National Approaches to Electrification – Finance
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Finance: Forms of funding used to finance electricity access
Private
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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 Information and Guidance
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Relevante Case Studies:
User
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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 Information and Guidance
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Relevante Case Studies:
Grants and Subsedies
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Definition: |
Funding provided without requirement for repayment, interest or return on investment. Grants and subsidies are generally provided to make electricity more affordable and extend the number of users to which it can be provided. Grants usually refer to up-front payments to off-set capital costs and costs of business development while subsidies refer to ongoing payments to off-set operational costs. It is notable that none of the NEA considered in this review have been delivered using purely commercial finance – all have required some grants or subsidies. Grants are often used to support activities that are viewed by the private sector as uneconomic or high-risk, or which act as a public benefit, the value of which the individual business cannot be confident of capturing, and are therefore unattractive for investment. Using grants to fund supportive actions (such as awareness raising), to cover the excess costs of entering a market in the early stages of its development or to demonstrate an innovative technology or delivery model, can provide the foundation for development of a sustainable future market. Grants and subsidies can take many forms, and originate from a range of different sources. They may be tied (provided under the condition that other specific actions are undertaken) or untied (funds given to the recipient for allocation without any related requirements). Grant funding is used in a very wide range of circumstances. For example, grants can be provided by Government to individual users or suppliers, or by international development banks to national governments for large-scale electrification programmes incorporating support activities, or by NGOs or corporate donors (as part of their corporate social responsibility programmes). While the essence of a grant or subsidy is that it is not repayable, grants and subsidies may be wrapped into other forms of funding. Thus the concessionary element of a concessionary loan may effectively constitute a grant. Criteria for awarding grants and subsidies may include cost-benefit analysis, commitment to invest, and social impact. Experience has shown (e.g. Chile) that the use of subsidies only for initial costs is most effective, with developers expected to show that they can make a profit from the supply of high-quality electricity. Grants are often based on results (eg new connections) achieved and may be awarded through a competitive process. Both providers and users are usually expected to provide a contribution to costs to ensure their commitment. To users – Grants to individual users can help to overcome upfront costs of connection to a grid or mini-grid or of purchase and installation of a standalone system. Grants to users can thus make electricity access more affordable and so stimulate the market and by increasing demand may bring down costs of provision. Channelling grants directly to users has the benefit that it leaves choice in the hands of the user and means that grants will be disbursed only to the extent that electricity access is taken up, but are generally more expensive to administer. Subsidies are usually directed to electricity providers rather than users (though with the purpose of benefiting users). To providers – Grants may be given to electricity providers to off-set the capital costs of development, infrastructure and extending provision to new users, or the costs of establishing businesses in new markets. These grants are usually intended to bring down user charges and so make electricity more affordable, extend the number of users who can take up provision and increase electricity demand (thereby potentially, through economies of scale, lowering costs of provision and making it more economically sustainable). Subsidies may also enable providers to charge affordable prices/tariffs eg lifeline tariffs to low-income or low demand users. The advantage of channelling grants and subsidies through electricity providers are that it is relatively efficient to administer, can provide funding at an earlier stage, and will be seen by providers as more certain and less risky than if channelled through users . To support activities – Alongside financial support to energy provision itself, grants and subsidies may be used to fund supporting activities such as awareness raising, capacity building or demand promotion, which can increase users ability to afford electricity or lower cost of provision. Government grants and subsidies – a national Government department or agency may provide grants or subsidies from its budget to facilitate national electrification. These may go to users, providers or support activities , or be channelled through a coordinated programme incorporating other interventions such as regulatory reform. International government grants – Governments (primarily from industrialised countries) may provide finance either directly or through international development organisations to support electrification activities in developing countries. These funds may be channelled through national governments , agencies or utility companies, or through implementing agencies employed by the donor government or agency. They may be used to provide grants or subsidies to electricity users or providers, or to fund support activities including technical assistance and capacity building to policy makers and regulators and other interventions. Non-governmental donors – Other donors such as NGOs, Foundations or corporate donors (as part of their corporate social responsibility programmes) may also provide non-commercial financial support to electricity access. This may be used to provide electricity access directly, or be passed in the form of grants or subsidies to other electricity providers or users, or used to fund support activities. |
Internactions wiht other NAE Categories:
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Technology
