15 CHAPTER 2 LITERATURE REVIEW 2.1 Renewable Energy The importance of developing new and renewable energy is to maintain the sustainability of earth and its ecosystems for the long term, in addition to the fossil fuels factor which contribute to one of the largest carbon emissions contributor and potential of fossil fuels scarcity in the future. According to Law Number 30/2007 concerning The Energy, the definition of new energy and renewable energy are as follows: “New energy is an energy source that can be generated by new technologies that come from renewable energy nor non-renewable energy such as; nuclear, hydrogen coal bed methane, liquefied coal and gasified coal”, “Renewable energy is an energy source that can be generated by sustainable energy resources if managed properly, such as; hydro, geothermal, wind, solar and bio energy”. [21] Moreover, renewable energy is constantly replaced by the nature sources that come from the solar (thermal, photo-chemical and photo-electric), wind, hydropower or other mechanisms from the environment, such as geothermal. [22] Below in an overview of renewable energy resources: Figure 2.1 Renewable Energy Resources [22] 2.1.1. Hydropower Hydropower is a type of energy that comes from water and processed in the turbines to be converted into electricity power. Some critical points to produce an energy from hydropower are the dams, water flows, the gravity 16 and it has specific site that requires a very large area. Based on the type of water flows and production cycle, hydropower plants are classified into three categories as follows: [22] 1) Run of river hydropower generation is a type which highly dependent on the river’s flow run-off and precipitation to produce energy, it may include a short term storage. 2) Storage hydropower generation, a type that requires reservoir to deposit the water for later utilization so that it does not depend on the variety of water inflows. 3) Pumped storage generation is an energy storage equipment to produce electricity power during the peak load hours and the water is pumped during the off peak period. Hydropower generation can be operated manually, in which the operator is located in the generation’s power house, or remotely from the control room that is in different location. However, the operator is always monitor the hydropower reliability, weather, reservoir water levels and reporting load conditions. 2.1.2. Geothermal Geothermal power is a thermal energy which generated from inside of the earth (magmatic heat source) and classified into convective, conductive and deep aquifer systems. [22] Below is summary of geothermal based on its resources, temperatures and their applications: Figure 2.2 Type of geothermal resources, temperatures and their applications [22] 17 2.1.3. Solar Solar energy is highly reliant on the sun’s availability where the characteristic of its energy production namely intermittent, meaning it does not produce electricity all the time. There are 3 types of solar energy system; Solar Photovoltaic, Concentrating Solar Power and Solar Thermal Heating and Cooling. Solar Photovoltaic (“Solar PV”) Solar PV systems transform the sun energy into the electricity whereby photovoltaic cells in solar panel turn the sunlight into direct current power (DC). Furthermore, an inverter converts the DC electricity into alternating current power (AC) to be used as an energy. The process of Solar PV systems as follows: Figure 2.3 Solar PV Mechanism (Source: Bank Mandiri, 2022) There are 2 types Solar PV systems, off-grid and on-grid. Off-grid system is Solar PV installations in areas without connecting to the grid or diesel, it can be implemented in the un-electrified areas. As for on-grid system is Solar PV installations in areas where interconnects with PLN’s grid. Solar PV has advantages that it can be utilized using individual solar panels which not only using sun energy but it also can produce electricity although the weather is uncertain. Below is summary for Solar PV characteristic, segmentation, capacity size based on its connectivity systems: 18 Figure 2.4 Summary of Solar PV Characteristic (Source: IESR, 2022) Concentrating Solar Power (“CSP”) CSP generates electricity through direct beam solar irradiance to heat a liquid or gas that will be used in a downstream process for electricity generation. The application of CSP is ranging from small distributed systems up to large scale that is generally concentrate sunlight by reflection and majority of plant installation using parabolic through technology. [22] Solar Thermal Heating and Cooling The mechanism of Solar Thermal Heating and Cooling is collect thermal energy from the sunlight to be transformed into hot water, space heating and pool heating for residential, industrial and commercial segments. [22] 2.1.4. Wind The definition of wind power is a conversion of wind energy using turbines into several benefits, such as wind turbines to produce electricity, wind pumps for drainage and mechanical power that generated by wind mills. [22] However, wind power is highly reliant on the speed and air density to generate kinetic energy to be converted into electricity. Moreover, a wind turbine only captures a fraction of 40% - 50% available energy thus the design of turbine is focusing on how to maximize the energy capture over the variety of wind speed. [22] 19 2.1.5. Biomass Biomass energy comes from residues or biomass feedstock available in the land and it can be converted to generate energy, such as heat, electricity and biofuel. It is essentially a photosynthesis mechanism and originated from plants, crops and trees. A development of biofuel’ refinery is needed to cover intermittent type of energy sources in the renewable energy mix to make sure the nation’s energy security. The attributes of biofuels that can be