Ministry of Finance Green Paper

Economic and fiscal policy

strategies for climate change
mitigation in Indonesia

Ministry of Finance, Republic of Indonesia

Australia Indonesia Partnership

Executive Summary
This report may be cited as follows:
Ministry of Finance (2009), Ministry of Finance Green Paper: Economic and Fiscal Policy Strategies for
Climate Change Mitigation in Indonesia, Ministry of Finance and Australia Indonesia Partnership, Jakarta.

Page ii  Ministry of Finance Indonesia Green Paper on Climate Change 

FOREWORD BY THE MINISTER OF FINANCE

The world has moved beyond the conventional view that economic growth objectives are
incompatible with environmental objectives. We know that left unaddressed, climate change
represents a serious threat to our economic wellbeing. On the other hand, sound economic
principles are also key to mitigating the impacts of climate change. Central to such principles is
the appropriate pricing of carbon and ensuring that climate change mitigation policies across the
board are both effective and economically efficient. This emphasizes the need for the Ministry of
Finance to play a central role in shaping Indonesia’s response to the climate change challenge
Indonesia is looking for solutions to curb greenhouse gas emissions, both through our own
domestic measures and working with the international community. To achieve this, we need to
better understand the interaction of climate change policies with our development objectives and
the broader economic reform agenda, to put sound policies in place, and to get the financing
aspects right.
Internationally, Indonesia is known as an advocate of pragmatic and effective climate policy, and
this commitment is exemplified by the recent announcement by President Yudhoyono that
Indonesia will seek to reduce its greenhouse gas emissions by 26 per cent by 2020 and up to 41
percent with international assistance. Indonesia has also played a strong and active role in the
international climate negotiations leading up to the COP15 conference in Copenhagen. Indonesia
hosted the 2007 climate conference which developed the Bali Roadmap for a new global climate
agreement, and initiated the first international meeting of finance ministers on climate change.
The Green Paper spells out a longer-term strategic framework, grounded in economic principle
and international experience, that can guide climate policymaking. Consistent with this framework,
the Green Paper sets out selected concrete strategies for fiscal and economic policies for climate
change mitigation. It focuses on the energy sector, setting out a policy package for geothermal
power; and on the land-use change and forestry sector, spelling out how regional climate change
action can be incentivized through Indonesia’s fiscal transfer mechanism.
I consider that the Green Paper will be an important part of Indonesia’s climate policy debate, and
that it will prove a solid basis for the Ministry of Finance to move toward design and
implementation of climate change mitigation policies.

Dr Sri Mulyani Indrawati

Minister of Finance
30 November 2009

Ministry of Finance Indonesia Green Paper on Climate Change Page iii 

FOREWORD BY THE HEAD OF THE FISCAL POLICY OFFICE

Indonesia’s commitment to reduce greenhouse gas emissions by between 26% and 41% by
2020, compared to a business-as-usual trajectory, poses important questions for fiscal and
broader economic policies. It is crucially important to understand the interaction of climate change
policies with the development objectives and the broader economic reform agenda, in order to put
sound policies in place, and to get the financing aspects right. We want climate change mitigation
policies to be both effective and efficient.
This emphasizes the need for the Ministry of Finance to play a central role in shaping Indonesia’s
response to the climate change challenge through domestic policies, and in bringing Indonesia’s
influence to bear in international climate finance. As the Ministry of Finance’s policy function rests
with the Fiscal Policy Office the Green Paper was developed by the Fiscal Policy Office in close
collaboration with Australian experts.
This Green Paper takes the Ministry of Finance’s engagement with climate policy to a new level. It
provides a sound framework for Indonesia’s climate policy design, and it spells out a number of
concrete strategies for domestic fiscal and economic policies for climate change mitigation, and
sets out international financing strategy considerations advantageous to Indonesia.
I consider the Green Paper required reading for anyone involved or interested in Indonesian
climate change policy, and for staff in many areas of the Ministry of Finance. I expect it will be an
important part of Indonesia’s climate policy debate, and that it will prove a solid basis for moving
toward detailed design and implementation climate change policies.

Dr Anggito Abimanyu
Head, Fiscal Policy Office, Ministry of Finance
30 November 2009

Page iv  Ministry of Finance Indonesia Green Paper on Climate Change 

ACKNOWLEDGMENTS

This Green Paper is a joint Indonesian and Australian effort.The Green Paper was prepared by Dr
Frank Jotzo and Mr Salim Mazouz, in close collaboration with the Fiscal Policy Office of the
Ministry of Finance. The team was guided by Professor Armida Alisjahbana (prior to her taking up
the post of Minister for Development Planning). Overall project guidance was provided by the
Australian Treasury’s Government Partnership Fund program through Mr Nathan Dal Bon. The
project was funded and managed by the AusAID Technical Assistance Management Facility
through Mr Bernie Carmody. Assistance was provided by a number of experts and analysts,
including Dr James Gifford, Dr Arief Yusuf, Dr Budy P. Resosudarmo, Dr Ida A.P. Resosudarmo,
Dr Axel Michaelowa, Mr Kurnya Roesad and others.
The preparation of the study has been helped enormously by the active support and guidance at
key stages by the Minister of Finance, Dr Sri Mulyani. Valuable ongoing input and guidance was
provided by Dr Anggito Abimanyu, Head of the Fiscal Policy Office, his senior colleagues Bapak
Askolani, Director of Budget Policy and Professor Singgih Riphat, as well as FPO staff members
including Pak Amnu Fuadym, Pak Kindy Syahrir and others.
Other stakeholders that provided valuable contributions include: other Directorates of the Ministry
of Finance; Bappenas; the Ministries of Environment, Forestry, Energy and Mineral Resources;
the National Council on Climate Change and various state-owned and private sector companies,
business associations and civil society organizations.

