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Subsidies

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Introduction

Normally subsidies would not be necessary in a perfect world. There is a lot of momentum to not subsidize infrastructure expansion but make this the responsibility of the private sector, and let it be the outcome of market development. However, to realize this in the presence of prevailing market failures, non conducive policy frameworks and lack of supportive concessional financing, and generally low disposable incomes for the target population, much more capacity development and institutional reforms are required than is realistically possible. It is nearly impossible to address all these shortcomings simultaneously and expect markets to take care of public service delivery. Hence, progress and achievements are greatly facilitated when subsidies can be used to provide smart incentives.


Indeed, subsidies were considered taboo by the international development community for a long time, but momentum is slowly gaining in favour of newly applying limited subsidies. Such subsidies should be designed to stimulate and initiate markets, avoid supporting the costs of operation and/or consumption in the long-run, and have a credible and transparent exit strategy. EnDev incorporated subsidies as an efficient and transparent mechanism to accelerate access to modern energy in rural and peri-urban areas.


We should not forget that the infrastructure in industrialized countries was built with a high level of subsidies and public support! Electricity has been around for more than 100 years now, but the bulk of the SSA population still does not have access and remains in the dark. This in itself could be sufficient reason to develop an emergency program to correct this and apply subsidies accordingly.

Sometimes pure logic or economic analysis fails to indicate that subsidies should be awarded after all: modern technologies are often cheaper in terms of life cycle costs / levelized energy costs compared to prevailing traditional technologies and services; data clearly shows that 4-7 month payback times exist for investing in modern lighting services. Yet, people are not investing on a large scale as could be expected. An explanation is that poor households already spend one third of their income on traditional energy like candles, kerosene and fuel wood and have no means to invest in modern technology, however urgently they are willing to do so. Subsidies really do make a difference, for households to invest in the modern technology and for the private sector to develop the infrastructure to deliver such technology. It is important to face and accept the basic trade-off: speed vs. sustainability. Access is long overdue and the focus should be on realizing this first, but in a sustainable manner and using minimum levels of subsidy.

It helps to make the subsidy support transparent; in most countries today, it is impossible to indicate the contribution of subsidies in the supply of grid electricity. Most likely these subsidies are huge, compounded throughout the supply chain: the generation capacity is subsidized, the fuel is subsidized or detaxed, the expansion of the transmission and distribution network is subsidized, connection fees and tariffs are subsidized, etc. Revenues from consumers do not cover the full costs of generation, transmission, distribution and bill collection.


In Rwanda[1]the electricity Roll-out program intends to connect 250,000 new customers over the next few years and applies a beneficiary contribution of less than 10% of the real cost of connection. It is not phrased as a subsidy, but effectively it is; imagine what could have been done with this amount of money in support of finding modern energy solutions for all rural households! In Senegal [2] several concessions have been awarded for increasing access to electricity; the average subsidy for a new connection in concession areas is about $350; alternatively, one could hand out for 5-7 free PV lanterns for the same amount.


Only a transparent cost and price structure lays the basis for continued discussion and optimization of the support given, the more so since subsidies always remain the outcome of a political process. Although this process cannot or should not be stopped, the subsidies it awards should be made transparent so that beneficiaries and non-beneficiaries alike understand where the support went.

Source: Robert vd Plas, Florian Ziegler in "EnDev Discussion Paper April 2010: Electricity Access for All - Illussions and Solutions"

[1]Lighting Africa Country Study (work in progress)

[2]Lighting Africa Country Study (work in progress)


Direct and Indirect Subsidies

► Read about what distinguishes indirect and direct subsidies here


Smart Subsidies

► Read about Smart Subsidies here


Transparency

GTZ Position (Subsidies….A Think Piece; Fuel Price Index; Access for All – Illusions and Solutions; REN21 etc.): More transparency of costs and prices is a precondition for discussion and participation. Finally, this can lead to a reduction of subsidies. This is the reason why the benefit of transparency is finally bigger for the politics, despite there may be lobbies that have an interest in intransparency.

