Assessment 2: Business Report

LB5229 – Economics for a Sustainable

World

1
Executive Summary

A Carbon offset business is proposed in Indonesia for the Australian company,

Lendlease. Lendlease is a construction and real estate business that creates urban
districts, communities for the elderly, retail precincts and infrastructure such as
hospitals, universities and stadiums. As one of Australia’s leading construction
companies, Lendlease believes it has a social responsibility to create vibrant
communities and a sustainable, healthier planet (Lendlease, 2020). The company’s
ambition is to live in a world warmed by no more than 1.5oC, and to be carbon
neutral by 2025 and absolute zero by 2040 (Lendlease, 2020).

Renewal Energy Certificates (RECs) were initiated by the Renewal Energy Act,
2000 to help reach the government target of 20% renewable energy sourced
electricity by 2020. It is a form of currency, that can trade for cash and fluctuates with
the market (Energy Matters, 2020). The current Renewable Energy Target requires
9,500 GWh of renewable energy to be delivered by energy companies, and by 2020
the target is 45,000 GWH (Energy Matters, 2020). To achieve this the Government
requires energy companies to surrender RECs into their holding account at the end
of the calendar year, at 20% of their market share. If this is not achieved, the
company is fined a significant amount more than the price of a REC (Energy Matters,
2020).

In conjunction with achieving a profit from renewable energy projects, companies

invest to reduce their carbon footprint, improve their environmental impact and retain
and attract employees, as they are perceived as more accountable for their carbon
footprint (Sustainable Travel International, 2020). By installing a windfarm in
Indonesia, Lendlease will be working towards the goal of reducing Lendlease’s
carbon footprint and be an environmentally conscious company, as well as achieving
a profit. They will be competing against other offshore windfarm companies in South
East Asia and will be the first offshore windfarm business operating in Indonesia
(IRENA, 2020).

Lendlease will aim for the installation and operation to be efficient, and project
managed adequately to ensure a profit is achieved. The installation costs will be

2
high, however the continuous costs of operating and managing wind farms is
relatively low. The marginal revenue of the project is predicted to significantly
decrease as output and quantity increase. The total costs will also decrease as
output increases, until a certain point, which is demonstrated in Graph 4. Data is
lacking on analysis of renewable business projects and their profits, total costs and
demand, therefore a high sensitivity analysis of 20% has been decided upon.

Substantial data and analysis have been performed to assess the Indonesian
market and its stability. There are risks of stagflation which could result in an
increase in the price of a REC. This shock would decrease demand and increase
supply. Therefore, it is imperative to ensure contracts are implemented to fix the
exchange rare prior to the business development to avoid this occurring. Lendlease
will be aiming for a business growth rate of 4.5% per annum (p.a.) and a rate of
return of 11% p.a. to optimise profit and grow sustainably.

The aim for the wind farm project is to build a business that is both profitable and
sustainable. As well as contributing to the Government target of increasing the use of
renewable energy.

3
Purpose of the business

Australia’s yearly carbon emissions are currently 550M T CO 2 e- (Climate Action

Tracker, 2020). The construction and real estate industry contribute to 25% of
emissions, which equates to approximately 137M T CO2 e-. The primary contributors
originating from electricity, water, waste and materials (Martek, I & Hosseini, M.R.
2020).

Graph 1 states that Lendlease’s Australian carbon emissions were just over 250K T
CO2 e- for the 2019 financial year. This is lower than 2018 which was just under 300K
T CO2 e-, but higher than the years of 2014 through to 2017 (Lendlease, 2020).

Graph 1: Lendlease’s Australian Carbon Emissions (Lendlease, 2020).

Lendlease aims to have a positive impact on the environment by implementing

various methods and projects (Lendlease, 2020). Installing a wind farm in Indonesia
creates the opportunity to expand into the renewable energy market which entails
low operating costs and instills offshore partnerships.

4
 Lendlease uses approximately 600 GWh p.a. (Lendlease, 2020). Therefore, as one
REC is equivalent to one megawatt of electricity generation (Energy Matters, 2020),
it is estimated that 600K RECs will be required to offset Lendlease’s operations in
Australia p.a. and 6M RECs over the next ten years. This business project will aim to
generate a profit, by striving for 12M RECs in ten years, thus enabling an opportunity
to on sell an estimated 6M RECs to the Australian market. This will be to energy
producers, who are required to forfeit 20% of their market share in RECs p.a.
(Energy Matters, 2020).

