Optimizing Results-Based Financing for Off-Grid Energy: Why Localization Can Provide a Pathway to More Effective Investment
The recent High-level Dialogue on Energy, the first U.N. gathering of world leaders in more than 40 years solely devoted to energy issues, highlighted the urgent need for action to achieve universal access to energy by 2030. With 770 million people lacking access to electricity – 75% of them in sub-Saharan Africa – the world is still far from achieving this goal. Fortunately, a path forward is emerging: According to the International Energy Agency, distributed renewable energy (DRE) solutions, like small-scale solar systems and mini-grids, are the least-expensive way to provide power to more than half of the world’s off-grid population.
But with investment volumes ranging from 259 million to 420 million over the past five years, the amount of funding to off-grid companies needs to grow at least twofold per year to achieve universal energy access by 2030. At least half of this funding will need to come from public and philanthropic subsidies, to unlock commercial finance and reach the poorest people.
Exciting new developments are underway to catalyse investments in distributed renewable energy, including a historic US $1 billion initiative launched by the IKEA Foundation and the Rockefeller Foundation in June – the single-largest DRE initiative to date. But more progress is needed. Below, we’ll explore the role results-based financing (RBF) can play in drawing more capital into the sector, and discuss why RBF approaches should have a strong focus on local stakeholders and innovators.
Unlocking Private Capital Through Results-Based Financing
Results-based financing has gained increasing recognition as a valuable instrument for donors and development partners, enabling them to de-risk commercial investment and incentivise the engagement of companies offering solutions in hard-to-reach markets. The key feature of RBF is payment upon delivery, with financing contingent upon the success of the business or initiative: That means the companies that receive the financing are expected to take the full risk until results are achieved. In the energy sector, RBF payments are only made after the successful verification of energy access being delivered by participating companies. This makes RBF less distortionary than other incentive programmes, producing better results for a lower expected cost – while leveraging private sector investment and enhancing financial as well as impact returns.
After initial scepticism and doubts around potential market distortion (including the risk of companies and consumers becoming dependent on subsidies), RBF has been embraced by the private sector as a key mechanism to accelerate additional investment and scale up energy access. Leading investors – including SunFunder – have encouraged further donor commitment to RBF schemes for mini-grids to unlock private capital. Also, SEforALL – the U.N. initiative driving faster action towards global energy access – has adopted RBF as the key funding mechanism to put the world on track to achieve both universal electrification and clean cooking access.
Trends, Opportunities and Risks in Results-Based Financing
While the first successful results-based financing schemes in energy access were developed and rolled out at a country level, we increasingly see a trend toward larger, multi-country RBF facilities. Different stakeholders and platforms have also made steps in terms of centralised fund management and ICT innovations to increase efficiency in RBF operations, which we recognise can help these initiatives achieve scale.
At the same time, the remote design and management of RBF programmes – often from Europe or the U.S. – increases the risk that RBF funds will exclude local actors and innovation. Decisions taken far away from the actual investments can lead to insufficient responsiveness to local market dynamics, and can result in RBF initiatives that largely subsidise international companies that are already well-capitalised. This can also lead RBF facilities to support only the lowest-hanging fruit in energy markets – often comprised of companies that would’ve attracted financing anyway – while failing to build sustainable market systems based on the inclusion of local players and vulnerable consumers. To avoid these issues, we call for a balanced approach, with local embedding of RBF alongside investment-readiness support to ensure longer-term sustainability. We’ll explore this approach below.
A Call for the Localisation of Innovative Financing Mechanisms
Why is local embedding of market support mechanisms like RBF so important? We give a summary of our main arguments below, further elaborated in a recently published white paper. We invite practitioners to join this emerging discussion.
1. Including local companies
When designed well, RBF can overcome market barriers constraining the private sector delivery of modern energy services to underserved communities. It can also de-risk and leverage commercial investment, as confirmed by research from the World Resources Institute. However, if RBF only rewards well-established commercial players for business activities they would have done anyway, it loses its purpose. RBF should stimulate new initiatives while crowding in additional capital for activity that otherwise would not have happened. To achieve universal energy access, we need more businesses – particularly local companies – delivering those services. And we need more companies that are product-agnostic and that adjust their business offerings to local needs.
Local companies have a hard time accessing investment for their sustained growth. They often require both smaller loans (under US $500,000) and accompanying investment-readiness support. This results in higher transaction costs, which make them unviable for commercial lenders. Between 2018-2020, SunFunder – in partnership with the IKEA Foundation, which subsidised part of those transaction costs – was able to work with over 10 early-stage companies, while referring over 30 companies to other investors or investment-readiness advisors. In the process, we learned three main lessons: 1.) There is a lack of high-quality, third-party business advisory and other services to help build the investment-readiness of small, early-stage and/or local businesses; 2.) Consistent with findings from the World Resources Institute, “entrepreneurial support services are best provided by early-stage investors themselves”; and 3.) Investment-readiness takes time (2-4 years), and there is a need to accelerate this timeline.