Ministry of Finance Indonesia Green Paper on Climate Change Page v 

EXECUTIVE SUMMARY

INDONESIA’S ROLE IN GLOBAL CLIMATE CHANGE MITIGATION

Climate change is an issue of high priority for Indonesia. It is highly vulnerable to
climate change (ADB 2009), and is a significant emitter of greenhouse gases.
Therefore Indonesia has a strong stake in the global effort to limit future climate Indonesia is playing an
change. active and constructive
role in the international
Indonesia is committed to making a significant contribution to limiting global negotiations and has
greenhouse gas emissions, and to helping make a global climate change committed to making a
agreement possible. President Yudhoyono has announced a target for Indonesia strong contribution to
to reduce emissions by 26% by 2020 compared to business as usual (see Box 1), global climate change
and by up to 41% with international support. mitigation.

Indonesia has played an active and constructive role in the international climate
negotiations leading up to the Copenhagen COP15 conference. For example,
Indonesia hosted the 2007 COP13 UN climate conference, which developed the
Bali Roadmap for a new global climate agreement. Indonesia initiated the first
international meeting of finance ministers on climate change, in conjunction with
the Bali conference. In addition, Indonesia’s Ministry of Finance has been
engaged with the climate change discussions in a wide range of international
forums, including the G20 and many others.
Indonesia’s response to global climate change must be consistent with its
Meeting these
development and poverty reduction objectives. Environmental policies need to be
commitments needs to
in line with economic goals. As President Yudhoyono stated at the G20 Leaders’ be consistent with
Summit in Pittsburgh, “We must tell the world it is possible to cure the global development and
economy and save the planet at the same time.” poverty reduction
objectives, and needs
sound economic
THE GREEN PAPER: TOWARDS ECONOMICALLY SOUND policy.
CLIMATE POLICY
The Green Paper identifies economic and fiscal policy strategies for climate
change mitigation – that is, reducing emissions of carbon dioxide and other
greenhouse gases – and how to do this in the most cost effective way. It lays out
strategies for the Ministry of Finance for efficient and effective policies, both in the
short term and the long term. The paper is grounded in economic principles, and
applies emerging international experience to Indonesia’s circumstances.
Indonesia is no different to other countries in that a carbon-constrained future
presents both significant challenges and opportunities. If Indonesia can put in
place policies that enable it to grow its economy along a path of low emissions, it
will have played an important part in the solution to the threat of global climate The Green Paper
change. At the same time, by moving early to restructure its economy around low details policy
emissions, it will gain a competitive advantage relative to other nations in the approaches for cost-
effective reductions in
region, and could stand to benefit economically and financially.
greenhouse gas
The Green Paper presents strategies that can guide longer-term policy reform for emissions.
climate change mitigation, including a move toward pricing of carbon emissions. It
sets out concrete options for geothermal policy, and for creating abatement
incentives for regional governments, especially to reduce emissions from land-
use change and forestry. In these areas it illustrates how economic principles can
be used to devise efficient and effective climate policies in the short term. These

Executive summary Page 1 

 
 Principles for climate principles can be extended to other aspects of energy and land-use
policy need to be change/forestry, and to other parts of the economy such as agriculture and
reflected in mining.
implementable policies,
and as steps towards a
The Green Paper also sets out strategies to access international financing and
longer term efficient canvasses the need for further institutional development. In brief, the strategies
climate policy proposed are as follows.
framework.

THE STRATEGIES IN BRIEF

Strategy for the energy sector:
 Work towards the implementation of a carbon tax/levy on fossil fuel
combustion, in parallel with removal over time of energy subsidies. Couple
this policy with access to international carbon markets, by negotiating a “no-
lose” target with appropriate parameters.
 Introduce complementary measures to incentivize energy efficiency and
deployment of low-emissions technology, exemplified by a specific
geothermal policy strategy.
Positioning Indonesia Strategy for the land-use change and forestry sector:
for a carbon-
constrained future  Support and incentivize carbon abatement measures by regional
means early governments through the intergovernmental fiscal transfer system, working
restructuring towards a toward the creation of a Regional Incentive Mechanism (RIM) for climate
low-emissions change.
economic structure.  Work with the appropriate ministries to bring existing fiscal policy settings
into line with carbon reduction objectives.
Strategy for international carbon finance:
 Support the creation of new, broad-based carbon market mechanisms like
sectoral targets and crediting. Support new and additional sources of
international public financing. Ensure adequate returns for Indonesia’s
emissions reductions.
Strategy for institutional development:
 Strengthen capacity for climate policy analysis at the Ministry of Finance.
Support policy coordination across government especially among the
economics ministries; and advocate a review of the broader regulatory
framework that relates to climate change policy.