In Germany the financial support was put in a new order with the 20th report on subsidies (2003). This report corresponds to the EU-Energiesteuerrichtlinie (RiLi 2003/96/EG), which shall achieve more transparency.<

For further information please refer to: GSI/UNEP, April 2010: Gaining Traction: The importance of transparency in accelerating the reform of fossil-fuel subsidies


Transparency can influence reform in at least four ways (Hale, 2008):

1. by institutionalizing public discourse: the act of disclosure starts a dialogue between the discloser and interested parties;

2. by compelling actors to tell the truth, making it difficult for discourse to be manipulated by one “loud,” deceitful actor;

3. by cutting through the flood of information and often contradictory claims to focus attention on facts;

and

4. by promoting self-reflection within the organization or government, compelling actors to comply with their own standards and norms.


In considering the extent to which improving transparency could assist reform, the key consideration appears to be one of ensuring its relevance. For transparency to be useful, information users and providers must desire disclosure of the information and see how such transparency can help meet their objectives. Improved information about fossil-fuel subsidies, in particular, can help governments meet their reform objectives. At the simplest level, information about the subsidy and its effects facilitates an assessment of its costs and benefits and, therefore, of the implications of reform. Making this information publicly available increases awareness of the effects of existing policies and allows public input to decision-making (Wolfe and Helmer, 2007). Many governments understand the economic, social and environmental problems created by subsidies, but are under political pressure to maintain them. Transparency can expose those winners and losers created by subsidies and therefore help to broaden support for reform (Victor, 2009).... Read more: http://www.globalsubsidies.org/files/assets/transparency_ffs.pdf

Global Subsidies Initiative (GSI) - "The Effects of Fossil-Fuel Subsidy Reform: A review of modelling and empirical studies"

The Global Subsidies Initiative (GSI) releases the publication of Jennifer Ellis’ paper “The Effects of Fossil-Fuel Subsidy Reform: A review of modelling and empirical studies.” This is the second paper to be published in the series Untold Billions: Fossil-fuel subsidies, their impacts and the path to reform. Subsidies are powerful instruments and when granted to fossil fuels, which are at the heart of all modern economies, subsidies have impacts throughout the economy, society and environment. Understanding the complex trade-offs between the different impacts of subsidy reform is a challenge for any government considering phasing out fossil-fuel subsidies. In this report, Jennifer Ellis provides a detailed literature review, focusing on the six modeling studies in the last 20 years that have attempted to analyze global impacts of subsidies for all fuels. The studies mostly considered effects on greenhouse gas emissions and gross domestic product, but very little of the work has considered other environmental impacts or social impacts. The paper highlights a number of areas where further research should be undertaken but concludes that there is already enough evidence to demonstrate the significant environmental and economic benefits of phasing out fossil-fuel subsidies, and recommends that policy-makers do not delay in beginning the reform process.

Download at: http://www.globalsubsidies.org/en/research/economic-social-and-environmental-effects


EARTH TRACK: EIA Energy Subsidy Estimates: A Review of Assumptions and Omissions

This Review provides a detailed look at gaps in federal tracking of energy subsidies in the United States. In addition to evaluating the research approach used by the US Energy Information Administration (EIA), the Review assesses how key assumptions and omissions in EIA's work resulted in a substantial undercounting of federal energy subsidies and an inaccurate portrayal of subsidy distribution across fuels. EIA estimates are also placed in the context of other assessments of domestic energy subsidies conducted over the past thirty years.

Read more: EIA Energy Subsidy Estimates: A Review of Assumptions and Omissions

IMF Note - Petroleum Product Subsidies: Costly, Inequitable, and Rising Petroleum product subsidies have again started to rise with the rebound in international prices. This note reviews recent developments in subsidy levels and argues that it is necessary to reform the policy framework for setting petroleum product prices in order to reduce the fiscal burden of these subsidies and to address climate change. In 2003, global consumer subsidies for petroleum products totaled nearly $60 billion. Read more: Petroleum Product Subsidies: Costly, Inequitable, and Rising


