per capita have grown by about 150% since the 1980s, and by about 67% since the 1990s.
About 56.5% of annual CO2 emission is from oil burning, 35% is from coal, and 18.5% is from
gas. Estimates for annual emissions vary from 250 million tons (t) to 280 million t. The power
sector is a major emitter, and this will increase further with the Government's plan to expand the
use of coal for power generation.

 7.     According to a Government study,3 if no effort is made to reduce emissions, total CO2
emissions from the energy sector could reach 1,200 million t by 2025. The Government could
significantly reduce these emissions using three simple strategies: (i) energy diversification, (ii)
energy conservation; and (iii) implementation of clean technology. The immediate solutions are
increased use of renewable energy, energy efficiency, and conservation. According to the
National Energy Conservation Master Plan 4 , Indonesia could save about 10%–30% of its
energy demand through conservation and efficiency measures. A detailed analysis of climate
change issues and overall emissions in Indonesia is discussed in Appendix 2.

8.      Despite the Government's plan to diversify energy resources and mainstream energy
efficiency, it is compelled to build more coal-fired power stations to meet immediate energy
demands. These short-term decisions are prompted by the many problems faced by the power
sector, some of which are discussed in section B.

B.      Analysis of Key Problems and Opportunities

        1.       Key Problems and Constraints

                 a.       Growing Power Demand, Supply Shortage, and Lack of Investment

9.       Indonesian electricity demand is growing rapidly; demand growth peaked at about 16%
per annum during 1994–1995, with a maximum demand of about 12,800 megawatts (MW) in
1997. This demand was met by power purchase contracts with independent power producers
(IPPs); most contracts were 30-year "take-or-pay"5 agreements in dollars. When demand growth
slowed in 1997, these take-or-pay obligations led PLN into a severe financial crisis and, as a
result, investments in the power sector fell considerably. New investments have not kept pace
with the growing demand for electricity; since 2001, electricity sales have grown by about 7%
and the peak demand by 6%, but during the same period PLN’s power system grew by less
than half of that amount—the transmission network grew by 3.2%, the distribution network grew
by 1.7%, and new generation capacity grew by 1.4%. Distribution rehabilitations were delayed.
The deferral of rehabilitation has no immediate impact on the distribution system but as
investments are delayed (due to budget shortfall), the distribution systems were overloaded and

  Climate Analysis Indicators Tool (CAIT). Available:
  Republic of Indonesia. 2007. National Action Plan Addressing Climate Change. Jakarta.
  National Energy Conservation Plan/ Rencana Induk Konservasi Energi Nasional (RIKEN)- Decree No. 100.K
  A buyer agreeing to buy a fixed quantity of electricity from a generator for an agreed price over a period of time
   irrespective of the actual need of the buyer in future.

losses increased. Because of lack of investments in the power sector, the main islands of Java
and Bali are experiencing power outages. With the high demand, the system reserve margin
has become smaller, causing frequent load shedding with blackouts lasting for 2–3 hours each
day. In December 2008, the maximum system demand was 15,570 MW (compared with 16,300
MW in 2007) in the Java–Bali grid and during the same month PLN had to shed between 80
MW and 860 MW every day from the peak demand. Detailed analysis of the power sector is in
Appendix 3.

                    b.        Dependency on Oil and High Cost of Power

10.      Oil is one of the most expensive fuels for power generation. As more than 30% of power
generation in Indonesia is based on either diesel or fuel oil, the cost of power generation is high.
In 2008, PLN's average cost of production was $0.13 per kilowatt-hour (kWh), while the cost of
power generation in neighboring countries was between $0.03/kWh6 and $0.11/kWh. Since PLN
is fully exposed to the international market price of oil, its reliance on oil also creates large
fluctuations in its power generation cost, while the tariff remains fixed.

                    c.        Lack of Incentives and Policy Support for Renewable Energy

11.     Indonesia has great potential for renewable energy, especially hydro and geothermal.
Solar technologies are becoming more attractive in Indonesia as price of solar panels has come
down and panel efficiencies have improved. In addition, there is scope for low-carbon emission
energy sources based on coal seam methane and coal mine methane. These sources improve
energy security as they are not exposed to international supply or pricing risks. The Government
has to provide direct incentives for renewable energy development, so that in isolated off-grid
areas and in remote islands, small-scale renewable energy generation could be established,
despite its high cost, rather than the ubiquitous stand-alone diesel generation.