EMISSIONS AND REDUCTION GOALS

Emissions from land- Indonesia’s current greenhouse emissions profile is dominated by land-use
use change, forestry change, forest degradation and peat fires. However, emissions from the energy
and peat dominate sector are growing strongly as Indonesia’s economy grows. If left unchecked,
Indonesia’s emissions emissions from this sector could overtake emissions from land-use change and
profile now, but energy forestry in a few decades.
could overtake within a
few decades.

Page 2  Ministry of Finance Indonesia Green Paper on Climate Change

 
Figure 1 A business-as-usual scenario for Indonesia’s greenhouse gas
emissions, based on current trends, MtCO2-e/year

4000

Data 
from Projection  by trend  extrapolation 
3500
SNC

3000

2500
Peat
2000

-26%
1500
-41%
Land-use change
1000 and forestry
Other sources
500
Energy / fossil fuel combustion

0
2000 2005 2010 2015 2020 2025 2030

Data sources and notes: see Figure 1.2 in Chapter 1.

Land-based emissions provide the bulk of cost effective short to medium term
emissions reductions opportunities. But to get the energy-sector onto a longer-
An integrated policy
term lower carbon trajectory, policy directions for low-carbon energy need to be
effort across all sectors
set now. An integrated policy effort across all sectors is needed for efficient
is needed for efficient
outcomes, rather than planning for specific quantitative reductions in each sector. outcomes, rather than
A 26% reduction below the business-as-usual trajectory at 2020 could mean a planning for specific
slight reduction below current emissions levels, while a 41% cut would mean a reductions in each
sector.
significant reduction. For instance, under both DNPI projections and trend
extrapolation from current data (Figure 1), a 26% and 41% reduction relative to
business-as-usual implies a reduction of around 6% and 24% respectively below
2005 emissions levels. These are significant challenges, in the face of rapid
economic growth – but with the right policy approaches they could be achieved.

Box 1 The importance of business-as-usual scenarios

A “business as usual” (BAU) scenario is a hypothetical trajectory for future carbon
emissions in the absence of policies and other measures to reduce emissions. In contrast,
policies with other objectives – such as energy security – are included in the BAU.
Many of the proposals for developing country action that are currently discussed in
international negociations define emissions targets relative to a BAU baseline. The BAU
scenarios are therefore central to the actual effort required to achieve any emissions
reductions as part of such proposals. Fo Indonesia, the BAU concept is already central
given the announcement of a target of 26% or 41% emissions reductions relative to BAU.
There is no single objective BAU scenario, because it depends on projections of future
economic growth, structure and technological development. In agreeing emissions targets,
the underlying BAU scenario and the deviation from it are both crucial.

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 INTERNATIONAL CARBON FINANCE
In an increasingly carbon-constrained world, there is likely to be an expansion of
both private market and public finance to support climate change mitigation in
Indonesia could attain developing countries (Figure 2). If suitable mechanisms are put in place
a larger share of internationally and domestically, Indonesia could be a major recipient of such
international carbon finance. Indonesia currently accounts for less than 2% of the Clean Development
finance than it has to Mechanism market, but might be able to attain 10% of much larger future carbon
date. finance flows, based on its share of emissions.

Figure 2 Carbon finance needs in developing countries, financing

proposals, and the size of the Clean Development Mechanism

Attracting carbon finance inflows is not an end in itself for Indonesia. Rather,
international finance should be seen as an important factor in enabling Indonesia
to restructure its economy in readiness for a low-carbon future.

Attracting carbon
To ensure that international mechanisms are favorable to its interests, Indonesia
finance is not an end in needs to continue to engage actively with international forums such as the
itself, rather, it can UNFCCC and the G20.
assist Indonesia There is a role for both public and private carbon finance. Public finance is
prepare for a low-
particularly important in the short term, before private markets are fully functional.
carbon future.
Public finance should be used to support capacity building, institutional reform,
and the up-front financing of mitigation initiatives, and to facilitate transformational
change.
Private markets, driven by demand from developed countries’ emissions trading
schemes, could provide the mainstay of carbon finance in the medium term. More
broadly based carbon finance mechanisms, such as sectoral targets and
crediting, can assist Indonesia to benefit from this global development (Box 2).

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 Box 2 A shift to broad-based carbon market mechanisms
New broad-based mechanisms are under discussion for framing developing country
mitigation actions and to base carbon market financing on, for example, sectoral targets
and crediting mechanisms. These mechanisms are more comprehensive than project-
based mechanisms such as the CDM. They are likely to be preferred by the main buyers of
emissions credits, and could also be highly suitable for developing countries that
implement carbon reduction policies.
Both the carbon pricing policy and the Regional Incentive Mechanism described below are
examples of broad-based interventions in the economy intended to internalize the unpriced
externality of carbon emissions. It is in Indonesia’s interest that links to international
finance be similarly broadly based.

