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05 Mar 2021

How new technologies and the private sector can reduce government subsidies for rural electrification in Africa

Africa; energy; renewable energy, finance, investment
Jacqueline Musonda, Jane Dougherty, Gabriel Davies and Erika Lovin
Solar panel in Africa

Affordable electricity is a fundamental driver of economic activity. We see this in countries where cheap electricity has allowed them to create entire industries. Iceland doesn’t have any aluminum, but is the largest producer of aluminum per capita in the world. Why? Because Iceland has some of the cheapest electricity rates in the world: five US cents per kilowatt hour (kWh) for commercial customers. Affordable electricity is critical for every scale of business, from the aluminum smelting companies in Iceland, to the 600 million people in Africa who still lack access to power. Those 600 million need electricity to light their homes and run their businesses.

For markets where diesel costs less than $1.50 per liter, as is the case in much of rural Africa, businesses cannot afford to use electricity at prices above $0.50 per kWh to run agricultural machinery like a grain mill or a water pump. Above that level, a grain miller or farmer may resort to using a diesel generator[1] or, more likely, will do the work by hand. But the economics of rural electrification makes it challenging to provide electricity below that price, and so diesel machinery continues to dominate the rural off-grid market.

Cross-subsidized tariffs are needed to make rural electrification affordable

The cost of electricity, typically measured by the levelized cost of energy (LCOE), is much higher for rural customers than for urban and peri-urban customers. Rural customers are remote and often more dispersed, and so have higher logistics and infrastructure costs to connect and service. This is true whether electricity is provided through main grid connections, mini-grids, or solar home systems.

Historically, governments around the world have solved this issue by using targeted subsidies. Rural customers can be charged the same price for electricity as urban customers if the gap between the cost of energy (LCOE) and the price of energy (tariff) is covered with a “cross-subsidy” from urban to rural customers.[2] For example, in Queensland, Australia, urban customers currently provide a cross-subsidy of $800 per year to rural customers.

African governments have acknowledged the critical role of subsidies for achieving energy access. In Zambia, the national utility is able to charge a uniform tariff to rural and urban customers because the higher costs incurred to serve rural customers are shared across the entire customer base, including the more profitable urban customers. And as the CEO of Uganda’s Electricity Regulatory Authority, Ziria Tibalwa Waako, recently put it, “given that social equity is key to building a sustainable electricity supply industry, an off-grid tariff harmonization and subsidy policy is key to achieving universal electrification.”

New research by the Innovation Lab suggests that extending cross-subsidies to new technologies, and the private sector, can reduce the amount of subsidy needed for rural customers.

 New research by the Mini-Grid Innovation Lab, run by CrossBoundary in partnership with Energy4Impact, and supported by the Rockefeller Foundation, UK aid, Shell Foundation, DOEN Foundation, and P4G suggests that by extending cross-subsidy mechanisms beyond the national utilities to include the private sector, and new technologies, governments could reduce the total cost of subsidies required to achieve universal electrification in their countries.

The importance of new technologies is well-recognized by governments. Zambia’s Rural Electrification Authority (REA) has a mandate to provide electricity infrastructure to all rural areas “using appropriate technologies” and has already implemented mini-grid projects and solar home systems in locations in Zambia in line with this mandate. The number of locations where mini-grids are the least-cost or otherwise “most appropriate” technology is growing rapidly. The World Bank estimates that mini-grids are the least-cost option to electrify 490 million people worldwide. However, to date there had been no empirical research on the cost of extending cross-subsidies to mini-grids.

To understand the impact of subsidizing tariffs which are affordable for rural customers but below developers’ LCOE, the Innovation Lab worked with developers in Tanzania to cut tariffs across five sites. The Lab provided sufficient subsidy to fully bridge the LCOE and reduced tariff.

Figure 1

Starting in June 2018, the Lab began testing the impact of reducing tariffs by between 50% and 75% at five rural mini-grid sites in Tanzania

After two years, the tariff reductions have negatively impacted the mini-grids’ financial viability because revenue from electricity sales has dropped: average Net Present Value (a measure of the profitability of a project over its lifetime) has decreased by 13%. In line with how rural electrification programs have been implemented around the world, the Lab’s data supports the position that developers should not reduce tariffs below the LCOE without financial support, or grids will not be financially viable.

Figure 2

At the site with the greatest reduction in tariff (75%), electricity consumption has increased by 3x after 2 years, and overall revenues have remained at baseline levels

Encouragingly, the 13% drop in revenues was much smaller than the 50% – 75% drop in tariffs. This is because rural customers consumed between 1.5 and 3 times more electricity at lower tariffs than at the original, higher tariffs.

Figure 3

The average value of the mini-grids decreased by only 13% despite an average tariff reduction of 64%.

This increased consumption has reduced the subsidy required to replace lost revenue per kilowatt hour. The Lab’s analysis suggests that the subsidy required to charge lower tariffs while maintaining the mini-grid’s lifetime profitability would be substantially lower than the ongoing subsidy required to charge the same tariff for main grid connections.[3] This means that governments can reduce the overall subsidy required to achieve universal electrification by incorporating new technologies such as mini-grids and working in conjunction with their private sector providers, rather than relying solely on extension of the main grid.

Even if partnership with the private sector is proven to be the path to electrification that requires least subsidization, can African governments afford to do it without international development funding? Yes! Historically, taxpayers and infrastructure users account for the majority of total electricity infrastructure expenditure in sub-Saharan Africa, with a smaller but significant portion coming from official development assistance (ODA), which includes concessional loans.[4]

Governments in Africa have already started to subsidize off-grid technology solutions delivered by the private sector. In Togo, the government is providing a subsidy of $4.00 / month per customer to enable the solar home system company BBOXX to reach more remote customers. The government is funding this by reallocating money from an existing kerosene subsidy program. To encourage African countries to scale up public-private partnerships to deploy off-grid energy, Rural Electrification Authorities (REAs) across Africa could commit to providing electricity infrastructure to all rural areas using appropriate technologies, and using private sector partners where appropriate.

The Lab is ready to prove at scale that private sector mini-grids can reduce the subsidy burden on governments

The Innovation Lab, in partnership with AMDA and with support from P4G, is looking for governments and donors ready to cross-subsidize mini-grid tariffs at the country level to expand the evidence base on subsidizing new technologies. Generating robust evidence is a first step in seeing this support provided to the mini-grid sector at scale across the continent through policy change at the government level. If you’re interested in collaborating in this ambitious initiative, please reach out to minigridslabs@crossboundary.com.

By: Jacqueline Musonda (Rural Electrification Authority, Zambia), Jane Dougherty (CrossBoundary), Gabriel Davies (CrossBoundary), and Erika Lovin (CrossBoundary)

Photo credit: IBIS

[1] Given a typical 3 kWh per liter output from a diesel generator, a kWh of power produced from the generator will be cheaper (though less clean) than a kWh provided by mini-grid electricity.

[2] Alongside tariff cross-subsidies, both the main grid and off-grid technologies continue to rely on capital expenditure (capex) subsidies to serve rural customers while making an investment return.

[3] Main grid subsidies are difficult to identify, but the Lab’s academic partners at UMass Amherst and Rochester Institute of Technology are publishing a paper that quantifies the implicit subsidy provided to the main grid. Recent research by the Duke University Energy Access Project examined subsidies provided to rural households in seven countries, and found an average subsidy of $1,300 per connection.

[4] Between 2001 and 2006, 81% of the total electricity infrastructure spend in sub-Saharan Africa came from sub-Saharan African taxpayers and infrastructure users.

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