Subsidies for Solar Home System Promotion

So far all SHS programmes have relied on subsidies of one sort or another. In doing so it is often argued that market imperfections (e.g. lack of private financial institutions in rural areas, lacking information on available SHS options) justify the subsidisation of SHS or related activities. The challenging task is then how to target and allocate those corrective subsidies. This is a difficult question because what is deemed a market imperfection may well be economic barriers or transaction costs correctly priced by the market. For instance, is it a market imperfection that small amounts of money are more costly to lend than large amounts, or that lending against a steady stream of income is less risky than a loan given to a household with irregular or no income? Probably not. One could still make a case for special support measures that redress social or economic imbalances, but the case would rest on other arguments than that of imperfect or distorted markets.

Hence, the core of the discussion on subsidies boils down to the question whether SHS serve economic development or other public policy objectives. If this question is answered in the affirmative, the alleged violations of free market principles often criticised by opponents of subsidisation appear in a different light. However, the claim of contributing to the achievement of general welfare objectives has important impacts on the design of projects: SHS projects should be designed as but one component of a larger programme aiming at a variety of development objectives like power sector reform, rural electrification, and rural development.

There are direct and indirect subsidies to be found in all projects supported governmentally and internationally, and at all levels. Subsidies are quite often undisclosed, and therefore not transparent enough to be clearly recognised as such by those who would benefit, and those who have the political authority to decide in favour. This leads to SHS financing programmes that are not able to fulfil the standards of finance sector conformity and long-term sustainability. In the partly controversial discussion going on about subsidies, the view that SHS can be propagated with the help of subsidies, as long as they are transparent, serve public interest and do not distort the market, seems to be gaining ground.

Possible direct subsidies for solar systems:

  • Direct price subsidies of systems that meet minimum specs and or providers who guarantee local hubs for replacements and repair.
  • Direct subsidies to compensate quality investments, warranty and recycling
  • Tax reductions
  • Support to MFI for consumer credits
  • Import of Containers and commissioning to local retailers(thus implicitly subsidizing risk premium, import unit prices and pre-financing costs).
  • Provide Coupons to qualified technicians against, which they can buy qualified systems.

Possible indirect subsidies:

  • Teaser & Road Shows
  • Skills development for technicians, retailers
  • Support local assembly through technology transfer measures


Source: GTZ: FINANCING OF SOLAR HOME SYSTEMS IN DEVELOPING COUNTRIES, THE ROLE OF FINANCING IN THE DISSEMINATION PROCESS, Volume I: Main Report, Updated edition 2001, Eschborn, March 2001.


Approaches

A variety of approaches and strategies of direct and indirect subsidies for SHS are used at different levels:

1. Buy down grant: direct (sub-)subsidy for the primary system, reaches the end-user mostly indirectly through the dealer or a microfinance institution (MFI). In case of a service based approach, buy down grant and start-up subsidy are mixed (see below).

2. Start-up subsidy: a start-up financing for the set-up of a new company, launching new products and new services or the establishment of a rural sales and / or service system in new regions.

3. Refinancing: granting of long-term reduced interest loans for the initial investment (service model) or financing of SHS (sales model).

4. Tax and customs reduction or exemption for SHS components, installation and service.

5. Formation and training for the start-up of a new company, launching new products and services or the establishment of a rural sales and / or service system in new regions.

6. Development and dissemination of standards and quality labels and contemporaneous support of actors (companies, MFIs, NGOs, CBOs) in the introduction and application of standards and labels.

7. In case of service-oriented models, permanent cross-subsidisation of decentralised energy services with revenues from the central electricity sale or taxes.

In reality, various strategies are often combined.

