PL 5103 SPATIAL ECONOMICS

Natural Monopoly of Electricity Sector in Indonesia and The Role of The Government
Ade
NIM : 25415056

1. INTRODUCTION

Electricity plays a key role in our daily lives and has become an integral part of the main
driver of economic growth. Most sectors such as industries, households, and public facilities depend
heavily on electricity as their power source. The 1945 Constitution of the Republic of Indonesia in
article 33 states “sectors of production which are important for the country and affect the life of the
people shall be under the powers of the State”, hence ensuring affordable and accessible electricity
supply becomes one of the mostt critical roles of the government. Over more than 50 years the
majority of electricity connections are provided by Indonesia state-owned company or Perusahaan
Listrik Negara (PLN). The company holds a monopoly in distribution the elecricity throughout
Indonesia. Nowadays, PLN is often blamed for its inability to provide sufficient electricity to the
consumers since the existing capacity of electricity generation is unable to serve the rapid growing
demand of electricity. As a consequence, blackouts occurs frequently due to power deficiencies. In
addition, as a large number of people lives in rural areas where the electricity tariff is not adequate
to cover PLN costs, the expansion of electricity grids seems to be not profitable due to high
investment cost. The provision of electricity service involves large power plants, transmission lines
and distribution system which are expensive. These high operating costs are partly covered by
government subsidies.
The Law Number 30 Year 2009 concerning on Electricity provides the opportunity of private
sectors to take part in providing electricity by operating large-scale Independent Power Producers
(IPP) . However, these IPPs are only allowed to sell their services to PLN based on certain
agreement. Furthermore, according to this law, the private sectors are permitted to sell their
generated power to the consumers as long as they operates in the area that is not being served by
PLN.
From economic point of view, electricity sector is a good example of natural monopoly. “A
firm producing a single homogenous product is a natural monopoly when it is less costly to produce
any level of output of this product within a single firm than with to or more firms” (Joskow 2007).
The presence of natural monopoly in electricity service provision involves two things. On one hand,
it would be better off to have one operator to provide the service due to the high initial investment
costs. On the other hand, it requires regulation regarding price in order to achieve efficiency of the
electricity supply and demand. In this paper, I would like to address the question “why it is necessary
to regulate natural monopoly in electricity sector in Indonesia?” and analyse the role of the
government in term of given subsidy.

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2. LITERATURE REVIEW

A firm that exhibits the scale of economies no matter how much they produced is often
termed as natural monopoly. A natural monopoly emerges when the average cost of production falls
as the firm gets larger, recalling from the fourth pinciple of urban economics which is “production
is subject to economies of scale” (O’Sullivan 2012). An electric company, specifically PLN, is a good
example of natural monopoly in Indonesia. . In this case, the term economies of scale means that
PLN can provide power generation, transmission, and distribution service more efficiently than
separate firms provide each type of the services. The initial costs required to produce electricity is
very high, but once the fixed costs involved with power generation, transmission lines, and
distribution system are paid, the average cost for each additional unit supplied will decrease. Having
two electric companies which split the electricity production, each with their own power plants and
power grids would lead to a near doubling price (“Benefits, Exceptions, and Ethics Natural
Monopolies” 2015). In the case of natural monopoly, allowing the new entrants to join the market
in order to increase the competition will lead to a potential loss of efficiency. It would be more
efficient to encourage only one company to supply the electricity to the market due to that allowing
competition means “a wasteful duplication of resources” (Economics Online 2015). Therefore,
competition in this area is not desirable.
In natural monopoly, economies of scale is very important. Economies of scale derived from
high-fixed costs and are regarded as a barrier to entry (Mosca 2006). The marginal principle can be
used to identify socially efficient level of the service (O’Sullivan 2012). The average-cost curve is
downward sloping which means as the quantity of output increases, the average cost will decrease.
As can be seen from the figure, the average costs are always higher than the marginal costs for
natural monopoly. This is due to high fixed costs since the natural monopoly is characterized by
huge capital costs. A natural monopoly which operates without any regulation from the government
will produce the quantity of output Q and sets its own price to P. In this case, the firm is in its profit
maximization level where the profit is maximized when the marginal revenue equals to marginal
cost, as shown by the red-shaded area in figure 1. In order to achieve socially efficient output where
the price equals to marginal cost, the firm has to produce Q 1 units of output. Hence, the average cost
will fall to C, however the price will decrease from P to P1. In this situation, the firm will experience
deficit, as indicated by the green-shaded area.
In order to cope with the deficit problems, the government has some choices. First, the
government could produce electricty service, set the price of P 1, and resolving the deficit with
general tax revenue. Secondly, the government could provide subsidy for the firm in order to be able
to supply electricity (O’Sullivan 2012). In Indonesia, PLN continues to receive subsidy from the
government in order to survive in its operation.

