CORPORATE RISK MANAGEMENT

PT Paiton Energy Indonesia

Syndicate 3 Hanna Friska Stephanie 29111020 Firra Astria Noezar 29111306 Alfan 29111356 Ridzki Anfasa 29111358 Sandy Widya 29111359 Darmawan Wijaya 29111351

MASTER OF BUSINESS ADMINISTRATION SCHOOL OF BUSINESS AND MANAGEMENT INSTITUT TEKNOLOGI BANDUNG 2013

Literature Review
Project Finance
Based on International Project Finance Association (IPFA), project finance is the financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project. Project finance is different from traditional forms of finance because the financier principally looks to the assets and revenue of the project in order to secure and service the loan. In contrast to an ordinary borrowing situation, in a project financing the financier usually has little or no recourse to the nonproject assets of the borrower or the sponsors of the project. In this situation, the credit risk associated with the borrower is not as important as in an ordinary loan transaction; what is most important is the identification, analysis, allocation and management of every risk associated with the project.

Public Private Partnership (PPP)

Public Private Partnership is a contract between a public sector authority and a private sector entity pursuant to which the private sector party agrees to perform some or all of the aspects of an infrastructure project or public services (for example construction, operations and maintenance). Through this agreement, the skills and assets of each sector (public and private) are shared in delivering a service or facility for the use of the general public. In addition to the sharing of resources, each party shares in the risks and rewards potential in the delivery of the service and/or facility. PPPs are used for public and social infrastructure projects such as highways, power plants, bridges, pipelines, airports and schools. Depending on the structure of the PPP and the nature of the project, ownership of the project may be leased or owned by the private sector party for a specified period.

Build Operate Transfer (BOT)

Build Operate Transfer (BOT) is a type of arrangement in which the private sector builds an infrastructure project, operates it long enough to payback project debt and equity investment and eventually transfers ownership of the project to the government. In many instances, the government

becomes the firm's only customer and promises to purchase at least a predetermined amount of the project's output. The advantages of BOT are:

Increased speed to market off-shore for Client Reduced risks of mistakes, particularly geo-political issues involved with start-up and operations Reduced financial risk, the BOT financial commitment is only through the operate phase, while building ones own center from scratch would typically be a longer term financial commitment by Client

Build Own Operate (BOO)

Build Own Operate (BOO) is a type of arrangement in which a private organization builds, owns and operates some facility or structure with some degree of encouragement from the government. Although the government doesn't provide direct funding in this model, it may offer other financial incentives such as tax-exempt status. The developer owns and operates the facility independently. The advantages of BOO is offering lowest price tariff than BOT and BOOT.

Build Own Operate Transfer (BOOT)

Build Own Operate Transfer (BOOT) is a type of arrangement in which a private organization conducts a large development project under contract to a public-sector partner, such as a government agency. This project is often seen as a way to develop a large public infrastructure project with private funding. The BOOT steps are: 1. The public-sector partner contracts with a private developer - typically a large corporation or consortium of businesses with specific expertise - to design and implement a large project. 2. The public-sector partner may provide limited funding or some other benefit (such as tax exempt status) but the private-sector partner assumes the risks associated with planning, constructing, operating and maintaining the project for a specified time period. 3. During that time, the developer charges customers who use the infrastructure that's been built to realize a profit. 4. At the end of the specified period, the private-sector partner transfers ownership to the funding organization, either freely or for an amount stipulated in the original contract.

The advantages of BOT are: The majority of construction and long-term operating risk can be transferred onto the BOOT provider. Corporate structuring issues and costs are minimal within a BOOT model, as project funding, ownership and operation are the responsibility of the BOOT operator

Limited Recourse Basis

Limited Recourse Basis is a financing arrangement where the lender can require the borrower to repay only in special conditions that are spelled out in the loan agreement itself, and otherwise must look to the collateral as a source of repayment. Borrowers may have to pay more for limited recourse financing.

Cost-plus Basis
An agreement to pay a company for a job based on the amount of money used to buy the materials required to complete that job plus an added payment. A cost-plus basis fully reimburses a contractor for the cost of materials and then adds additional money to arrive at the total cost of the job.

