Proceedings of International Symposium on Sustainable Energy and Environmental Protection (ISSEEP) 2009 Yogyakarta, Indonesia, October 2009

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1 Proceedings of International Symposium on Sustainable Energy and Environmental Protection (ISSEEP) 2009 Yogyakarta, Indonesia, October 2009 Understanding the Challenges of Indonesian CPO-Based biodiesel Producers on Meeting Indonesia s 2025 biodiesel Target through development of Business Models using Systems Dynamics Approach Akhmad Hidayatno 1,2,*, Teuku Yuri Zagloel 1, Widodo W. Purwanto 2 1 Industrial Engineering Department, Faculty of Engineering, University of Indonesia 2 Chemical Engineering Department, Faculty of Engineering, University of Indonesia *akhmad.hidayatno@ui.ac.id ABSTRACT Government of Indonesia has established an ambitious target of renewable energy mix by creating regulation that by 2025 to answer our current condition as net importer of oil. Indonesia established the National Biofuels Development Team which develops a detailed blueprint and roadmap for national Biofuels program, through Presidential Decree No.10 / 2006, as a follow-up of Presidential Instruction No. 1 Year 2006 about Biofuels provision and utilization. One of bio-fuel commodity that has leading potential to be developed in Indonesia is CPO-based biodiesel, because this commodity has relatively low production cost and has equal performance compared with diesel fuel properties. In addition, Palm oil as raw material of the biodiesel has been produce in the massive quantity at mature industrial scale. Naturally, the government would count on the private sector to supply the required biodiesel production target to compliment the production capacity from the state-owned enterprises. In order to this, the private biodiesel producers must have the necessary business climate to operate reasonably which should be provided through structured government policy. Therefore, we need to have a business model as an objective tool of understanding the financial challenges that producers will face and how government policy would affect the attractiveness of producing biodiesel. The business model was developed based on 3 stages of CPO-Based Biofuels productions: Palm Oil Plantation, CPO Production, and Biofuels Production. We create the production process map of each stage through secondary data and calculate cost originated from each proses. We also conduct a mental model mapping through discussion with CPO producers and analyzing other systems dynamics model of Biofuels challenges. For this model we develop 3 ownership types of the industry, differ on different vertical integration along the 3 supply stages, and analyze challenges for each type of ownership. The production process map is the basis to develop the causal loop diagram, and subsequently the stock and flow diagram to be developed in the system dynamic software. The model is verified by developing the same calculation in the spreadsheet applications to verify all the calculation in the original model. Based on the constructed simulation model, sets of policy scenarios are constructed based on the characteristics of biodiesel industry in Indonesia. The characteristics includes blending percentage of biodiesel in BioSolar, price subsidy in the transportation fuel, export tax for CPO and possibility of subsidy in the CPO price which is the highest cost component in biodiesel Production. The result shows that generally the long term biodiesel utilization target couldn t be accomplished without the support from the government in form of subsidy, and the best policy to apply is to decrease the subsidy for diesel fuel. The model also shows the best ownership type is complete vertical integration along the supply stages; however the government must also make sure that monopolistic condition does not occur in the industry.