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Grid system construction and extension is highly capital intensive and almost all national grids (including those in developed countries) are constructed using public funding from government, sometimes supplemented by concessionary loans and grants from international agencies. The bulk of ongoing grid funding generally comes from users charges, but the grid is often seen as a national asset and electricity from it as a public good supporting national economic development, and governments may therefore choose to provide continuing subsidies either on a general basis, to incentivize extension to new users, or fund provision to specific groups of users (eg through lifeline tariffs). The primary financing for mini-grids will generally align with the delivery model, with publically-owned mini-grids using public finance and privately owned mini-grids drawing on private finance. However, where incomes are lower or system costs higher, grants and /or subsidies are likely to be needed to make electricity from mini-grids affordable to users and the mini-grid businesses economically sustainable. Standalone systems are most frequently provided commercially and purchased directly by users. Grants may be used, as seen in the NAE Case Study of the IDCOL programme in Bangladesh, to make systems more affordable to users, to enable providers to establish their businesses and to fund support activities. Where standalone system providers are moving towards pay-as-you-go arrangements their need for capital will increase and it may be more appropriate to channel grants and subsidies to them, allowing them to reduce monthly charges and charges to users for electricity used. Standalone systems may also, as can be seein in the NAE Case Study South Africa, be provided through a public delivery model and subsidized through that model. | |
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Delivery Models
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By definition, any public delivery model will use public finance - effectively government (and international ) grants and subsidies – combined with finance from users, while a purely private delivery model must be purely privately financed (since inclusion of any grants or subsidies finance would cause the delivery model to be categorized as a public-private partnership). All public-private partnership models will involve a combination of private and public finance, frequently through explicit grants and subsidies (or tax exemptions or guarantees) or through partial public ownership acting as a form of grant /subsidy. | |
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Legual Basis
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A concession may be used as a means of channelling grants or subsidies into electricity provision through the terms of the concession agreement. A license would not generally be linked directly to a grant or subsidy, but may be one of the qualifying requirements for accessing them. Grants and subsidies will most often be linked to some form of regulation to ensure proper use of funds. | |
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Price/Tariff Regulation
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Any price/tariff regulation must factor in grants or subsidies received by the electricity business, so that their effect is to reduce prices or 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 or tariffs are more likely to be regulated. Where combined with a uniform price/tariff arrangement, grants and subsidies may make electricity access more affordable, but if they, too, are set on a uniform basis, while they may extend the group of users to whom electricity can be economically provided, they are also likely to create additional excess profits for those elements of electricity provision which could have been delivered economically at a lower subsidy level. This implies that where uniform prices or tariffs are used, grants or subsidies should be structured to reflect costs of provision. Where prices or tariffs are set on an individual basis, the prices/tariffs themselves can be made cost-reflective. Where prices/tariffs are unregulated, it is left to market competition to ensure that grants and subsidies are passed to the users rather than unnecessarily retained by the business to boost profits to excessive levels. | |
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Other Forms of Finance
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Private Finance – private finance will depend upon the investor’s (or lender’s) assessment of the financial return and the level of risk involved. Grants and subsidies can directly increase probable return and reduce risk by off-setting costs and increasing demand by making electricity affordable for more users. Indirectly grant-funded technical assistance, local capacity-building, awareness-raising, and promotion of uses of electricity by potential customers can also make investment in electricity access more attractive to private financiers. User finance – grants or subsidies paid to users provide one source of user finance, allowing users to off-set up-front and/or ongoing charges. Grants and subsidies paid to electricity businesses have the same effect indirectly. Because grants and subsidies do not require repayment they provide an absolute reduction in users’ need to secure other forms of finance, not just a timing shift. Cross-subsidies – sit alongside grants and subsidies as finance which is not derived from commercial investment in the specific electricity provider or payments from the users being supplied. They may therefore be seen as an alternative to grants and subsidies, but it must be recalled that they are taken from other businesses and users and so, unlike grants and subsidies simply redistribute the costs of electricity rather than reducing them Tax exemptions and Guarantees – Act as indirect forms of grant or subsidy by reducing costs and risks | |
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Non-Financial Interventions
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Direct provision of electricity can act as a vehicle for grants and subsidies if it is undertaken at below cost, or if it uses funding (eg from the public purse) which is not required to be repaid. Grants may be used to fund other non-financial interventions, such as technical assistance and awareness raising. (Non-financial interventions undertaken at no cost to the electricity provider could also be regarded as grants or subsidies, but are not treated as such in categorizing NEA). |