Case Review
Background
By 1994 Indonesias economy was growing at more than 7 percent a year and electricity demand was growing at more than 14 percent a year. PLN had not been able to meet the demand. It was estimated that Indonesia would require an additional 24.000 MW of capacity, an increase of 75 percent, over the following 10 years, at a cost of US$35 60 billion. Most of this new capacity would come from Independent Power Plants (IPPs) as part of the countrys independent power programme. PT Paiton Energy is an Indonesian limited liability company owned by MEC Indonesia, an indirect subsidiary of Edison Mission Energy Company. The project originated in 1991 when the Indonesian Ministry of Mines and Energy invited competitive proposals for the private development of two 600 MW units in the Paiton complex. In August 1992. after several clarification sessions with each bidding group, the Government of Indonesia awarded the sponsors the exclusive right to conduct further negotiations on the proiect. From the end of 1992 until March 1994, the sponsors negotiated the power purchase agreement with the Government of Indonesia.

Principal Project Contracts

The principal project contracts are the PPA, the construction contract, the warranties, the operation and maintenance agreement, the fuel supply agreement, the coal purchase agreement, the mining and barging contract, the coal terminal services agreement, the contract of affreightment, and the Kelanis Facility agreement. The PPA defines the rights and obligations of Paiton Energy and PLN relating to development, financing, construction, testing and commissioning of the project and operation and maintenance of the plant; the making of capacity and energy payments. risk allocation in the event of force majeure and changes in the regulatory environment; events of default; rights of termination and consequences thereof; insurance, liability and indemnity obligations; and dispute resolution. The construction contract provides for the contractor, a consortium of Mitsui, Toyo, and Duke/Fluor Daniel to provide design, engineering, procurement, construction, startup, testing and commissioning services, and the equipment and materials necessary for construction of the

plant on a fixed-price, turnkey basis. If the plant is not in compliance with defined emissions limits, the contractor pays US$750,000 per MW for each MW by which the net electrical output has to be reduced in order to comply with emissions limits. If each unit does not achieve a minimum electrical output of 61 5 MW, the contractor pays US$5 million per MW for each MW by which the net electrical output falls below 61 5 MW. The operation and maintenance agreement defines the terms under which Edison Mission Energy's Indonesian affiliate will provide operations, maintenance, and repair services necessary for the production and delivery of electricity. The fuel supply agreement provides that BHP will be the exclusive supplier of coal to the project, and defines BHP's obligations under the coal supply plan The coal purchase agreement defines Adaro's obligations to sell to BHP all of the coal BHP is obligated to deliver under the fuel supply agreement. The mining contract between Adaro and PT Pamapersada defines PT Pamapersada's obligations to mine coal, transport it to the Kelanis terminal, strip overburden, and provide routine maintenance services on the roads between the mine and the terminal. The barging contract between Adaro and PT Rig Tenders Indonesia describes the latter's agreement to transport coal from Kelanis to the terminal. The coal terminal services agreement describes PT Indonesia Bulk Terminal's agreement with BHP to store coal in a terminal, blend coal located at the terminal, unload coal from barges, and load coal onto vessels. The contract of affreightment describes Louis Dreyfus et Cie's obligation to transport coal from the Kelanis terminal to the Paiton plant. The Kelanis facility agreement, signed by each of the sponsors, Paiton Energy, and Adaro, defines Adaro's obligation to construct and operate a crushing and load-out facility and a coal stockpile. The coal supply plan, required under the PPA, is a plan for the reliable supply of coal submitted to PLN by Paiton Energy. The sponsors and lenders were concerned about the dependability of the fuel supply. Each hired separate coal advisers. They did great deal of due diligence to verify the coal reserves, and to make sure that it could be produced at a reasonable cost and delivered to the plant.

Negotiating the Power Purchase Agreement

Despite experience with private investors in other industries, the Indonesian government was just beginning to learn about private power project financing. They explored the possibility of a corporate commitment, but found the sponsors only willing to do a project financing on a limited recourse basis. The Indonesian government was accustomed to purchasing plants on a cost-plus basis and needed to learn why a fixed-price turnkey contract was required for a limited-recourse financing. The sponsors persuaded PLN that the PPA should be more oriented toward defining the amount of power to be delivered and giving the sponsors appropriate economic incentives.