2 1 INTRODUCTION Considering its heavy reliance on oil, coal and gas, Indonesia is one of the countries which are highly dependent on fossil fuel. After the Asian economic crisis, Indonesia s growth has been steady, which also means that our energy needs is increasing. By 2007, daily national oil consumption reaches 1.2 million barrel and is predicted to increase by 2.8% annually, showing a trend that will not easily be coped with due to difficulties in finding substitute to oil. Coal consumption is predicted to soar due to its use for briket in electricity generation and household use. National coal consumption reached 28.4 Mtoe (Million tonnes of oil equivalent) in 2007 and is predicted to grow by 4.7% annually. National consumption of gas was noted to reach almost 36 billion cubic metres in 2006 and is predicted to increase at an annual rate of 2.8% due to its use in fertilizer production and electricity generation. [1]. National demand for electricity has climbed up from GWh in 2003 to GWh in 2005 and GWh in Currently, 46% of the energy supply comes from coal and 32% from gas [2]. Unfortunately, the soaring energy consumption is negatively in line with the diminishing fossil energy resources. Oil production in Indonesia, which is 1.1 million barrels in 2006, is predicted to decrease 0.5% every year, due to a number of reasons, including lack of oil fields, various conflicts of interest in exploration for new oil fields, inconsistent regulation, and unpredictable investment climate [1]. In the year 2002, Indonesia has begun importing oil, and changed its status from oil exporter into oil importer. The contrast between energy consumption and available energy reserves, marked the entry of Indonesia's into energy crisis and also financial burden of importing oils. Hence, energy resource diversification is indispensable to add energy source options as well as to reduce oil dependency. Responding to the issue, Indonesian Government directed their focus on renewable energy, with the main highlights on biofuels and set its very first biofuels national policy as part of the efforts to ensure the fuel supply availability [3]. The government also saw an opportunity to create new jobs (especially in rural areas), to strengthen the agricultural sector, as well as to discover new export opportunities [4]. Early government plan estimates that biofuels will cover 10 percent of total fuel consumption for transportation sector, creating thousands of employment opportunities and self-sufficient energy for rural areas. Unlike other countries developing similar diversification program, greenhouse gases reduction is not the primary goal of the biofuels development program. Therefore, through Presidential Decree No.10 / 2006, as a follow-up of Presidential Instruction No. 1 Year 2006 about biofuels provision and utilization, the government established the National Biofuels Development Team for Acceleration of Poverty and Unemployment Reduction, where one of its tasks is to prepare the blueprint and roadmap for the national biofuels development, as a reference for stakeholders in accomplishing the biofuels development multiple objectives: cutting down on poverty and unemployment, as well as biofuels provision and utilization in the national energy mix, in [5] Table 1. National biodiesel and Biofuels Roadmap [5] Years % Diesel Fuel Market 15% Diesel Fuel Market 20% Diesel Fuel Market Mandatory for biodiesel Mandatory for biodiesel Mandatory for biodiesel 2.41 Million kl 4.52 Million kl Million kl For biodiesel Total Biofuels 2% National Energy Mix 5.29Million kl 3% National Energy Mix 9.84Million kl 5% National Energy Mix 22.26Million kl The CPO-based biodiesel is currently has a strong prospect to be developed, because this commodity has relatively low production cost and has equal performance compared with diesel fuel properties, therefore engine modification is relatively minimum [6] [7]. In addition, Palm oil as raw

3 material of the biodiesel has been produce in the massive quantity at mature industrial scale. Indonesia is the largest palm oil producer in the world and also the second largest palm oil exporter in the world (after Malaysia) [8]. Currently, Indonesia has succeeded in producing million tons of CPO to the area of land 6.78 ha [9]. This figure is driven up by the private sector who participated in developing oil palm plantation in Indonesia. Since the private sector controls more than half of the total land area of Palm Oil Production, with government controlled only 12 percent. Therefore, both government and private sector have important role in this biodiesel development program. The role of government in the national biofuels development is presented in the Presidential Decree No. 1/2006 detailing the roles of 13 minister involved in the policy of biofuels, with addition of all governors and bupati of the area that connected with biofuels supply chain. Planning in a comprehensive and integrated fashion is a definitely complex issue and required a tool that can help decision makers to understand the relationships between variables and factors. This complex decision making could be supported with a business model to simulate the perspectives of biodiesel producers to supply the long-term projection of biodiesel needs and learn the interrelationship of the elements using systems dynamic approach. Analysis of the long-term behaviours resulting from this simulation model will then become the basis of consideration in the policy development to achieve the long term biofuels target achievement. 2 METHODOLOGY The systems dynamic approach is not new in biofuels, Bantz and Deaton studied the dynamics in the biodiesel development in the United States that leads to the rapid growth or slowdown in the biodiesel market [10]. Grosshans discussed same problem, covering more details and stresses more on the sustainability perspective [10]. In addition, John K evaluated the future role of biofuels by considering the interrelationship between the influencing factors [11]. In the macro level, systems dynamics was also used in evaluation However all the approach above has not yet discuss in them micro level (industry level) about biodiesel producers and challenges faced by them. Therefore, the research aims to obtain a system dynamics simulation business model as an objective tool of understanding the financial challenges that producers will face and how government policy would affect the attractiveness of producing biodiesel. The methodology of the research is based on the iterative framework for systems dynamics modelling, in which the first stage is formulating the purpose of the model, and the general problem and conditions surrounding the model [12]. A system diagram is created to illustrate the whole concept and to serve as the framework in designing the simulation model (Figure 1). Policy Options Export Tax Retail Price Blending % Direct Subsidy External Variables Demand for Diesel Fuel World Oil Price World CPO Price CPO Market Land Availability Palm Plantation Cost Capacity Expansion Systems CPO Plant Production Price BioDiesel Plant Supply Demand Outcomes Criteria (to serve the goals) Biofuels Supply based on target Reasonable & Sustainable Price Sustainable Biodiesel Business Problem Owner Government Goals Achieving the Target of Biodiesel in Energy Mix Diversification Stakeholders Producers, Consumers, NGOs Figure 1. The Simplified System Diagram of biodiesel Production