The cornerstones of an international carbon finance strategy, based on the

agenda of supporting longer-term economic reform and development objectives,
include the following:
 Strive for good access to international private carbon finance, by supporting
the creation of broad-based, effective new carbon market mechanisms that
match domestic policy initiatives, including a no-lose target for Indonesia’s Suitable strategies for
fossil fuel emissions. Ensure that an adequate proportion of emission Indonesia include:
reductions triggered by government policies can be sold in international proposing a no-lose
carbon markets, and are sold at market prices. target for fossil fuel
emissions; ensuring
 Strive for public carbon finance to be available to Indonesia, particularly in appropriate value is
the short term until private markets are fully functional. Ensure that it is obtained from permit
additional to existing aid and multilateral financing, that emission reductions sales; and supporting
assisted by public finance can be sold in carbon markets or count toward the creation of an
Indonesia’s target rather than other countries’, and that climate loans are REDD mechanism with
strongly concessional. Support new sources of public carbon finance, such sub-national
as a global levy on air and sea transport or the auctioning of emissions implementation
allowances in industrialized countries.
 In global developments toward the creation of a funding mechanism for
reducing emissions from deforestation and forest degradation (REDD),
support market mechanism that involve a national approach with subnational
implementation, and broad coverage of emissions sources. Secure access
to public REDD financing particularly in the start-up phase and for specific
activities like improved peat land management.

ENERGY AND CARBON PRICING

Energy is a development issue for Indonesia. Total energy demand is growing by
around 7% per year, as the transport and industrial sectors grow, and as
households become more affluent.
The electricity generation capacity is struggling to expand quickly enough to keep Significant price
up with this demand. Substantial capacity expansion programs have been put in distortions remain in
the energy sector and
place over the last few years, but the projected increases in demand will continue
climate policies
to grow strongly as Indonesia’s economy develops.
provide an opportunity
During the last decade, the emissions intensity (that is, the quantity of to enhance economic
greenhouse gas emissions per unit of energy consumed) of Indonesia’s energy efficiency in addition to
sector has been rising. This is due in large part to the increased reliance on coal reducing emissions
for electricity generation. Coal has been favored in capacity expansion because it
reduces Indonesia’s dependence on foreign oil imports, and because it is seen as
the cheapest source of electricity. However, the assumption that coal is the

Executive summary Page 5 

 
 cheapest source of electricity omits important economic factors that affect the
economy and the government budget.
The mainstay of efficient reform of the energy sector should be to ensure that
Introducing carbon
economic price signals are transmitted accurately through the market. This
pricing is necessary in
the medium to long
amounts to ensuring that explicit and implicit subsidies do not distort relative
term to achieve prices and induce “wrong” investment or consumption decisions. In addition, it
emissions reductions does not cost producers anything to emit carbon at present, so economic agents
at least cost. act as if emissions were free. This means that there is no pressure to reduce
emissions, and so emissions will naturally grow.
Efficient mechanisms for modifying the economy to reduce carbon emissions are
to remove energy subsidies over time and to introduce a price for carbon
emissions.
Removing subsidies will ensure that only energy that is worth more to users than
it actually costs to produce is used, reducing emissions and increasing
productivity at the same time.
Introducing a carbon price would ensure that the price of activities and goods that
involve high emissions will go up relative to low-emissions alternatives. If these
Accelerated removal of shifts in relative prices are allowed to flow through to users, they will induce a shift
energy subsidies and in activity away from high-emissions activities, toward low-emissions activities. In
the introduction of this way, the lowest-cost abatement options available in the economy are
carbon pricing are
selected and emissions abatement is achieved at least cost (see Box 3).
desirable and can be
done in parallel. Thus, both accelerated removal of energy subsidies and the introduction of
carbon pricing are desirable. However, note that introducing a carbon tax/levy is
not contingent on removing energy subsidies first, it can go hand-in-hand with
phasing energy subsidies over time. A carbon tax/levy can provide an immediate
price signal to shift to lower carbon options in power supply and industry, and
would create a forward price signal taken into account in investment decisions.

Box 3 Emissions pricing versus other policy options

Once emissions pricing is introduced, any abatement option that costs less than the
carbon price will become economically favorable, and abatement options that are more
expensive than the carbon price will remain unfavorable. The automatic selection of least-
cost abatement options through a carbon price contrasts strongly with emission reductions
achieved through specific regulatory interventions, or more piecemeal fiscal policy
interventions. These require policy-makers to single out a particular abatement option
without any guarantee that there are no lower-cost options available elsewhere in the
economy.
That said, the application of emissions pricing is limited due to the difficulty of measuring
and accounting for carbon in the agricultural and land-use change and forestry sectors. In
addition, a number of obstacles prevent the market mechanism from selecting abatement
options on the basis of price. There is therefore a legitimate and strong role for measures
to complement carbon pricing, such as providing incentives for additional energy efficiency
savings and the deployment of low-emissions technology. Measures to offset the effects
on households and businesses of price rises associated with carbon pricing also have a
legitimate role in complementing carbon pricing.

