The mini-grid tariff dilemma – a political choice
There are lots of challenges facing mini-grid developers in Africa, and – as yet – their potential remains unfulfilled. At the heart of the challenge are two political issues:
Many politicians want to provide electricity access to all citizens at a universal tariff, i.e. reflecting the principal that all citizens should be able to gain electricity access at the same price. Not an unreasonable political desire. But it is widely assumed that this is incompatible with mini-grid projects being financially sustainable.
In many countries government stakeholders (for example the utility and/or a Rural Electrification Agency) are keen to be visible in the delivery of energy access solutions. A completely private-sector driven solution is in conflict with that desire, and this can lead to resistance to such solutions.
Most stakeholders are pushing for a regulatory regime based on cost-reflective tariffs, where each mini-grid project is treated independently.
The existing consensus amongst those setting up regulatory regimes for the off-grid sector is that solutions should be entirely driven by the private sector. There is little or no attempt to address the legitimate political objectives noted above. In most countries where mini-grids are being developed they are developed project-by-project by the private sector, with a tailored cost-reflective tariff being agreed for each individual project. This is a model that can be made to work, but it does have several challenges:
Most obviously, it is in direct conflict with the political objectives set out above, which exist stated or unstated in many African countries.
It leads to piecemeal regulation, with high regulatory transaction costs with every sizeable mini-grid project requiring regulatory approval – it is questionable whether this is financially sustainable for project developers.
Arguably it leads to a balkanised electricity system, with different rules and tariffs applying to different sets of consumers, with those consumers having little choice over the regulatory regime under which they are governed.
Perhaps most importantly, under this model developers continue to need significant donor support for projects to be viable. It seems unlikely that this requirement will be eliminated soon. This is not sustainable, and it is not scalable.
No country in the world has perfectly cost-reflective tariffs. What is critical is that the electricity sector – however we choose to define it – is financial sustainable.
We sometimes talk about the importance of cost-reflectivity in tariff regulation. This makes economic sense: the more that each part of the value chain is exposed to true underlying economic costs, the more efficient the market response should be. However, no country in the world has truly cost reflective tariffs. For example, in the UK households in isolated rural communities do not pay the full cost of the network infrastructure required to serve them. Those costs are at least partly socialised across all electricity consumers. In a pure economic sense this dulls the incentive for a more efficient outcome, but a political decision is made to share certain costs. Most of us would agree that this is a reasonable compromise.
This shows that we already accept the concept of a universal tariff when it suits us. Is it not hypocritical to draw a regulatory distinction between the main grid and mini-grids, simply because the infrastructure happens to be physically separate?
Policy makers do have a choice. A well designed virtual single buyer could meet political objectives, while also allowing off-grid projects led by the private sector to scale.
Putting in place a credit-worthy single buyer is normally a critical step in creating the right environment for the development of IPPs. The single buyer purchases power from IPPs under PPAs that include cost-reflective tariffs. The tariff charged to the end consumer reflects the overall cost of running the system, shared between all power consumers. This concept could be extended to off-grid power projects, as shown in the schematics below.
Under this virtual single buyer model, the single buyer signs a virtual offtake agreement with a mini-grid. The offtake agreement would include a cost-reflective tariff and could even be closer to a tolling agreement in structure, mitigating the demand risk of the mini-grid. Whatever tariff structure is chosen, the same tariff could then be charged to all consumers. The consumer-facing retail component of the business could be structured in many different ways, but the model would still allow off-grid developers to manage their own retail operations. Solar home systems could, in theory, be covered under the same mechanism, extending the reach of such systems into areas where they would otherwise be unaffordable.
What does this achieve?
The mechanism makes the required cross-subsidy endogenous to the regulatory framework – just as has happened for every country that has achieved universal access to electricity using the grid.
The model is scalable. Virtual offtake contracts can follow a template and be easily replicated with no need to negotiate each mini-grid project individually.
A single offtaker could benefit from all of the credit support mechanisms that would be in place for an on-grid IPP.
In turn, this would make projects attractive to more commercial sources of capital, lowering the cost of capital and ultimately reducing costs for end consumers.
The mechanism would address the political barriers highlighted earlier. A single tariff would apply to all consumers, regardless of delivery mechanism, and government could be more visible in the delivery of energy access.
Therefore, policy makers have a choice.
They can continue the march towards strictly cost reflective tariffs for each individual mini-grid. But it must be recognised that this is politically difficult. Just as it would be politically difficult to charge remote grid-connected communities in the UK, US, Germany, or any other country using a fully cost-reflective tariff.
Or we could come up with a more radical solution that encourages more coordination between on-grid and off-grid ventures. We can share and reallocate costs to accelerate the deployment of the most cost-effective solutions for delivering energy access.
It is right for African policy-makers to be the ones making this decision. A solution that addresses the challenges they raise does not need to undermine the innovative projects being developed by the private sector. Instead, it can turbo-charge them.