                    d.        Lowest Electrification Rate in the Region

12.     About 90 million people, or 38% of the Indonesian population, have no access to
electricity and most of the rural population relies on biomass for their primary fuel for cooking
and kerosene for their lighting needs. Because of the lack of incentives for private investment
and shortage of capital for public investment, access to electricity by the Indonesian population
remains one of the lowest in the region.

                    e.        Inefficient Lighting Contributing to High Energy Intensity

13.     Indonesia's energy consumption per capita is much smaller than it is in both Thailand
and Malaysia, while Indonesia's energy intensity is significantly higher than that of its neighbors.
Use of relatively inefficient appliances by residential consumers contributes to this. Although
electricity consumption by the residential sector varies widely across different income classes in
rural and urban areas, on average more than 50% of the electricity is used for lighting by
residential customers. Consumers are aware of the benefits of energy efficient compact
fluorescent lamps (CFLs), however they continue using incandescent bulbs which are cheaper
but consume about five times more energy. Consumers are concerned about the cost and
quality of CFLs, but unaware of the quality, standard, or regulated labeling for CFLs. While good
quality CFLs can last for 8,000–15,000 hours, poor quality ones often fail within 100 hours.
When cheap ones fail after a short time, consumers are reluctant to replace them.

    The average wholesale electricity price in the National Electricity Market of Australia.

                   f.       Main Cause of the Problems

14.      Most problems described in paras. 9-13 stem from the following main causes: (i) low
tariffs and high subsidies, (ii) policy gaps as a result of poor coordination and decision making,
(iii) barriers to private sector investment and lack of regulatory clarity, (iv) PLN's overall
monopoly position, and (v) the absence of a rural electrification strategy and financing. In
addition, the Indonesian power tariff is one of the lowest in Asia and, because of the low tariffs,
PLN only recovers part of its cost of electricity production and supply from its sales revenue.
Electricity tariffs have remained the same7 since 2003, although the cost of supply has more
than doubled from $0.056 to $0.132 per kWh during the same period. Since the Government
has maintained these low tariffs for social reasons, it provides direct subsidies to PLN to meet
the financing gap. In 2008, subsidies to PLN became a major drain on Government budget and
reached the all time high of $7.6 billion, increasing from $315 million in 2004. Detailed
discussion on tariffs and subsidies is in Appendix 4. The low tariffs and associated subsidies
have created a range of disincentives for PLN, consumers, and other stakeholders, leading to
the main problems in the sector.

          2.       Government’s Policies and Plans

15.       As Indonesia is an oil producing country, the Government has always faced the policy
issue of allocating the right amount of oil for local consumption and for export, especially during
periods of high prices. For example, after the oil crisis of the 1970s it progressively reduced the
proportion of oil for power generation from about 70% in the 1980s to about 54% in 1993 and to
21% in 1998. However, this proportion rose back to about 36% in 2005, and the high domestic
consumption made Indonesia a net importer of oil. This prompted immediate policy change, and
the Government increased domestic oil prices by 49% in March 2005 and by 105% in October
2005, causing the price of high-speed diesel to triple, from $0.18 per liter in 2004 to $0.55 per
liter in 2006.

16.     In addition to raising prices, the Government initiated a fast-track program8 to reduce
dependency on oil for power generation. Under this program, it plans to develop 10 coal-fired
power plants in Java–Bali (7,520 MW) and 23 coal-fired power plants outside Java–Bali (1,963
MW). A second fast-track program that includes about 60% renewable energy generation will be
implemented between 2009 and 2014. These initiatives will address the immediate problems of
power shortage, the high cost of power (and dependency on oil), and low use of renewable
energy. As a policy support to encourage these investments, in April 2009 the Government
issued ministerial decree No.5/2009, which removed the previous price cap of $0.045/kWh for
power purchase from IPPs, and gave PLN the exclusive authority to decide on IPP prices. PLN
has increased the price for new IPPs to between $0.065/kWh and $0.085/kWh, and since then
has acted as a single buyer of electricity from the IPPs. ADB's engagement in the power sector
will help the Government to switch to clean coal technologies and renewable energy options for
future power generation (discussed in paragraph 29).