Indonesia has had a delayed response to the development of renewable energies

compared to other nations (Arci, 2018). However, the country is optimal for this
renewable energy project due to its geographical closeness to Australia, location,
wind energy potential, inexpensive labour costs and the opportunity for positive
business relationships (IRENA, 2020). The International Renewable Energy
Association (IRENA) estimates that nearly 85% of potential wind farm locations to be
in the Java, Bali, Nusa Tenggara and Sulawesi regions due to feasibility of
operations and wind capacity (The ASEAN Post, 2018). Indonesia also has
thousands of islands and has 54,720 km of coastline (Embassy of Indonesia, 2017),
which is ideal as this is where wind farms are most efficient (IRENA, 2020).

Indonesia will consequently benefit from the wind farm project too. Jobs will be
created and will eventually replace ones currently held in industries with negative
impacts on the environment, such as palm oil and petroleum. It will also demonstrate
to the Indonesian government that wind farms and other renewable energy projects
are achievable and profitable, therefore potentially resulting in an increase in
renewable energy projects nationwide. If this happens, it will increase Indonesia’s
Gross Domestic Product, trade, welfare and lead to technology transfer and
advancements, which indirectly has positive effects on the economy (IRENA, 2020).
An increase in renewable projects in Indonesia will also have a positive effect on the
environment by reducing pollution, and as a result will reduce incidence of illnesses
related to pollution and poor air quality (IRENA, 2020).

The reason wind turbines have been chosen over other renewable energy is due to
wind being an efficient energy source on a large scale. Wind turbines produce more
energy than solar, require less energy and release less carbon dioxide (Solar Feeds,

5
2019). Once installed, they are low maintenance and the fuel source is free, as well
as abundant and inexhaustible. Wind is sustainable and is a clean fuel source that
does not pollute the atmosphere. Wind turbines can also be installed on established
farms, allowing farmers to continue to farm off the land (U.S Department of Energy,
2020).

6
Industry structure
At this stage, there is only one wind farm in Indonesia, operated by a private
Indonesian company. This is Sidrap Wind Farm, located in South Sulawesi. The
project has been operating since March 2018 and currently has thirty wind turbines,
which produce 230,000 MWh of renewable energy p.a., supplying 70,000 local
homes (Gold Standard, 2020).

The proposed location for this business project is the island, West Tenggara. This
is due to its high wind volume, large land capacity and geographical location.
Currently, there are no offshore wind farm projects in Indonesia, so this company will
have a monopoly in Indonesia. It is crucial to start this project as soon as possible,
as other nations and companies will begin to recognise the potential of renewables in
Indonesia. It is also crucial to be first to the market for economic success and to
establish the most ideal location (Dyer, Gupta & Wilemon, 1999). This business will
be required to be competitive against other offshore renewable businesses,
particularly in the South East Asia region. Currently India is the leading nation
specialising in offshore renewables in this region. India’s coastline has very high
wind activity, therefore can generate a significant amount of energy (Kumar et al.,
2020).

It is imperative for this wind farm project to operate at low costs and efficiently to
ensure that it can sell RECs at lower prices than other South East Asian projects. It
will also need to operate ethically and sustainably to uphold a environmentally
conscious reputation. There will also be a marketing team to ensure that energy
companies in Australia are aware of this business.

The business model will take inspiration from India’s offshore Wind Power projects
such as Metocean Study, FOWPI Wind Turbine Layout and AEP and Advisory
Electrical Concept and Design (Government of India, 2020). Numerous companies
from the European Union already have renewable projects in India and trade carbon
credits.

The unit of the product being sold is RECs, which can be on a large and small
scale. Large scale renewable energy projects, such as wind and solar farms are
permitted to create large generation certificates (LGC). One LGC is equivalent to 1

7
MWh, which is 1 REC. A nominated person can submit a claim for a LGC at the REC
Registry (Australian Government, 2019). Once claimed, RECs can be sold to energy
providers in Australia who are obliged to purchase at least 20% renewable energy
p.a. Alternatively, RECs can be transferred to companies to offset their own carbon
emissions (Australian Government, 2019).

