A Blessing or a Curse?

April 23, 2018

Reflections on pooling private and public finance for rural electrification
Subsidies for energy access is a disproportionately contentious subject. Researchers estimate that the global fossil fuel industry is subsidised to a tune of $5.3 trillion (6.5% of global GDP) every year yet this raises few eyebrows. We believe that subsidies for energy access related projects are not an outlandish proposition and in fact, if implemented correctly could be the catalyst that tips the nascent rural off-grid sector into rapid scalability.
Our journey starts with what was arguably a failure of subsidies. Brighterlite, a commercial outfit selling solar home systems (SHS) in Myanmar had planned their sales strategy in close cahoots with the National Government and after close consideration of an $80 million World Bank SHS electrification program. Both were selectively applying subsidies for these systems specifically in border areas of the country and Brighterlite determined to ply their trade in other, non-border areas.
The problems came, when the government started blurring the boundaries of where it was applying the World Bank funded subsidies and where it was not. In an unintended feedback loop, potential customers in non-subsidised areas became reluctant to purchase a system from Brighterlite, in the hope that the subsidies might be soon extended to their area. Eventually Brighterlite had to pull out of Myanmar at a loss of $2 million that had been invested. It is no surprise that founder Jorund Buen is now keen on “discouraging others from subsidising the price end users pay for solar.” Particularly if they take the form of “donor funded giveaways”.
Sam Slaughter, co-founder of PowerGen, a Kenyan-based company building (largely) solar microgrids across East Africa argues that we need to “embrace subsidies”.
Without subsidies the African rural consumer will be unique and they will bear the full cost of their power which has never happened on any other continent in the history of electrification.
So why the disconnect? How can subsidies be applied in a way that supports the private sector rather than crowding it out?
Widespread rural electrification has been held back to date by the financial obstacles to profitable distribution of power in the farming areas…Chief among the financial obstacles are the farmer’s small cash income, coupled with the large unit investment required in distribution systems to serve only a few farms per mile of line.
As is often the case, there is some value in looking at historic precedents. To find an example of where subsidies have been successful at hitting ambitious electrification targets in rural areas that arguably would be untouchable by the private sector, one has to look no further than the electrification of rural America in the early 20th century. The quote above which is entirely applicable to the business case for microgrids in rural Africa in the 21st century is actually from a 1926 research report put together for the US Congress.
With apparent far-sighted appreciation of the value of rural investment, in 1935 President Franklin Roosevelt established the Rural Electrification Administration (REA).
In its first 5 years, the REA provided over $227 million in government subsidized loans ($3.6 billion in today’s dollars) to connect rural farmers through laying distribution lines, wiring homes, and even building local diesel generation plants.
As far as we are aware, the majority of rural electrification strategies active or planned in Africa today involve the private sector. This, it is argued, reduces the costs to the national government but opens an entirely different can of worms. How does one stimulate and subsidise the market whilst maintaining the drives for efficiency and cost effectiveness that characterise private sector projects? The World Bank Group’s ESMAP (Energy Sector Management Assistance Program) team argue that this is best achieved through subsidies targeting demand rather than supply. We would tend to agree with this. The problem with targeting only the large, upfront costs associated with building a microgrid is that it concentrates and delivers all incentives before any services are actually provided. In their words:
“…demand side-subsidies work better than fuel or supply side-subsidies because they have better targeting properties and provide stronger incentives for expanding coverage and sustaining services.”
The perception however, seems to be that demand side subsidies are much harder to implement.
It is common practice for utilities to charge customers a connection fee to access electricity for the first time. These upfront costs are often too high for poor customers and present a barrier to entry into the market even though they would be able to afford the ongoing electricity prices by offsetting existing energy costs on, for example kerosene. For example, the subsidy of the upfront connection cost was an effective strategy for the South African utility ESKOM. It has also been successful for smaller utilities. Cagayan Electric Power and Light Company (CEPALCO) is a distribution utility serving a small town in the Philippines. Their model was to waive the connection fee and request a small deposit on the first monthly bill. This lowered barrier to entry proved to be a successful strategy and the utility now serves 96% of the households in its franchise area. This author’s experience running a solar microgrid based microutility in rural Kenya tells a similar story. SteamaCo charged a nominal connection fee to new customers well below the cost of connecting them. This served more as a mechanism to secure commitment (and avoid time-wasters) than as a cost recovery fee. We found this to be particularly important when signing up customers on new projects where there was understandable skepticism and first mover hesitance. In areas where people are more acquainted with the standard practice of upfront connection fees, this might be less problematic.
A less common consumer finance mechanism is the subsidising of an end-user’s ongoing energy costs. Although this is probably the most direct way to stimulate ongoing demand for energy services, it is not widely applied. There are a number of reasons for this, chief of which is the technical complexity of subsidising multiple micro-payments. As we have previously argued the ubiquity of mobile-based payment services across the spectrum of off-grid energy access routes from SHS to microgrids reduces the burden of complexity enormously. This is echoed in a report for the UNCDF by the Better than Cash Alliance which advises Governments to “explore the digitization of direct benefit transfers as a way of achieving more precise targeting around clean energy subsidies.”