17.   The overall sector strategy is reflected in the Government’s Blueprint of National Energy
Management 2005–2025, which recognizes the high share of oil in the energy mix and
dependence on oil imports, and sets the following targets for 2025: to reduce the use of oil to

    In real terms, the tariffs have actually been reduced by about 50% since 2003, as the Indonesian consumer price
    index increased to 161.73 in 2008 from 105.65 in 2003. Source: Statistics Indonesia.
    Presidential Decree No. 71 of 2006, requiring PLN to invest in new coal steam-fired power plants under its energy
    diversification strategy and add about 10,000 MW to address the power deficit.

less than 20% and increase the use of (i) coal (from 15.7% to more than 33%), (ii) liquefied coal
(to more than 2%), (iii) natural gas (from 23% to more than 30%), (iv) geothermal energy (from
1.9% to more than 5%), and (v) biofuels and other renewable energy (to more than 10%).

18.     The Government is addressing the issue of lowest electrification in the region in its
National Electricity Development Plan, which aims to increase the electrification ratio to 90% by
2020. PLN plans to connect around 10 million new customers between 2010 and 2014 to
achieve the Government’s commitment to increasing the electrification rate, and has a long list
of investment plans with an estimated cost of about $14.4 billion.

       3.      Opportunities

19.     In some respects the power sector in Indonesia has significantly improved in recent
years compared to the 1990s and early 2000s. These improvements are in line with broader
trends to better economic management and governance in Indonesia. For example, PLN has
introduced greater transparency in reporting, established good corporate governance and
independent audit, and strengthened financing to support issuance of international bonds. It is
also moving from an engineering-dominated culture to one with greater emphasis on other
disciplines. For example, losses have been reduced gradually since 2004. In 2007, the
gigawatt-hours sold per employee increased to 3.8 GWh from 1.7 GWh in 2002, and the
number of customers served per employee increased to 941 from 648 in 2002. PLN has also
developed separate accounting reports for the operations of its distribution businesses in
geographic regions. Sector issues are discussed in details in Supplementary Appendix A.

20.     In relation to energy efficiency, the energy policy currently being developed should set
out principles that guide priorities, identify specific areas for immediate attention, and consider
budget implications. ADB's sector study recommends the setting up of a separate directorate
general for energy efficiency and renewables to lead implementation of the energy efficiency

21.     As Indonesia’s subsidized energy sector contributes to inefficient public spending and
impedes investment to modernize the sector, there is a strong economic justification for
investing in projects that mitigate climate change. In addition, because the subsidies are linked
to world energy (and price shocks), potential carbon payments for emission reductions will not
only provide economic benefits but also reduce exposure to oil prices—sufficient incentives to
promote energy efficiency.

22.     PLN is committed to increasing efficiency in its distribution network. During 2004–2008
PLN invested about $730 million in the Java–Bali distribution network, averaging about $175
million each year, except in 2008 when the investment level dropped to about $33 million
because of the high price of fuel. Investments were made in electrical equipment and in
replacing old equipment that did not meet load specifications. Networks were optimized to meet
the changing needs of growing power demand and changing load flow conditions, and to avoid
overloading of equipment and bottlenecks in the network. These investments reduced
distribution losses. PLN management is committed to reducing distribution losses to 6% (the
international norm is 3%–5%) by investing about $1.2 billion between 2010 and 2014. In 2008,
the distribution system loss was about 8.4%—its lowest level ever—as a result of PLN's network
optimization investments since 2003.

23.   Through the proposed Project, ADB will establish a partnership with the AFD to support
PLN's energy efficiency initiative. It will also bring in expertise and processes to quantify and

capture the benefit of the avoided CO2 emissions as a financial benefit to the project, and
participate in the global efforts to mitigate the threat of climate change. If this approach and
partnership is successful and progress is made on implementation of some of the policy
recommendations, ADB will scale up this small investment with a sector project for energy
efficiency and renewable energy to meet the growing local investment need and to generate the
global public good of emission reduction to tackle the threat of climate change.