As of 19th of April 2020, a price of a LGC REC was $42.25 Australian Dollar (AUD)
(RET Australia, 2020). The price has grown significantly in the last ten years as
renewable energy becomes a more prominent figure and there are more incentives
to purchase them (Green Energy Markets, 2020). By 2030, it is predicted that the
value of a REC will be approximately $55 AUD (Brinsmead, Hayward & Graham,
2014).

Electricity is the main product from wind farms in Australia. Wind power is
converted into electricity by magnets moving past stationary coils of wire, known as
stator. As the magnet passes the stator, it converts into alternating current and then
direct current, which then feeds into a grid interactive inverter for feeding power into
the electricity grid (Energy Matters, 2020). The output of a wind turbine depends on
the turbine’s size and the wind speed. An average wind turbine can produce more
than 6M KWh p.a. (The European Wind Energy Association, 2016). Lendlease is
aiming to sell 12M RECs in the next ten years. Therefore, to achieve its goal, the
business will be required to produce 12,000 GWh, which is 1,200 GWh p.a.

RECs will be sold in AUD and converted from rupiah prior to trading. $1 AUD is
currently 10,494 Rupiah (Morningstar, 2020). As the Indonesian Rupiah is more
volatile than the Australian dollar, Lendlease will enter an agreement to fix the
currency at a certain rate prior to selling RECs. This is to ensure stability and
certainty for the business. As the Rupiah has recently plummeted, it would be in
Lendlease’s favour to enter an agreement and start negotiating as soon as possible.
RECs will also be subject to the Australian Goods and Services Tax prior to selling in
Australia. This is the standard 10% on all goods that enter Australia and is non-
negotiable (Australian Government, 2018). This tax will be passed onto the energy
companies when selling.

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Graph 2: Supply and Demand of RECs

Graph 2 demonstrates the projected supply and demand curve model for RECs for
this business project. In Australia, as energy is a necessity and energy companies
are seeking a 20% yearly portion on RECs, they are in high demand. Therefore,
RECs are relatively inelastic in the short run, with a change in price only leading to a
small change in demand. This is only in the short run and as renewable energies
become more abundant in the future. This will result in more renewable energy
options, therefore making the product more competitive and elastic in the future.

Figure 1: Elasticity of RECs

9
 Figure 1 demonstrates the projected elasticity of RECs. As the price changes, the
quantity does not change significantly, therefore demonstrating that RECs are
relatively inelastic.

10
Business Structure
The life cycle of wind farm’s carbon emissions has been widely studied, particularly
by wind farm companies to prove its low carbon credentials. However, it has proven
difficult to estimate the carbon emissions on wind farms due to variabilities such as
wind intermittency, uncertainties in emissions, differences in methodologies and
technologies (Thomson & Harrison, 2015). Thomson & Harrison (2015) claim that
the lifetime carbon emissions of coal schemes are approximately 100 times more
than the lifetime emissions from wind projects. It is also important to note that the
manufacture and installation of the wind farm account for 90% of its lifetime carbon
emissions. This is due to the extraction of land, manufacturing materials and
transport. Offshore wind farms will also cause more carbon emissions through
transporting materials (Thomson & Harrison, 2015). The remaining emissions are
through operation and maintenance activities and are relatively low (Thomson &
Harrison, 2015). As the installation process emits the most significant amount of
carbon, Lendlease will ensure the wind farm is installed efficiently and adequately,
therefore enabling a high standard of operation for a long period.

As the proposed location is in Indonesia, it is ideal to estimate the production of

wind energy based on an already established wind farm in Indonesia. The Sidrap
Wind Farm’s project produces 230,000 MWh from 30 standard size wind turbines
p.a.. Therefore, to produce Lendlease’s goal of 1,200 GWh of energy p.a.,
approximately 160 wind turbines of the same size will be required. This is assuming
that the wind strength and frequency is similar in Nusa Tenggara. Sidrap’s wind
turbines are 2.5 MW, which are relatively powerful and efficient. However, Lendlease
should consider the economic viability of installing higher powered wind turbines.
The costs associated with this product will initially be higher, however it will be more
profitable in the long run by reduced labour, maintenance, operation and installation
costs and the amount of land required (Thomson & Harrison, 2015).