stored, carried and converted into clean energy play an important role in the renewable energy development plan. [22] 2.1.6. Marine The waves, ocean current and thermal energy conversion, tidal range and currents, salinity gradients are resources for marine energy. These resources require distinctive technologies for energy conversion, however this type of energy still in the development phase. [22] 2.1.7. Advantages and Disadvantages of Renewable Energy Resources Considerations to develop renewable energy resources are because of the potential fossil fuels scarcity and cannot be maintained indefinitely in the long run, additionally environmental issue which affected by emissions. According to, Ellaban Omar, Abu-Rub Haitham, Blaabjerg Frede, 2014, Renewable Energy Resources: Current Status, Future Prospects, and Their Enabling Technology [22], the advantages and disadvantages of renewable energy can be summarized below: Figure 2.5 Advantages and Disadvantage Renewable Energy Sources [22] 20 2.2. General Overview of Financing 2.2.1 General Products of Bank Financing 2.2.1.1. Cash Loan Cash loan facility is a loan facility in the form of cash and or fund overbooking in which effectively accounted as a customer or borrower’s payable to the bank and it is accounted in the balance sheet of the bank. (Bank Mandiri, 2021) There are several types of cash loan based on the loan objective, underlying document and tenor as follows: 1) Working Capital Working capital loan facility is a maximum of one-year loan tenor (short term) to finance inventory, account receivable, project, sales general administrative of the company to support its operational requirements. The typical of working capital loan is divided into 2 forms; revolving loan where the company or borrower can borrow, repay, and borrow again within the loan limit and tenor. As for the non-revolving loan, the company or borrower can borrow a one-time lump sum of fund and repays it in regular installments over a specified loan tenor. Unlike the revolving loan, once the company or borrower repays the loan, the credit does not become available again thus the limit will be reduced based on the installment amount that has been repaid. There several type of working capital loan as follows: Working Capital – Transactional The purpose of a transaction based working capital loan is to fund the working capital requirement based on company’s inventory as its underlying financing. The object of financing is inventory, such as: raw materials, semi-finished goods, finished goods and other production materials. The loan tenor is 1 year and it can be renewed based on bankability and risk acceptance criteria set by the bank. Working Capital – Account Receivable A financing provided to the company based on its account receivables as an underlying financing to support its short term working capital needs. The object of financing is account receivable, such as: invoice to the buyer or bouwheer of the project. 21 The loan tenor is 1 year and it can be renewed based on bankability and risk acceptance criteria set by the bank. Working Capital – Operating Account It is a working capital loan facility with specific purpose is to finance working capital needs based on company’s operating accounts as its underlying financing. The object of financing is sales, general and administrative accounts in the financial statement of the company in which direct and indirect selling expenses to generate revenues, such as: cost of goods sold, maintenance, personnel expenses. The loan tenor is 1 year and it can be renewed based on bankability and risk acceptance criteria set by the bank. 2) Investment Loan or Term Loan Investment Loan or Term loan facility is a medium to long term loan to finance company’s specific business requirements, such as; capital expenditure, business expansion, cash flow gap, merger and acquisition and/ or other specific business needs. The typical of term loan facility is non-revolving loan as mentioned in the previous section. The loan tenor is more than 1 year that will be reviewed and assessed based on company’s bankability, business cycle, cash flow and risk acceptance criteria set by the bank. 2.2.1.2. Non Cash Loan Non cash loan facility is a guarantee provided by the bank in which no cash withdrawal and or fund transfer included in the transaction. This facility is recorded in the bank’s administrative account or off balance sheet. (Bank Mandiri, 2021). Moreover, other definition of this facility is a written commitment issued on behalf of the applicant for the benefit of third party in relation to satisfactory of works agreed between those parties under a project contract, thus the applicant of this guarantee is obligated to comply with the covenants set forth. 22 There are several types of non cash loan facility based on the loan objective, underlying document and tenor as follows: 1) Bank Guarantee It is a formal letter issued by the bank to protect the rights of beneficiary which stipulated in the project document and the bank has the obligation to pay to the guarantee’s beneficiary if the claim requirements are met. There are various types of Bank Guarantee as follows: Bid Bond or Tender Bond It is a form of guarantee on behalf of project’s bidder or applicant, where it is stipulated a commitment from the applicant that will not pulled-off during the tender process and committed to sign the contract and fulfill the obligation after being appointed as the winner. The main objective of tender or bid bond is to protect the guarantees’ beneficiary during the tender process and to ensure if the applicant awarded as the winning bidder and failed to perform and meet the obligations under the contract then the beneficiary will be compensated for any financial losses incurred. Performance Bond It is a financial guarantee