By Martin Baart, Ecoligo
Sub-Saharan Africa, a sun-belt region, not only has great conditions for producing solar energy; there is a strong economic argument for it, too. The price of electricity for businesses and industries in countries such as Ghana is as high as 38 euro cents per kWh, which has been cited as the biggest problem for businesses and hinders economic growth. And still there are frequent blackouts. The recent price escalations from many African utilities can be seen as a step towards reducing the subsidies in the power sector, which is crucial for these state-owned utilities to run profitably. Nevertheless, they add price uncertainty into the mix.
As the cost of producing solar electricity continues to fall, solar projects to supply these businesses are technically and financially viable — however, they are not being implemented. This is because there is a structural finance gap in sub-Saharan Africa that prevents many solar projects from having access to finance and thus being realized. But with such obvious cost benefits, why does this finance gap exist?
High transaction costs
Implementing renewable energy solutions comes with high transaction costs typically transpiring from activities such as technical feasibility studies, financial assessments, legal structuring of projects risk appraisals and other development expenses. These are usually performed through external companies, resulting in fixed costs which are independent of the size of the project. Therefore, it makes financial sense for commercial investors to invest in larger rather than smaller projects as the fixed cost can be justified.
Short loan tenors and high interest rates
In most sub-Saharan African countries, suitable bank loans for solar systems are infamously unavailable. This is because local banks only provide short loan tenors of not more than three years with interest rates that sometimes reach 20% or more. This is a commonly known bottleneck that development organizations try to address with very limited success so far in the field of renewables. Consequently, this is not a viable option for the finance of solar systems.
What is the impact of the finance gap?
Rural electrification projects are often financed through dedicated energy access funds, development organizations or microfinance institutions. At the other end of the scale, development finance institutions provide debt financing for utility scale solar farms and very large systems. However, due to the reasons listed previously, the finance gap largely impacts systems with a financing volume of between €50,000 and €2.5 million.
This translates roughly to solar systems with a capacity of between 30 kWp and 2 MWp, which are the ideal size to provide commercial and industrial (C&I) customers with solar as their power demand is typically in the same range. These companies, although financially stable, do not normally invest outside of their core business.
Many of these companies, struggling with unstable or insufficient grid electricity, often turn to diesel generators as backup. A recent Bloomberg New Energy Finance report estimated the market for small-scale power generation in sub-Saharan Africa to be around 2–4 GW per year, often coming from such generators. While this is expensive, for businesses that must stop production without power, it is necessary for them to stay afloat. High CO2 emissions are another consequence, but for a region that’s so far contributed the least to human-influenced climate change, this is not a priority.
In Kenya, the C&I sector consumes 72% of the country’s utility-supplied electricity. If the finance gap can be closed, solar projects represent an opportunity to both support the economy and reduce strain on the national grid, freeing up capacity for households.
How can the projects be financed?
Different methods of financing have been tested to overcome the finance gap in sub-Saharan Africa. One possibility is for the end customer to directly finance and own the system, usually with some form of co-financing involved. An example is the 991 kWp solar hybrid system that powers Krystalline Salt Ltd. in Kenya, which was mainly financed by the company itself and was supported by a grant from the Japanese government’s Joint Crediting Mechanism (JCM), which has the aim of reducing greenhouse gas emissions in Kenya. This is a common way to co-finance projects: solar project developers try to acquire grants to subsidize the system costs for the client, in order to meet the client’s return expectations and reduce the client’s investment risk.
In some projects in the past, grants for small pilot projects have even reached levels of up to 100% as development organizations tried to boost the market. However, this doesn’t solve the problem of the finance gap and thus tends to have low scalability.
A more viable and scalable method to reach high solar penetration levels in the C&I sector of a country are business models in which a solar independent power provider (IPP) supplies power to the C&I customers and arranges external finance for the projects. This is often done contractually using Power Purchase Agreements (PPAs) or leasing agreements, in which the client either pays only for the electricity consumed or pays a fixed monthly price while the ownership and responsibility to maintain the solar system stays with the IPP.
Larger projects at the upper end of the financing gap, such as the 858 kWp system at Garden City Mall in Kenya, have seen financing through private equity funds that provide full equity finance not leveraged with debt. However, with equity investors typically expecting returns of at least 18% p.a., this is not viable for most projects. Secondly, private equity funds also have high transaction costs, which is why this is only a viable option for projects with an equity tranche of above one million euros.
Besides private equity funds, alternative finance methods such as crowdinvesting have begun to finance independent solar power projects. One example is the 118.9 kWp solar project supplying a flower farm in Kenya, for which €144,000 was raised on ecoligo.investments in just 10 days. In this case, the money is provided as debt to the owner and operator Ariya Leasing.
In general, it has been argued that traditional financing methods are simply not well suited to the solar market in sub-Saharan Africa, as the expectations of investors often don’t match market reality. Crowdinvesting, on the other hand, has more flexibility and can be applied to both on- and off-grid projects.
Finance provided by a crowd of private investors or even by wealthy individuals has worked well for smaller solar projects with financing volumes below €500,000 in the recent past. However, with little track record for crowd-financed installations in the MWp range, it is unknown whether the success of crowdinvesting will continue for larger projects. The current trends in the market give a strong positive indication that such milestones will soon be hit.
When this potential is realized, it will not simply add clean electricity capacity in sub-Saharan Africa: the most significant benefit will be sustained economic growth, boosted by a C&I sector that has is no longer held back by high energy costs.
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