The wind farm business aims to offset 250K T CO2 e- from Lendlease’s emissions,
which equates to 600K RECs p.a. The business is aiming to generate 12M RECS
over the next ten years and to on sell 6M RECs. This will create a substantial profit
for the business.

11
Revenue
Graph 3: Marginal Revenue and Marginal Cost of business

Graph 3 demonstrates the predicted marginal revenue and marginal cost of the
proposed wind farm project. The marginal revenue is the revenue gained by
producing one extra REC. As RECs are relatively inelastic, the demand curve is
steep, as the marginal revenue always less than the demand. Marginal revenue is
downward sloping as the business lowers its costs as input increases. Marginal cost
is the change in the total cost when the quantity produced changes by one unit. The
downward slope of Graph 3 demonstrates the decreasing marginal costs as more
RECs are produced. As the curve slopes up, it represents the diminishing marginal
returns of RECs, therefore becoming unprofitable. Where the marginal revenue and
marginal curve intersect in the graph, reveals where the optimal profit to produce
RECs is. It is important to note, that this is the prediction in the short run and in the
long run variables change and the graph will alter.

12
Figure 2: Optimal resource extraction of RECs 2020 vs 2030

p0 = p0 – c0 = 42 – 11 = 31

now = p0 x (r + 1) x Q0 = 31x 1.11 x Q0 = 34Q0

p1 = p1 – c1 = 55 – 15 = 40

later = (QT – Q0) x p1 = (12M - Q0) x 40 = 480M - 40Q0

therefore, to find Q0

34Q0 = 480M – 40Q0

74Q0 = 480M

Q0 = 6.5M

As Q0 + Q1 = 12M RECs

Q1 = 5.5M RECs

Therefore, it is most profitable to extract 6.5M RECs and sell in 2020 and extract
5.5M RECs in 2030 and sell

13
 This is the equation of when to sell RECs based on costs and profits now vs later
(2030). This is assuming a REC in 2020 is $42 AUD and $55 AUD in 2030
(Brinsmead, Hayward & Graham, 2014). As well as the rate of return of renewals of
11% p.a., which was based on estimates from a United Kingdom offshore wind farm
company, Deloitte (Deloitte, 2014). It also assumes cost per unit, increase slightly
with inflation.

14
Costs

The installation costs of setting up the wind farm project is high compared to the
ongoing costs. The high upfront costs are often a barrier preventing individuals or
businesses investing in wind energy (IRENA, 2012). The installation costs consist of
the investment of wind turbines, construction, grid connection, land acquirement and
other unspecific operations. The costs of installing a wind farm offshore are
significantly higher than onshore, this is due to the transportation of materials and
turbines, installing foundations and grid connection (IRENA, 2020).

Graph 4: Installation costs of wind farm (IRENA, 2012)

Graph 4 breaks down the estimated costs of installing a wind farm. The investment
of wind turbines is costly, with a typical commercial wind turbine ranging in price from
$2.6 - $4 million (Weather Guard Lightning Tech, 2020).

Wind farms can be connected via the transmission network or distribution network.
The proposed project requires a distribution network due to its location and
transportation of energy requirement, therefore costs increase approximately 30%
(Douglas-Westwood, 2010). Grid connection can also vary depending on the location

15
of installment, as well if the company is onshore or offshore. Offshore connection
costs are significantly higher (IRENA, 2012).

The civil and construction costs of a wind farm include the installation of the wind
turbine, its foundation, transport and the potential construction of roads. The
foundation type can be pouring concrete or drilled steel monopiles, with material and
transportation costs being reduced per wind turbine (IRENA, 2012). Transport and
installation costs only increase slightly as turbine size does (IRENA, 2012). Offshore
wind farms transport costs are higher, this is due to the construction of purpose-built
vessels for the turbines and cranes. However, these costs are predicted to decrease
in the future as new technology emerges (IRENA, 2012).

Operation and maintenance costs are factored into the fixed costs of the wind farm
project. It is difficult to assess and estimate the costs associated due to variance in
labour wages by country, continuing advancement of technology requiring less
maintenance and comparing offshore and onshore projects (IRENA, 2012). Given
that offshore wind farms are a relatively new phenomenon, operation and
maintenance remain highly specific, however are predicted to improve when
technologies advance and operations are more streamlined (IRENA, 2012).