Advantages and Disadvantages
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If users are not themselves able to pay the full cost of electricity access, some form of grant or subsidy will be essential to make it affordable. (It is notable that none of the NEA considered in this review have been delivered using purely commercial finance – all have required some grants or subsidies.) Well designed grant and subsidy programmes can thus serve social objectives and promote equity by reducing electricity costs for poorer social groups, enabling them to gain access to electricity and use it to improve their lives and livelihoods – and thereby support national economic development. Grant funding can also leverage private, commercial, finance by expanding the number of users able to afford electricity and so encouraging private financiers to invest in electricity provision. The greatest concern over grants and subsidies is their reliance on government and donor funds. This limits the extent of electricity provision they can support and raises the question of whether, it is sustainable for electricity access to continues to rely on grant and subsidy funding in the long term? Given other calls on these funds there is always the risk that grant or subsidy programmes will be terminated – and this may itself distort the behaviour of electricity providers. The other issue is that grants and subsidies may be misdirected, potentially creating excessive profits for some providers while failing to support market development or, in the worst case, have a negative impact by undermining the existing nascent market and thereby reducing the prospects of longer term expansion of electricity access. There needs to be sufficient understand and capacity in the grant provider to ensure that the funding is carefully applied and monitored to ensure its effectiveness – this requires sufficient capacity, usually within Government which is often stretched in this regard. |
Further Information and Guidance
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Relevante Case Studies:
Cross-Subsidies
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Definition: |
Funds drawn from charges on one (usually existing or high income) group of users and used to subsidize provision to another (usually new or low-income) group of users. Cross subsidies may be established within electricity businesses, with the price/tariff structure being shaped to increase charges from some groups (eg commercial or higher-consuming household users) in order to allow prices or tariffs for others (eg industrial users or lower-consuming users) to be reduced. Alternatively mechanisms (such as an energy fund) may be established to take funding from one electricity provider or set of providers, whose underlying cost of provision is relatively low (eg the national grid company) to subsidize another set of providers. While cross subsidies may reduce costs and make electricity affordable for the users who benefit from them, they will inevitably increase costs for other users. Some element of cross-subsidy is inherent in any electricity business, simply because it is impractical to charge each user at their individual cost-recovery level. To enable effective cross-subsidy, it is essential to define groups of users which are as homogeneous as possible, to understand what the costs of provision to these groups are, and what alternative forms of electricity they may be able to access, in order to set appropriate prices or tariffs and cross-subsidy transfers. Any cross-subsidy arrangement which operates between providers will require government intervention. |
Internactions wiht other NAE Categories:
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Technology
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Some degree of cross-subsidy exists within any grid system because it is impossible to determine costs of provision for individual users and prices or tariffs are therefore generally set uniformly across broad classes of user. This cross-subsidy effect can be increased and targeted by deliberately setting differential prices or tariffs. The same cross-subsidy effect exists, though on a lesser scale within individual mini-grids and again prices/tariffs can be shaped to benefit specific groups. For standalone systems costs of provision vary less (for a given type and size of system) and users are generally charged the specific system cost, or something close to it. Standalone system providers will be reluctant to provide cross-subsidies in the absence of a concession or pricing structure set by government or regulator, because they will fear competition from others. Cross-subsidies between different technologies delivered by a single provider (for instance | |
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Delivery Models
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Active cross-subsidies are more likely to be put in place within a public delivery model, where the delivery organisation has social as well as financial objectives. In a private or public-private model cross-subsidies may be established either for social reasons (provided this does not threaten investor returns) or for commercial reasons (eg where a mini-grid operator believes that commercial customers will be willing to pay for electricity at a higher price than the cost of supplying them, and this can be used to lower charges to and so increase demand from households, thus increasing overall revenues). Otherwise cross-subsidies are likely to be the result of regulatory action. | |
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Legual Basis
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Concessions can provide a vehicle for cross-subsidisation, with finds transferring between concessionaires under the terms of concession agreements. Under a licensing structure some form of levy and energy fund will probably be needed. Cross subsidies between providers are unlikely to be practicable in an unregulated environment. | |
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Price/Tariff Regulation