Source: Study done by SiNERGi for EnDev


SHS Dissemination and Subsidies within different Projects

Sales Models Subsidies
Type Country and Project Examples 1. Buy down grant 2. Start up subsidy 3. Refi-nancing 4. Tax/ Customs Exemption 5. Formation/ Training 6. Standards, Quality Label 7. Cross-subsidisation
1. Cash sales or
dealer credit
EnDev Nicaragua X X
EnDev Uganda X X X
GTZ Tansania X X X X
2. ‚One hand model
Credit and service from one source
EnDev Bangladesh I X X X X X
EnDev Bangladesh II X X X X X
3. ‚Two hand model
Credit and service separated
EnDev Honduras X X X
Sri Lanka RERED X X X X X
Fee for Service Models Subsidies
Type Country and Project Examples 1. Buy down grant 2. Start up subsidy 3. Refi-nancing 4.Tax/ Customs
Exemption
5. Formation/ Training 6. Standards, Quality Label 7. Cross-
subsidisation
1. Concession based regulated service EVU or RESCO EnDev Senegal X X X
GTZ Pakistan X X X X X
2. Non regulated
service through RESCOs
Sunlabob Laos X X ? X ?
3. Service through local NGO or cooperative Solarstiftung Äthiopien X X ?
4. Management contract with RESCO Sunlabob Laos X ? X ?


As the tables show the sales models prevail; subsidy rates range between 0% and 60 %. The target group and the availability of affordable loans for the target group are obviously critical drivers, besides the size of the system.
Fee for service models have higher subsidy rates (70-100%). This may be caused by:

1. aiming for a high market penetration (Poor and dispersed households are more involved, than in the sales models)
2. establishing and substituting a aftersale service.


Besides direct subsidies (buy down grant, start up subsidies), a lot of projects use indirect subsidies, too:

• All projects foster training and qualification (except Bangladesh, because this was already done by the World bank- project
• In most of the project-countries SHS are free of purchase tax and tolls
• Some projects offer low interest refunding for local MFIs and RESCOs. To lower the transaction costs, the smaller projects in Tanzania and Honduras offer allowances to setup capital for the further dissemination of SHS instead of credits.
• Quality standards and certifications are only used within the big programmes of the world bank. Their implementation is obviously too expensive for smaller, short-term projects. But it may be possible that the projects in Senegal, Tanzania and Uganda will take over this approach in the long run.

Source: SiNERGi study


Summary SHS Subsidies

The various existing subsidy approaches are independent of the diffusion models; this can be divided in sales oriented or service oriented models

Sales-oriented models:
The SHS will end up getting into the hands of the user; he will also assume the responsibility for maintenance and operation.

1. Cash payment: immediate payment or short-term (more expensive) credit, mostly for not more than 6 months and 50% of the cost Due to the high cost of SHS and often inadequate after-sale service of this model rarely reaches poor communities in remote areas.

2. One-hand model: Hire-purchase leasing. The SHS is directly in the property of the purchaser, who will therefore normally take full responsibility for operation and maintenance. The credit institution and installer are the same institution, the SHS serves as collateral. The loan is repaid in monthly installments over 2-3 years.

3. Two-hand model: Hire-purchase leasing. The difference with the one-hand-model is that the credit institution and installer are different companies, this gives greater flexibility of the provider, but twice the cost structure of service).
4. Leasing systems: the user rents the SHS only for a certain period, and he is also responsible for maintenance and operation, but this is rarely used in practice.


In the next table an overview of distribution costs, retail prices and subsidy shares are given.
Table: Cost and subsidy comparison

Country Model Dissemination cost in € per SHS Cost for the user in € Percentage of the direct subsidy1
EnDev Nicaragua Cash 600 (75-85 Wp) 220-280 54-63%
EnDev Honduras Two hand 576 (54 Wp) 231-301 60%
EnDev Bangladesh One hand 341 (50 Wp) 290 15%
EnDev Bangladesh II One hand 142-149 (21 Wp) 98-115 19-34%
EnDev Uganda Cash 420 (50 Wp) 420 0%2
EnDev Senegal Concesion 498 (50 Wp) 30 Anschluss,

6 pro Monat

70%
GTZ Tansania Cash 200 (14 Wp) 200 0%
Roshan Pakistan Concesion  ?? (40 Wp) 4,10 Anschluss, 1,76 pro Monat 100%
Solar donation Ethiopia Service NGO 200 (10 Wp) Anschluss frei, 0,17 pro Monat 100%
Sunlabob Laos Service RESCO  ?? (20 Wp)  ?? Anschluss, 2,5 pro Monat 0%3
Sri Lanka RERED Two hand 372-437 (?30? Wp) 310-375 14-17%

1: Direct cost of the system and the installation without O&M.
2: For private costumer, for social institutions will be up to 85% of the cost subsidized.
3: But preferential refinance credits


For an evaluation of this economical data, more information about the quality and sustainability of the SHS as well as O&M should be collected. In addition to the question, how far could the target group of rural poor population in the various examples be achieved?