The acquirement of land is also necessary when analysing costs. Under Indonesian
law, it is not possible for a foreign individual or business to purchase land. Therefore,
for Lendlease to operate a business and have ownership over all infrastructure, a 30
year lease agreement will need to be attained, with an option of a 20 year extension
(Gaffar, 2018). This will be a fixed cost and will be reasonably low, as leasing land in
Indonesia, particularly West Tenggara is cheap. Other fixed ongoing costs of the
wind farm project are wages, tax, marketing, service contracts, administration,
scheduled maintenance and insurance.

Variable costs are correlated with REC generation and unforeseen circumstances.
REC generation will depend on demand and supply and what process is the most
economically sensible for the business to achieve a profit. The business will analyse
when to sell RECs depending on the current price and trend of RECs. There will also
be operation and maintenance costs that will vary such as unforeseen upkeep and
repairs and other labour costs.

16
Pricing

The Lendlease wind farm project is a price taker in the Australian renewable energy
market. The REC is currently valued at $42.25 AUD and predicted to be $55 AUD by
2030 (Brinsmead, Hayward & Graham, 2014).

Graph 5: ATC curve

Graph 5 demonstrates the predicted average total costs of the wind farm project.
The average total cost is the total of the fixed and variable costs, divided by the
quantity. As more RECs are sold, the average total cost decreases significantly, until
it intersects with the marginal cost curve, then slightly increases. This is due to wind
farms installation costs being significantly high and then being relatively low costs to
run. However, due to input and output logistics, it is predicted that the average total
costs will reach a point, that it does not make economic sense to keep producing
more energy. This is demonstrated by the slight increase of the average total cost
curve, after intersecting the marginal cost curve.

17
Sensitivity analysis

The fixed and variable costs of the project can be difficult to analyse and foresee
based on various reasons such as being the first offshore wind farm business in
Indonesia and renewable energy being a relatively new business project (IRENA,
2012). Economic profit also depends on demand, in the short run this is not
predicted to change significantly.

The economic profit range is difficult to predict as it depends on variations of the

costs and market stability. Martin et al. (2015) concludes that offshore wind farm
operations and maintenance cost vary by 10-20%. Therefore, it is predicted that
economic profit variance from the wind farm project will range between 20-30%.

18
Macroeconomic Analysis
1. Scenario analysis (foreign stagflation & foreign government and central
bank response)

High unemployment and inflation in Indonesia will have negative effects on

Lendlease’s wind farm project. The currency exchange rate will have been agreed to
and set at the beginning of the project to avoid this situation, so the value of a REC
will not change. However, if there were no agreement in place, as inflation in
Indonesia rises, the price of a REC increases and therefore energy will be of a
higher value. Lendlease will pass this tax onto the consumer – the Australian energy
companies, which will increase the price of a REC. This will make RECs unattractive
to the consumer and could potentially shock the market and result in a decrease in
demand and increase in supply. This will cause the supply graph to suddenly shift to
the left. Graph 6 demonstrates this.

Graph 6: The Supply Shift after a Tax Increase

However, due to RECs being relatively inelastic, the Australian energy companies
will continue to purchase RECs and the supply and demand may not change.
Regardless, shocks to the supply and demand curve are always a short-term
phenomenon and the product will eventually return to an equilibrium. In the long run,
everything is elastic. Australian energy companies will begin to seek alternative
companies to purchase RECs and more offshore energy projects will be introduced.

19
Graph 7: ATC, MR and MC after a tax increase

The blue lines on Graph 7 demonstrate the shifts due to a tax increase. The
average total costs and marginal costs will increase. As the costs increase, the cost
of a REC will increase. In the short run, marginal revenue will not change, however
over time the marginal revenue will decrease due to a demand shortage.

If the increase in company taxes are significant, it may be worth considering moving
the project’s profits to Australia. Currently, the Indonesian Government taxes foreign
businesses at 25% (PwC, 2020), which is less than the rate in Australia, so
accountants should assess the different tax rates and shift the profits accordingly. A
positive outcome of stagflation would be high unemployment, which will cause wage
stagnation and increased availability of workers. Therefore, the company will not
have to increase employee’s wages significantly and have employee options.