Paired with RBF grants to de-risk commercial investment, providing investment-readiness support to local companies will contribute to inclusive growth and the scaling needed to achieve universal energy access. Technical assistance and capacity building for local companies requires a physical presence in those markets, and investors with that local presence can be best-positioned to provide targeted, hands-on support. Encouraging the participation of local companies also requires an adaptive approach from fund managers, in which they tailor the fund design, eligibility criteria, financing conditions, tools and templates to be used, in order to meet these companies’ unique needs. Working alongside companies to develop their capacities – e.g., in financial management and business planning – will contribute to pipeline development and risk reduction for investors.
RBF mechanisms have successfully triggered the engagement of dozens of companies, including many local players. Examples include the Kenya and Tanzania RBF facilities, which SNV managed as part of the broader EnDev RBF portfolio funded by UK Aid. In Kenya alone, with the support of these RBF facilities, 1.6 million people gained access to cleaner energy solutions and 4,678 new jobs were created along the solar and cookstoves value chains, with at least 40% of these jobs going to women. In Tanzania, the RBF scheme SNV implemented from 2014 to 2018 worked with 11 off-grid solar companies to deliver solar home systems in remote parts of the country not reached by these companies before. As a result, by the end of 2018, 390,000 people had gained access to electricity and 1,256 new jobs had been created. Since then, participating firms have continued to deliver energy access, and with the further scale-up of the facility, the Tanzania solar RBF has helped provide over 1.1 million people with access to clean energy services so far.
2. Supporting national-level ownership and an enabling environment
Ensuring universal access to energy is at the top of the agenda for many national governments, with off-grid energy solutions increasingly seen as necessary to achieve this goal. There’s growing recognition among governments that they play a critical role in ensuring the enabling environment conditions to support DRE market development – particularly for the mini-grid sector, where companies depend on regulatory frameworks and conditions put forward by government authorities, including concessions, licensing and tariffs. Without stable enabling conditions, commercial investment (and hence the deployment of RBF schemes) is a risky business.
A good example of government efforts to support this enabling environment is the UK Aid-funded BRILHO Energy Africa programme in Mozambique. The initiative includes a component on Policy Reform and Institutional Strengthening in addition to its US $19 million Market Development Fund, which includes early-stage grants, RBF and technical assistance for DRE companies. Working with Mozambique’s Ministry of Mineral Resources and Energy, the Mozambique Energy Fund and other critical stakeholders, BRILHO supported the development of the country’s first mini-grid energy regulation.
Another example is the Government of Kenya, which seeks to close the energy access gap in underserved areas of the country through the US $150 million Kenya Off-Grid Solar Access Project (KOSAP), supported by the World Bank. Central to KOSAP is a US $47 million RBF facility paired with a debt facility, managed by SNV and SunFunder. KOSAP’s emphasis on encouraging the sustained growth of local, early-stage companies is also noteworthy. To this end, working with SNV and SunFunder’s local offices allows KOSAP to provide closer engagement with emerging players, cost-efficient due diligence, and investment-readiness and other capacity-building support.
3. Contributing to systems change
Beyond delivering concrete results in terms of new energy access connections, RBF facilities can – and arguably should – target systemic change, making sure that impact continues to be delivered and scaled up after the RBF financing has come to an end. To accomplish this, RBF funding can support:
- the sustained presence of DRE companies with viable, scalable business models that continue to deliver quality products and services;
- stable, reliable regulatory frameworks and conditions that allow further market growth;
- financial mechanisms that ensure affordability for end-users, leaving nobody behind; and
- fair local employment, creating private-sector-driven pathways for the professional development of women and youth.
This requires an ecosystem approach in which supply, demand and enabling environment conditions are considered in an integrated manner. Often, a standalone RBF mechanism to incentivise only the supply side will not do the trick.
Successful RBF facilities do not work in isolation, and they require close collaboration with multiple stakeholders in both the energy and finance sectors – as also shown in SNV’s systems change case study from Tanzania. The odds for success increase when certain preconditions are in place (e.g., regulatory frameworks, tax regimes, consumer awareness and mobile money access), as well as private sector capacity and the potential to leverage pre-financing. In most markets, at least some of these conditions are missing or deficient, and hence complementary support, technical assistance and partnerships are needed to create them. These support measures differ by geography and require a localised approach to truly achieve systems change.
When designing new RBF mechanisms, there are many ways funders can support growth – both in individual energy companies and initiatives, and in the broader energy access sector. We should centralise what we can, to make fund management operations more efficient. We should make optimal use of ICT innovations and centralised data management systems to simplify the procedures that verify energy access provided by RBF-funded companies, and to minimize the time investment, both for fund managers and participating companies. Several platforms are currently available to further facilitate this development.
At the same time, we must also do justice to the complexities of ensuring sustainable market development and systems change. Lasting progress will require localised solutions, the inclusion of local companies (and special attention to their needs and investment readiness), and close coordination with government authorities. To achieve universal energy access, we need all hands on deck.
Photo credit: Russell Watkins, UK Aid