Click here to register!
Impact of Tariff Structures on the Economic Viability of Mini-Grids
Background
Mini-Grids
Mini-Grids vary significantly in terms of their design and structure, depending on their location, available natural resources in the area, the local policy framework and the demographic being served by the grid. Therefore, many different tariff structures are being implemented and tested in mini-grids throughout the world.
For more information on mini and micro-grids in general have a look at the energypedia articles: Mini-Grids, Mini-grid Policy Toolkit and the Micro-Grid Portal
Economic Viability
A project is economically viable when it is able to secure initial funding to cover the capital cost and when the revenues are able to cover the operation and maintenance (O&M) costs throughout the entire lifetime of the project while still generating an acceptable rate of return on the initial investment. In order to achieve this, the project should have a set operation plan which is flexible enough that it can adapt to future changes including political and regulatory changes, ownership hand over or economic fluctuations. Long term economic viability can be achieved through careful planning and economic modelling, taking into consideration external costs. (LafargeHolcim Foundation, n.d.) In a mini-grid the expected sale of electricity can be used to calculate financial indicators such as project return, equity return expectations and payback periods. These values provide the bases on which investment decisions can be made (Al-Hammad, et al., 2015).
Economic Viability of Mini-grids
“A financially viable microgrid balances financial incentives/subsidies and revenue streams from tariffs with debt, equity, and operational expenses obligations both in the short and long run.” (Deshmukh , et al., 2013). This does not necessarily mean that the funds needed must all come for consumer tariff payments. Some mini-grid are dependent on support from local or national governments to supply the funds needed to cover the operation and maintenance costs of the mini-grids. A mini-grid dependant on external funding can be just as financially viable as one in which all the costs are met through tariff collection, as long as it follows the set-out operation schedule and delivers the expected amount of power and energy, allowing the customers of the mini-grid to benefit from improved energy access. However, the operation plan for mini-grids which are dependent on government funding should consider the risk of political shifts which might affect the future availability of subsidies for the mini-grids. (Schnitzer, et al., 2014)
According to the Micro-grids for Rural Electrification study, “it is impossible to compare tariff design without first looking at the elements of the microgrid that tariffs are expected to cover” (Schnitzer, et al., 2014). Figure 1 shows a comparison of different Mini-Grid projects around the world and the costs which the consumer tariffs charged in that mini-grids are expected to recover.
IMAGE
For-profit mini-grid companies will want to recover all the costs as well as to make a profit on their investment. Therefore, tariffs in a mini-grids installed by a for-profit company are likely to be quite high. If tariff levels are too low, then even high rates of tariff collection will be insufficient to retrieve the necessary fund. However, if tariffs are too high, customers might be unwilling to pay for the electricity and collection rates will be lowered.
On the other hand, NGO developers will often design tariffs so that the mini-grid remains self-sufficient once installed, meaning that the tariff is expected to cover everything except for the initial capital cost and occasional rare maintenance costs (sometimes referred to as break-even tariffs). In government owned mini-grids, tariffs are usually designed to cover only the basic O&M. This usually results in relatively low tariffs. (Schnitzer, et al., 2014, p. 87)
Tariff Building for Mini-Grids – Different Options
Tariff designs can be very varied and should always be adapted to the specific circumstances of each individual mini-grids. Usually tariffs have two basic components, a connection fee and a usage/service fee (often paid monthly) (Gavaldà, et al., n.d.).
Connection fees are used to cover the connection costs incurred by the mini-grid operator. Furthermore, they can be used as a measure to ensure a high level of commitment from the electricity consumers. In this way, connection fees can help increase the economic viability of the mini-grid, by covering a part of the capital cost, as well as by making sure that all the costumers of the mini-grid have a vested interest in the project. Consumers who have paid an initial connection fee are likely to be willing to ensure that the mini-grid remains operational for a long period. Therefore, they might be more willing to pay usage/service fees which cover the operation and maintenance costs for the grid (Franz, et al., 2014).
Usage/service fees are collected in the form of consumer tariffs. Tariffs can be structured in many ways, depending on the mini-grid in question. Most tariffs can be divided into the following categories:
- Energy Based Tariffs: Depend on the actual electricity consumption and require that the consumer’s kWh usage is measured
- Power Based Tariffs: Based on the maximum power available to the consumer. The tariff is calculated based on capacity cap put in place, which is given in Watts. The consumer pays a fixed amount of money each month for this capacity.
- Fee-for Service Tariffs: Based on the services provided rather than the energy consumed. For example, to tariff could set a fixed price for 1 hour of TV usage or 5 hours of lighting.
These tariffs can either be pre-paid or post-paid. Pre-payed tariffs result in more planning security for both the consumers and the mini-grid operators. More detailed types of tariff structures include:
- Customer Class Tariff Regime: sets diverse tariffs according to consumer group, e.g. residents, institutions and businesses. It is mostly used to cross-subsidise residents.
- Stepped Tariff Regime: includes different tariffs depending on consumption level of the consumers.
- With progressive tariffs, consumers pay low tariffs for the first kilowatt-hours (or Watts) and higher tariffs for further consumption (cross-subsidisation). It may also include a lifeline tariff, which is a subsidised tariff providing basic electricity needs.
- With regressive tariffs, larger consumers pay a lower unit price
The Article: Effects of Different Tariff Systems on Social Cohesion of Villages offers further information on the different tariff structures and their respective impacts.
Consumers usually do not like high fixed costs and prefer tariffs based on their actual energy usage, since this allows them to be more financially flexible. Therefore, the economic viability of the mini-grid depends on selling a certain minimum amount of electricity (kWh) every year. More electricity sold results in higher profits for the mini-grid operator. (Franz, et al., 2014)
The financial risk for the mini-grid operator is lowest if the tariff is composed of a fixed basic tariff element, which is high enough to cover the O&M, and an electricity consumption tariff element, which is slightly higher than the variable costs incurred by the operator. The disadvantage of fixed tariffs, however, is that they provide no incentive for the consumer to use electricity efficiently. This can be problematic, since, due to the limited power generation and distribution capacity available, the efficient use of electricity is particularly important in mini-grids. Therefore, flat rate tariffs can lead to problems in mini-grids. The highest risk for mini-grid operators occurs when the tariff structure contains only energy consumption based tariff elements, such as pay-as-you-go systems. (Franz, et al., 2014)
Figure 2 summarises the main challenges which a tariff structure must overcome as well as listing the main points which a tariff structure should aim to achieve.
IMAGE