2. Scenario analysis (optimized and sustainable carbon offsets)

The estimated rate of return of the proposed wind farm in Indonesia is 11% p.a.
(Deloitte, 2014), however the rate of return of a carbon offset company is 1.57%
which is not the case for this business. The proposed project is aiming to offset
Lendlease’s carbon emissions, as well as achieve a profit. Therefore, based on this
data this wind farm will be profitable.

By installing a wind farm and offsetting the carbon emissions, Lendlease is on the
right track to achieving its goal of being carbon neutral by 2025 and absolute zero by

20
2040. In a world that still runs primarily off fossil fuels, voluntary offsetting of a large
amount of a business’s carbon emissions is critical to become more environmentally
conscious. Despite the criticism of carbon offsetting as the ‘selling of indulgences’,
this is a significant first step, in a global context, to create a greater consciousness
about reducing emissions.

21
Sustainability practice
Production

Wind farms are environmentally beneficial as they generate off wind, therefore do
not produce pollutants common of conventional generators such as carbon dioxide,
nitrogen oxide and sulphur dioxide (Cullen, 2013). An increase in wind energy will
offset the production off traditional fossil fuel electricity production in the long run. It
can be difficult to assess by how much, as there are various sizes, types and
production processes of traditional generators (Cullen, 2013). Glennie (2016)
estimates that it takes approximately six months for a wind farm to offset the amount
of carbon emitted installing the wind farm (Glennie, 2016). Therefore, this whole
project will require approximately 600K RECs of the 12M it will produce.

Carbon is emitted through the extraction and manufacturing of raw materials,

transportation, erection, operation and maintenance of the wind turbines (Glennie,
2016). Wind turbines also have a backup generator on standby, this is when there is
no wind. However, the carbon emitted has been calculated and assessed by various
bodies and concluded to be minimal or negligible (GE Energy, 2010).

Consumption

There will be approximately 6M RECs sold by the project and consumed in the
Australian energy market over the next ten years. The Australian Government is
aiming to generate 45M RECs by 2020 (Energy Matter, 2020). Therefore, the wind
farm project is making a small, but significant impact of helping them to achieve this
goal.

There is criticism if this process of offsetting carbon is allowing large corporations

the ‘right to pollute’. However, by investing in renewable energy, companies are
assisting Australia in achieving its mandated Government targets. This will result in
more projects and jobs in renewables, resulting in more competition amongst fossil
fuel companies and therefore decreasing their use (Energy Matters, 2020). The
system is not perfect, however will continue to improve and thus, help to reduce
fossil fuel emissions in the future.

22
Business viability in the long run

It is crucial for this wind farm project to grow and profit sustainably. Sustainable
growth is achieving a profit at a steady rate. As Tarantino (2004) states, if a
business’s growth exceeds its capacity to fund the increase in assets and impedes
cash flow, it is growing unsustainably and can result in negative financial
consequences. The renewable energy market is predicted to grow at 6% p.a. (BCC
Research, 2020), therefore the Lendlease wind farm project is aiming for a
conservative growth rate of 4.5%.

Renewable energy is an emerging and ever-changing market, as more companies

continue to carbon offset and become more environmentally conscious. The
Australian Government is providing renewable energy companies with subsidies and
creating more incentives to enter this market. Additionally, the Government is
ensuring energy companies purchase 20% renewable energy, or alternatively pay a
significant fine. The amount these companies are required to purchase will most
likely increase in the future. Due to Governments worldwide creating more
incentives, businesses are becoming more environmentally conscious. Due to these
reasons, a renewable business project is a reasonably safe market to currently be
investing in.

23
Conclusion

Lendlease pride themselves as being environmentally conscious, striving to create

a healthier environment and emit less carbon. Therefore, a business to offset their
carbon emissions will be a positive step to achieving their goals.

The aim will be to produce 12M RECs over the next ten years, selling
approximately 6M RECs as a profit. The rate of return will be approximately 11% p.a.
and aiming for an annual growth rate of 4.5% p.a. The installation costs will be
significantly high, however the operation, maintenance and other ongoing costs will
be reasonably low, therefore this business is profitable.

Renewable energy projects are an emerging phenomenon and ever-evolving

market. As Government and corporate bodies worldwide are creating subsidies and
incentives for the renewable business and the consumer, it is a reliable and safe
business to be entering.

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