A suitable strategy is
The recommended strategy is to introduce carbon pricing through a relatively
to introduce a modest
carbon tax/levy on
modest carbon tax/levy initially. Once carbon measurement and accounting
fossil fuel combustion systems capable of supporting emissions pricing have been extended beyond
initially. fossil fuel combustion, drawing in more potential market participants, the carbon

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tax/levy could be replaced by emissions trading, potentially with direct linkages to
international carbon markets. Coverage can be
expanded and the
To underpin the introduction of carbon pricing, regulations would need to be put in tax/levy replaced with
place (see Figure 3). emissions trading as
the measurement
systems are further
developed.
Figure 3 Sequencing of the introduction of carbon pricing

In the case of Indonesia, energy prices are regulated for many energy users,
which means that the carbon price signal does not get passed through to energy
and energy intensive goods. However, in order to have an effect on investment
and consumption decisions, the carbon price does need to be passed through.
As an indication of magnitude, the carbon tax/levy could start at a level of
Rp 80,000 per tonne of CO2, and rise at a rate of 5% (real) per annum to 2020.
This measure is projected to reduce emissions from the energy sector by around
10% from business-as-usual levels by 2020, assuming full carbon price pass- Carbon pricing could
through. By then it could produce a taxation/levy revenue stream of around Rp 95 yield large new
trillion per year (in today’s terms). revenues, which can
be used to assist
The revenue from a carbon tax/levy would accrue to the budget and can be used business and poor
as the government considers appropriate. That said, the suggested strategy is to households, as well as
use the revenue to assist the process of reform and help alleviate the impact of for additional climate
higher prices on the poor. change measures.

Cash transfers directed at poor households and tax reductions (of the most
distorting taxes) can improve income distribution. The revenue can also be used
to compensate businesses for losses incurred through the carbon tax/levy, either
through direct compensation or by using the revenue to promote efficiency-
enhancing reforms that make it easier for affected firms to do business (see
Table 1). The revenue from the carbon tax/levy can also be used to support
additional abatement incentives, where this is economically sound.

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 Table 1 Average price impact of Rp 80.000 carbon price, projected
revenue, and possible revenue uses

Price increase Tax/levy revenue Possible use of revenues

Electricity Rp 60 per kWh Revenue would rise Government free to

to around Rp 95 decide on revenue use.
Diesel/kerosene Rp 235 per liter trillion by 2020 per Proposed strategy: Offset
Gasoline Rp 190 per liter year. the impact of price rises
Additional permit on households and on
export revenue of businesses; reduce other
several billion taxes; support additional
dollars per year abatement initiatives.
may be available

Economic modeling indicates that a relatively low carbon tax/levy, implemented

while other distortions are still in existence, and with judicious recycling of tax/levy
A carbon tax or levy revenue, could yield both a small increase in GDP and a reduction in the poverty
could yield both a rate. Depending on how the revenue is used, small costs in GDP terms are also a
reduction in poverty possibility, but could be offset by exports of emissions permits to international
rates, and an carbon markets.
increase in GDP.
The proposed introduction of a domestic carbon tax/levy would allow Indonesia to
take a powerful position to the international negotiating table, and gives it a
substantial early-mover advantage. Indonesia could propose that, as part of its
26% unilateral emissions reduction, it would create a “no-lose” target for
emissions from fossil fuel combustion (see Chapter 3 for discussion of how the
“no-lose” target mechanisms would work).
The no-lose target would be set somewhat below the internationally agreed
business-as-usual emissions trajectory, and any reductions further below that
target would allow Indonesia to sell abatement units in international carbon
markets. For example, if Indonesia were to negotiate a 5% reduction below an
agreed business-as-usual trajectory, and actual emissions turned out to be 15%
below it, then Indonesia could sell 10% in international carbon markets.
A carbon tax/levy on fossil fuels would be a very credible and transparent tool to
achieve the reductions to underpin a no-lose target.
If agreed to, this kind of target arrangement would create a large new export
A no-lose sectoral
opportunity for Indonesia. Economic modeling undertaken for the Green Paper
emissions target could
yield large amounts of and various abatement cost curves for Indonesia, suggest that at an international
permit export revenue price of US$30 per tonne of CO2, reductions in Indonesia’s fossil fuel emissions in
for Indonesia, and the order of 24% from business-as-usual levels would be possible. If, for
send a strong signal illustration, a 10% reduction were agreed as the target, then such a reduction
internationally. would give rise to export revenue of US$2–3 billion per year by 2020.
The price mechanism for carbon emissions is the backbone of the emissions
reduction strategy in the energy sector. However, where obstacles prevent the
market mechanism from selecting abatement options on the basis of price, there
is a role for complementary measures to supplement the carbon tax/levy,
including providing incentives for additional energy efficiency savings and the
deployment of low-emissions technology.

GEOTHERMAL ENERGY
Geothermal energy stands out as an important opportunity for the Indonesian
economy. Indonesia is host to 40% of the world’s geothermal resources, and has
by far the largest resources of any single country. Geothermal power produces
almost zero emissions and is a renewable source of energy. As the world moves