Tariff Structure
The sponsors and PLN agreed on a tariff that declines over time. It was calculated to provide a reasonable cost to PLN over the full 30 years on a discounted cash flow basis, but also to provide a cash flow cushion in the early years when debt-service requirements would be particularly heavy. The bankers thought that such a structure would help attract the debt that was required. The problem with that structure was a public perception that the tariff was high in the earlier years, even though it was lower in the final 18 years of the contract. The PPA defines four tariffs, tariffs A, B. C, and D. Tariffs A and B are capacity payments that PLN has to make if the plant is ready to produce electricity, whether or not PLN is taking it, and tariffs C and D are energy payments that PLN pays only when the plant is generating electricity. The Tariffs structure can be seen on the following table

Year 1-6 7-12 13-30

Tariffs (Cents / KWh) 8.47 8.27 5.45

Force Majeure Events

The PPA provides that if a force majeure event prevents PLN from receiving electricity, or is the result of governmental action that affects the company's ability to produce electricity, the plant will be "deemed dispatched" and PLN will remain obligated to make capacity payments as if the force majeure event had not occurred. The plant will also be deemed dispatched if a coal supply force majeure event prevents

the Adaro mine from delivering coal and requires the company to limit output as a result of using qualifying alternate coal to meet environmental requirements.

Event of default and termination

The events of default is divides by the PPA into remediable events and nonremediable events. Companyremedial events include not achieving commercial operation by the target date, suspension of construction or operation and various other obligations under the PPA. Non-remediable events that remain uncured can lead to termination of the PPA (a party receiving notice of remediable event has 30 days to furnish the other party with a plan to cure the event). PLN can buy the plant at any time, whether or not a nonremediable event has occured. PLN has the option not the obligation to purchase the plant when there has been a company non-remediable event for an amount equal to principal and interest under senior debt facilities minus unfunded sponsor commitments.

Foreign Exchange Protection

Based on the case, PLN is indicates willingness to provide rupiah-US dollar protection because most of the countrys export earning are in dollars. but resisted rupiah-yen protection because Indonesia already had heavy yen exposure and the yen was strengthening. If Paiton is unable to converts its rupiah revenues to dollar, PLN has the responsibility to ensure that Paiton eventually gets the appropriate amount of dollars.

Environmental Requirement
Environmental laws in Indonesia specified a maximum ground-level sulfur concentration for all eight units at the Paiton site. The sponsors had to persuade PLN to establish specific environmental requirements for Paiton Energy's two units. Othenvise, in the future, Paiton Energy could be penalised for emissions of the other units. This was a risk that lenders would be unwilling to accept.

Negotiating Other Contract

The sponsors were reluctant to spend a lot of time negotiating the EPC, OGM, and fuel supply contracts and requesting competitive bids for equipment before the PPA was finalised. The coordinating banks had to try to move both the project contracts and the financing ahead at the same time. Some decision on financing documents could not be made because the credit structure was not yet defined by the project documents.

The Bank Underwriting

The sponsors wanted some kind of underwriting commitment from Chase and IBJ. Chase and IBJ had to start by estimating the total amount that could be raised and the maximum tenor available from each market such as the ECAs, the multilaterals, and the commercial banks.The ECAs were offering a maximum maturity of 10 years for power plants, although there was some indication that they might go out as far as 12 years in a competitive bidding situation. The commercial banks appeared to have a capacity of about US$300-400 million dollars for uncovered Indonesian risk, and were willing to go out as far as eight years, with a four-year construction period and four years of amortisation. The two coordinating banks sought internal approval to underwrite the deal before syndication with as much flexibility as possible. the coordinating banks talked to six additional commercial banks, hoping that at least four would be willing to match Chase and IBJ's US$250 million underwriting commitments. They all accepted, so all eight banks were ratcheted down to US$187.5 million. The coordinating banks were used to working in a fluid environment. But the ECAs were not so flexible. They said they didn't have enough information to analyse the credit because they didn't have the project documents. Another delay was caused by Exim Banks, right from the beginning that they said they would not assume construction risk, but after a lot of time and effort, the coordinating banks were able to persuade Exim to take construction risk. An underwriting of this size prior to syndication was a real milestone for the Asian market.

Structure of Financing
1. The US$900 million Jexim facility finances up to 85% of the amounts payable by Paiton Energy to Mitsui for Japanese good and services pursuant to the construction contract, and for Indonesian goods and services as long as they do not exceed 15 % of the amount exported from japan. The Facility has two tranches: Tranches A: USS 540 million loan at a fixed rate of 9.44 %. Tranche B: Provide rates based on LIBOR ranging from 4.875% to 11.375%

2. US$ 540 Million four year US Exim loan with the interest rate of 9.382% 3. US$ 200 Million 12-year loan from OPIC based on LIBOR rates

4. The commercial bank facility has two tranches: Tranche A: USS180 million uncovered four-year construction loan at Libor plus 2.25 per cent with a four-year amortisation period. Tranche B: US$93,750,000 uncovered stand-by contingent facility available for funding project cost overruns after US$ 175 million sponsors' overrun equity is fully used. 5. US$ 374 Million subordinated debt from the sponsors 6. US$ 306 Million from equity

The structure of financing in PT Paiton Energy can be seen below:

Government Support Letter

ECA were asking for guarantees since they want to avoid the risk, however Indonesias government had agreed with the sponsors on support letters and was not willing to change the condition. Without price reduction, it can increase the risk. The support letter issued by the Ministry of Finance (MOF) states that the government will cause PLN to discharge its payment obligation. Lenders considered it as enough, but it was not guaranteed.