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Any cross-subsidies will be linked to price/tariff regulation. Where prices or tariffs are shaped to subsidize one group of users by increasing prices or tariffs for another group within a regulated electricity business, the price/tariff structure will require regulatory approval, and may be driven by regulatory requirements. Any cross-subsidies between providers will almost inevitably be driven by government or regulatory requirements. Either cross subsidies or grants or subsidies from outside the sector will be needed within any uniform price/tariff arrangement to prevent providers in higher cost areas or to higher cost groups becoming insolvent, while those with a lower cost base are enabled to make excess profits. Within an individual price/tariff regime, any cross-subsidies should be factored in to price/tariff calculations, and may be used to make electricity more affordable for those it is more costly to supply, and hence more equitable. | |
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Other Forms of Finance
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Cross-subsidies may be used to attract private finance – but may also discourage it to the extent that funds are extracted from some businesses and thereby reduce returns. If they are seen as arbitrary or politically driven this is particularly likely to drive away private investment. Cross-subsidies will also directly affect user finance, since it is effectively a means of reducing the level of finance required from one set of users and increasing that from another. Cross-subsidies may also be seen as an alternative to external grants and subsidies – but it must be recalled that they merely move funding within the electricity sector rather than bringing new funds into the sector as a whole. | |
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Non-Financial Interventions
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Regulatory reform will be required to define any cross-subsidy framework and agree the introduction of such a framework with all relevant parties before it can successfully be implemented. Any cross-subsidy arrangement between providers will also need backing from Government policy, and should align with and support electricity access targets. Cross-subsidies may also be an appropriate means to support introduction of new technologies. Capacity building and technical assistance may be needed to enable policymakers and regulators to establish cross-subsidy arrangements which are effective and will produce desired outcomes without adverse unintended consequences. |
Advantages and Disadvantages
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The great advantage of cross-subsidies is that they can increase electricity access to low-income groups without having dependence upon external sources of finance. By providing a price/tariff structure that is tailored towards different levels of consumption (reflecting the levels of affordability), those most able/willing to pay for electricity can offset the costs for lower-income groups, and those to whom relatively low cost electricity can be supplied can support electricity access for those for whom it relatively expensive to provide it. Cross-subsidies therefore support more equitable electricity access. The main disadvantage of cross-subsidies is that their negative impacts and limitations are often forgotten or ignored. While they may work well if prices or tariffs are to a large group of relatively affluent users are raised by a small amount to provide support for a relatively small group of lower income users, cross-subsidies will not work if the group of low income users is too large or the support needed is too great relative to the group of users from whom the subsidies are drawn. In these circumstances excessive cross subsidies may lead to the group who are being expected to fund subsidies looking for alternative means of electricity access (eg business users may turn to diesel generators) and/or the electricity providers from which the subsidies are drawn becoming insolvent. Where cross-subsidies are non-transparent it is easy for both policy makers and users to forget them. Policy makers may then fail to understand their negative consequences while users come to take them for granted and demand that they be extended and increased beyond the point at which they are beneficial, and they may become the subject of political pressure. The complexity and difficulties in setting up and administering effective cross-subsidy arrangements without incurring these unintended consequences are also often underestimated. |
Further Information and Guidance
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Relevante Case Studies:
Tax Exemptions
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Definition: |
Waivers granted by government on taxes on electricity, equipment used in generating or distributing electricity or electricity businesses. Any tax exemptions is effectively a grant or subsidy from government towards electricity provision, increasing affordability for users. It is particularly important to ensure that electricity is not disadvantages relative to other, less beneficial, forms of energy, such as kerosene by tax exemptions Three key forms of exemption are: Import tax – import tax exemptions are used to incentivise renewable generation of electricity and deployment of off-grid systems for electrification in many countries (as seen in the Tunisia, Bangladesh, Ethiopia, Mali and Nepal NAE Case Studies). Value Added Tax– electricity itself is often VAT exempt, but electricity costs may still be impacted significantly by VAT charged on equipment and services used in electricity provision. This negative impact of VAT has been recognised and addressed in several countries. The NAE Case studies from Kenya and Tanzania for example show that in these countries VAT has been removed on solar products, while in Senegal and the Seychelles there is tax exemption for any renewable energy equipment. Corporate taxes – taxes charged on electricity businesses and their operations reduce returns available to investors. By reducing these taxes, governments can enable businesses to charge lower prices while maintaining acceptable levels of returns, and to extend electricity provision into areas where it might otherwise not be economically sustainable. This approach has been demonstrated in Zambia for example. |
Internactions wiht other NAE Categories:
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Technology