        4.      Clean Development Mechanism Credits

24.      Under the Kyoto Protocol, the Clean Development Mechanism9 (CDM) was developed to
set targets for emissions and create a market for emission reduction with economic value. The
CDM allows emission reduction (or emission removal) projects in developing countries to earn
certified emission reduction (CER) credits, each equivalent to 1 ton of CO2 and these CERs can
be traded, sold, and used by industrialized countries to meet part of their emission reduction
targets set under the Kyoto Protocol. Indonesia has large potential to reduce emissions either
by energy saving or through energy efficiency. As Indonesia relies heavily on oil and coal for its
power production, it is, theoretically, a country with high CDM potential in the Association of
Southeast Asian Nations (ASEAN) region. An emission factor of more than 0.8 tons of CO2 per
MWh implies that each megawatt-hour of avoided power generation in Indonesia produces
about 60% more emission credit than it does in the Philippines, which has an emission factor of
about 0.5 tons of CO2 per MWh. Despite this large incentive, according to the database of the
United Nations Framework Convention on Climate Change (UNFCCC), as of October 2009 only
24 projects had been registered from Indonesia with the executive board of the CDM and about
224,000 CERs had been issued, indicating that Indonesia had only been able to capture about
2% of the global CDM market.

        5.      ADB Strategy

25.     The developing countries of Asia are gradually developing strategies and programs for
both their climate change and adaptation measures. To mitigate energy-associated emissions,
energy efficiency improvements and low-carbon and zero-carbon solutions are being adopted.
Already, ADB is working with new financing mechanisms and capacity building for energy
efficiency improvements, renewable energy, waste to energy, sustainable transport, and other
emission mitigation projects. This will be achieved through ADB's clean energy and environment
programs, including the Energy Efficiency Initiative, Carbon Market Initiative (CMI), and
Sustainable Transport Initiative.

26.      ADB has initiated a range of energy programs including the Energy Efficiency Initiative10
to increase the number of clean energy projects in Asia and the Pacific. One of the key
components of the program is the CMI, which provides technical support and up-front financing
for clean energy projects with greenhouse gas mitigation benefits. The CMI is a value-added
service extended to renewable energy and energy efficiency projects in Asia and the Pacific that
are suitable for ADB financing. It contributes to ADB’s sustainable development efforts by
providing additional financial incentives to project developers and sponsors to construct and
operate clean energy projects. In Indonesia, ADB provided technical assistance to develop
institutional capacity to process and promote CDM projects.11

   More information is available at
   Launched in July 2005, with the aim of investing $1 billion per year on clean energy from 2008 to 2010
   ADB. 2004. Technical Assistance to the Republic of Indonesia for Institutionalizing the Clean Development
   Mechanism. Manila.

27.     ADB has had a long relationship with the Government of Indonesia and PLN. ADB
started its lending in 1970 and has financed 30 power projects totaling about $3.4 billion and 36
technical assistance projects totaling about $14 million. The lending has focused on the
generation and transmission sectors. ADB Independent Evaluation Department studies for the
sector show that ADB has a comparative advantage in providing loans for energy, transport,
communications, social infrastructure, and finance projects. The Independent Evaluation
Department noted that in the power subsector, with few exceptions, the completed loan projects
succeeded in achieving their expected outputs and immediate objectives, including the provision
of additional capacity to match load growth, the removal of transmission system constraints,
improvement in system efficiency and reliability, increase in the use of indigenous energy
resources (hydropower and geothermal), and contribution to socioeconomic development.

28.      ADB’s country strategy and program for 2006–200912 and country operations business
plan 2009–2011 13 support a medium-term growth rate of 6% per annum and highlight the
importance of removing infrastructure bottlenecks in the power sector and establishing
attractive, effective, and transparent incentives for private sector participation.

29.     Clean energy and energy efficiency will be the target of ADB's future investments in
Indonesia. Investment in the generation sector will be either in the form of public–private
partnerships (to encourage private sector investments) or through the use of guarantee
instruments to mobilize commercial cofinancing that will be limited to renewable energy
(hydropower or geothermal power) and efficient thermal power plants 14 (with supercritical or
ultra-supercritical boiler combined-cycle gas-fired power plants). ADB's involvement will play a
catalytic role by attracting other investors. ADB's interest will be limited to strategic transmission
investments that will (i) link different islands to reduce the overall need for reserve capacity to
improve system reliability, remove transmission bottlenecks, and transmit cheaper power from
one area to the other; or (ii) connect two transmission grids across national boundaries where
both countries will benefit from cross-border power trading with ADB playing the role of an
honest broker. In addition, ADB will promote political-risk guarantees or other guarantees to
reduce the risk of private investments in power transmission. ADB's focus on distribution will
cover both rehabilitation for loss reduction and reliability improvement, and new investments to
support new connections.

