The energy transition will be a long, highly capital-intensive journey with significant execution risks to be ironed out. How funding from Just Energy Transition Partnerships (JETPs) is used will be fundamental to its effectiveness for Indonesia and Vietnam's energy transition efforts.

What's JETP?   These agreements on financing help the energy transition in emerging economies that require funding support for reducing their dependence on fossil fuels. They are usually signed with wealthier economies and multilateral organizations. Indonesia announced its participation in November 2022, as did Vietnam in December 2022. Indonesia and Vietnam, signatories to such agreements, now have to implement policies that get the partnership funds invested and encourage private funding to fill the gap in energy transition costs.

Why it matters:   In the run up to COP28, which started in Dubai on Nov. 30, 2023, Indonesia launched its Comprehensive Investment and Policy Plan (CIPP) on Nov. 22, 2023. Vietnam also published its Resource Mobilization Plan on Dec. 1, 2023. These plans are key steps in executing broader strategies the nations committed to under their JETP agreements.

Financial commitments under JETPs are small relative to investments required to meet the net-zero trajectory envisaged by the governments of Indonesia and Vietnam, mostly market-priced, and conditional on progressive improvements in emission controls. However, the frameworks can help accelerate structural reforms and in turn disbursement of funding under JETP, which can catalyze private capital for projects that will facilitate the energy transition.

Focus Mainly On Power Sector With Tighter Targets

The JETP agreements signed by Indonesia and Vietnam focus solely on emissions from the power sector. In both countries, the energy sectors are the largest source of greenhouse gas emissions, contributing 60%-65% of the total. The power sector emits most carbon dioxide, largely driven by hefty reliance on fossil fuels for electricity generation (see charts 1, 2, and 3).

Decarbonization of the power sectors is important given a likely increase in electricity demand.

Chart 1

Indonesia and Vietnam are gearing up to tighten their power sector transition targets as signatories to JETPs.   Indonesia plans to commit to peak on-grid power sector carbon dioxide emissions at 250 million metric tons (MT) by 2030 (2020: about 294 million MT). The plan then calls for a decline to net-zero by 2050, compared with 2055 previously.

Vietnam also aims to limit peak power sector emissions to 170 million MT of carbon dioxide equivalents by 2030 (2020: around 150 million MT), followed by a reduction to net-zero by 2050, with support from international partners under its JETP. The greenhouse gas emissions trajectory under the government's latest Power Development Plan (PDP 8) is for emissions from power production to be 204 million-254 million MT carbon dioxide equivalents in 2030 and around 27 million-31 million MT carbon dioxide equivalents in 2050.

Renewables To Facilitate The Transition, Execution Risks Ahead

The energy transition plans for Indonesia largely rely on sharp increases in solar power and gas-fired electricity to replace or retire some coal plants, and there are plans to add some nuclear capacity (see chart 2). These plans are yet to be achieved on scale in the country. For Vietnam, the government's PDP 8 forecasts onshore and offshore wind capacity to lead solar capacity additions (see chart 3). However, offshore wind projects are unproven. Meanwhile, we consider incommensurate strengthening of the weaker transmission and distribution network as the key risk to Vietnam's transition plans.

Chart 2

Chart 3

Transition is dependent on lower costs, better grid, and technological breakthroughs.   Indonesia's energy transition plans and associated investments rely on significant reductions in the cost of renewable power over time (see chart 4). The eventual reduction in cost of supply supported by economies of scale will moderate cost-reflective power tariffs. In Vietnam, solar and wind tariffs are already lower than those for coal- and gas-fired power, even in the absence of carbon taxes.

Chart 4

Indonesia's local content requirements for solar power are not staggered. Local content is currently costlier and lower in quality. In 2020, domestically produced solar PV modules were more than double the international average cost, according to the Ministry of Energy and Mineral Resources and the Danish Energy Agency. Renewable power is expensive, lowering off-take and in turn reducing the need for domestic manufacturing capacity.

Vietnam's step-up in offshore wind capacity over 2030-2050 is possible only if execution risks with project complexities, supply chain constraints, and permitting processes are addressed. Battery life and cost competitiveness also need to improve meaningfully for successful integration of renewable power. Potential economical use of green hydrogen to run gas-fired assets would also need cheaper renewable power to produce green hydrogen. Utility-scale carbon capture, utilization, and storage projects remain costly.

