Smart Incentives for Mini-Grids through Retail Tariff and Subsidy Design
Clean energy mini-grids are receiving increasing attention as a cost-effective means to deliver energy access and achieve climate change commitments. However, the economics of mini-grids in developing countries remains challenging, as mini-grids often have high upfront capital and operational costs and tend to serve a lower-revenue customer base. How tariff and subsidy policies are designed has become a central factor in determining the viability of private sector participation in scaling deployment of minigrids as an effective energy access solution.
This case study was developed as an input into discussions of the AMG-CoP regarding the optimal means of incentivising private sector participation in scaling up investment in mini-grids and delivering energy access and rural electrification objectives. An extensive literature review formed the basis of the study, with the objective of capturing and synthesising previously documented knowledge to inform policymakers and stakeholders. Semi-structured key informant interviews were held with industry stakeholders to add supplementary information from the perspective of the private project developer.
“Overall, regulators of mini-grid tariffs and subsidies are faced with a dynamic, complex and interlinked set of considerations when establishing policy. They must consider the needs of the local community and their ability and willingness to pay, the costs of serving those communities, and the needs of the mini-grid operators to cover their costs and deliver a return to their companies and their investors. These conditions vary significantly across geographies, and there is no one-size-fits-all approach to establishing effective and fair tariff and subsidy structures.”
Retail tariff policies: When setting retail tariff policies, policymakers must balance between the politics of tariff rates in different communities, developers who need to maintain viable business models and customers who want access to energy at a tariff that they can afford and are willing to pay.
Subsidy policies: There are a number of ways effective subsidy policy can be designed. Subsidies can be delivered by either supplying certain elements to the developer directly, or by a financial transfer paid for inputs or outputs, generation or distribution outcomes, or on a capital or operational basis. Of note, output-based capital subsidies for distribution outcomes (connections) are a common option. Policymakers must also select how the subsidy will be disbursed, in terms of both timing (on which milestones disbursements are made, impacting project finance requirements) and verification (balancing certainty with effectiveness), as well as how to quantify the subsidy amount. The value of the subsidy should be high enough to ensure that the mini-grid operation is sustainable and profitable, but low enough to maximise the impact of limited subsidy resources.
This case study was made possible through support from the German Government’s International Climate Initiative Mobilizing Private Investment Program. The case study was compiled by Electric Capital Management, the Co-Chair of the LEDP GP Finance Working Group. Read the full resource HERE.