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toward a carbon-constrained future, countries that can supply low-cost, low-
emissions energy will have a strong competitive advantage and stand to gain
economically.
There is a role for
Today, only around 3% of Indonesia’s geothermal resources are developed. The regulatory and fiscal
main reason for this is that geothermal energy cannot compete with conventional measures to
energy sources, given the existing distorted price structure of the Indonesian complement emissions
energy sector. The distortions arising from explicit and implicit subsidies favor pricing. Policies to
fossil fuel generation, to the near exclusion of geothermal. incentivize geothermal
power generation
The skewed energy production mix arising from this distorted price structure provide a case in point
represents a genuine economic loss for Indonesia. Energy could be produced
more cheaply if these distortions were neutralized. There is also a substantial
danger in building energy capacity under a distorted price structure, since the
long life of investments in the energy sector mean that investment decisions
made under today’s conditions will affect Indonesia for decades to come.
The carbon tax/levy applied to fossil fuels will go some way toward unwinding the
distortions in the price structure for energy, and should make geothermal a more
attractive option to energy producers. However, the proposed carbon tax/levy is
modest compared to likely international carbon prices, and provides only a partial
answer. In addition, there are other price distortions present in the system that
need to be addressed before geothermal can compete on a level playing field.
Therefore, there is a role for complementary measures, on top of the carbon
tax/levy, to promote geothermal development in Indonesia. The need for such
measures is even more pronounced ahead of the introduction of carbon pricing.
The economic viability of a potential geothermal development can be determined
by comparing its generation costs with those of conventional technologies. It is In addition to a carbon
important to include all costs, explicit and implicit, when comparing the generation price premium for
costs of geothermal and conventional (typically coal). Many, very real costs borne geothermal power,
by the Indonesian government are not included in the simple book cost paid by geothermal tariffs need
to reflect the true cost
PLN to the independent power producers (IPPs). For instance, price pass-through
of electricity currently
arrangements for the coal generators mean that the government pays when the incurred by the
coal price rises. This amounts to an implicit subsidy (essentially a coal price Indonesian
hedge) for coal generation and must be included when comparing the costs of government.
geothermal and coal generation.

Figure 4 Breakdown of the true cost of coal-fired electricity

14
Carbon price
12
Air pollution & carbon
10 price risk cost

Fuel price risk cost

cents/kWh

6 Fuel cost

4 Operating cost

2
Capital cost

0
True cost of energy

Source: McLennan Magasanik Associates modeling for the Green Paper

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 By including all explicit and implicit subsidies on top of the “book price” of
electricity, the full cost of electricity generated through conventional technologies
can be calculated. In practice, calculating such costs is not straightforward,
A reasonable and suggesting a fiscally conservative approach of using a best-effort conservative
conservative estimate
value.
of the actual true cost
of electricity incurred A value of 13 cents per kWh is taken as a reasonable and conservative estimate
by the Indonesian of the true cost of electricity, using figures from McLennan Magasanik Associates
government is 13 cent (MMA) (Figure 4) and keeping in mind that geothermal in part displaces more
per kWh. expensive generation technologies such as oil based generation (see Chapter 4).
In addition, other benefits of expanding Indonesia’s geothermal capacity, such as
greater security of supply, further enhance the value of geothermal, but the “full
cost of electricity” as defined above gives a minimum price that geothermal
should fetch.
It is therefore economically reasonable for the government to pay at least 13
cents per kWh for geothermal electricity with any excess profits by operators
recouped through profit sharing arrangements.
Geothermal development is also hampered by other issues, such as high levels of
uncertainty regarding the value of the geothermal resource in a particular area
coupled with high up-front investment costs. In addition to providing better
investment conditions by providing a clear and government backed tariff, the
provision of enhanced exploration information is necessary.

The strategy for geothermal development has the following three pillars.
1. Enhancement of the existing pre-tender field survey and exploration studies,
to ensure that the geological data available before tender are of the highest
quality possible. The data gathered from surveys and exploration before
The proposed tender would ideally be added to a public geothermal database for
geothermal policy Indonesia, which will become a valuable national asset in its own right.
strategy has three Indonesia’s Clean Technology Fund bid would be well suited to supplying
pillars: enhance the the initial funding for a revolving fund to finance confirmation drilling.
information available to
potential investors; 2. Geothermal tariff. A generic power-purchasing agreement between PLN and
provide a geothermal geothermal IPPs should be created that gives IPPs the right to sell
tariff consistent with geothermal electricity at the “full cost of electricity,” as described above.
the true cost of Since this price may be higher than the price PLN is paying for conventional
electricity; and institute electricity, the Ministry of Finance should reimburse PLN for the difference.
efficient profit sharing
3. Profit-sharing arrangements, applied to the IPP’s profits after cost recovery,
arrangements.
will ensure that the government obtains a fair share of the economic profits
resulting from the geothermal resource, while maintaining the IPP’s
incentives for efficiency.

A vibrant geothermal program in Indonesia could result in healthy receipts from

the sale of emissions abatement on international markets. If Indonesia can
negotiate sectoral crediting across all fossil fuel emissions, as discussed above,
then any geothermal electricity generated will contribute directly to reducing
Indonesia’s fossil fuel emissions, and hence will generate export revenue once
the target is reached. If a comprehensive sectoral target is not achieved, then
international carbon finance could still be accessed through other avenues, and
public carbon finance can also play important complementary roles (Box 4).

Page 10  Ministry of Finance Indonesia Green Paper on Climate Change

 
 Box 4 International funding models
A narrower alternative to a broad sectoral target for all fossil fuel emissions is a sectoral
crediting arrangement for abatement from geothermal resources. This would also allow
Indonesia to reap benefits from geothermal resources that are facilitated by government
policy, by selling abatement on international markets.
This would be more desirable and more applicable than project-based access to
international funding. The Clean Development Mechanism, for example, has high
administrative overheads and may not apply to investments that are made viable through
government policy actions.
Multilateral or bilateral financing in the form of grants or concessional loans is also likely to
be available, and could among other uses help to establish a revolving fund for geothermal
exploration.