Meeting the Financial Closing Deadline

When PPA was signed in 12 February 1994, government set a one-year deadline for both signing loan agreement and advancing the funds. If the deadline cannot be met, government could reopen negotiations on the price defined in the PPA. As the deadline seemed unrealistic, the team kept informing PLN for their milestone, therefor PLN can see the progress and the evidence. When the documents were delivered, government decided to extend the closing from 12 February to 21 April. Issues remaining until the end are the real estate security and the interpretation of the government support letter. On the first issue, the lenders had to settle for a provision in the PPA that indemnified project against claims against the site. For both issues, government is also unwilling to change their mind. If the deal was not closed by 21 April, they would have the right to terminate PPA.

Intercreditor Issue
It is predicted that to arrange a deal with banks, bondholders, and ECA is very difficult due to the intercreditor issue. Intercreditor issue is the problems among creditors about the set of position, right, and liabilities of each creditors and its impact to the other creditors. Intercreditor agreements are often used financing companies and lenders to determine relative rights of multiple creditors and establish priorities in payments and other issues. It is common for the intercreditor agreement to include buy-out rights that give the second lien lender the option to acquire, at par, the first lien lenders claims and liens. That purchase option is typically triggered by specified events, such as the filing of a bankruptcy case by or against the borrower. However, the 3 parties are able to sit together to reach agreements. If there is a default under the bank ot the ECA agreement the bondholders can rely on cross-acceleration. Cross-acceleration is Common stipulation in loan agreements under which a bank has a right to deny access to balances in any or all loan accounts to a borrower (with several loans at the same bank) even if only one loan goes into default. In fact, a bank can apply all available balance in all account of the borrower to satisfy any loan in default. Bankers justify this clause on the logic that a default sours the bank client relationship, not a just a loan agreement.

Credit Rating
Indonesia rating at that time was BBB according to Rule 144A. Therefore, Standard & Poor gave the US$ 180 million of 9.75% bond privately placed. The primary risks are listed below:

Three years of construction remained before commercial operation of the project began. Creditors right and enforcement were subject to uncertainty, lack of precedent, and interpretative differently under Indonesian Law.

Since the bond principle only presenting 10% of the US 1.8 billion debt outstanding, remedies and abilities to take action would be controlled primarily by bank and agency lenders and not by the bondholders.

Facing these risks, the rating agency listed number of strengths as the following: Project will help increasing capacity in Indonesia. The plant design. Project construction was to be under contract with highly qualified consortium. PPA and PLN are well-structured to hedge inflation, fuel price, and regulatory risk. The letter of support issued by the Government of the Republic of Indonesia. Project sponsors contributing 27% of the project capital and were obliged to provide up to US$300 million in the overrun commitments.

Lesson Learned as of 1996

People from United States, Japan, and Indonesia were locked up in conference rooms for months. The different cultures among them make it seemed that the deal was not going to get done. However, over time they grew to understand each other. The 12-month of deal was unrealistic. The common time in US on most independent power projects are 18 months. Most PPAs in US have sunset dates between 24-36 months from signing. The deadline would be easier to be reached if the negotiations for more of contracts were started while PPA negotiations were under way.

Indonesias Economy and Credit Rating

The following is the chronological of Indonesias economic condition affecting its credit rating since year 1997 to 2001: Date Institution Standard & Poor Credit Rating BBB Economy Market-oriented economic policies More than 30% of GDP on savings and investments

1997

Political risk due to the transition from Suharto as president

Moody

Ba 1

50% drop in the Rupiah value Loss of investor confidence Deepening financial crisis Suspension of foreign currency debt servicing for troubled corporation

Standard & Poor 1998

From BB to B -

Vital of power transfer from Suharto Prediction of 40% of NPL Deepening political risk No strong government leadership No proper implemented bank recapitalization plan

Moody

B- to C+

Standard & Poor CCC+ -

Review of loan rescheduling Estimation of NPL was increasing to 75-85% Underdeveloped local equity and debt markets Governments debt was growing to 110% of GDP