The integration of intermittent and distant renewable energy requires significant expansion and upgrades of the transmission grids in both Indonesia and Vietnam, along with technological breakthroughs in enhancing battery capacity. Vietnam Electricity (EVN) has had to curtail renewable power in the last couple of years because of inadequate transmission capacity. This resulted in significant financial losses to many developers.

Both governments plan for declines in coal capacity after 2030 peaks.   This will be 41 gigawatts (GW) in the case of Indonesia and 30GW in the case of Vietnam, as per PDP 8. Thereafter, the countries will start repurposing or retiring their coal capacity base. Indonesia intends to gradually retire a total of 1.7GW of coal capacity through 2040. It will then retire or repurpose the entire fleet by 2050. Vietnam plans to repurpose the majority of its coal fleet to run on biomass or ammonia by 2050.

Early retirement of coal plants will be challenging.   We believe retirements are unlikely at relatively young coal-fired power projects in Indonesia and Vietnam that have yet to recover substantial amounts of financial capital. The capacity-weighted average coal plant age is about 12 years in Indonesia and nine years in Vietnam, according to BP Statistical Review of World Energy, against usual useful economic life of 25 years. Long depreciated, largely inoperative, or inefficient plants are the ones likely to be closed. We expect any early retirement of regulated coal projects to be supported by grants and/or concessional loans .

Massive Funding Needs May Pressure Creditworthiness

Massive investment is required to meet net-zero objectives. Indonesia estimates an investment of US$97 billion over 2023-2030 and US$580 billion over 2023. The outlay is significant relative to the nation's real GDP of about US$950 billion in 2022, with about 5% annual GDP growth likely over next few years.

Vietnam also estimates a total capital expenditure (capex) need of US$135 billion over 2021-2030, and US$400 billion over 2030-2050 to meet its PDP 8 targets. Based on technological evolution and economics, Vietnam's requirements could increase to US$523 billion over 2030-2050. Surpassing Indonesia, Vietnam's investment requirements are in multiples of the country's real GDP of about US$273 billion in 2022.

Governments, consumers, or utilities will need to bear the cost of energy transitions.   Which parties pay how much will determine credit rating impact on utilities. Credit profiles of power utilities may deteriorate if they adopt more aggressive leverage for investments and if their cash flows do not increase adequately. The impact will be more pronounced on unregulated players than regulated utilities. This is because regulated utilities usually benefit from adequate cost-pass through mechanisms.

We believe the Indonesian government's ongoing policy of protecting households from sharp increases in power tariffs could lead to a rising subsidy burden for the government.   Timely monthly subsidy payments and quarterly deferred compensation payments to Perusahaan Perseroan (Persero) PT Perusahaan Listrik Negara (PLN) will remain key for the credit health of the power sector. Large investments required by EVN will mean the government's funding plans for EVN will drive the credit health of the power sector.

The investments imperative for net-zero transition are substantial against annual capex incurred by PLN and EVN over last few years.   PLN, and EVN to a larger extent, have both underspent their capex targets (see charts 5 and 6). They have been limited by a combination of delays in financial closure, bureaucratic processes, delays in land acquisitions, and/or the implications of COVID-19.

Chart 5

Chart 6

Mostly Market-Priced and Conditional Financial Commitments

A low proportion of grants and concessional loans could render JETPs in Indonesia and Vietnam ineffective. Most of the money under the JETPs will need to be paid back with interest. And not at a discount.

Private funding is required.   Indonesia has secured an initial commitment of US$20 billion under its JETP; Vietnam has tied US$15.5 billion to be rolled out over next three to four years. Around 50% of the total will come from public financing. The remainder of the money will be sourced from market-priced private funds.

Public financing is also not all grants or concessional loans.   In the case of Indonesia, grants will be worth around US$295.4 million, while concessional loans will be another US$6.9 billion. Similarly, Vietnam will receive grants of about US$321.5 million and concessional loans of US$2.7 billion. The balance of public financing will be at market prices as well.