30.     Recently the Government requested the International Energy Agency (IEA) to undertake
an energy policy review for Indonesia, which suggested six areas for priority attention: (i)
domestic energy pricing and subsidies; (ii) policy coordination, decision making, and
implementation; (iii) energy sector investment; (iv) independence and authority of energy
regulators; (v) harnessing of a sustainable development agenda particularly through renewable
energy implementation; and (vi) mainstreaming of energy efficiency and conservation policy. As
a necessary next step of the IEA study, ADB has finalized a detailed sector diagnostics and a
sector strategy. These studies are in Supplementary Appendixes A and B.

         6.       Development Coordination

31.    The World Bank's strategic focus is on strengthening the technical and operational
capacities of state institutions such as PLN. Together with ADB and Japan, the World Bank is

   ADB. 2006. Indonesia Country Strategy and Program (2006–2009). Manila.
   ADB 2008. Country Operations Business Plan, Indonesia (2009-2011). Manila
   Using less coal (less CO2 ) for the same amount of power generation by increasing plant efficiency.

supporting effective targeting of electricity subsidies and development of a sustainable pricing
policy. The policy loans of ADB and the World Bank have the objective of increasing private
investments in the energy sector through public–private partnerships, focusing on clean and
renewable energy projects (such as geothermal power investments together with Pertamina
Geothermal Energy and the $500 million Upper Cisokan pumped storage project), and power
transmission and distribution projects including gas distribution.

32.     Japan's lending to Indonesia has been similar. About 26% of its total portfolio in
Indonesia is for the energy sector; ¥377 billion of development assistance was lent to the sector
during 1996–2006. Japan has also prepared a geothermal sector master plan, which was
completed in December 2007, and an energy efficiency study, finalized in 2008. Project lending
by Japan has mainly focused on generation, including both small-scale geothermal and gas-
fired power plants. In 2009, Japan International Cooperation Agency signed an agreement with
PLN to finance the $1.8 billion high-voltage direct current link connecting Sumatra with Java to
meet the growing demand for power in the Java–Bali grid. Cooperation and harmonization of
development partners in the power sectors has been generally fluid with regular invitations from
each of the key players to participate in meetings or missions and exchange of information and
documents. Policy dialogue was undertaken jointly on several occasions and this is well
received by the Government in light of the Paris Declaration. Key activities and strategies of
major development partners are described in Appendix 5.

           7.      Lessons Learned

33.     During and after the Asian financial crisis, many components of the then ongoing
projects had to be cancelled due to inadequate counterpart financing. ADB's last energy sector
project loan 15 had sufficient allocation for counterpart financing. However, difficulties in
complying with ADB’s social and environmental safeguards policies and slow processing of
contract awards delayed the implementation of these projects. Although both the projects were
designed to be completed by March 2008, less than 30% of the combined loan amount had
been disbursed as at February 2010. Land acquisition and resettlement has been the main
cause of implementation delay of these two projects. The proposed Project will not face these
delays as it involves no new civil works.

34.      The risk of procurement delays has been addressed through advance procurement
action for consultant selection and for preparation of bidding documents. ADB's procurement
specialists have been involved in designing the procurement plan and its contract packages to
minimize the risk of future delays. Because the project components involve rehabilitation, they
will not trigger any of the social and environmental policy safeguards of ADB.

                                    III.    THE PROPOSED PROJECT

A.         Impact and Outcome

35.    The impact of the proposed Project will be reduced CO2 emissions by the power sector.
The reduction will be about 330,000 tons each year for about 15 years— a small amount
compared with the total annual emission by the Indonesian power sector. Despite its small
impact, nationally the Project will demonstrate the ability to (i) defer large investments in
     ADB. 2002. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the
     Republic of Indonesia for Renewable Energy Development Project. Manila (Loan 1982-INO); and ADB. 2002.
     Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Republic of
     Indonesia for Power Transmission Improvement Project. Manila (Loan 1983-INO).

generation and distribution system capacity through energy efficiency, and (ii) earn revenues
from the CDM mechanism. Once successful, a larger operation of a similar type will reduce
large emissions by the power sector.

36.     The outcome of the Project will be to contribute to PLN's corporate effort to improve
overall distribution efficiency and improve quality of power supply. Overall loss will be reduced
to 7.0% from 8.4% by 2013. Customers' power supply voltage will improve in all regions,
especially in rural areas. In 2008, on average, each customer’s power supply was interrupted
about 6.8 times. The project will contribute to reducing the average number of power
interruptions per year to three interruptions by 2013. Reliable and higher quality power in the
house will have a positive impact on household income and social activities, especially in the
evening. The increased longevity of appliances (in households, schools, or hospitals) will
increase service delivery and economic activities.