4 The system highlights the perspective of the Indonesian government as the problem owner, which has a goal to achieve national energy security by providing the targeted amount of biodiesel. Achieving goal requires the involvement of other stakeholders, the biodiesel producers and palm oil producers. They require a more conducive business climate for investment and operations, such as guaranteed market and reasonable prices. In the context of this simulation modelling system, the biodiesel producers and palm oil producers are two sub-systems that mutually interacts one another. The separation of the two systems is to create an opportunity to test 2 ownership types based on 3 stages of CPO-Based Biofuels productions: Palm Oil Plantation, CPO Production, and Biodiesel Production. We also map the production process map of each stage through secondary data [13] and calculate cost originated from each proses, biodiesel production and palm oil production data, financial aspects of biodiesel and palm oil system, and macro-financial data. The next step is to develop causal loop diagrams based on problem concept and production process map. In accordance with described in the system diagram, there are two systems in the simulation model, biodiesel system and palm oil system (figure 2). Figure 2. One of the Main Causal Loop Diagrams of Biodiesel System The Causal Loop Diagram highlights the mental model of Palm Oil and biodiesel Producers, considering the perceptions of profitability (cost, tax, margin and demand), product channelling (to biodiesels or direct export), and capacity expansion (market growth and market share). This is the strong advantage to use the systems dynamics approach. Causal loop diagram is then translated into the stock and flow diagram as the basis of the simulation modelling, illustrated in Figure 3. It will be divided into 2 groups, production flow sequence, and pull by price and demand projections, and the next group represent the information flow (cost and other information). The model is link with spreadsheet software to generate the business sheets of cash flows which will feed back into the model. Verification is conducted by testing the calculated results from the model with the spreadsheet calculation. Validation test is conducted by comparing simulation results with historical data, checking adequacy of limits, structure assessment, extreme conditions

test, integration error test, reproductive behavior test, and sensitivity analysis. From both, it can be concluded that the simulation model reflects the behavior of the actual existing system.

5 test, integration error test, reproductive behavior test, and sensitivity analysis. From both, it can be concluded that the simulation model reflects the behavior of the actual existing system. The validated model is used to simulate the case; simulation period starts from year 2006 to 2025, with the time step of 1 year. The details and policy scenarios sets can be seen in table 2. KAPASITAS PRODUKSI BIODIESEL 852,074,341, ,136,283,856, NPV CPO- PERKEBUNAN TAMBAH KAPASITAS 2,302,558,903, NPV CPO- PERKEBUNAN TANPA TAMBAH KAPASITAS 2,203,487,660, NPV BIODIESEL TAMBAH KAPASITAS EKSPEKTASI PROFITABILITAS EKSPANSI KAPASITAS BIODIESEL 0.00 ton/yr² NPV BIODIESEL TANPA TAMBAH KAPASITAS 0.00 ton/yr SKENARIO RANTAI SUPLAI KAPASITAS TAHUNAN BIODIESEL EKSPANSI KAPASITAS PLANT BIODIESEL 160, ton/yr 45, ton/yr 0.00 ton/yr 0.67 PERMINTAAN BIODIESEL UNTUK TIAP PERUSAHAAN 1 TAHUN BERIKUTNYA PERENCANAAN KAPASITAS PRODUKSI BIODIESEL TAHUNAN BIODIESEL YANG DAPAT DIPRODUKSI DARI SUPLAI CPO TAHUN BERIKUTNYA KONSTRUKSI KAPASITAS AWAL BIODIESEL Figure 3. One of the Stock and Flow Models of Biodiesel Production Capacity Table 2. Scenario Sets and Expected Model Output The scenario sets in Table 1 is based on 2 major combinations: industry characteristics and probably policy. Industry characteristics are to accommodate 2 types of ownerships, independent biodiesel producers and total integrated biodiesel with palm oil producers. Each main scenario has variations listed on the table from the profit margin (for independent biodiesel producers only) to palm oil allocation or sources. The second group of scenarios would be conducted if the palm oil is completely supplied by the producer s plantation, or if they bought the palm fruit from other produces, which will affect their cost structure. Palm oil allocation is important since the biodiesel productions must compete to get the feedstock with direct CPO exports. Therefore, in total we have 6 scenarios.