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Exemptions from import tax and VAT are particularly important to catalyse development of renewable standalone systems and generating equipment, where capital costs represent a higher proportion of overall costs than for fossil-fuelled electricity, and equipment often has to be imported. Materials involved with grid extension and mini-grid distribution systems are more difficult to differentiate from other industrial applications and are therefore more rarely subject to tax exemptions. It is particularly important to ensure that tax treatment is equitable - If (grid provided) electricity is exempt from VAT, shouldn’t standalone off-grid systems enjoy similar exemptions? | |
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Delivery Models
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Organisations involved in public delivery models may enjoy tax exemptions by virtue of their public ownership. (The question of equity with those providing electricity under other models should then be considered). Specific exemptions are more likely to be relevant to private and public-private models. | |
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Legual Basis
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Tax exemptions may be written into Concession agreements. Licences are more likely to provide a qualification requirement for accessing tax exemptions. Import tax and VAT exemptions may be provided even where provision is unregulated, by attaching the exemption to the type of equipment rather than the type of business. | |
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Price/Tariff Regulation |
Tax exemptions, like any other form of public subsidy, should be factored into price or tariff calculations as part of any regulatory process. | |
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Other Forms of Finance |
Tax exemptions effectively act as a form of grant or subsidy and have similar effects in attracting private investment and making electricity more affordable to users (and thereby reducing the need for user finance. | |
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Non-Financial Interventions
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Qualification for tax exemptions may be linked to compliance with technical and quality standards. Tax exemptions may also be introduced to support introduction of new technologies. Technical assistance can be useful in developing effective tax exemption arrangement and Capacity building is particularly important to support implementation. |
Advantages and Disadvantages
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There are advantages to project developers, investors, local communities and to Government from the provision of tax exemptions for activities related to electrification. For developers and their financiers, the reduced cost of system components and related materials means that projects can be more cost effective, with upfront costs reduced to provide lower investment risk – this can be the difference between the developer achieving access to finance and not. For local communities, electricity can be offered at a lower price since the costs have been reduced. And for Government, the reduced income from tax payments is may be balanced by the reduced need for Government expenditure to provide a basic service for remote households; the project developers can now meet this demand, which otherwise would have required the allocation of public services budget from the Government. Tax exemptions may seem less painful than explicit grants and subsidies, since they do not require any payment from government, but they nevertheless represent a reduction in government revenues. This may also carry the downside of lack of transparency. Moreover tax exemptions represent a relatively blunt instrument and care must be taken to ensure that it is those who would not otherwise be able to afford electricity, and not the relatively affluent, who benefit. Most problems related to tax exemptions, however, arise from their implementation. Establishing clear criteria for their application can be difficult and lack of clarity (to the officials involved as well as to the potential recipients) can lead to inconsistency, delays, costs and frustrations that undermine the positive intentions. Implementation also requires awareness, cooperation and understanding of electrical technology and standards from officials such a customs officers who would not normally have much involvement or interest in the electricity sector. |
Further Information and Guidance
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Relevante Case Studies:
Guarantees
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Definition: |
A promise from an institution (the guarantor) with sufficient resources to assume the financial obligations of one party to a contract if that party defaults. A guarantee is a type of “insurance policy” that protects companies and investors from the risks of non-payment. This financial tool has been a foundation of financial markets all over the world for many years. Guarantees play an important role in helping the private sector make investments that promote growth and create jobs, in particularly in unfamiliar sectors or contexts, such as rural electrification in developing countries, which they regard as high risk. A guarantee can be unlimited or limited, depending on whether the guarantor assumes liability for the whole potential loss or only a part of it. Governments are often well-placed to offer guarantees (except where the protection is against their actions), and may be able to attract private investment and lower user prices by removing or reducing risks which investors view as significant but which from a government perspective may be quite acceptable. Other potential guarantors are international development agencies. Guarantees may be provided on a commercial basis in return for fees (like any other insurance policy), or for free as a form of grant, or on a concessionary basis. In the context of electricity access provision, guarantees may be structured to protect against:
In more general terms, types of guarantee include: Development Finance Guarantees – may be offered by multilateral development banks and national development banks to assist with the implementation of projects in developing countries, particularly those that involve significant capital costs. Such guarantees provide any project developer, or the national Government of the country concerned, with security against the loss of funds due to unforeseen circumstances. For example, the Multilateral Investment Guarantee Agency (MIGA) is organized by the World Bank to help investors and lenders to deal with political risks by insuring eligible projects against losses relating to currency transfer restrictions, breach of contract, expropriation, war and civil disturbance. With this backing, there is a much greater chance that a developing country, or related project implementer, can attract and retain the necessary private investment. Partial Risk Guarantees – PRGs (also known as political risk guarantees), cover private lenders and investors against the risk of the government (or a government owned agency) failing to perform its obligations regarding a private undertaking such as electrification expansion in a developing country. The aim of a PRG is usually to attract private sector financing, accelerate foreign direct investment, promote infrastructure development, and encourage private sector participation in public-private partnerships. A PRG will typically cover up to 100% of all repayments expected by a project developer or investor when they have financed project development costs (e.g. for the purchase of electrification systems/infrastructure) and the repayments cannot be received due to the non-performance of the government or a state-owned entity. For example, a PRG could be used by a project developer who partners the national electricity utility in a developing country, using the utility’s customer payment channels to receive repayments for an expanded electrification system. In the event of a lack of repayment due to incapacity of the utility, the PRG would reimburse the project developer (according to the specific conditions of the guarantee). |
Internactions wiht other NAE Categories:
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Technology
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Guarantees are generally most relevant for technologies which involve capital investment in infrastructure which, once installed, is difficult and expensive to re-locate and re-use, ie grid and mini-grid systems. | |
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Delivery Models
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Under a public delivery model, governments will usually “self-insure”, so explicit guarantees are more likely to be relevant under private or public private partnership models. However, many types of guarantee are associated with political risk, with the aim being to provide some form of financial cover to the project developer/investor in the event that the Government or state entity involved in the project fails to meet its obligations to the project. Clearly one way to mitigate this risk is to work very closely with the public-sector partner and determine at an early stage the risk of any default regarding project implementation. Forming a PPP, with clear terms and obligations agreed between the partners, can help to reduce the need for any form of guarantee. | |
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Legual Basis
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A concession arrangement is based on government commitment and hence is exposed to political risk, so any third party guarantee providing protection from this risk may be valued by investors. Under a licensing arrangement this reliance is less (except as it relates to price/tariff regulation), so guarantees for this type of risk are less important, but guarantees for other areas of risk such as exchange rate or user payment risk remain relevant. | |
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Price/Tariff Regulation |
While price/tariff regulation can increase clarity and the confidence with which future revenues can be forecast, it also poses the political risk of changes to the regulatory regime, and a third party guarantee can provide protection against this. | |
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Other Forms of Finance |
By reducing risks, a guarantee can make it easier to attract private finance and reduce the cost (return required) of that finance. This cost reduction will raise the level of affordability for the user and thereby reduce the need for user finance. A guarantee is thus an indirect form of subsidy or grant and its use can thus reduce the need for other forms of grant/subsidy. | |
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Non-Financial Interventions |
Guarantees are unlikely to be used in the context of direct provision of electricity. Guarantees, like any other form of insurance or risk management, are a specialist area and technical assistance will almost certainly be needed to establish a sound guarantee arrangement. |
Advantages and Disadvantages
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A clear advantage to a project developer/investor from the use of a guarantee is the reduced risk profile of the project as far as financial returns are concerned. A guarantee offers assurance to the financier that the funds invested will not be lost due to unforeseen circumstances, or lack of capacity to implement the project at the local level. A guarantee can also address uncertainties over political instability, and thereby facilitate access to project finance that may otherwise be unavailable. The disadvantages associated with a guarantee include its cost, and the interpretation of liability. The preparation of any form of guarantee involves detailed assessment of the risks and, if it is secured on a commercial basis or if the government or agency providing it charges a fee, the developer may judge that the cost exceeds the benefits from the guarantee. It should also be noted that the cause of any default is often not absolute so there will be a process to determine who or what was the cause – this again has negative implications for costs and lost time. It may be possible to provide a guarantee which is valuable to the electricity provider, but which the guarantor government or agency can manage or off-set in some way which has little cost. Even if the guarantor is required to make payment under a guarantee, because of their greater resources they should be able to absorb a loss which could have crippled the electricity provider. However, guarantee arrangements are highly complex and if ill-designed could result in significant liabilities being taken on unknowingly. It is this complexity, and the resulting cost of establishing a guarantee arrangement which are the main disadvantages to guarantees. |
Further Information and Guidance
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Relevante Case Studies:
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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