Connecting The Unconnected: Reflections On Using Subsidies For Rural Electrification

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The lack of access to affordable, reliable energy is a barrier to development, whether that be powering autoclaves and centrifuges in rural clinics to improve health indicators or powering local agricultural processing to retain more of the value of production locally. The African Development Bank estimates that 645 million Africans, nearly 60% of the continent’s population, don’t have access to electricity. The rapid urbanization of Africa also means that the urban/rural divide becomes ever larger, with rural areas often being forgotten in efforts to modernize. The so-called “Bright Light Syndrome,” where the young migrate to cities in search of opportunity, only serves to exacerbate this problem.

So how to address this energy access imbalance when extending the national grid to these rural areas is often seen to be impossibly expensive. The International Energy Agency (IEA) estimates that by 2040, as a result of the falling costs of ever-improving technology, 70% of new rural power supply will be most affordably provided by off-grid technologies and microgrids. Currently, these efforts to electrify rural areas are being carried out largely by international private sector players with little or no support from National Government. Is there a case for subsidizing the private sector to achieve national development goals? Can the domestic private sector be supported to keep more money in-country?

Subsidies for energy access is a disproportionately contentious subject. Researchers estimate that the global fossil fuel industry is subsidized to the tune of US$5.3 trillion (6.5% of global GDP) every year, and yet this staggeringly high sum raises few eyebrows. If implemented correctly, energy access subsidies could be the catalyst that tips the nascent rural off-grid sector into rapid scalability.

To subsidize or not

Our journey starts with what was arguably a failure of subsidies. Brighterlite, a commercial outfit selling solar home systems (SHS) in Myanmar, had planned its sales strategy in close cahoots with the national government and after close consideration of an US$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 its 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. As a result, potential customers in non-subsidized areas became reluctant to purchase a system from Brighterlite, in the hope that the subsidies might soon be extended to their area. Eventually Brighterlite, originally from Norway, had to pull out of Myanmar at a loss of US$2 million that had been invested.

Sam Slaughter, co-founder of the Kenyan-based microgrid company PowerGen, argues that we need to “embrace subsidies” and that “without subsidies the African rural consumer will be unique, 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?

Lessons from History

“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. The quote above, which is entirely applicable to microgrids in rural Africa in the 21st century, is from a 1926 research report put together for the US Congress. In 1935, President Roosevelt established the Rural Electrification Administration (REA). As Gabriel Davis, Head of Energy Access at CrossBoundary, points out, “in its first five years, the REA provided over US$227 million in government subsidised loans (US$3.6 billion in today’s dollars) to connect rural farmers through laying distribution lines, wiring homes, and even building local diesel generation plants.”

Supporting supply or demand?

The majority of rural electrification strategies active or planned in Africa today involve the private sector. A notable exception is the regulation passed by the Nigerian government in 2016 specifically addressing microgrids. This reliance on the private sector reduces the costs to the government but opens a different can of worms. How does one stimulate and subsidize the market whilst maintaining the drives for efficiency and cost effectiveness that characterize private sector projects? The World Bank Group’s ESMAP (Energy Sector Management Assistance Program) argues that this is best achieved through subsidies targeting demand rather than supply. In other words, it is better to pay a subsidy for every unit of energy consumed than paying someone simply for having built a microgrid.

We would tend to agree with this. The problem with targeting only the large, upfront costs associated with building a microgrid is that it delivers all incentives before any services are actually provided, in this case people converting electricity into useful work lighting their homes or grinding their maize for example. In ESMAP’s 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 among national governments and donors, however, seems to be that demand side subsidies are harder to implement.

It is common practice for utilities to charge customers a connection fee, but these 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. When commissioning early microgrids in poor fishing communities on the shores of Lake Victoria with SteamaCo, we would always charge a nominal connection fee to new customers well below the cost of connecting them. This served more as a mechanism to secure commitment than as a cost recovery fee.

A new era of data-driven subsidies

A less common consumer finance mechanism is the subsidizing of ongoing energy costs. In this case every unit of energy bought and consumed by the user is subsidized. This usually results in lower costs for the user leading to increased uptake and demand, and improved revenues for the operator. 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, chiefly the technical complexity of subsidizing multiple micro-payments.

These days, however, a great number of rural energy users consume their energy via sophisticated web-enabled smart meters. This not only makes the microgrid business model fundamentally workable, it also means that every watt hour of energy being consumed by each and every customer is being logged in near real time, and crucially, users are able to buy very small amounts of power upfront using MPesa and other mobile phone based payment channels. This means a chapati vendor in rural Kenya can tap a few buttons on her old Nokia phone and a few moments later her smart meter receives the credit and the lights on her chapati stall spring to life.

The emergence of mobile payment

The presence of mobile-based payment services across the spectrum of off-grid energy access routes from SHS to microgrids reduces the burden of complexity enormously.

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 a 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 digitized ‘Pay-As-You-Go’ mechanisms despite the ubiquity of mobile money platforms in places like Kenya. Another problem with this mechanism seems to lie in the processes of traditional funding organizations. One of the inherent problems of a demand side subsidy, either paying all or part of the cost of connection or subsidizing ongoing energy purchased, is the inability to predict how much will be spent through the scheme. Demand uptake is unpredictable. For an organization with strict spending targets this is a risky undertaking and naturally not a first choice for an intervention.

On the necessity of working together

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 hybridized 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 privatized and operating under a concession model. These utilities typically connected end-users at a rate 29% higher than their publicly 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 subsidize 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 incentivized 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 crooked government officials.

An approach rather than a solution

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 subsidizing 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 ongoing task of connecting the unconnected to clean, modern energy services.

By Sam Duby and Tobias Engelmeier, TFE Consulting GmbH

Tobias Engelmeier, Managing Director and Founder, TFE Consulting GmbH:  Tobias is an entrepreneur and advisor with experience in organizational change and growth-oriented business models. He has founded Bridge To India and India Goes Solar, and has worked for investors, technology companies and governments on managing industry transitions. He founded TFE Consulting to provide consulting services on industries that are undergoing rapid transformation.

Sam Duby, Africa Director, TFE Consulting GmbH: With 10 years of field experience and having founded an award-winning IOT energy access company in East Africa, Sam is well aware of what it takes to deliver successful projects in developing countries. He is an expert in appropriate design and implementation, leveraging PAYG, community and cross-sector engagement and financial studies focused on the energy access and frontier technology space.

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