National Approaches to Electrification – Finance
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Finance: Forms of funding used to finance electricity access
Private Finance
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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. 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:
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Technology
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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. | |
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Delivery Models
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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. | |
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Legual Basis
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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. | |
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Price/Tariff Regulation
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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. | |
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Other Forms of Finance
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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. | |
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Non-Financial Interventions
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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
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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
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Relevante Case Studies:
User Finance
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Definition: |
Finance from charges paid by users for electricity or purchase of standalone systems, and finance made available to users to pay these charges Users may pay a fee for connection to the main electricity grid or a mini-grid, for membership of the local customer group for a mini-grid, or purchase of a stand-alone system, flat monthly charges, and/or charges for electricity used. These charges serve to fund the costs of provision of electricity access, ongoing operational and maintenance costs, and costs of extending electricity access. Public subsidies and grants may be used to cover some of the cost and make electricity more affordable to users, but to the extent that private finance has been used to establish the means of energy access or the energy access business, payments from users will be needed to repay the private investment and pay any interest on loans or return on capital. Where users are required to pay charges up-front this can create a major barrier to access to electricity (even if the user could afford the cost if spread over time). If users would otherwise be unable to access bank loans or micro-finance to cover these upfront costs, loans may be provided as part of an intervention programme. Another solution is for the service provider (e.g. the national utility or mini-grid company) to source this funding, either by providing loans themselves, or by structuring their charges to reduce upfront payments. In the case of standalone system providers this may be achieved through pay-as-you-go arrangements where users pay for systems over months or years rather than up-front. For suppliers to reduce up-front charges it will usually be necessary for them to secure additional finance themselves, but this should have a lower cost than individual users borrowing. When planning to provide electricity to target customers, it is thus essential for the supplier to consider how the costs can be both afforded and financed by users. |
Internactions wiht other NAE Categories:
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Technology
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Grid and mini-grid electricity access has generally been paid for by users through a combination of connection charges, monthly charges and electricity usage charges. Those providers who are able to remove up-front connection fees, recovering investment through ongoing energy charges, have generally seen substantially higher connection rates. Standalone systems have usually in | |
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Delivery Model |
Any delivery model, whether public, private or a PPP partnership will ultimately rely on user payments to cover ongoing costs and fund expansion. Under a public model, part of the funding may come from central public funds, making access more affordable to users, and under a PPP model the same can be achieved through grants and subsidies. The issue of enabling users to finance any up-front costs will remain regardless of the delivery model. | |
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Legual Basis |
There is clearly a direct link between user finance and price/tariff regulation arrangements, with the charges to be paid by users being set through any regulatory framework. | |
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Price/Tariff Regulation | ||
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Other Forms of Finance
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Private/Market Finance – sufficient user finance is a critical factor for any private sector investor to determine whether there is a sustainable market for electricity consumption. The affordability of up-front costs and/or monthly payments will determine whether the supply of electricity to any potential customer(s) is a viable business opportunity. For low-income communities, the supplier may rely upon public sector support to ensure that households can afford the necessary services. The private finance sector may also be a source of finance for users to cover upfront charges. However, it is in the longer-term interests of the supplier to introduce a level of electricity, together with an appropriate financing mechanism, that the consumer can pay for directly without dependence on external resources. Grants/Subsidies – Supply of electricity to some groups of the population will require funding in addition to payments that can be made directly by individual users. Non-commercial funding that does not require any repayment (grants) can be made available from government, or international donors, either to electricity providers to reduce charges or directly to users, and so reduce upfront costs. In a similar way, public sector payments to offset some of the ongoing costs associated with electricity supply (subsidies) can be introduced to increase affordability for users and reduce prices/tariffs charged by providers. Cross-subsidies – Another option is for electricity provision to some users to be subsidized from charges paid by other (higher income) users, rather than from general public funds. Cross-subsidization can occur within a single electricity provider’s business (with some degree of cross-subsidization being inherent in any multi-user system) or arrangements for cross-subsidy can be established between electricity businesses. This approach can be effective provided that the balance in numbers between the groups of users is such that electricity can be made affordable for the subsidized group while remaining acceptably priced for those providing the cross-subsidy. Tax exemptions – Provide an indirect means of subsidizing electricity costs and so making charges more affordable for users and reducing their need to access finance. Guarantees – One means of enabling users to access finance is for government or other donor, such as an international development bank, to provide guarantees to micro-finance providers and other potential lenders to encourage them to offer loans to those wishing to access electricity. | |
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Non-Financial Interventions
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Capacity building and technical assistance to electricity providers and regulators may be needed to support design of price/tariff structures and finance arrangements which will increase affordability of electricity access to users. Awareness raising and capacity building to finance providers may also assist them to enter this market and design financial products which lower the barrier of upfront costs to electricity access. Demand promotion is key in enabling users to increase productive use of electricity and allowing providers to reduce per kWh charges and thus making it more affordable to users. User finance may itself be an element in demand promotion programmes, enabling users to access the finance to buy equipment and develop businesses based on electricity use. |
Advantages and Disadvantages
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Charges paid by users provide the ultimate source of funding for electricity access. Only if users are able to pay for electricity access, at least in the medium to long-term will it be economically sustainable and cease to be a burden on public and donor funds. Providing finance to users has the great advantage of addressing affordability at its source –making additional resources available directly to people in remote areas without the risk of loss to intermediaries. User finance can often be the catalyst required to bring electricity supplies to low-income customers, thereby stimulating demand for increased supply and so helping to develop a sustainable market. However, electricity access provision is a long term enterprise and if user-finance is made available on conditions which do not meet user’s needs or for only a short period, then the impact may rather be to undermine any nascent local market that may have been developing. If user finance is provided without a clear exit strategy and then withdrawn, there is a danger of market disruption and potentially collapse, so long term planning of any user finance is required from the outset. Careful targeting of user finance is essential to ensure a positive impact. User finance is a critical element in electricity provision, both as a source of funding and an area of need, but one which is often disregarded. |
Further Informaiton and Guidance
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Relevante Case Studies:
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 -
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.
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