Indonesia relaxes regulation of the geothermal market

An overview of the key changes introduced by Indonesia’s new geothermal law, Law No. 21 of 2014.

A new geothermal law, Law No. 21 of 2014 (New Law), came into force on 17 September 2014, replacing Law No. 27 of 2003 (Old Law). The New Law relaxes the old legal and regulatory framework and has the potential to make way for the much needed development of Indonesia’s renewable energy market. Indonesia is thought to house the world’s largest reserves of geothermal energy - around 40% of global potential – but current legislation has meant a severe lack of interest in the sector. The Indonesian Government hopes that the New Law will alleviate the current energy shortages in the country by improving access to and speeding up the development of geothermal resources.

The development of geothermal energy is an expensive process which requires significant upfront capital investment. Combining this with historically low tariffs for geothermal-derived electricity has meant relatively low rates of return for investors, and, with additional bankability issues, has limited investment interest in geothermal projects.

The New Law supplements the recently implemented electricity pricing policy - a further sign that the Government of Indonesia is committed to the geothermal energy market.  Historically, Perusahaan Listrik Negara (PLN), the state-owned power utility, paid between USD0.10 and USD0.185 per kWh to geothermal independent power producers.  The new policy, in line with World Bank recommendations, sets a price range per kWh of USD 0.115 to USD 0.29.  The applicable tariff will depend on the year in which commercial operation of a project commences and the area in which the project is located.

Whilst the New Law is widely regarded as a major breakthrough in Indonesia’s renewable energy sector, it is still too early to assess its impact. Many are hopeful that the New Law will attract investment into Indonesia’s renewable energy sector although there remains skepticism as to how much of an impact the New Law will have in practice. It is also hoped that the expansion of the geothermal energy industry will reduce Indonesia’s reliance on less ecofriendly and more costly fossil fuels and reduce Indonesia’s greenhouse gas emissions. However, inconsistencies between the New Law and existing legislation and regulations need to be addressed before the New Law can be effectively implemented. The Indonesian Government is working to release the implementing regulations for the New Law (these had been anticipated by the end of 2014 but are still awaited) though it is questionable whether these regulations will be sufficient to address the inconsistencies discussed below or whether amendments to primary legislation will be required.

The New Law

The main changes introduced by the New Law include:

  • geothermal activities no longer considered ‘mining activities’ 
  • distinction between direct and indirect utilization 
  • restriction on transfers of licenses and shares in license holders
  • concept of a mandatory ‘production bonus’ 
  • centralization of the tender process for indirect utilization projects

No longer considered ‘mining activities’

Under the Old Law, geothermal development activities were classified as ‘mining activities’ and, as such, developers were required to obtain a ‘geothermal mining use license’ (izin usaha pertambangan – panas bumi) (IUP).  The New Law takes geothermal activities outside the scope of ‘mining activities’. It also permits the development of geothermal fields in conservation areas, which is promising as it is thought that approximately 60% of Indonesia’s total geothermal resources are located in conservation areas. Other legislation must however keep apace for the effective implementation of the New Law.

Critically, geothermal development activities continue to be classified as ‘mining activities’ under other legislation and regulations, including under:

  • the Indonesian forestry law1 (Forestry Law), and
  • Government Regulation No. 28 of 2011 on the Management of Nature Reserves and Conservation Areas (GR No. 28/2011).

The Forestry Law limits rights to use forest areas for activities other than ‘forestry activities’.  ‘Strategic activities’, of which mining is one, are permitted with a ‘borrow and use license’ (izin pinjam pakai) in production forests (opencast and underground mining) and protected forests (underground mining only) but ‘mining activities’ in conservation forests are strictly prohibited. 

GR No. 28/2011 also prohibits ‘mining activities’ in nature reserve areas, which include conservation forests.

Distinction between direct and indirect utilization

The New Law distinguishes between the purposes for which geothermal resources are harvested.  For direct utilization (use of geothermal for purposes other than energy generation), developers must obtain a ‘direct utilization license’ (izin pemanfaatan langsung), whereas for indirect utilization (use of geothermal resources for electricity generation) a ‘geothermal license’ (izin panas bumi) must be obtained.  This is in contrast to a ‘mining use license’ which applied equally to direct and indirect utilization.  Whilst this distinction may be an attempt by the Government to demonstrate a commitment to renewable energy development, it is not clear whether the application process for a ‘geothermal license’ will necessarily be anymore straight forward than the application process for an ‘indirect utilization license’.