Nevertheless, some preliminary conclusions can be done:
• Credit systems, whether one-or two-hand models, for their success need a small increase in the amount of subsidy.
• Fee for service systems, in comparison to sales systems, need to be stronger subsidised.


Source: SiNERGi study


Subsidies for Improved Cookstoves

► Read more here


Further Information

  1. New study on energy access subsidies conducted by EnDev and SV PPI available. Energy Subsidies: Why, When and How?
  2. Energypedia-article about Financing Models for Solar Home Systems
  3. Mirco Gaul's (SiNERGi) study on Subsidy schemes for the dissemination of improved stovesgives a brief overview of the current state of approaches and strategies for the promotion of improved stoves as implemented by EnDev projects in Bolivia, Burkina Faso, Ethiopia and Mali
  4. paper by Kenneth P. Thomas: Assessing Sustainable Development Impacts of Investment Incentives: A Checklist, IISD, 2009
  5. ASTAE: Best Practices for Photovoltaic Household Electrification Programs, World Bank, Washington DC, 1996
  6. Barnes D. F.: Meeting the Challenge of Rural Electrification in Developing Nations: The Experience of Successful Programs, Word Bank, ESMAP, March 2005
  7. ESMAP: Best Practice Manual: Promoting Decentralized Electrification Investment, October 2001
  8. Gunaratne L.: Rural Energy Services - Best Practices, USAID / SARI Energy Program, May 2002
  9. Hankins M., Banks D.: Solar Photovoltaics in Africa, Experiences with Financing and Delivery Models, UNDP-GEF M&E Report Series No 2, New York, May 2004
  10. IEA PVPS: Summary of Models for the Implementation of Solar Home Systems in Developing Countries, Part 1 and 2, Report IEA PVPS T9-02:2003
  11. IEA PVPS: Financing Mechanisms for Solar Home Systems in Developing Countries, Report IEA PVPS T9-01:2002
  12. IEA PVPS: 16 Case Studies on the Deployment of Photovoltaic Technologies in Developing Countries, Report IEA PVPS T9-07:2003
  13. International Resources Group: Evaluating the Potential for Scale-Up of Off-Grid Renewable Power, World Bank, Washington DC, July 2003
  14. ISES: Rural Energy Suply models – RESuM, 2001, http://resum.ises.org/
  15. Komives K., Foster V. et al.: Water, Electricity, and the Poor: Who Benefits from Utility Subsidies?, World Bank, Washington DC, 2005
  16. Lindlein P., Mostert W.: Financing Instruments for Renewable Energy, Part of World Bank’s ”Road Map for Scaling up Access to Modern Energy Services and Clean Energy”, World Bank, Washington DC, 2005
  17. Martinot E. et al: World Bank/GEF solar home system projects: experiences and lessons learned 1993–2001, Renewable and sustainable Energy Reviews 5 (2001) 39-57
  18. Martinot E., Reiche K.: Regulatory Approaches to Rural Electrification and Renewable Energy: Case Studies from Six Developing Countries, Working Paper, World Bank, Washington DC, June 2000
  19. Owens G.: Best Practices Guide: Economic & Financial Evaluation of Renewable Energy Projects, USAID 2002
  20. Reiche K., Covarrubias A., Martinot E.: Expanding Electricity Access to Remote Areas: Off-Grid Rural Electrification in Developing Countries, WorldPower (2000) 52-60
  21. World Bank Renewable Energy Toolkit: http://go.worldbank.org/Y20OGSRGH0
  22. Examples of Legal Texts and Regulations to Lift Import Duties for PV Products
  23. National Approaches to Electrification - Review of Options


References