Posted by Steven von Eije, Senior Consultant, Sustainable Business Practices – Clean Energy & Lara Pawlak, Director of Human and Intellectual Capital
Lack of energy access slows economic growth, limits the productivity of people and businesses, and has severe negative impacts on health due to the indoor combustion of solid biomass for cooking and heating. The most reliable and affordable energy services have typically been provided via national electrical grids, but connecting households and small businesses to the power grid in remote rural areas with low population density requires a high investment per capita.
With renewable energy sources becoming increasingly cost competitive, decentralized mini-grids that are at least partly powered by renewable energy are starting to provide a serious alternative to national grids providing centralized, fossil-based electricity. Compared to other off-grid options such as solar home systems, mini-grids are able to deliver a considerably higher voltages capable of powering heavier equipment for commercial purposes, such as refrigeration or manufacturing. Another important advantage of mini-grid development is the fact that it is typically less time consuming than grid extension.
The International Energy Agency estimates that 140 million Africans who currently don’t have access to electricity could be served by mini-grids. This would mean, however, that between 100,000 and 200,000 new mini-grids would need to be deployed – 4,000 to 8,000 per year through 2040 – which is a much more rapid pace of development than is currently observed.
Interest in developing mini-grids has grown significantly in the last few years, but the business case remains challenging, thereby preventing large scale investment from the private sector. Among other logistical and technical challenges, the main obstacle is the relatively high level of capital investment required to install them in the first place. Especially since the populations to be served are predominantly low income, it is not possible to recoup these initial capital expenditures through ongoing fees for service within a reasonable time frame for private sector developers.
Mini-grid development today is therefore largely dependent on donor-driven initiatives or heavily subsidized by governments. An assessment performed by Enclude regarding mini-grid development in sub-Saharan Africa did not identify a single example of a mini-grid that was developed on a fully commercial basis; all were at least partly financed with grants or subsidies.
We would argue, however, that it may not be appropriate to judge the merits of mini-grids purely on their business case; electricity networks should rather be considered essential infrastructure. Other types of essential infrastructure also require a significant amount of public funding. Once the infrastructure is in place, governments often invite the private sector to provide public services on a commercial basis in a regulated environment, allowing at least minimum required returns for the private sector operator. This makes infrastructure services more sustainable, while society also benefits from the increased efficiency of private sector delivery of these services.
Conventional grid connection in urban areas in Africa generally requires a public contribution of between 500-1000 USD per household connection. In less densely populated areas, these costs would be significantly higher. Public investment in installation of cable for mini-grids in rural areas could be justified by the downstream business opportunities for operators and productivity increases for households and businesses then connected to the mini-grid (not to mention improvements in quality of life). The subsequent investment in generation capacity, back up supply and metering could be made by private sector entities with a proven track record, which would also carry the costs of operating and maintaining the generation capacity. In exchange, the operators would charge a tariff to their customers for energy service delivery.
This arrangement would eliminate typical concerns from the private sector about the national grid later expanding into the area of the mini grid and providing lower-cost service. If the initial investment were to be made by a private sector entity, it would be a sunk cost that could not be recovered if/when the national grid reached the area. At the same time, however, renewable energy is drawing ever closer to cost-competitiveness of fossil-fueled power, depending on the local regulatory environment. While the capital expenditure per KWh of generation capacity is lower for fossil-based electricity, the operating costs of renewables are lower.
As the national grid usually has back up capabilities through centralized generation, more expensive and polluting generation capacity such as diesel generators could be disconnected from the former mini-grid and deployed in other unserved areas once the national grid comes to town. Batteries could also be employed elsewhere or provide additional security of supply when the national grid is not sufficiently reliable, as is often the case right now. This way, mini-grids can both accelerate electrification and result in increased uptake of decentralized renewable energy sources in developing countries. Connecting mini-grids to the national network could then become a national goal in the quest for full electrification without posing a threat to private sector investors.
The renewable energy team within Enclude’s Sustainable Business Practices unit is actively working on mini-grids, often pulling in expertise from other relevant practice areas such as inclusive finance, digital financial services and capital advisory. With funding from the European Investment Bank, we are currently providing technical advice to the Participatory Microfinance Group for Africa (PAMIGA), which would like to invest in mini-grids through a network of microfinance institutions in 8 countries. For PAMIGA, we assessed the opportunities for micro finance institutions to finance the construction and operation of mini-grids, and which factors to take into account when entering this market. What we found was that a better business opportunity for the MFIs would lie in financing the ongoing operations of mini-grid operators, though with significant grant and subsidy support, financing the construction of the grids themselves might also be possible.
The next step on the PAMIGA project will be to convert insights on the opportunity for MFIs to finance mini-grid operations into an Excel-based investment decision making tool. The tool will take into account existing studies and aggregate a number of existing tools to consider a wide range of variables including local energy tariffs, regulatory environment, number of customers to be served, cost of capital and many other factors. Once finalized this tool will facilitate the decision making process of a potential investor—either from the private sector, an MFI or a support organization like PAMIGA–about whether or not invest in a specific mini-grid opportunity. We also see opportunities to utilize our expertise in digital financial services to help mini-grid operators to reduce the costs related to tariff collection by enabling Pay-as-You-Go services via digital payments through partner microfinance institutions.
A lot of work remains to be done in order to connect the 1.3 billion people who currently lack access to energy. We believe that mini-grids are a promising solution within the broader renewable energy sector and could make a big difference for consumers and for national productivity if national governments succeed in creating an enabling environment for the private sector. We look forward to participating in this growing field by helping private sector operators develop competitive business models and successful partnerships with micro-finance organizations, facilitating the development and launch of appropriate digital payment channels to pay for energy services, and advising players on how to navigate or improve the regulatory environment for mini-grid development.