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Figure 1 Natural Monopoly

Source : (Economics Online 2015)

3. ANALYSIS
1. Current Electricity Industry Structure in Indonesia
Electricity sector covers three main activities namely power generation, power
transmission, and distribution and sale. The former electricity law which is Law Number 15
Year 1985 on electricity mandated that the electricity supply in Indonesia was conducted by
PLN as Indonesia state-owned company and the private sector is given the opportunity to
operate power plants for the purpose of selling it to PLN. Law Number 30 Year 2009 as the new
law of electricity provide bigger opportunity for the private sectors by operating large-scale
independent power producers (IPP). However, these IPPs are only allowed to sell their services
to PLN based on certain agreement. Private sectors that had intention to sell their generated
power are required to construct their own closed off-grid networks. In addition, according to
this new law, the private sectors are allowed to sell produced power to the consumers as long as
it operates in the area that is not being served by PLN.

2. Electricity Selling Price and Cost Structure

The problem with natural monopoly is that if the firm is left unregulated, it will provide
much less quantity of output and set the price much higher than the socially optimum output
where marginal cost equals to marginal benefit. Therefore, it requires government regulation.
The electricity sector in Indonesia has been traditionally dominated by PLN and the electricity
tariff is set by the government as a regulator from time to time as mandated by the Law Number
30 Year 2009 concerning on electricity. There are six main categories of tariff based on types

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of consumers namely residential, commercial, industry, social activities, government, and street-
lighting (PT. PLN (Persero) 2015). These classifiation is further based on the maximum power
received. Residential consumers on average tend to pay lower compared to other categories.
Table 1 shows the electricity tariff set for the residential consumers based on Ministerial
Regulation of Energy and Mineral Resources Number 31 Year 2014 concerning on the
electricity tariff provided by Indonesia State-Owned Electricity Company. PLN also introduced
pre-paid option electricity that has been popular in the last two years particularly among
residential and business consumers. This option enables consumers to manage their own
electricity usage more efficiently. In 2014, the electrification ratio which is the ratio of PLN’s
household consumers to the total households accounted for 84.4% (National Energy Council
2015).

Table 1 Electricity Tariff for Residential Consumer

Regular Use
Class of Pre-Paid
No. Power Limit Load cost
Tariff Usage Cost (Rp/kWh) (Rp/kWh)
(Rp/kVA/month
1 1st Block : 0 – 30 kWh : 169
Up to 450 2nd Block : above 30 kWh – 60 kWh :
R-1 11.000 415
VA 360
3rd Block : above 60 kWh : 495
2 1st Block : 0 – 20 kWh : 275
2nd Block : above 20 kWh – 60 kWh :
R-1 900 VA 20.000 605
445
3rd Block : above 60 kWh : 495
3 R-1 1.300 VA *) 1.352 1.352
4 R-1 2.200 VA *) 1.352 1.352
5 3.500 - 5500 1.352
R-2 *) 1.352
VA
6 Above 6.600 1.352
R-3 *) 1.352
VA
Note:
*) Applied minimum account (RM):
RM1 = 40 (The number of hours electricity used) x Connected Power (kVA) x Price of Usage

Source : (Minister of Energy and Mineral Resources 2014)

The operating costs of PLN are characterized by high investment costs of generating
electricity and transmission. In order to be able to maintain its operation, the company relies
heavily on the subsidy from the government. The cost of generating electricity relies on the cost
of primary source of energy which are varied based on the type of power plants. Some primary
sources of energy are quite expensive, particularly oil-based fuel and coal, whereas other sources
can be acquired almost freely such as hydro power, geothermal, etc. However, it still requires