1999

IMF agreed to resumed lending after Indonesian published the corruption scandal

Default on US$ 850 million of foreign-currencydenominated commercial bank loans

2000 Standard & Poor SD to B-

Rescheduling of about US$5.8 billion of principal on bilateral debt

Suffering from uncertainties regarding legal reform, bank lending quality, and the sale of assets by government-run Indonesian Bank Restructuring Agency

2001 Moody B-

Wahids faltering grip on power and interethnic violence across archipelago Delay of IMF loan

Project Developments
In October 1997, Standard & Poors investigate that PLN was seeking to reopen the negotiation of PPAs because the electricity tariffs that PLN was paying to the IPPs is higher than the tariffs that it charged to consumers. Despite all of the country instability, in June 1998, no IPP had missed a payment from PLN and Paiton project remained on schedule and would start operations in 1999. In September 1998 PLN and Pertamina fail to make payment in full for electricity delivered by DSPL and CE Indonesia. Paiton Energy power plant came on stream in May 1999, but PLN refused to buy power and paid Paiton Energy only the cost of fuel. PLN also defaulted the first monthly bill to Paiton. In October 1999, PLN filed a lawsuit seeking to nullify its PPA with Paiton Energy, because it was negotiated on corrupt ground. But in December 1999, President Wahid ordered to drop the lawsuit and renegotiate the original agreements. In February 2000, PLN and Paiton Energy reached an interim agreement that PLN agrees to pay at a reduced rate. But this agreement was not sufficient as at the reduced rate, Paiton could not make the principal payments on the bank loans. Later in 2000, tentative agreement was reached which Paiton would gradually increase their rates starting from 2.6 cents per KW hour with the opportunity to extend the 30-year term, build another power plant, and increase electricity sales. By 2001, PLN reached another agreement with Paiton Energy to pay 4.93 cents per KW per hour for 40 years and to pay arrears of $450 million. In February 2002, PLNs president expected that the electricity demand will grow at 8% annually. In March 2002, Paiton Energy began to negotiate with lenders to finance Unit 3 and Unit 4 on Paiton power plant site. In 2002, Paiton sponsors signed a term sheet for debt restructuring with the four major agencies involved in the power plant.

Credit Rating of Paiton Energy

Date 1997 Institution Credit Rating Standard & Poors From BBB to B Moodys Standard & Poor Moody From Baa3 to Ba1 From B to CCC From Ba1 to Caa2 CCC to CC B3

1998

2000 Standard & Poor 2003 Moodys

Risk Analysis
Risk Identification
No. Name of Risk Nature of Risk Disaster Risk, Compliance Risk Remarks Manage Risk Event prevents PLN from receiving electricity, or is Plant will be "deemed dispatched" and PLN will the result of governmental action that affects the remain obligated to make capacity payments company's ability to produce electricity as if the force majeure event had not occured. Event prevents the Adaro mine from delivering coal and requires the company to limit output as a result by using qualifying alternate coal to meet environmental requirements Not achieving commercial operation by the target date, suspension of construction or operation, and various other obligations under the PPA

1 Force majeure events

Plant will be "deemed dispatched" Receiving notice of a remediable event has 30 days to furnish the other party with a plan to cure the event PLN has the option but not the obligation to purchase the plant when there has been a company non-remediable event for an amount equal to principal and interest under senior debt facilities minus unfunded sponsor commitments

2 Underachievement risk

Business Risk

3 Liquidity Risk

Financial Risk

Failure to make required payments

4 Foreign Exchange Risk 5 Emission Risk 6 Undefine Project Documents

7 Construction Risk

8 Intercreditors disputes

9 Indonesian Risk 10 Credit Collateral Risk

Risk Exposed because Yen strengthened to US Foreign exchange contracts Dollar Environmental laws in Indonesia specified a Environmental Risk maximum d ground-level sulfur concentration for all Using coal with a very low sulfur content eight units at the Paiton site Some decisions on financing documents could not Operational Risk yet be made because the credit structure was not yet defined by the project documents. If the plant is not in compliance with defined emissions limits, the contractor pays US$750,000 per MW for each MW by which the net electrical output has to be reduced in Operational Risk, Compliance Underachievment and not comply with government order to comply with emissions limits. If each Risk regulatory unit does not achieve a minimum electrical output of615 MW,th e contractor pays US$5 million per MW for each MW by which the net electrical output falls below 615 MW. Dealing across cultures, across time zones, and under time pressure made this project a particular Simply sitting down together and patiently People Risk challenge. People from the US, lapan, and working out each issue Indonesia had very different approaches to business when they started to work together Risk exposed because of political conditions in Country risk Indonesia Financial Risk No actual guarantee from Government to banks Market Risk

