Unlocking the potential of microgrids
Recently there has also been a shift in donor focus towards less centralised power solutions. In a previous post I presented some (very back-of-the-envelope) calculations on the economics of decentralisation, and when it might make sense to disconnect, or defect, from a centralised power network. Large-scale power projects are not about to disappear, but the latest Power Africa Roadmap sets the tone, recognising the increasing importance of off-grid projects in meeting its objective of adding 60 million new electricity connections.
However, so far the role of microgrids in Africa has been limited. Why is this, and what challenges might need addressing to scale-up microgrid business models?
There are many different applications of microgrid solutions. The first thing to note is that the term ‘microgrid’ is a useful label, but also a potentially misleading one. The reality is that the term is used to describe a variety of applications, ranging from single buildings, to grids centred around an anchor commercial load, to grids serving a rural or sub-urban community. The appropriate commercial and financing structure clearly depends on the application. Two example models:
One model is the A-B-C model: the microgrid starts with an Anchor load, then branches out to local Businesses, before reaching the surrounding Communities. Each customer tranche has a difference risk profile and this could in theory be reflected in structuring the financing.
At the other end of the spectrum are companies like Powerhive, which Caterpillar recently invested in. Powerhive’s projects rely on mobile payment revenue models, like the M-KOPA model for home solar kits.
Barriers remain to scaling up these models. Most of the companies innovating in this area are still reliant on VC finance. What they are doing is exciting, but scaling up will require regulation and business models that allow these businesses and projects to tap a more diverse range of funding options.
Could utilities have a role in scaling up microgrids? One possible model for scaling up micro-grids to more communities across Africa could be to increase utility involvement. Rwanda issued a tender back in 2014 for the development of microgrids, on a DBFO (Design-Build-Finance-Operate) basis. The projects would have a PPA with the state utility, and the the utility would collect end-user tariffs, even though the projects are not connected to the utility’s own network. The proposal even included an availability fee structure to shelter investors from demand risk. This starts to look a lot more like an IPP, possibly opening up access to cheaper tranches of capital. However, it also inherits many of the challenges of IPPs in Africa – most obviously the credit-worthiness and payment records of many incumbent utilities on the continent. For much of Africa, adopting this model would just be back to square one.
We need regulation and business models that manage uncertainty. The challenge then is to develop new business models that open up lower cost, and deeper sources of capital for microgrid projects, while not always relying on utilities. These models need to address a number of challenges:
Balancing scalability and demand uncertainty – power consumption in Africa remains very low and, if access to power is successful in providing a platform for further growth, grids will need to scale up. Designs could pre-empt this (e.g. with network ratings that accommodate growth), but demand risk might be an obstacle to making pre-emptive investments. Securing anchor customers and adopting the A-B-C model may help to mitigate these risks.
Credit risk – credit risk can often be a challenge for power sector project in less developed countries. But microgrid projects might have a less diverse portfolio of customers. Financial intermediaries could perhaps play a role in diversifying this risk, with IFIs perhaps designing insurance instruments to help establish those markets.
Securing the benefits of competition for consumers – microgrids offer the potential of a breakthrough in increased access to power in many parts of the world. But there is a risk that in the push to develop business models that secure investment, we lock consumers in less developed parts of the world into contracts at uncompetitive rates. Third party access rules should apply to microgrid systems in the same way they should apply to the centralised system.
Preserving optionality – the pace of technology change means that the fundamental economics of where it might make sense to connect to the centralised network, and where it might not, is bound to continue changing. Regulation should allow for the integration of existing microgrid infrastructure into expanding distribution networks, and microgrid commercial models need to take this scenario into account.
The potential of microgrid infrastructure is exciting, but the reality is that it is still a relatively small sector, largely limited to VC fundraising. Many challenges remain, and business models and sector regulation will require further innovation to realise the full potential of microgrids. A flexible approach is required, allowing for the many different applications of microgrid systems, and allowing for a wide range of technology pathways.