Geothermal power plant investment evaluation study case: Indonesia

Fuadi Arif Nasution ST, M.Eng Bina Nusantara University, Jakarta, Indonesia e-mail: [email protected]

ABSTRACT Indonesia as an island country and has more than 28,000 MW (NGAI 2010) geothermal potential still facing problem due to low electrification rate which is only at level 66%. To address this issue, the government of Indonesia issuing several Policies that give legal basis for geothermal to produce electricity and expected to attract private investors to participate. The objective of the paper is to develop different scenarios to assess attractiveness of geothermal investment in Indonesia. Those scenarios are for instance state-owned modeling projects, private sectors modeling projects and external additional income in term of carbon values were imposed for both scenarios. For investment evaluation, further analysis was conducted to check sensitivity analysis with usage of NPV and IRR as parameter analysis. The comparison results could be found in Table 7 page 8 in content of the paper.\ The simulation results for all of the scenarios have indicated that the geothermal as a business investment in Indonesia is not very attractive. This is due to Indonesia being a developing country which already facing certain risks leading to a higher expected rate of return calculated by Weighted Average Cost of Capital (WACC). It could be further exploited with the issue of risk regarding climate investment and the guarantee for long term investment. Besides that, it could be seen that external additional income from CERs would contribute rise from a value around 3% increase of IRR. When observed from a further optimistic expectation on CERs revenue at US$ 20, the IRR gap will increase at level 5%. From above results, some program still recommended to support the geothermal power plant development such as renewable energy pricing policy, lift-off subsidy for fossil-fuels price, taxes or carbon charges, exemption of taxes or some other relevant policies that expected conducted by government to support geothermal development.

KEYWORDS: Geothermal, Investment, IRR, NPV, Policy Abbreviations CDM CERs IPPs IRR NGAI NPV PLN

Clean Development Mechanism Certified Emission Reductions Independent Power Producers Internal Rate Return National Geological Agency of Indonesia Net Present Value Perusahaan Listrik Negara

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INTRODUCTION Indonesia as an island country has more than 200 volcanoes along Sumatra, Java, Bali and eastern parts of Indonesia, which is known as “The Ring of Fire”. The Ring of Fire is coherent with geothermal potential resources which were estimated by the National Geological Agency of Indonesia (NGAI) to be more than 28,000 MW. Currently, Indonesia’s electrification rate is only 66% (see note 1). To address this low percentage, the government of Indonesia plans to utilize geothermal energy resources as a main source for alternative energy to substitute fossil fuels in the coming years. Geothermal power is a safe, renewable, low-carbon option as a solution for producing base load electricity in Indonesia. Developing geothermal reserves can address issues of energy, famine, global warming, and the independence of energy resources in Indonesia.

POLICIES AND REGULATIONS In 2003, Government of Indonesia issued Law No.27/2003 which give legal basis for geothermal business. Following the issue of Law No. 27/2003, guidance for implementation stated in Government Regulation No. 59/2003 for geothermal business activities which introduce tendering process for geothermal working area. Latest issuance of Ministry of Energy and Mineral Resources (MEMR) Decree No.32/2009 that determined the ceiling price of power purchasing by PT PLN at US$ 9.7 cents/kWh expected give incentives to the involvement of private sector in geothermal business in Indonesia. Besides that incentives from Ministry of Finance No.177/2007 for import duty exemption for geothermal upstream equipment and Law on utilization of forest area for geothermal Law No.24/2010 are the others policies that expected to support development of geothermal energy.

BARRIERS AND CHALLENGES Basically the barriers in geothermal industry could be from technical aspects and nontechnical aspects. From technical perspectives, geothermal is classified as mature technologies with most common technology are used condensing steam plants and binary cycle plants. But major obstacles for geothermal development in Indonesia are non-technical factors. This paper will more focus on financial factor that hindering geothermal development. The main barrier is high investment cost in geothermal project can resulted in low investor’s interest in participating in this sector. It will take 5 years from the day of Geothermal Working Area awarded until the electricity produce. The second barrier is recent government policy to support petroleum products give disincentives for renewable energy to compete in the market. In Indonesia, electricity price from geothermal is higher than petroleum, gas and coal prices due to hidden subsidy. Major factors contributes to high prices of geothermal energy is because the high investment cost in the beginning and upstream risks of developing the fields have to be taken by private investors.