B.     Outputs

37.     The proposed Project has five outputs: (i) reduced losses in the Java–Bali power
distribution system, (ii) incremental sales resulting from increased distribution capacity, (iii)
increased access to power by new customer connections, (iv) reduced peak demand and
increased awareness of efficient lighting options in isolated grids and selected islands, and (v)
efficient project implementation.

       1.      Part 1: Reduction of Distribution Losses

38.      Output 1. The Project will reduce distribution losses by (i) reconfiguring electrical
equipment through optimization of its location and size, (ii) reconductoring or replacing old low-
and medium-voltage overhead distribution lines, (iii) replacing overloaded low- and medium-
voltage transformers with new transformers of appropriate specifications, (iv) inserting additional
transformers (splitting feeders into two) in long low-voltage overloaded distribution lines, (v)
installing cubicles that will operate within design parameters, and (vi) new switching stations and
capacitors. By 2012, the total savings from loss reduction will be about 400 GWh each year—
comprising about 100 GWh in Jakarta, 40 GWh in central Java, 50 GWh in west Java, 180 GWh
in east Java, and 30 GWh in Bali. The value of the 400 GWh of saved power (assuming a
marginal cost of $0.15/kwh) is about $60 million each year.

39.     Output 2. Incremental sales are the additional energy the distribution network will be
able to distribute to customers because of the optimization of its distribution system. As some of
the bottlenecks will be removed, the network's overall capacity will increase because of the
Project. Incremental sales will be the result of (i) reconfiguring the equipment, (ii) reconductoring
both low- and medium-voltage overhead lines, (iii) additional transformer capacity, and (iv)
capacitors that will reduce reactive power. The overall incremental sales will be about 635 GWh
per year, with about 175 GWh in Jakarta where, for each square kilometer (km), PLN's load
density is about 2.2 MW serving about (6,800 people), and about 85 GWh in central Java,
where the load density is 68 kilowatts (kW), serving about 980 people.

40.    Output 3. Increased access to power is an indirect output of this Project. The energy
saved in output 1 will be enough to connect about 1.2 million new customers to the grid in
Jakarta (275,000), central Java (110,000), west Java (110,000), east Java (620,000), and Bali
(85,000). As a result, the waiting time for new connection will be reduced. The waiting list for
new connection has grown from 414,000 in 2004 to about 800,000 in 2008. At the end of 2008,
while PLN connected about 800,000 new customers, another 819,000 were on the waiting list—

225,000 in west Java, 200,000 in Jakarta, 210,000 in central Java, 160,000 in east Java, and
24,000 in Bali. Larger numbers of customers will be connected through incremental sales.

           2.      Part 2: Efficiency Lighting Pilot

41.     Output 4. Reduced peak demand in pilot areas will be achieved by promoting energy
efficient lighting solutions to residential customers. Compact fluorescent lamps (CFLs) are a
well-established alternative to incandescent light bulbs. According to recent IEA studies,16 about
25% of the energy consumed by CFLs is converted to visible light compared with just 5% for a
conventional incandescent lamp. Hence a typical CFL consumes about 20%–25% of the energy
used by an incandescent light bulb for the same level of light. Put simply, if 1 million
incandescent bulbs are replaced with CFLs at a cost of about $1.0 million, the electricity
demand will be reduced by 50 MW. The impact on the power system will be the same as
building a new 50 MW power station, which may cost at least $50 million, another $2 million–$3
million each year to operate, and take 3–4 years to construct.

42.     Electricity consumption by Indonesia’s residential sector varies widely across different
income classes in rural and urban areas. However, more than 50% of the electricity is used for
lighting by residential customers, making efficient lighting the main focus for immediate energy
efficiency gains. Under this Project about 500,000 CFLs and LEDs will be distributed in selected
isolated and island grids covering the entire country. Multiple sites (either island grid or isolated
systems within the main islands) will be part of the pilot. This will include the distribution of about
30,000 CFLs on the island of Nusa Penida, which will have a large visible and quantifiable
output. Nusa Penida has an installed capacity of about 3,400 kW, of which about 900 kW is
generated by wind and solar and the remainder by diesel that is shipped to the island.
Preliminary estimates suggest that the maximum demand of 1,900 kW of the island could be
reduced by 300 kW if efficient lighting is used by its 7,000 users. The marginal cost of
generation on Nusa Penida is about $0.30/kWh that involves burning about 7,000 liters of diesel
fuel each day at a cost of $7,000, including transport cost. This could be reduced by 30%—a
potential saving of $800,000 each year—if each family on the island replaced their incandescent
bulbs with low-wattage CFLs or equivalent LEDs. A detailed description of this in
Supplementary Appendix F.