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huge initial investment costs. In addition, the increase in oil and fuel prices also gives burden to
the operation of PLN.
In 2014, PLN generated operation revenue which accounted for 292.7 billion rupiahs
including the subsidy from the government, which consists of the revenue from electricity sales,
the connection fees, the subsidy from the government, and other revenues, as shown in table 2.
The government subsidy accounted for more than halved of the revenue from the electricity
sales. PLN’s expenditure for operation costs constituted 246.9 billion rupiahs which consists of
the electricity purchase and diesel rented, fuel and lubricant oil cost, maintenance cost, the cost
for the employees, depreciation, and other costs. If the government subsidy is excluded from the
revenue, PLN experienced deficit since its operation costs exceeded its revenue. Therefore, PLN
is subsidized by the government in order to maintain its operation. From the table 2, it can be
clearly seen that the proportion of the cost for fuel and lubricant oils is the biggest compared to
other operation costs.

Table 2 Profit/Loss of PLN (in million rupiahs)

No. Description December 2014

A OPERATION REVENUE
1 Electricity sales 186,634,484
2 Connection fees 5,623,913
3 Government Subsidy 99,303,250
4 Others 1,159,544
Total Operation Revenue 292,721,191

B OPERATION COST
1 Electricity purchase and diesel rented 11,359,026
2 Fuel and Lubricant Oil 170,487,926
3 Maintenance 20,206,661
4 Personnel 15,749,478
5 Depreciation 23,618,262
6 Others 5,488,617
Total Operation Cost 246,909,970
Profit (Loss) From Operation 45,811,221
Source: (PT. PLN (Persero) 2015)

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Since the given subsidy gives burden to the national budget, the government plans to
remove subsidy of the class of tariff 450 VA and 900 VA, which will be started on 1 January
2016 (Kompas 2015). The subsidy will only be allocated for the poor since the existing subsidy
disproportionately benefit households at the top of the income distribution. This subsidy will be
allocated to other sectors such as infrastructure and social sectors.

4. CONCLUSION
1. Natural monopoly exists when the average production cost decrease as the firm gets larger.
2. Electricity sector in Indonesia is a classic example of natural monopoly even though the Law
Number 30 Year 2009 concerning on Electricity provide an opportunity for the private sectors
to provide electricity supply under some circumstances.
3. Natural monopoly is characterized by huge capital costs.
4. In order to be able to maintain its operation, the electric company needs subsidy from the
government.
5. In order to acquire the socially optimum output in which marginal cost equals to marginal
benefit, the government have to impose the regulation in term of tariff.

5. REFERENCES

“Benefits, Exceptions, and Ethics Natural Monopolies.” 2015. Accessed December 21.
http://cs.stanford.edu/people/eroberts/cs181/projects/corporate-
monopolies/benefits_natural.html.
Economics Online. 2015. “Natural Monopolies.” Accessed December 21.
http://www.economicsonline.co.uk/Business_economics/Natural_monopolies.html.
Joskow, Paul L. 2007. “Regulation of Natural Monopoly.” Handbook of Law and Economics 2: 1227–
1348.
Kompas. 2015. “Mulai 1 Januari 2016, Subsidi Listrik Hanya Untuk Si Miskin.”
http://bisniskeuangan.kompas.com/read/2015/10/25/171800726/Mulai.1.Januari.2016.Subsidi.
Listrik.Hanya.untuk.Si.Miskin.
Minister of Energy and Mineral Resources. 2014. Ministerial Regulation of Energy and Mineral
Resources Number 31 Year 2014 on Electricity Tariff Provided by Indonesia State-Owned
Electicity Company.
http://www.pln.co.id/dataweb/TTL2014/Permen%20ESDM%2031%202014.pdf.
Mosca, Manuela. 2006. “On the Origins of the Concept of Natural Monopoly.” Università Di Lecce
Department of Economics Working Paper, no. 92/45.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=975461.
National Energy Council. 2015. Executive Reference Data National Energy Management. 2015
Edition. National Energy Council. Accessed December 22.
http://www.den.go.id/upload/booklet/file/executivedata-2015.pdf.
O’Sullivan, Arthur. 2012. Urban Economics. Eighth Edition. New York: McGraw-Hill/Irwin.
PT. PLN (Persero). 2015. Statistik PLN 2014. Jakarta: Sekretariat Perusahaan PT. PLN (Persero).
http://www.pln.co.id/wp-content/uploads/2012/01/Statistik-PLN-2014_for-website-10-Juni-
2015.pdf.