FINANCING GEOTHERMAL PROJECTS IN INDONESIA The next part will access different scenarios based on geothermal project development by state-owned company (Pertamina and PLN) and through private sector as the project developer. Financial implications from development by state owned company and investment evaluation of

(note 1) Source: Directorate General of Electricity and Energy Utilization, 2008,

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development project by private sector would be discussed with the usage of IRR and NPV as parameters for sensitivity analysis. The options on the scenarios will cover these aspects: • • •

Base-case scenario (State owned Company) Policy-driven scenario (Private Sectors) Scenario based on a low priced carbon and high priced carbon

WACC calculations are based on this equation: WACC = Cost of Equity * Equity + Cost of Debt * Debt Cost of equity was calculated with Capital Asset Pricing Model (CAPM) which describes the company’s own equity equal to country risk-free rate plus risk premium that investors expect for bearing the systematic risks in the market. The country risk free rate value in percentage, Rfc could be generated from the interest rate of the Government National Bond for a thirty year timeframe. However the systematic risks are influenced by macroeconomic factors with different magnitudes of risk market, Rm and risk free market, Rf in the stock market. The market risk constant, βj is a variable of risk with relations to the specific sector or companies involved. CAPM (Method) = E(Rj) = Rfc + β j ( E(Rm) - Rf )

(note 2)

E(Rj) = Cost of equity Rfc = country risk-free rate of return β = investment or sector-specific risk in correlation to the market E(Rm) – Rf = reward the market offers for bearing systematic risk Total Cost of Equity = 10% +1.51 ( 8.5% + 2.5%) Since Indonesia Stock Exchange was only active starting late 1990s, the (E(Rm) – Rf) values were taken from United States of America’s 80 years of market risk premium (8.5%) with adjustment to the difference of country rating. With relations to the difference of the country rating, it could be assumed that the total Cost of Equity is 26.61%. The parameters that are used are listed in the table below:

Table 1: Parameter in Calculating WACC [Source: Author calculation unless defined in sources] Rf

Value 10%

β leverage

1.51

Cost of Equity Risk free Premium Bank Interest (market) Bank interest (soft loan)

26.61% 2.50% 12% 5%

(note 2) Ross, et al., page 426

Source SUN Seri FR 0050 (www.bi.go.id) June 22, 2010 ANTAM April 2009 till May 2010 CAPM Method Commercial Bank (e.g ADB, DED, WB)

Vol. 17 [2012], Bund. W Corporate Tax Cost of Debt (market) Cost of Debt (soft loan) Debt Equity WACC (market interest) WACC (Soft Loan)

3248 34% 7.92% 3.3% 60% 40% 12.62% 15.4%

MoF Decree No.35/2010 Calculation Calculation Assumption Assumption Calculation Calculation

Table 2: Proposed Scenarios for Geothermal Power Development [Author] Description of Scenarios

Base-case Scenario

Policy Driven Scenario

This scenario is developed before the release of Geothermal Law 2003, where the fields are owned by Pertamina and the development of the geothermic projects are basically subsidized with a guarantee blanket from Government. This scenario is developed based on the current MEMR Decree where the maximum selling price of electricity at 9.7 US$ cents/kWh. This value was used as an electricity price assumption especially for projects developed by private investors or foreign investors.

Carbon Value Various carbon values (USD 12 and 20/tCO2) were imposed for both Scenario the Base-case scenario and Policy Driven Scenario.

The Input data for the different scenarios were obtained from a common data pool of geothermal projects developed in Indonesia which can be seen in table 3. For the purpose of evaluating the feasibility of developing a geothermal power plant, the author has chosen an optimistic installed capacity of 120 MW for the scenarios. The Capacity Factor taken is based on the assumption of the average installed geothermal project in Indonesia which is 90%. The Capital expenditure chosen at US$ 3,000 as a sensible value with informative support based on an interview with several project developers. Additionally, this project evaluation used a 60:40 Debt to Equity Ratio which is a common value for power plant projects in Indonesia. Depreciation is straight line to zero. Therefore, the basic assumptions used for the base-case scenario were built deriving from those data above and tabulated in Table V.6

Table 3: Proposed Scenarios for Geothermal Power Development [Author’s calculation] Parameters

Value

Unit

Installed Capacity

120

MW

Capacity Factor

90%

Electricity production

946,080

MWh/year

Capital Expenditure (CAPEX) *

3,000

US$/kW

Operational Expenditure (OPEX) **

2.1

US$ cents/kWh

Project Lifetime

30

Years

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Income Tax (JOC) ***

34%

Debt

60%

Equity

40%

Cost of Equity ****

26.61%

* Based on existing geothermal power plants plus inflation adjustment ** Based on Star Energy operational cost for Phase I and Phase II *** MoF Decree No.24 /2010 **** Cost of Equity Calculation based on CAPM Method

In order to conduct an investment evaluation, there are several methods that could be used: 1. 2. 3. 4.