If users pay for services using their phones and a local mobile money platform, the data on the payment is routed through a third party (the mobile platform operator). This provides an ideal, transparent access point for a results-based subsidy. Why then has this not been used as a subsidy mechanism? One problem of course is that not all rural electrification schemes involve digitised PAYG mechanisms and mobile money platforms.
Another problem with this mechanism seems to lie in the processes of traditional funding organisations. One of the inherent problems of a demand side subsidy, either paying all or part of the cost of connection or subsidising ongoing energy purchased is the inability to predict how much will be spent through the scheme. Demand uptake is unpredictable. For an organisation with strict spending targets this is a risky undertaking and naturally not a first choice for an intervention.
There is a case for ‘hybrid’ approaches than can exploit the best aspects of, for example, the public and private sector to achieve universal electrification. One example of a hybridised approach is the public private partnership (PPP). A PPP can operate in a number of ways but let us consider the role of concessions. In this context, a concession is the granting, to a private operator of a license to operate their commercial business within the government’s jurisdiction and subject to certain conditions. This is, in other words, state sanctioned (and controlled) private enterprise.
Typically a supply side mechanism, historically, this seems to be an effective model for electrification. A 2009 study by Gassner et al. on 250 electricity companies operating in 50 countries suggested that the greatest electrification rates were achieved by once public utilities, now privatised and operating under a concession model. These utilities typically connected end-users at a rate 29% higher than their publically owned counterparts.
Key to the success of a concession based model seems to be the careful design and management of incentives. One notable example of this working well comes from Chile which at the time, had a rural electrification rate of only 50%. To address this, the national government launched a scheme to subsidise private companies for each rural user connection they made. Bidding companies were encouraged to present proposals to regional governments who made the final selection. Regional governments received their fiscal allocation from national government only if electrification targets were hit. In this way, regional governments were incentivised to select only contractors that combined low-connection costs with effective connection rates.
The age old problem with concessions of course is the risk of undue influence, corruption and collusion on sector-governance decisions and the award of concession contracts. Often, programs like the Chilean example above are funded externally (in this case through concessional loans from the World Bank and the Inter-American Development Bank) and these large sums of money are a tempting target for government officials.
Clearly, as in the case of Brighterlite, a misaligned private and public sector can be disastrous for the former when it comes to subsidies. There are of course also numerous examples of successfully subsidised SHS programs. IDCOL in Bangladesh is a notable example. The examples of purely public sector initiatives show some promise, but there are obvious flaws such as the bluntness of subsidy tools often leading to the value of subsidies being captured by the better off rather than the poor. We have hints of workable public/donor direct demand side subsidy mechanisms, though points of friction seem to arise from organisational momentum or modus operandi. PPPs has proved to be successful in many parts of the world, but there are fundamental issues of procurement irregularities and government corruption.
There is of course no magic bullet or one-size-fits all solution. All of the approaches discussed have advantages and disadvantages depending on how and where they are applied. This then, would seem to suggest that value can be derived from the continued documentation and dissemination of best practice and the development of open-source toolkits. These should be accessible and used across the energy access spectrum, from smart meter developers designing transparency into their systems, to donor funded projects looking at using satellite imagery and algorithms to map the potential for rural sites for commercial off-grid projects (effectively subsidising the site selection process for commercial operators). These tools are also useful to governments looking to increase rural electrification rates through cost-effective mechanisms to close the viability gap, paving the way for commercial expansion into rural electrification markets.
The good news is that as the costs of technology (in particular solar PV and storage) continue to fall and stakeholders from across the spectrum get better at designing, implementing and accessing a nuanced range of subsidies, friction points will be eased and barriers will be lifted. All of this of course, contributing to the laudable efforts to chip away at the inequalities between rich and poor, rural and urban and connecting the unconnected to clean, modern energy services.

Sam Duby

c Sam has extensive in-field, on-site experience, developing and delivering energy access projects in remote and resource-deprived locations. The appropriate combination of technology, local capacity building, productive use stimulation, business model innovation and relevant stake holder engagement is key to the success of these interventions. Sam has worked at the nexus of all of these, alongside National Government, international donors, private sector players and most importantly rural end users, focused on catalysing access to, investment in and impact from these essential services. Currently based in Cape Town, Sam is the Africa Director for TFE Consulting, a Munich based firm committed to achieving a global, equitable energy transition.

Tags: energy subsidies, microgrids, renewable energy transition