National Approaches to Electrification – Finance

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Finance: Forms of funding used to finance electricity access

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Private Finance

Definition:

Finance provided by investors or lenders in the expectation of financial returns (profit).   Private finance will be input on commercial terms, meaning that the investor or lender will expect to receive returns that exceed the original investment or loan and at a level that reflects the risks involved. Factors considered by financiers may include risks to implementation, delivery and technology performance, risks of cost escalation, market/demand and credit/payment risks, regulatory and macro-economic risks and external risks such as policy framework and weather. Any financier will require clear information on forecast revenues and potential risks before providing funding.  It may be difficult for new electricity businesses working in new markets, and for users without a formal credit-record, to give commercial funders the confidence they require. Finance for electrification may come in the form of equity investment, or capital asset or working capital loans, and may be provided to a business as a whole, to a specific project or to end-users. Equity - Any equity investment implies partial business ownership, with the investor taking the risk of losing their investment if the electricity venture fails, but also expecting to receive bonus returns if forecast targets are exceeded. Early stage investment in new businesses often relies on finance from entrepreneurial individuals, angel investors or venture capitalists who are willing to take large risks but expect to receive high returns on their investment if it’s successful. Loans - capital asset loans are used, generally in later stages of business development and on specific projects, to leverage equity investment enabling businesses to scale up and expand their assets. Capital lenders expect repayment of loans over fixed periods and with pre-agreed (fixed or variable) interest rates, so that if profits fall short of forecasts payments are reduced only once equity capital has been exhausted, but if forecasts are exceeded lenders receive no additional benefit. Working capital- alongside capital investment, most businesses require working capital to bridge the gap between expenditure and receipt of revenues. Working capital is particularly needed by, for instance, solar product businesses, where there may be three months or more between purchase/ import of the product by the business and sale to the end-user. Sources of finance - Often both international and local finance is required to support electrification – particularly where capital equipment or products are imported. The scale of funding needed for electrification may require international finance, and international financiers may have greater familiarity with, and hence be more comfortable with, some of the issues associated with the energy sector, particularly if their funding is channelled through an international company. However, local private funders will be more familiar with the national context and be more confident in resolving, and hence charge less premium for, risks associated with it. Exchange rate, and hence macro-economic, risks will always be an issue for private financiers where any of the electrification costs are in foreign currency. This issue will be greater where international funding is used to cover more than just import costs, and international funders will be very reluctant to provide finance if repatriation of funds is constrained.

Internactions wiht other NAE Categories:

	Technology	Most national grid systems are constructed using public funds, though private finance can be introduced through privatisation of existing assets, inviting private generators to feed into the national grid, or establishment of distribution/grid-connected mini-grid concessions.  For instance, the introduction of feed-in tariffs (e.g. in Tanzania) has provided the basis for private investment in generation. Mini-grids are more frequently, though by no means always, financed by the private sector since the smaller investment and shorter payback period can reduce the risks and provides a more manageable business opportunity. Stand-alone systems offer even greater opportunities for market-based finance since the relatively short period between purchase and sale to the user means that that only business establishment and a small amount of equipment capital investment is at risk.
	Delivery Models	Application of market-based finance, by definition, requires private sector ownership or a public-private partnership (PPP).  PPPs are often an effective way to attract private finance since the public-sector element can offer funding and offset the risk associated with financing of electrification. Any private or PPP financing will require a business model with clear investment requirements and projections of income that provide expected return on investment over an acceptable timeframe, and with acceptable levels of risk and uncertainty.
	Legual Basis	Any private finance provider will consider the legal basis of electrification in terms of the risk profile it presents to them. The lower the risk and the greater certainty, the more likelihood that private finance will be available and at a lower cost. The most fundamental requirement for any private investment in fixed assets is clarity around the legality of operating and selling electricity. This may be provided explicitly through a concession or license, or through a general exclusion of certain types of electricity provision (e.g. mini-grids below a certain size) from the need to be licensed. Without this basic regulatory clarity, and so with the risk that future introduction of regulation may undermine their business and restrict their levels of income, it will be extremely difficult to attract private finance for electrification.
	Price/Tariff Regulation	Is a critical factor for private investment in electrification, with inadequate or inappropriate price/tariff regulation often cited as the key barrier to such finance. Whatever form of price/tariff regulation is used the critical requirement is that it is clear and transparent, as without this, private financiers will see a significant risk of political pressure reducing prices or tariffs to the point below which they fail to cover investment costs.
	Other forms of Finance	In many cases some other form(s) of public finance such as grants, subsidies, concessionary loans, tax exemptions or guarantees (to reduce investment risks) will be needed alongside private finance to overcome the lack of user spending power and the high costs of early market development. User Finance – Charges paid by users provide the means to repay electricity providers’ loans and equity investments and pay interest and return on capital. Where upfront charges are imposed on users, they may in turn seek to borrow to cover these charges and then repay the loan over time.  Alternatively the electricity provider may seek additional finance in order to reduce up-front charges and so minimize barriers to users accessing their services.
	Non-Financial Interventions	Most support activities to assist national electrification will reduce the perceived financial risk and so help to attract private sector investment and sustainable market development.  Providing policies and targets, standards and technical assistance for new electrification initiatives will all increase the private financier’s certainty regarding the likely outcomes and so reduce the risk of investment.  Market information, capacity building and customer engagement through promotional activity will all have a similar positive effect.