REGIONAL ACTION ON LAND-USE CHANGE, FORESTRY AND

PEAT EMISSIONS
Indonesia emits large amounts of carbon from land conversion, forestry and peat
lands (Figure 5). The bulk of near-term emissions reductions in Indonesia are
expected to come from reductions in these emissions sources. Land conversion,
forestry and peat land
There are plentiful opportunities to curb carbon emissions from forestry, land-use management offer
change and peat fires, by changing land-use practices, reducing deforestation, great opportunities to
promoting reforestation, conserving peat land, and preventing fires. In many cut emissions.
cases, the technical and opportunity cost of such measures – for example to
establish a palm oil plantation on grassland rather than on forested land – would
be very low. In many cases, it can be cost-competitive with alternative abatement
actions even after taking into account implementation costs and the need for
cushioning social impacts.
Regulatory, fiscal and budgetary measures will all be important in achieving the
emissions reductions that Indonesia is aiming for. This Green Paper focuses on
ways to harness the intergovernmental fiscal transfer system for the task, which is
one important aspect of the overall climate policy package for land use change
and forestry.
Regulatory, fiscal and
Figure 5 Estimates of emissions from land-use change, forestry and budgetary measures
peat for Indonesia will all be important in
achieving emissions
2,000 reductions.
Peat decomposition

Peat fires
1,500
Land-use change & forestry
MtCO2 / year

1,000

500

-
Second National Second National IFCA, average DNPI, 2005 Comparison:
Communications, Communications, 2000–2005 Energy and other
2004/2005 average 2000- sources, SNC
2005 2005

Sources and notes: see Figure 5.1 in Chapter 5.

Executive summary Page 11 

 
 One difficulty is that the people, businesses, and institutions on the ground that
control land-use-change practices reap little or no direct benefit from actions to
cut carbon emissions, and so lack the incentive to pursue them. Carbon mitigation
policy also needs to heed local aspirations for development.
Many decisions relevant to land use and forestry management, and other aspects
of climate change, are under the control of local governments in Indonesia.
Hence, one avenue for promoting climate change action at the regional level is to
use the intergovernmental fiscal transfer system. Through it, the Government of
Indonesia could make payments to the regions to support and incentivize climate
The intergovernmental change action by regional governments.
fiscal transfer system
is a promising avenue The intergovernmental fiscal transfer mechanism could also be used to channel
to support regional payments for forest carbon (REDD) from industrialized countries to tropical
climate change action. developing countries. The intention is to put a financial value on the carbon stored
in forests, and thereby change land-use decisions toward lower-emission options
where this is economically sensible. REDD payments are likely to be attributed in
large measure at the national level, creating the need to transfer financial
incentives down to the regional and local levels.
This could be achieved through a Regional Incentive Mechanism, providing
payments to regional governments to support climate change mitigation action,
including payments linked to successful program implementation, and for carbon
reduction outcomes (see figure 6, where down arrows denote monetary flows and
up arrows denote emissions reductions). Regional governments would be free to
take part and have full control over the design and implementation of projects,
while the central government would choose the most cost-effective proposals for
implementation, taking into account development priorities, possibly by way of a
tendering system.

A performance based The central government would manage the national and international aspects of
Regional Incentive the scheme, including management of international finance inflows from REDD.
Mechanism is a The scheme could be revenue-neutral over time, with a share of the overall
suitable vehicle. international REDD payments to Indonesia covering the payments to regional
governments.

Figure 6 Payment transmission under a Regional Incentive Mechanism

International carbon finance, public and private market sources

National taxes and subsidies for land-use and forestry

National regulatory policies for land-use and forestry

Payments to Indonesia
Carbon emissions cuts

Central govt budget

or climate change fund

Intergovernmental
fiscal transfer mechanisms

Payments to regions
Carbon emissions cuts

Other
Regional governments (districts and provinces)
entities

Page 12  Ministry of Finance Indonesia Green Paper on Climate Change

 
Capacity-building programs and pilot activities would be vital during the start-up
phase, and would form the initial focus of the scheme. These could be supported
through donor financing, building on existing initiatives like those under the
Indonesia-Australia Forest Carbon Partnership.
Implementation could occur through existing and emerging avenues under
Indonesia’s intergovernmental fiscal transfer system. The first vehicle for
implementation is the Special Purpose Fund (Dana Alokasi Khusus, or DAK).
Climate change funding could be channeled through existing DAK programs or
through new integrated climate change DAK programs, and could in future also Three potential
include a reward or incentive component. avenues for
implementation exist,
Another possible avenue is direct grant agreements with selected provinces or using current and
districts, for specific, agreed climate change programs and outcomes. These emerging transfer
would also allow funding to be linked directly to international inflows of carbon mechanisms.
financing.
A performance-based Regional Incentive Fund (Dana Insentif Daerah) for social
and economic performance is planned for 2010. This transfer model provides a
third option for climate change incentive payments. Payments to regional
governments would be made on the basis of performance on aggregate indicators
of outcomes, for example carbon emissions, area of deforestation or
reforestation, and incidence of peat fires.

Box 5 Regional climate change incentives beyond REDD

The Regional Incentive Mechanism could be used as a framework to incentivize and
support a wide range of locally based measures on climate change, not just forestry.
Candidate activities would include energy efficiency programs managed by local agencies,
improved waste management methods, and mitigation actions in agriculture. Fiscal
transfers could also be used to finance local actions to adapt to the impacts of climate
change, possibly through the channeling of international adaptation payments.