Restrictions on license and share transfers

The New Law introduces new restrictions on the transfer of licenses and shares in entities holding such licenses. Previously, an IUP could be transferred, with approval from the relevant Minister, Governor, and or Regent/Mayor, to an ‘Affiliated Business Entity’, a business entity which directly controlled, or held at least 25% of the issued shares with voting rights in, the IUP holder.  This meant that an IUP could be transferred to a shareholder of the IUP holder, subject to the relevant authority’s approval.

Under the New Law, there is an absolute prohibition on (i) the transfer of geothermal licenses, and (ii) the transfer of shares in holders of geothermal licenses during the exploration phase. However, after the exploration phase has ended shares in license holders may be transferred on the Indonesian stock exchange with the Minister’s approval. While the New Law does not specifically address rights to transfer unlisted shares, it appears that any such transfer would be prohibited, even with approval.  The New Law effectively fetters the rights attaching to shares in holders of geothermal licenses and locks in shareholders of private companies, presumably until the company lists or is dissolved.

The rationale for these restrictions is not entirely clear and the requirement for ministerial approval is likely to affect the liquidity of the stock market.  Ministerial approval is not always forthcoming and, if every transfer of listed shares requires approval from the Minister, there is a significant risk of a slowdown in trading activity.

Mandatory production bonus

Whereas the Old Law was vague as to requirements regarding payments, the New Law introduces a mandatory production bonus payable to the local government in which the geothermal field is located.  This bonus will be calculated based on a proportion of the developer’s gross revenue generated from commercial operations.

The mandatory bonus provisions will apply equally to holders of existing IUPs and those whose permits are issued under the New Law.  Production bonuses are payable from the later of 1 January 2015 (where production has commenced) and the date on which commercial operations commence.  

Tender and license administration

Under the Old Law, either of the Ministry of Energy and Mineral Resources (MEMR), governor or mayor (depending on the location of the project) would issue the IUP. As a general rule, the New Law divides responsibility for the tender process for geothermal projects and issuance of licenses as follows:

  • the tender process, and issuance of licenses, for indirect utilization projects to be administered by the central government, and 
  • the tender process, and issuance of licenses, for direct utilization projects to be administered by the regional government according to the area in which the field is located. 

The central government may however still issue licenses under certain circumstances, for example, where the geothermal area is within a conservation forest (see table below).

Central Government
(Minister)
Provincial Government
(Governor)
Regency/City Government
(Regent/Mayor) 
Geothermal resources located in the following areas:
• areas which are in more than once province, including production and protected forest areas;
• conservation forests;
• water conservation areas; and
• areas more than 12 miles from coastline.
Geothermal resources located in the following areas:
• areas which are in more than one regency/city within the same province, including production forest areas and protected forest areas; and
• areas up to 12 miles from coastline.
Geothermal resources located in the following areas:
• within the borders of a regency/city; and
• a third of territorial waters under provincial government jurisdiction.

License Period

There does not appear to be any real change to the license period under the New Law other than to distinguish between the exploration and feasibility stages of a project.

The Old Law provided for issuance of licenses for:

  • exploration for a maximum of 3 years (extendable twice for a one year period each time)
  • feasibility studies for a maximum of 2 years, and 
  • exploitation for a maximum of 30 years (extendable indefinitely for further periods of 20 years per extension).

Geothermal licenses issued under the New Law may be granted for: 1) an exploration (including feasibility) period of up to seven years (initial five year term with the possibility of up to two one year extensions); and 2) a production period of 30 years (extendable for further periods of 20 years per extension).

Sanctions

The New Law introduces tougher sanctions for breach of law.  There are two levels of penalties depending on the severity of the breach:

  • administrative, and
  • criminal. 

Administrative sanctions, including the issuance of warning letters, temporary suspension of activities or revocation of a license, are some of the new measures the Government may impose for minor breaches of the New Law. 

For more serious breaches, criminal sanctions can be imposed, which include prison sentences of up to seven years and/or fines of up to Rp70 billion (US$7 million).  Offences for which criminal sanctions may be imposed include conducting geothermal activities outside the allowed working area, or without a license, and hindering geothermal activities. To address the difficulties that developers have faced from the local population when conducting geothermal activities, criminal sanctions are more likely to be imposed on parties who attempt to hinder geothermal activities. 

 


1Law No. 41 of 1999 and Government Regulation No. 24 of 2010 (as amended by Government Regulation No. 61 of 2012)

 

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