6 The policy is set to 4 course of policy that based on the government s perspectives, P1. Different percentage of BioDiesel Blending in BioSolar, which will affects the total subsidy cost. P2. Subsidy Reduction. The policy if the the BioSolar price is move according to the market with subsidy reduction. P3. The policy to impost higher palm oil export tax, which will make palm oil producers could prefer to make biodiesels rather than exporting directly as CPO. P4. Subsidy to purchase CPO (feedstock), explores what if the government is giving biodiesel producers subsidy to purchase the feedstocks. 3 RESULTS AND DISCUSSION The results obtained from each scenario are compared with one another to obtain a general picture of the model simulation results which are presented in figure 4 and figure 5. Rp3, Rp2, Rp2, Rp1, Rp1, Rp P1 P2 P3 P4 P1 P2 P3 P4 P1 P2 P3 P4 P1 P2 P3 P4 P1 P2 P3 P4 P1 P2 P3 P4 Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5 Scenario 6 Figure 4. The Comparison of Biosolar Subsidy (Rp/L) for Each Scenario From the graph shown in the figure 4, it can be seen that scenario 1 and 2, i.e. the scenarios with the characteristics of a single biodiesel industry, require BioSolar subsidies greater if compared with the other four scenarios. BioSolar is the market name product of biodiesel, sold by PERTAMINA, the state oil company, who handles the distribution of all subsidized fuel. This is due to the raw material cost which is very large influenced by the high domestic palm oil prices, as shown in the results of the sensitivity analysis. This causes the cost to produce 1 liter of biodiesel to become increasingly expensive and they have to determine the price to cover the costs. This high biodiesel price causes a greater deal of the BioSolar subsidy in order to match the price of diesel fuel. Billions Rp700 Rp600 Rp500 Rp400 Rp300 Rp200 NPV CPO NPV Biodiesel Rp100 Rp- Rp- P1 P2 P3 P4 P1 P2 P3 P4 P1 P2 P3 P4 P1 P2 P3 P4 P1 P2 P3 P4 P1 P2 P3 P4 Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5 Scenario 6 Figure 5. The Comparison of Producer s Profitability for Each Scenario