Payback Period IRR ( Internal Rate of Return ) NPV ( Net Present Value ) PI ( Profitability Index )

An investment evaluation based on the Payback Period has some severe shortcomings. The Payback Period is a method by simply adding up future cash flow without discounting the value. In this method of evaluation, the time value of money is completely ignored. In addition to that, Payback Period evaluation ignores cash flows beyond the cut off, which might lead to misinterpretations. Nevertheless some projects might be profitable when viewed as a long-term investment. For the purpose of the project sensitivity analysis, only two parameters would be used which are Net Present Value and Internal Rate of Return. NPV is equal to Present Value of cash flow subtract with initial investment.

Co =

Initial Investment

Ct =

Cash flow in year, t

r

Discount rate.

=

In this particular case we use WACC as discount rate or as benchmark rate of investment in geothermal sector in Indonesia In this case, an investment should be accepted if the NPV value is positive and rejected if it is negative. The second alternative for an investment evaluation is the Internal Rate of Return (IRR). IRR is closely related to NPV. The IRR on an investment is the required return, that results in zero NPV when it’s used as the discount rate.

∑ r

=

Internal Rate of Return, IRR

Co =

Initial Investment

Ct =

Cash Flow in Year t

n

Period of Investment

=

(

)

= Co

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Basically IRR could be associated with the Expected Return from the project. If the result of IRR is more than the Expected Return, then an investment is acceptable. It should be rejected if the value is less than Expected Rate of Return.

Scenario 1 Project developed by Pertamina for steam development and PLN operated power plant or whole developed by Pertamina Basic assumption for the base scenario: Besides of the basic scenario, there are additional assumptions that could built based on specific scenario. The assumptions are tabulated in the Table 4. Table 4: Parameters for Scenario 1 Parameters

Value

Unit

Source

Inflation

6%

Data 2008-2009

Escalation electricity price

2%

PLN

Debt-Equity Ratio

60:40

Author

Interest Rate

5%

Tenor

30

Years

0.063

USD/kWh

Electricity Price Discount rate (WACC) Lifetime project Cost of Debt

ADB, WB Author (assumption) PLN

12.62% 30

Author Years

MEMR

3.3%

Calculation

Based on these assumptions, the projected income statement (profit/loss) of the scenario generated could be observed in detail in the balance sheet. The Discount Rate for the scenario calculated are based on WACC results, which was covered previously in this sub-chapter. After calculating profit loss of the project from the information above, the results of the IRR and NPV are as follow: NPV

81,367,075

IRR

7.14%

From the private investor perspective, investing in geothermal power plant is not attractive due to the negative NPV value and IRR result was less than the required return level at 12.62%. The simulation above had taken into account the Debt-Equity Ratio of 1.5 and interest rate only 5%. This interest rate is lower than market interest rate which is commonly between 9-12% (see note 3).

Scenario 2 Policy Driven Scenario In the second scenario, the recently issued MEMR Decree that determined the maximum price of electricity purchased by PLN at US$ 9.7 cents/kWh. Due to the MEMR Decree, this price is a (note 3) Interview with Risk Assesor Bank Mandiri

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negotiable price between both parties ranging to a maximum of US$ 9.7 cents/kWh. For the purpose of the scenario development, it was assumed that the price of electricity is US$ 9.7 cents/kWh. The basic assumptions for the second scenario is basically develop by the government policy to attract private sector to invest in geothermal business in Indonesia.

Table 5: Parameters for Policy Driven Scenario Parameters

Value

Inflation

4.5%

Unit

Source Data 2008-2009

Escalation Electricity Price

2%

PLN

Debt : Equity Ratio

60:40

Author (assumption)

Interest Rate

12%

Private Bank

Tenor

15

Years

Private Bank

Electricity Price

0.097

USD/kWh

PLN

Discount rate (WACC)

15.4%

Cost of Debt

7.92%

Lifetime project

30

Author Calculation Years

MEMR

The above assumption will generate a different result than the base scenario. From the input data, the interest rate assumption at market interest rate is significantly higher at 12%. This will make the WACC value higher due to the higher cost of debt. Nevertheless, the electricity selling price is much higher ranging at US$ 9.7 cents/kWh. The generated cash flow of the project which are discussed in detailed in Annex, IRR and NPV would provide the following results: NPV IRR

-1,049,954 15.33%

The resulting value that could be seen with the higher electricity price would still contribute a negative value of NPV and IRR rate lower than benchmark which set at 15.4%. As a conclusion, it is commonly still tolerate to invest in this scenario even at lower NPV value and the low IRR value compared to the benchmark. But due to the risk of upstream project in geothermal, the project needs some additional incentives for example in the form of CDM revenue and/or lowered interest rate.