Support for climate change mitigation measures through intergovernmental fiscal

transfers is only one part of an overall policy platform for carbon reductions in
land-use change and forestry. There may be other channels for carbon finance to
reach the local level. Further detailed analysis is needed to design financial
systems for managing international carbon finance inflows as well as domestic
payment distribution.
Equally important components of the national policy toolbox for curbing land-use A review and reform of
and forestry are national regulatory measures, as well as the tax and subsidy fiscal and regulatory
system for land conversion, forest and agricultural industries. These regulations policies affecting land-
and policies sometimes overlap or are contradictory, and often promote high- use change and
emissions outcomes. The Ministry of Finance is currently investigating natural forestry is needed.
resource management arrangements and opportunities for fiscal and regulatory
reform, with assistance from Australia.
A systematic approach to policy review and reform – involving both the Ministry of
Finance and the relevant line ministries – is needed to ensure that carbon
reduction objectives are reflected in the fiscal policy settings for forestry and land
conversion. A suitable strategy for the Ministry of Finance is to work with the
appropriate ministries, principally Forestry and Agriculture, to bring existing fiscal
policy settings into line with carbon reduction objectives.

Executive summary Page 13 

 
 INSTITUTIONAL REFORM
The evolution of institutions for climate change policy overseas may provide
useful insights for Indonesia. Australia, for example, followed a pattern of
increasing climate policy integration across government, rising involvement by the
agencies of the head of government, and a central and increasing role for
economic agencies in the formulation of climate policy.
In deciding where climate policy and economic input into climate policy may best
be situated in Indonesia, a number of government agencies need to be
considered.
 The key coordinating roles in relation to climate change are shared between
the Coordinating Ministry of Social Affairs, the Coordinating Ministry of
Economic Affairs, the National Development Planning Board (Bappenas),
the Ministry of Environment, and the National Council on Climate Change
(Dewan Nasional Perubahan Iklim, or DNPI).
 The majority of the relevant policy settings continue to be determined by line
ministries and agencies, including the Ministries of Forestry, Agriculture,
Environment, Energy and Mining, Trade, Industry, Transportation, Public
Works and others.
In practice, in such a complex institutional environment, the formulation,
Effective policy coordination, and harmonization of climate change policy has proven difficult.
coordination is key to Overlapping and inconsistent formulation and implementation of policies have
successful climate hampered efforts to achieve a uniform approach to climate change. Indonesia will
policy. need stronger and more effectively integrated policy formulation, coordination,
and implementation to achieve the announced emissions targets without
impeding development goals, and to gain access to carbon finance. The new
government has an opportunity to review the existing arrangements for the
management of climate change issues to ensure a more cohesive approach to
policy formulation and implementation.
The Ministry of Finance is central to climate policy development and
implementation, not only because fiscal and budgetary instruments matter for
effective and efficient carbon policy, but more fundamentally because policies to
reduce emissions can have significant economic impacts, including on state
finances. In addition, the ministry has an important role to play in helping to
maximize access to international climate financing and channeling payments
domestically.
The Ministry of Finance will also have a key role in the allocation of funding for
climate change through the budget. As such, it will need to ensure that climate
measures are economically sensible and cost effective. A useful metric in climate
Ministry of Finance is change mitigation is the cost per tonne of emissions reductions. Furthermore, the
central to climate Ministry of Finance can assist in assuring consistency in budget allocations over
policy development time, in both medium- and long-term expenditure plans.
and implementation
Indonesia’s economics agencies more broadly – in particular the Coordinating
Ministry of Economic Affairs, Bappenas and Ministry of Finance – have a crucial
role in coordination, bringing sound economic approaches to climate policy across
government, and in safeguarding the national economic interest when policy is
contested by powerful interest groups (as has been the case in developed
countries that have implemented climate change mitigation policies).

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SUGGESTED STRATEGY

1. Establish a climate policy unit within the Ministry of Finance.

This would strengthen its capacity to evaluate and contribute to the
formulation of climate change policy. It would also include efforts to ensure
consistency and effectiveness of budget allocations for climate measures. A
high-powered climate policy unit as part of its formal structure is best suited
for the task. It could consist of selected officers, drawing in experts from
across the ministry, and possibly externally.
2. Establish a working group on climate policy across the Ministry of Finance,
Bappenas, and the Coordinating Ministry of Economic Affairs.
The working group would ensure that economic considerations related to
climate change policy formulation and implementation are coordinated
across government. A coordinated approach would help to establish
mainstream economic principles in climate policy across government, and to
ensure that Indonesia’s climate policy portfolio achieves the desired
outcomes at least cost and with maximum economic benefit.
3. Encourage an interministerial review of existing legal, regulatory, and
institutional structures affecting climate change policy formulation and
implementation.
A thorough review of the impact of government rules, regulations, and
institutions on climate change policy implementation is warranted, through a
time-bound interministerial review. This could include recommendations to
fix the issues that are identified. This is essential if a national climate change
vision is to be achieved and successfully implemented.
4. Encourage the commissioning of an integrated review of climate policy.
Good policy in a new field like climate change requires systematic analysis
to explore options, scrutinize proposals, and make the latest thinking
accessible to all stakeholders and the broader community.

Executive summary Page 15 

 
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