7 The comparison of the profitability based on net present values of each scenario is shown in figure 5. The graph proves that the characteristics of single biodiesel industry yield lower net present values if compared with those of integrated biodiesel industry characteristics with palm oil system. The integrated biodiesel industry characteristic scenarios (i.e. scenario 3 to scenario 6) show additional cash flows from the palm oil factory and plantation. High net present value still can be obtained in a single biodiesel industry characteristic, as shown in scenario 2 results, however, in the condition of sales margin 50%, which cause scenario 2 has the largest solar subsidies compared to other scenarios as shown in figure 4. In general, there are no significant differences between the scenarios with different integration nature (i.e. between scenario 3 and scenario 5 as well as between scenario 4 and scenario 6. However, differences occur in the extent of how much palm oil supply is allocated for the feedstock of biodiesel production. In this case, comparison is made between scenario 3 and scenario 4, as well as between scenario 5 and scenario 6. It is found that full allocation of palm oil production for biodiesel production is not able to provide greater benefits than partial allocation of palm oil production to meet the export needs. This is due to high palm oil export price that gives a large benefit for the palm oil manufacturer. The comparison between the results of each policy in every scenario is shown in figure 4, whereas it is found that in single biodiesel industry characteristics (scenario 1 and scenario 2), the policies yielding in the lowest BioSolar subsidy are biodiesel blending policy (P1) and diesel fuel subsidy reduction (P2). From the biodiesel producers point of view, as shown in figure 5, the policies influencing the cash flows of biodiesel producers are the first two scenarios (scenario 1 and scenario 2) is the feedstock subsidy policy (P4), which minimizes the raw material cost yielding a more positive cash flow. Figure 4 shows that in the integrated biodiesel system and palm oil system scenarios, the policy with the lowest BioSolar subsidy is diesel fuel subsidy reduction (P2). Palm oil export tax policy (P3) is the second policy with the lowest BioSolar subsidy, nonetheless, the policy also negatively influence the palm oil cash flows, as seen in figure 5. It can be inferred that biodiesel blending policy (P1) can serve as the alternative policy to apply considering its low BioSolar subsidy, which does not vary much with that of export tax policy, and considering its zero impact to the producer s cash flow. 4 CONCLUSION Using the constructed systems dynamics model with the sets of scenarios and policies, our research concluded that, In general, for all simulation model scenarios, the effort to accomplish the long-term national program biodiesel utilization target can not be separated from government policy support in the form of subsidy. The policy with the minimum need of BioSolar subsidy is diesel oil price reduction policy to follow the market price. The percentage determination of biodiesel blending with diesel oil policy is another option to apply in accomplishing the long-term national program biodiesel utilization target. The ideal biodiesel industry characteristic is full integration between biodiesel business unit and palm oil business unit. Coherent with the circumstances of the real conditions, the most influencing factor to the high price of biodiesel is the feedstock cost, i.e. palm oil price. The systems dynamic model of the micro supply chain structure could be use as rich tool for policy makers to have a better perspective on the effect different type of policy scenarios.

8 REFERENCES [1] BP plc, BP Statistical Review of World Energy June June 2009, British Petroleum London, UK. [2] Ministry of Energy and Mineral Resources, Indonesia Energy Statistics , Centre for and Information Data on Energy and Mineral Resources. [3] Presidential Decree No. 1/2006, Provision and Mandatory use of Biofuels as Other Fuels Government of Indonesia, Editor [4] Wirawan, S.S. and A.H. Tambunan, The Current Status and Prospects of biodiesel Development in Indonesia : a review, in Third Asia Biomass Workshop. November 16, 2006: Tsukuba, Japan. [5] Timnas BBN, Blueprint : Pengembangan Bahan Bakar Nabati untuk Percepatan Pengurangan Kemiskinan dan Pengangguran (Biofuels Development for Acceleration of Poverty and Unemployment Reduction ), Departemen Energi dan Sumber Daya Mineral (Ministry of Energy and Mineral Resources), Editor. December 2006, Republik Indonesia (Government of Indonesia): Jakarta. [6] Basha, S.A., K.R. Gopal, and S. Jebaraj, A review on biodiesel production, combustion, emissions and performance. Renewable and Sustainable Energy Reviews, 2009: p. 7. [7] Murugesan, A., et al., Bio-diesel as an alternative fuel for diesel engines A review. Renewable and Sustainable Energy Reviews, In Press. [8] IPOB, Indonesian Palm Oil in Numbers, ed. I.P.O. Board. 2007, Jakarta: Indonesian Palm Oil Board. 27. [9] Pusat Data dan Informasi Departemen Pertanian, Statistik Perkebunan Indonesia (Indonesian Plantation Statistics ), in Statistik Perkebunan Indonesia, Pusdatin Deptan, Editor. 2009, Ministry of Agriculture, Republic of Indonesia: Jakarta [10] Bantz, S.G. and M.L. Deaton. Understanding U.S. biodiesel Industry Growth using System Dynamics Modeling. in Systems and Information Engineering Design Symposium Charlottesville, VA: IEEE. [11] John K. The Economics of Biomass-to-Liquids Fuels. in 2007 International Conference of the System Dynamics Society Boston, MA: The System Dynamics Society. [12] Sterman, J.D., Business Dynamics: System Thinking and Modeling for A Complex World. 2000, Boston: The McGraw Hill Companies, Inc. [13] Pahan, I., Panduan Lengkap Kelapa Sawit: Manajemen Agribisnis dari Hulu hingga ke Hilir. 2008, Jakarta: Penebar Swadaya.

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