Risk Measurement
Probability High Likely Moderate Unlikely Low General Criteria Time Limit Always happen and intense More than once in every three months Easy to happen and more frequent At least once in every 3 months Relatively happen frequently Once in a year Seldom to happen At least once in a year Relatively not to happen At least once in every 5 years Specific Criteria Always happen in all condition and environment both internally and externally Can happen and vulnerable from internal and external condition and environment Can happen from several internal and external conditions and environment Can happen from specific internal and external conditions and environment Can happen from the very specific internal and external conditions and environment

Risk Mapping
Severity Corporate HR Loss of key personnel bring losses to corporate competitiveness Credit Rating Downgrade, Finance Long Term Negative ROI and ROE, Objective cannot be achieved, may have Catastrophic financial problems, incompetent, selling of SBU, even liquidation Major Moderate Minor Objective may not be achieved, must modify strategy with big investment Corporate restructuring with moderate/low investment

Stock Price Deterioration Short term stock price decline for one Extra effort to maintain key personnel year Decline ROI anbd ROE but price of Modify process business and review key personnel stock relative stable Decline of ROI ad ROE compare with Operation objectives can not be achieved Low motivation in key personnel average industry ROI and ROE Still positive

Insignificant Minor problems in operational objectives Key personnel only have minor problems

Catastropic

1 3, 5, 10 9 4 8 2, 6, 7

Very Low

Major

Low

Moderate

Tolerable

Minor

High

Insignificant

Very High

Low

Unlikely

Moderate

Likely

High

No

Name of Risk Force majeure events Underachievement risk Liquidity Risk Emission Risk Undefine Project Documents Construction Risk Intercreditors disputes Indonesian Risk Credit Collateral Risk

1 2 3 4 5 6 7 8 9 10

Nature of Risk Disaster Risk, Compliance Risk Business Risk Financial Risk Environmental Risk Operational Risk Operational Risk, Compliance Risk People Risk Country risk Financial Risk

Probability Unlikely Likely Unlikely Moderate Unlikely Likely Likely Likely Unlikely Unlikely

Severity Catastropic Moderate Major Major Major Moderate Moderate Major Moderate Major

Mapping High High Tolerable High Tolerable High High Very High Low Tolerable

Foreign Exchange Risk Market Risk

Financial Analysis
Initial Agreements
Energy Produced
To calculate the annual energy produced, the formula are:

Paiton energy installed 2 of 615 MW power plant, making it able to produce 1,230,000 KW per hours Total number of hours in a year is The availability factors of Paiton 1 is 83% hours

Based on the data above, the total energy that Paiton 1 produced each year are 8,943,084,000 KW.

Tariffs Structure
The initial tariffs that had agreed on the PPA between PLN and Paiton are:

Year 1-6 7-12

Tariffs (Cents / KWh) 8.47 8.27

13-30 5.45

The tariffs are based on four components, and the structures of the tariffs are:

No 1 2 3

Cost Components Component A (element of payback period of investment) Component B (element of fixed costs for operations and maintenance) Component C (element of fuel cost)

First 6 years 7-12 Year Cost Cost 7.07 6.87 0.4 1.0 0.4 1.0

13-30 Year Cost 4.05 0.4 1.0

Component D (element of variable cost for operations and maintenance) Total Cost of Generation (US Cents / KWh)

0.1 8.47

0.1 8.27

0.1 5.45

The calculation of the generation cost is based on the following assumptions: The price of component B,C,D did not change for the rest of the agreement The calculation above does not include 30% tax

Calculation on Initial Agreements

Based on the above data and assumptions we can generate the annual Free Cash Flow of Paiton Energy by :

Based on the formula above, the annual Free Cash Flow of Paiton are: Year 1-6 7-12 Free Cash Flow US$ 442,593,227.16 US$ 430,072,909.56

13-30 US$ 253,536,431.40

After the annual free cash flow is gained, we can calculate the Payback Period, Net Present Value and Internal Rate of Return on this projects:

Initial Agreements Payback Period 5.65 NPV $ 1,742,530,808.16 IRR 16%

The Assumption used in these calculations are: Tax rate is 30% The discounted factor is 8% as it is the growth rate of electricity demand There are no new investment made during the years There are no changes in the working capital

The detailed calculation of the Payback Period, NPV and IRR for the initial agreement can be seen in the following table:

Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Free Cash Flow $ (2,500,000,000.00) $ 442,593,227.16 $ 442,593,227.16 $ 442,593,227.16 $ 442,593,227.16 $ 442,593,227.16 $ 442,593,227.16 $ 430,072,909.56 $ 430,072,909.56 $ 430,072,909.56 $ 430,072,909.56 $ 430,072,909.56 $ 430,072,909.56 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40 $ 253,536,431.40

$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $

Acc. FCF (2,500,000,000.00) (2,057,406,772.84) (1,614,813,545.68) (1,172,220,318.52) (729,627,091.36) (287,033,864.20) 155,559,362.96 585,632,272.52 1,015,705,182.08 1,445,778,091.64 1,875,851,001.20 2,305,923,910.76 2,735,996,820.32 2,989,533,251.72 3,243,069,683.12 3,496,606,114.52 3,750,142,545.92 4,003,678,977.32 4,257,215,408.72 4,510,751,840.12 4,764,288,271.52 5,017,824,702.92 5,271,361,134.32 5,524,897,565.72 5,778,433,997.12 6,031,970,428.52 6,285,506,859.92 6,539,043,291.32 6,792,579,722.72 7,046,116,154.12 7,299,652,585.52

PVIF 1.000 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215 0.199 0.184 0.170 0.158 0.146 0.135 0.125 0.116 0.107 0.099

PV FCF $ (2,500,000,000.00) $ 409,808,543.67 $ 379,452,355.25 $ 351,344,773.38 $ 325,319,234.61 $ 301,221,513.53 $ 278,908,808.82 $ 250,943,411.99 $ 232,355,011.10 $ 215,143,528.80 $ 199,206,971.11 $ 184,450,899.18 $ 170,787,869.61 $ 93,224,819.65 $ 86,319,277.46 $ 79,925,256.91 $ 74,004,867.51 $ 68,523,025.47 $ 63,447,245.80 $ 58,747,449.82 $ 54,395,786.87 $ 50,366,469.32 $ 46,635,619.74 $ 43,181,129.39 $ 39,982,527.21 $ 37,020,858.53 $ 34,278,572.71 $ 31,739,419.18 $ 29,388,351.09 $ 27,211,436.20 $ 25,195,774.26

Actual Conditions and New Agreements

Energy Produced
In the final agreements of PLN and Paiton in 2001, Paiton negotiated that they can generate more capacity to 85%. To calculate the annual energy produced, the formula are:

Paiton energy installed 2 of 615 MW power plant, making it able to produce 1,230,000 KW per hours Total number of hours in a year is hours

The availability factors of Paiton 1 is changed 85% based on the new agreements

Based on the data above, the total energy that Paiton 1 produced each year are 9,158,580,000 KW

Tariffs Structure
In remainder of 1999, PLN refuse to pay Paiton and only pay for the fuel cost (Component C) amount at 1 Cent per KWh. In 2000, PLN pays Paiton 3.3 cents per Kwh according to the interim agreements. In 2001 PLN and Paiton reached a tentative agreement to pay 2.6 Cents per KwH. And finally the tariffs agreed on the PPA between PLN and Paiton had been negotiated in 2002 to the price of 4.93 Cents per KWh for 40 Years.

Tahun 1999 2000 2001 2002-2038

Tahun ke 1 2 3 4-40

Tariffs (Cents / KWh) 1 3.3 2.6 4.93

No 1 2 3 4

Cost Components Component A (element of payback period of investment) Component B (element of fixed costs for operations and maintenance) Component C (element of fuel cost) Component D (element of variable cost for operations and

New Agreement Cost 3.53 0.4 1.0 0.1

maintenance) Total Cost of Generation (US Cents / KWh)

4.93

Calculation on Actual Condition and New Agreements

Based on the above data and assumptions we can generate the annual Free Cash Flow of Paiton Energy by

Based on the formula above, the annual Free Cash Flow of Paiton are:

Tahun 1999

Tahun ke Free Cash Flow 1 64,316,700 2000 2 295,121,772 2001 3 232,520,184 2002 4 676,308,512 2003-2038 5-40 226,308,512
The assumptions used in the calculations above are:

Explanation PLN only pays fuel price Paiton completed in May Based on interim agreements Based on tentative agreements Based on final agreements and PLN pays arrears of $450 Million Based on final agreements