The JETPs financial commitments areconditional on reforms being implemented.   Governments need to roll out reforms and capacity additions on the ground to fulfil the agreements' conditions for continued disbursement of funds. A proportion of the committed public financing will only be released following government reform. Similarly, changes in the power sector will need to be made before private funds, even those committed under JETPs, are invested.

JETPs Financial Support Can Help Reduce Sector Risk

The funds committed under JETPs account for only a small percentage of total investment required for transition of power sectors in Indonesia and Vietnam. However, they can support and accelerate structural reforms to catalyze private investment. Indonesia and Vietnam's potential concrete measures to address subsidized power, cheaper coal, and inadequate risk allocation in power purchase agreements (PPAs)-- especially for Vietnam--may help attract required private investment into the power sector, in our view.

Electricity tariffs reflecting cost of power supply would be credit positive

Market-based electricity pricing would encourage investment in power generation and increase the efficiency of power utilization. A combination of green power supply and efficient demand management can eventually result in moderate or even lower electricity tariffs, as well as climate risk mitigation.

Indonesia's electricity tariff framework lacks transparency because of ad-hoc tariff adjustments and incomplete pass-throughs. The government imposes tariff caps for various end-customers owing to sociopolitical considerations. PLN's credit profile is reliant on timely and adequate payments from the government to account for a shortfall in its cost and return recovery.

Vietnam also doesn't have a record of revising electricity tariffs to reflect supply costs in a timely manner. The government introduced a tariff regulatory framework in the middle of 2017. According to the policy, EVN could revise tariffs up to 5% every six months to reflect increases in certain costs related to power supply. Any increase from 5% to 10% requires approval from industry and trade ministry. An increase of higher than 10% needs approval from the prime minister.

Despite the documented tariff regulatory framework, Vietnam has revised electricity tariffs only four times. These hikes fell short of increases in the cost of power supply and investment requirements. The tariffs were increased in December 2017, March 2019, May 2023 and November 2023 by 6.1%, 8.4%, 3.0% and 4.5%, respectively. Unlike PLN, EVN is not compensated through subsidies either. The consequent lack of investments in the country's power sector has resulted in various blackouts over the last few years.

Masking the costs of coal distorts market dynamics

Indonesia and Vietnam's coal price caps for the power sector result in indirect subsidies and distort market dynamics. The caps artificially make coal-fired electricity cheap and stable. The utilities therefore often prioritize coal, pushing out renewable capacity additions. The coal price caps also discourage investments in efficiency measures and may result in rehabilitation of coal-fired power projects as the actual cost of power generation is masked.

Some PPAs lack adequate risk allocation

Vietnam's PPAs lack adequate risk allocation. This hurts the bankability of various projects, including capital intensive offshore wind assets and green hydrogen projects. Indonesia's PPAs have evolved over time and are generally stronger than in Vietnam; however, there are still a few shortcomings.

Most of Vietnam's PPAs do not penalize EVN for curtailment of electricity. The PPAs are also usually silent on termination payments, which is particularly important in the absence of direct sales to commercial and industrial customers with EVN as largely the single counterparty.

The curtailment risk in Indonesia is borne by PLN with its take-or-pay contracts. However, there could be a grace period before deemed dispatch is applicable and its length can vary from one contract to another. Moreover, the utility can unilaterally restructure material conditions of the agreement in cases of hardship or, in certain cases, at its discretion. PLN's PPAs allow for termination payments but in local currency. The contracts usually do not specify calculations for termination cost, beyond stating they should be to the extent reasonable.

Vietnam's policy support for synthetic Direct PPAs (DPPAs) for renewable assets and focus on exponential uptick in roof-top solar capacity will support investments in the sector, in our view. This support can sidestep EVN's credit and PPA risk and bolster the bankability of projects.

A Long, And Capital-Intensive, Way To Go

Indonesia and Vietnam will need massive investments and technological breakthroughs to exponentially increase their renewable capacity and meet their net-zero ambitions. JETPs can help catalyze private investments by supporting the governments accelerate sectoral reforms. However, the governments, consumers, or utilities will need to bear the cost of energy transitions. Which parties pay how much will determine credit rating impacts on power utilities.

Editor: Richard Smart

Digital Designer: Halie Mustow

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