Advantages and Disadvantages

If private finance is attracted, it can support rapid electrification at a large scale, and can free up public funding to be used for other things. If market conditions are such as to attract purely private finance, this indicates that the electrification process will be self-sustaining without dependence upon external grants or subsidies from the government or donor organisations.  Where customers are able to pay for electricity at a level that allows the supply to be maintained under market conditions, there is no concern over the withdrawal of public funding that may then prevent continued access to electricity. Experience also indicates that involvement of private finance can drive innovation and efficiencies in electrification as in other sectors. Private finance, however, requires clear evidence that revenues will provide returns on investment, and this may be an insurmountable barrier, particularly for forms of electrification such as grid and mini-grid systems which have high upfront capital costs that will be recovered over long periods (perhaps 20 years). Even where macro-economic conditions are stable, regulatory frameworks and prices/tariffs transparent, and users able to afford electricity, financiers may be reluctant to provide support in the absence of established companies with a track record of performance. Much time and effort may be expended in the attempt to attract sufficient private finance without the required results. Furthermore, private finance is usually more expensive than general government borrowing and this will particularly be the case for programmes that are seen by the financiers as carrying significant levels of risk.

Further Informaiton and Guidance

De Montfort University (2013), Financing Energy Access and Off-grid Electrification: A Review of Status, Options and Challenges https://www.dmu.ac.uk/documents/technology-documents/research-faculties/oasys/project-outputs/peer-reviewed-journal-articles/pj7--financing-energy-access--rser-paper.pdf UNEP-FI (2012), Financing renewable energy in developing countries http://www.unepfi.org/fileadmin/documents/Financing_Renewable_Energy_in_subSaharan_Africa.pdf

Relevante Case Studies:

Bangladesh, IDCOL Solar Home Systems Brazil, Luz para Todos (Light for All) Cambodia “Light Touch” Regulation Ethiopia, Solar Market Development Kenya, Off-Grid for Vision 2030 Mali, Rural Electrification Programme Philippines, Islanded Distribution by Cooperatives Rwanda, Sector-Wide Approach to Planning Tanzania, Mini-Grids Regulatory Framework Vietnam, Rapid Grid Expansion

User Finance

Definition:

A regime under which the price or tariff at which each  provider can sell electricity (or standalone systems) is separately agreed with the regulator. An individual price/tariff arrangement may: Address purchase costs for standalone systems or connection charges and charges for electricity used or flat monthly changes Encompass a set of prices or tariffs for different classes of user (eg household, commercial and industrial) or for different levels of provision (eg size of solar home system)    Relate to electricity from one or more technologies and/or standalone systems as long as these are all provided by a single entity Cover a single unit within the provider’s operation (eg a single mini-grid) or the entirety of the provider’s operation Be based (most usually) on the provider’s average or incremental costs, net of any grant or subsidy (cost-recovery tariffs) or on estimates of the avoided cost of grid extension to the area, or some other basis

Internactions wiht other NAE Categories:

	Technology	It is in principle possible to set individual prices/tariffs for different areas within a grid system. This could have the advantage of incentivizing the grid company to extend into more remote areas where costs are higher, but is often politically unacceptable and a uniform price/tariff structure is therefore most often used. Grid connected mini-grids and distribution systems rely on the sale of electricity to the grid, and import of electricity from the grid and its sale to users, as well as sale of own-generated electricity to users. Clarity on how each of these tariffs is set and regulated is vital. Tariffs for import of electricity from and export to the grid will usually be on a uniform price/tariff basis. Tariffs for users of grid- connected mini-grids as well as isolated mini-grids are usually set individually for each mini-grid or distribution area (or mini-grid company) to reflect their specific costs and any subsidies or grants they may have received. For larger, particularly grid-connected, systems, these factors may be overcome by political considerations and attempts to achieve equal treatment of users considerations (but cost-reflective grants or subsidies, or cross-subsidies, will then be needed to maintain economic sustainability). At the other end of the scale it may be concluded that the costs and bureaucracy of agreeing individual tariff levels for single small mini-grids may be unjustified. It is most usual to leave tariffs for mini-grids below a certain size unregulated (on the basis that they do not create an effective monopoly and so purchase decisions can be left to users), though use of a uniform price/tariff is also an option. Prices for standalone systems are also generally unregulated, though where public funding is used to support provision of standalone systems, it may (as with the NAE Case Study of the Bangladesh IDCOL programme) be regarded as appropriate to regulate prices. If the move towards pay-as-you-go, with users paying for electricity as they do from grid or mini-grids, while suppliers retain ownership of the capital equipment, continues or accelerates, regulation of electricity prices may become more relevant. If they are regulated it’s more likely to be on a uniform than an individual basis (since standalone system businesses are not usually tied to a location and so differences in costs are likely to be linked to their technology offer, efficiency of operation, or financing structure rather than any fundamental factors outside the businesses control).
	Delivery Model	An individual regulated price/tariff structure may be used with a public delivery model where multiple public entities are involved in electricity provision. It is in the context of a private or a public-private delivery model, particularly,  that individual regulated prices or tariffs are most likely to be needed, since this offers the private sector element both clarity and the opportunity to recover costs.
	Legual Basis	Individual prices or tariffs may be established through either concessions or a licensing system. Without some form of licensing it is impractical to regulate individual prices or tariffs.
	Finance	An individually regulated price/tariff regime will give those considering investing long term private capital confidence, reducing risk while protecting users. Whether this attracts finance will depend critically on whether the prices/tariffs set enable them to make adequate return on investment. A clear and transparent framework which allows potential investors to understand how prices/tariffs will be set and estimate levels likely to be acceptable to regulators will be key. (For smaller-scale, shorter-term investments, individual price/ tariff regulation may be regarded as a burden rather a protection). Any framework must factor in grants or subsidies received by the electricity business, so that their effect is to reduce prices/tariffs and make electricity more affordable to users. This also serves to ensure proper use of public funding and so where grants and subsidies are made available, prices/tariffs are more likely to be regulated. (Any cross-subsidies should also be incorporated into price/tariff calculations, but these are unlikely to be used alongside individually regulated tariffs). Tax exemptions and guarantees, will be reflected through their impacts on equipment, finance and other costs. The levels at which prices/tariffs are set will obviously directly affect finance derived from users through these charges and the need for users to be able to access finance, or pay-as-you-go arrangement to cover any up-front element.
	Non-Financial Interventions	Establishing individual price/tariff regulation will require regulatory reform and capacity building or technical assistance may be needed if the key actors lack the capacity to undertake this reform.  Other non-financial interventions, such as policy and target setting, establishment of quality and technical standards, awareness raising and demand promotion amongst users and service providers, provision of market information and training (capacity building) for businesses and workers, may be beneficial but are not specifically related to a uniform price/tariff structure. National energy planning will be key to establishing the optimum mix of technologies to meet electrification needs across the country and should feed in to design of the price/tariff regulation system.