In 1999, Paiton operate on June-December, the energy produced on the period are 6,431,670,000 KW. PLN only pays the fuel cost which is 1 cent per KWh. In 2000, PLN pays Paiton the tariffs according to the interim agreement amounted at 3.3 Cents per KWh In 2001, PLN pays Paiton the tariffs according to the tentative agreements amounted at 2.6 Cents per KWh In 2002, PLN pays Paiton the tariffs according to the final agreements amounted at 4.93 Cents per KWh In 2002, PLN pays arrears to Paiton amounted at US$ 450 Millions In 2003-2038, PLN pays Paiton the tariffs according to the final agreements amounted at 4.93 Cents per KWh

After the annual free cash flow is gained, we can calculate the Payback Period, Net Present Value and Internal Rate of Return on this projects

New Agreements Payback NPV IRR 9.44 $ 443,339,817.76 10%

The Assumption used in these calculations are: Tax rate is 30% The discounted factor is 8% as it is the growth rate of electricity demand There are no new investment made during the years There are no changes in the working capital

The detailed calculation of the Payback Period, NPV and IRR for the initial agreement can be seen in the following table:
Year FCF 0 (2,500,000,000) 1999 1 64,316,700 2000 2 295,121,772 2001 3 232,520,184 2002 4 676,308,512 2003 5 226,308,512 2004 6 226,308,512 2005 7 226,308,512 2006 8 226,308,512 2007 9 226,308,512 2008 10 226,308,512 2009 11 226,308,512 2010 12 226,308,512 2011 13 226,308,512 2012 14 226,308,512 2013 15 226,308,512 2014 16 226,308,512 2015 17 226,308,512 2016 18 226,308,512 2017 19 226,308,512 2018 20 226,308,512 2019 21 226,308,512 2020 22 226,308,512 2021 23 226,308,512 2022 24 226,308,512 2023 25 226,308,512 2024 26 226,308,512 2025 27 226,308,512 2026 28 226,308,512 2027 29 226,308,512 2028 30 226,308,512 2029 31 226,308,512 2030 32 226,308,512 2031 33 226,308,512 2032 34 226,308,512 2033 35 226,308,512 2034 36 226,308,512 2035 37 226,308,512 2036 38 226,308,512 2037 39 226,308,512 2038 40 226,308,512 Acc. FCF (2,500,000,000) (2,435,683,300) (2,140,561,528) (1,908,041,344) (1,231,732,832) (1,005,424,320) (779,115,809) (552,807,297) (326,498,785) (100,190,273) 126,118,239 352,426,750 578,735,262 805,043,774 1,031,352,286 1,257,660,798 1,483,969,309 1,710,277,821 1,936,586,333 2,162,894,845 2,389,203,357 2,615,511,868 2,841,820,380 3,068,128,892 3,294,437,404 3,520,745,916 3,747,054,427 3,973,362,939 4,199,671,451 4,425,979,963 4,652,288,475 4,878,596,986 5,104,905,498 5,331,214,010 5,557,522,522 5,783,831,034 6,010,139,545 6,236,448,057 6,462,756,569 6,689,065,081 6,915,373,593 PVIF PV FCF 1.000 (2,500,000,000) 0.926 59,552,500 0.857 253,019,352 0.794 184,582,019 0.735 497,106,946 0.681 154,021,770 0.630 142,612,750 0.583 132,048,843 0.540 122,267,447 0.500 113,210,599 0.463 104,824,629 0.429 97,059,842 0.397 89,870,224 0.368 83,213,170 0.340 77,049,232 0.315 71,341,881 0.292 66,057,297 0.270 61,164,164 0.250 56,633,485 0.232 52,438,412 0.215 48,554,086 0.199 44,957,487 0.184 41,627,302 0.170 38,543,799 0.158 35,688,702 0.146 33,045,095 0.135 30,597,310 0.125 28,330,843 0.116 26,232,262 0.107 24,289,131 0.099 22,489,936 0.092 20,824,015 0.085 19,281,495 0.079 17,853,236 0.073 16,530,775 0.068 15,306,273 0.063 14,172,475 0.058 13,122,662 0.054 12,150,613 0.050 11,250,567 0.046 10,417,192

Summary of Financial Analysis

To summarize, below is the difference between initial agreement and actual conditions and new agreements in the term of Payback Period, NPV and IRR

Lesson Learned as of 2003

In an economic crisis the value of a government support letter is diminished because a project participant can no longer afford to abide by their terms. In the future, lack of competitive bidding and involvement of the relatives of the head of the state should be viewed as danger signals. One of the main factors in the sponsors ability to salvage a difficult situation was their persistence including their consistent denial of corruption charges and their willingness to explore other choice such as extending the term of contract and building new power capacity and extending equity funding.