           3.      Part 3: Project Implementation

43.     Output 5. The Project will also provide consultants to support Project implementation,
preparation and evaluation of bidding documents, and construction supervision. Although PLN
has the technical competency to design and implement similar projects, implementation
consultants will support PLN to implement the project within the tight 2-year time frame. In
addition, the consultant will assist PLN in all aspects of procurement and will also ensure that
the design is the least-cost solution for the individual region.

C.         Investments

44.     Under the Project, the following investments will be made in the five regions of Java–
Bali. The investment in equipment will be supported by implementation consultants to ensure
timely delivery of the outputs.

     International Energy Agency. 2006. Barriers to Technology Diffusion: The Case of Compact Fluorescent Lamps.

        1.       Jakarta Region
45.     The distribution network in the Jakarta region has been progressively overloaded over
the years and needs urgent rehabilitation. The medium-voltage feeders are short and the main
part of the network is underground. The sustained heavy feeder loads have damaged parts of
the distribution network. Hence, system reconfiguration, including reinforcement by new,
efficiently located urban substations, is required to reverse this situation. In Jakarta and the
Tangerang region the Project will (i) install around 226 additional distribution transformers with
315 kilovolt-amperes (kVA), 400 kVA, 630 kVA, and 1,000 kVA ratings; (ii) upgrade 77 existing
distribution transformers and connecting low-voltage lines; (iii) lay about 180 km of medium-
voltage underground cables and about 25 km of overhead distribution lines; and (iv) connect 21
additional distribution transformers on the medium-voltage overhead line in the industrial areas
of Tangerang and Kebayoram.

        2.       West Java
46.     In west Java and Banten, most feeder lines are long, resulting in high losses and a
network that operates on a poor power factor of less than 0.85.17 The city of Bandung faces a
large number of outages each year as feeder lines are overloaded. The Project will procure new
efficient transformers, and shorten the length of feeder lines to reduce losses to improve the
quality of supply, especially in the main industrial areas. The Project will cover Bandung (the
capital city of west Java), Banten (the capital of Banten province), Bekasi, Depok and Karawang
(industrial areas near Jakarta), and Bogor.

47.      The Project will (i) add 15 new switching stations on land already owned by PLN; (ii)
install new medium-voltage feeder lines (about 249 km of underground cables and 45 km of
medium-voltage overhead distribution lines); (iii) reconductor around 160 km of medium-voltage
distribution lines; (iv) install or replace 62 medium-voltage cubicles in switching stations; (v)
motorize 110 remote-controlled reclosers, load break switches,18 and cubicles; (vi) install around
350 new pole-mounted distribution transformers, and 6 transformers (400 kVA and 630 kVA)
connected by 150 km of low-voltage distribution lines equipped with twisted cable; (vii) upgrade
108 distribution transformers; (viii) replace around 50 km of low-voltage-line conductors,
changing from 35 square millimeter bare conductors to low-voltage twisted cable; and (ix)
replace 915 low-voltage panels in the distribution transformers.

        3.       Central Java
48.     The central Java distribution system supplies large rural areas and some big cities. In
rural areas, the single-phase system is unable to cope with load density and growth. The long
feeder length, which in some cases exceeds 60 km, causes large voltage drops and high
losses. The power factor (about 0.8) is also seen as a problem in this region. In central Java
(central Java and Jogyakarta), the Project will (i) transform about 85 km of single-phase
medium-voltage lines to three-phase lines; (ii) upgrade about 61 km of three-phase medium-
voltage lines; (iii) upgrade 2,888 pole-mounted distribution transformers according to the above
upgrading; and (iv) install 13 capacitors banks along 13 medium-voltage feeder lines.

   Power factor is the ratio of the real power to the apparent power, and is a number between 0 and 1 expressed as a
   An electric switch designed to operate (open or close) a circuit with several hundred thousand volts.
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