Advantages and Disadvantages

The main advantage of an individual price/tariff regulation system is that it can reflect genuine underlying differences in the costs of provision under different circumstances and so enable economically sustainable electricity provision and attract private finance and businesses, while also protecting users from over-charging, particularly in a monopoly or quasi-monopoly situation, and ensuring that public financial support is properly used and benefits users by increasing affordability (rather than boosting private profits beyond those needed to attract capital). One disadvantage is that, if not well designed and rigorously applied by an expert and knowledgeable regulator, it may fail to incentivize energy businesses to work efficiently and control costs. Another is that, calculation and agreement of prices or tariffs for multiple providers on an individual basis is costly and resource intensive. This may be ameliorated by establishing a standard framework for price/tariff calculation, but some cost will remain. When deciding on an individual price/tariff calculation arrangement, consideration should therefore be given to materiality and the balance of costs and benefits. A greater issue is that, relative to a uniform price/tariff system, it discriminates between users, allowing those who can be supplied with electricity at lower cost (particularly in urban areas and within reach of the grid system) to access electricity at a lower price and to benefit from the cross-subsidies inherent in a grid system, while requiring those in more remote areas to pay the full cost of their access. While grants and subsidies may partially off-set these differences they are unlikely to eliminate them entirely. Not only is this inequitable, but it constrains those receiving more expensive forms of electricity from using it economically, improving their livelihoods and increasing demand to levels at which electricity would become cheaper. It thus acts as a constraint on economic development in higher cost areas and holds people back from moving up the energy access ladder. As a result an individual price/tariff regulatory system may lead to “tariff envy”, as those who initially welcomed modern electricity as providing them with better energy at lower cost than traditional sources, see neighbouring communities receiving it at still lower cost – and hence to political pressures to move away from individual towards uniform prices/tariffs. Thought should therefore be given when setting up an individual price/tariff regulation system to the future, how the system may need to be amended as the national electricity access context changes, and how this can be achieved on a basis which maintains both users acceptability and investor confidence.

Further Informaiton and Guidance

EUEI PDF (2014), Mini-grid Policy Toolkit: Policy and Business Frameworks for Successful Mini-grid Roll-outs http://www.euei-pdf.org/sites/default/files/field_publication_file/RECP_mini-grid_Policy_Toolkit_1pageview_(pdf,_17.6MB,_EN_0.pdf IRENA (2016), Policies and regulations to support renewable energy mini-grid development through private sector involvement http://www.irena.org/DocumentDownloads/Publications/IRENA_Policies_Regulations_mini-grids_2016.pdf

Relevante Case Studies:

Costa Rica, Distribution Cooperatives Mali, Rural Electrification Programme Philippines, Islanded Distribution by Cooperatives Tanzania, Mini-Grids Regulatory Framework

Unregulated

For more information on this topic please see the 'Unregulated' Sub-Section on the NAE Legal Basis Page.

References

Authors

Authors: Mary Willcox, Dean Cooper

Acknowledgements

The Review was prepared by Mary Willcox and Dean Cooper of Practical Action Consulting working with Hadley Taylor, Silvia Cabriolu-Poddu and Christina Stuart of the EU Energy Initiative Partnership Dialogue Facility (EUEIPDF) and Michael Koeberlein and Caspar Priesemann of the Energising Development Programme (EnDev). It is based on a literature review, stakeholder consultations. The categorization framework in the review tool is based on the EUEI/PDF / Practical Action publication "Building Energy Access Markets - A Value Chain Analysis of Key Energy Market Systems".

A wider range of stakeholders were consulted during its preparation and we would particularly like to thank the following for their valuable contributions and insights: - Jeff Felten, AfDB - Marcus Wiemann and other members, ARE - Guilherme Collares Pereira, EdP - David Otieno Ochieng, EUEI-PDF - Silvia Luisa Escudero Santos Ascarza, EUEI-PDF - Nico Peterschmidt, Inensus - John Tkacik, REEEP - Khorommbi Bongwe, South Africa: Department of Energy - Rashid Ali Abdallah, African Union Commission - Nicola Bugatti, ECREEE - Getahun Moges Kifle, Ethiopian Energy Authority - Mario Merchan Andres, EUEI-PDF - Tatjana Walter-Breidenstein, EUEI-PDF - Rebecca Symington, Mlinda Foundation - Marcel Raats, RVO.NL - Nico Tyabji, Sunfunder -

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Any feedback would be very welcome. If you have any comments or enquires please contact: mary.willcox@practicalaction.org.uk, benjamin.attigah@euei-pdf.org, or caspar.priesemann@giz.de.

Download the Tool as a Power Point: https://energypedia.info/images/a/aa/National_Approaches_to_Electrification_-_Review_of_Options.pptx

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