Scenario 3 Low and High Price Carbon For the third scenario, additional incentives from selling CERs were taking into account to accommodate the optimistic and pessimistic future carbon price, low price at US$12/ton CER and high price at US$ 20/ton CO2. According to UNFCCC in term of CDM Project Additionality, in term of financial barriers, it could be observed from the previous sub chapter results of NPV and IRR that serves as a signal if geothermal power plants are not attractive. For the carbon scenario, certain assumptions made as listed in Table 6.

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Table 6: Parameters for Carbon Scenario Parameters

Value

Unit

Source

Emission Reduction factor

0.84

ton CO2/MWh

Emission Grid PT PLN

CER Price (Low Price)

12

CER Price (High Price)

20

USD / ton CO2

JICA Study

From the above information with relations to the base scenario and policy-driven scenario, further analysis was conducted to check the effect of the additional income towards the value of the NPV and IRR as parameter analysis. The comparison results could be found in Table V.10.

Table 7: Results of Scenarios Development [Source: Author’s calculation] Scenario 1

Scenario 2 With CERs

With CERs Without CERs

Low Carbon Price

High Carbon Price

Without CERs

Low Carbon Price

High Carbon Price

NPV

-81,367,075

-32,917,681

-618,085

-1,049,954

39,274,389

66,157,284

IRR

7.14%

10.49%

12.58%

15.33%

17.89%

19.63%

From table result, it could be seen that additional income from CERs would contribute rise from a value around 3% increase of IRR. When observed from a further optimistic expectation on CERs revenue at US$ 20, the IRR gap will increase at level 5%. In overall this would give a huge boost to the development of the geothermal power plants in Indonesia.

ANALYSIS OF RESULTS This difference of value could lead to a higher level of geothermal development in Indonesia. Nevertheless with the current authority body and policies in Indonesia, which distinguish the flow between upstream and downstream sector would create some disincentives for the private and foreign investment. It is hoped that a harmonization policy between upstream and downstream sector in Ministry of EMR could speed up geothermal development in Indonesia so that there would be no party who would have a conflict of interest. The simulation results for all of the scenarios, with the exception of the Base-case scenario, have indicated that the geothermal as a business investment perspective is not very attractive. This is due to Indonesia being a developing country which already facing certain risks leading to a higher expected rate of return calculated by Weighted Average Cost of Capital,(WACC). It could be further exploited with the issue of risk regarding climate investment and the guarantee for long term investment. From the scenario simulation, the unwillingness of PLN to buy electricity at a higher price could halt the power plant development, in particular geothermal power plant developments. However, this challenge could be overcome by a certainty of high price. The second scenario showed that with additional revenue from CERs would give a better rate of return that might increase the attractiveness of the project. Nevertheless, there is no certain guarantee that geothermal projects would be approved under CDM and of course due to the lengthy application process from registration until issuance of CER that could reach more than 4 years. As a conclusion, it would be impossible to expect an installed capacity of 9,500 MW by year 2025 without further enactment of policy that would support the development of power plants particularly geothermal power plants.

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CONCLUSION Based on the abundant geothermal resources, Indonesia is attractive for geothermal business. Financing the initial investment is the general main barriers besides of the certainty of electricity purchasing from utility at profitability level of the company. The additional incentives, like CERs revenue and global trust fund to support renewable energy development in Indonesia could accelerate the development. Besides that, geothermal development is very relevant with supporting macro-economic growth and can ensure sustainability of electricity supply for industry, commercial and households.

REFERENCES 1. Al-Dabbas, M.A.A (2009) The Economic Environmental and Technological Evaluation of using Geothermal Energy. European Journal of Scientific Research. 2. Armannsson, Halldór (2003) CO2 emission from Geothermal Plants, page 7; Paper on International Geothermal Conference, Reykjavík, Iceland. 3. DGEEU (2008) Generating Dialogue Clean Energy, Good Governance and Regulation, Presentation of Directorate General of Electricity and Energy Utilization, Ministry of Energy and Mineral Resources, Jakarta 4. Hance, C.N. (2005) Factors Affecting Cost of Geothermal Power Development, Geothermal Energy Association, Washington DC, United States. 5. Geological Agency (2009) Status of Geothermal Energy Potential in December 2009. Center for Geological Resources, Geological Agency, MEMR 6. Geothermal Energy: Clean Sustainable Energy for The Benefit of the Humanity and the environment. 2001. Energy and Geoscience Institute University of Utah. 7. Ross, Stephen A; Randolph W. Westerfield, Bradford D Jordan (2008) Corporate Finance Fundamentals 8th Ed. McGraw-Hill International Edition, page 86 8. Sukhyar, R et al. (2010) Geothermal Resources and Development in Indonesia. Geological Agency, Ministry of Energy and Mineral Resources, Jakarta Indonesia.

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