issued by the bank, on behalf of project’s winning bidder or applicant, where it is stipulated a commitment from the applicant to fulfill the obligation under the contract or underlying document agreed between the beneficiary and applicant. It provides financial protection to the beneficiary or project’s bouwheer in the event of applicant’s default. The main objective of performance bond is to provide assurance to the project owner or beneficiary that the applicant will complete the project according to the terms and conditions specified in the contract. Advance Payment Bond This guarantee is issued on behalf of project’s winning bidder or applicant, where it is stipulated a commitment from the applicant to fulfill the obligation under the contract or underlying document agreed between the beneficiary and applicant, once the applicant has received project’s advance payment from the beneficiary. 23 Advance payment bonds are commonly used in construction projects or contracts where the project owner provides an upfront payment to facilitate project commencement or to cover initial expenses. They provide financial protection to the project owner and help ensure that the advance payment is used for its intended purpose. Contractors or suppliers should fulfill their contractual obligations and utilize the advance payment responsibly to avoid triggering a claim on the bond. The main objective of advance payment bond is to protect the project owner's financial interests by ensuring the repayment of the advance payment made to the applicant. It provides assurance that if the applicant fails to perform or defaults on the contract, the beneficiary of advance payment bond will be able to recover the advanced funds. 2) Letter of Credit Letter of Credit is a payment guarantee form and it cannot be revoked (irrevocable) by the issuing bank under the conditions if the beneficiary has submitted underlying document required under the contract and accepted by the applicant. (Bank Mandiri, 2021). In general, Letter of Credit is required by the seller and buyer to secure the transactions in which both parties fulfill the obligations under the sales contract. 3) Standby Letter of Credit Standby Letter of Credit is a written promise and irrevocable terms by the bank that is issued under the request of applicant to comply with payment obligations to the beneficiary subject to all requirements have been met under the sales agreement and accepted by the applicant. (Bank Mandiri, 2021) 2.2.2 Renewable Energy Financing Main Challenges for Renewable Energy Financing Indonesia has huge potential renewable energy resources up to 3,686 GW, nevertheless only 0.3% which has been utilized as of December 2022 (MEMR, 2022). The development of renewable energy resources as energy mix is one of GOI’s program to aim net zero emissions in 2060, however there are many challenges and common issues related to the financing in the perspective of lenders, such as; technology selection, land readiness, bankability of PPA which makes investments 24 unprofitable in some cases, high margin and interest rates loan thus decreasing the project internal rate of returns and smallish project size. As stated by ADB report in 2019, Renewable Energy Financing Schemes for Indonesia, investment barriers in renewable energy are shown below: [8] Figure 2.6 Investment Barriers [8] Based on the Figure 2.6 above, the main barriers that are related to financial institutions nor banking sector are; the tariff for renewable energy project is considered low thus the investment returns is unattractive for the investors. Project collateral that is required by the lender leads to fund raising problem for the sponsors. Expensive loan margin resulting in a high project costs in which affecting the project expected returns and potentially drag down the owner’s estimate (e.g. PLN’s project cost estimation in order to assess the reasonableness of the proposal). [8] Furthermore, lack of experience and technical skill from the project developer and lender are barriers in the investment space. Financing Instruments for Renewable Energy Financial stimulus to the project developers as a response to the investment challenges can be designed through public funding intervention, namely the Energy Resilience Fund so that it can upgrade viability of the project. The financial encouragement options provided by the GOI are in the form of Viability Gap Funding, Project Development Fund and Credit Enhancement Funding. [11] 1) Viability Gap Funding (“VGF”) VGF is a revenue-based subsidy mechanism and direct incentives from the GOI, 25 thus it does not include the commercial terms. As an illustration in the PPA, VGG improves the PPA earnings for IPP’s grid connected project as it appears as PLN’s subsidy therefore the electricity purchased is cheaper and this benefit will be received by the household, industry and business customers. [11] The most suitable option for VGF funding is throughout bilateral or international agencies’ grants, for instance; JICA (Japan) and UNDP. 2) Project Development Funding (“PDF”) Prior to project development, it is mandatory to conduct feasibility study which aims to review expected project returns, identify potential risks and mitigations, as well as project timeline. The developer’s expenses in the feasibility study can be reimbursed in the form of PDF that aims to improve the project’s viability in achieving financial close. [11] A preferred option for PDF funding can be sourced from philanthropies, foundations and bilateral agencies as follows: International impact funds, philanthropies and foundations:  Blue Orchard.  Oxfam Novib.  Rockefeller Foundation.  MacArthur Foundation.  MCE Social Capital.  Facebook Energy Access Program. European bilateral development finance institutions:  Netherland’s FMO.