Unlocking Off-Grid Energy Finance: What Options Are Available for the Last Mile?
Editor’s note: This post is part of the NextBillion Series “New Frontiers in Renewable Energy” that explores the dynamic changes reshaping the sector.
Extending the power grid to dispersed communities and remote areas of the world is often prohibitively expensive. This is one of the main reasons that decentralized renewable energy (DRE) is increasingly recognized as an essential solution in the energy mix. The International Energy Agency (IEA)’s Africa Energy Outlook estimates that DRE solutions – mini-grids and stand-alone systems – will be the least costly option to enable the majority of the population in Africa to gain access by 2030 (with mini-grids reaching 30% and stand-alone systems serving around a quarter of the population). Other research has backed this claim, indicating that DRE solutions would be the lowest-cost approach for the large majority of unconnected populations across countries such as Bangladesh, Kenya and Togo.
However, investments have historically been focused on grid-connected electricity: Of the total energy access finance tracked in 2017, only 1.2% was directed towards DRE solutions. This limited access to finance at the local and national levels – and insufficient targeted finance flows at the international level – have been critical barriers in delivering energy access to disadvantaged communities.
The Energy Access Financing Challenge
There are some specific challenges in financing energy access through DRE, particularly for the “last mile” (characterized here as geographic areas that are under-served or beyond the reach of the grid, or as communities with low income, high vulnerability, and/or a scarcity of resources – including low levels of energy consumption). At the local level, these challenges include the perceived risk among local financial institutions of lending to poorer communities, and mismatched expectations about acceptable and realistic returns on investments in energy enterprises focused on last-mile communities. These may also be a consequence of limited understanding among financiers and investors about these communities, or about the technicality of DRE systems and risk-mitigation mechanisms. Beyond these factors, the availability and access to finance for last-mile DRE provision is adversely affected by high transaction costs incurred by development finance institutions (DFIs) and investors in financing smaller volumes – and also by the siloed perspectives of national governments and international organizations, which prevent a more integrated approach to energy interventions.
In a recent discussion paper, Hivos sought to explore opportunities to unlock finance for DRE solutions that impact the last mile. The paper attempts to revitalize the discussion on the types of sources and instruments that could help address the challenge of financing DRE in communities where affordability is a major constraint.
Potential Financing Mechanisms for Decentralized Renewable Energy
Before diving into specific financing mechanisms, it’s worth noting that investing in energy access for the last mile would require support for three main categories of stakeholders: energy end-users, energy providers (such as enterprises), and ecosystem developers (such as civil society organizations, technology and system innovators, financiers, local government agencies, etc.). Moreover, each stakeholder category has its own needs – from ongoing payments for energy systems, to capital for diversification of products, to funding for capacity building, training, and policy and regulatory arrangements.
Meeting these financing needs would require the use of a variety of financing instruments, beyond the traditional options of debt, equity and direct grants. There are a number of examples of organizations within the sector that have been exploring alternatives that involve an infusion of soft capital or blends of various forms of capital – let’s look at a few:
Revolving funds: Through an initial infusion of grants (or extremely low-cost loans), these funds can address small and large credit needs, for energy end users or enterprises. They are particularly relevant in communities and contexts that have limited access to formal financial institutions, and/or have inadequate credit flowing through their informal savings-credit channels.
Concessional debt and guarantees through local financial institutions: Concessional debt in the form of interest-subsidies, waivers on down payment and longer repayment periods can make loans more accessible and affordable for end-users and enterprises. Guarantees, on the other hand, can reduce the risk borne by investors and financiers, and help last-mile energy users develop a credit history which could, over time, unlock financing for other household needs as well.
Subsidies: Research has shown that subsidies could shape sustainable markets if they are designed appropriately for local contexts, made available for an extended period (with clear timelines and plans for phase-out), structured to avoid crowding out private investment, and readily standardized for quality assurance and support beyond finance.
Aggregation: Aggregation platforms that pool investor money and blend public and private financing can channel larger volumes of funding into enterprises and end-users that have smaller financing needs. This mechanism reduces risk by spreading investments across projects and portfolios. And by pooling together smaller loans and assets from DRE projects and enterprises, it also creates larger investment products that meet the needs of organizations seeking bigger investments.
Results-based financing: The use of this approach is contingent on the ability to measure desired outcomes and attribute these outcomes to the program. Payments are made after results have been achieved and verified. This provides a mechanism for energy providers to overcome the challenges of reaching a wider base of end-users in rural areas, and the issues of high transaction costs and limited access to working capital.
While all of these have been tried by different organizations, many have not seen large-scale deployment. It’s important to understand what barriers – beyond those facing financing in general – are preventing the widespread use of such instruments. Prior to replication, it’s also worth reviewing the conditions under which each of these have worked. All of them are context-specific: Some may work better in contexts with local financial institutions that are well-established but risk-averse, while others may be better suited to areas that have a dearth of well-functioning financial institutions. The application of specific instruments also depends on the needs of stakeholders and the sources of financing available.
Sources of Financing and Opportunities
Beyond these financing mechanisms, there is a large range of public and private domestic and international financial sources that could be much better utilized by governments, international development organizations and DFIs in particular. These include:
- Public domestic sources: national and sub-national government budgets (including taxes and subsidies), and national public banks
- Public international sources: bilateral and multilateral development aid organizations and DFIs
- Private sources: commercial and cooperative banks, household savings, impact investors, crowdfunding, private foundations, philanthropies, etc.
Here are a set of potential opportunities for stakeholders – including DFIs, government agencies, philanthropies and financiers at all levels – to capitalize on:
- Improving the design of development interventions to include financing for energy solutions, for instance, by including funding for sustainable energy interventions in the budgets of national and international programs for education, health care, livelihoods and combating climate change.
- Strengthening mechanisms for financial inclusion and capitalizing on them to extend credit for energy access solutions to last-mile account holders, first-time borrowers or borrowers below a certain income level, while leveraging existing financial agent networks.
- Increasing the accessibility of international development and DFI funding through loans, concessional credit and investments in last-mile enterprises and local financial institutions. This may mean using soft funding sources to cover transaction costs involved in lending for small ticket sizes, or designing programs with higher transaction costs built in.
- Promoting incentives linked to taxation and subsidies, by doing away with value-added taxes and import duties on DRE solutions; taking care to ensure benefits accrue to end-users, and to maintain stringent quality standards for systems.
- Funding innovation and leveraging grant funding strategically, through mechanisms such as results-based financing and concessional finance.
These opportunities need to be combined with broader measures, such as investing in building the capacity of financiers at all levels, and increasing government commitments to DRE. Substantial increases in public funding are needed, particularly in the form of grants and subsidies to leverage commercial investments. It will also require stakeholders to restructure impact investments to increase the availability of patient equity, and to support initiatives that build the broader ecosystem for energy access. Finally, it will require governments, international aid organizations, DFIs and development NGOs to step out of their siloes and take a more integrated approach to budgeting, planning and program design.
Many of these measures are neither new nor unknown to the sector. But their transformative impact for the last mile is becoming clearer, and this warrants both renewed discussion and renewed efforts to improve on the ways we finance energy access.
Photo courtesy of European Space Agency.