Utility tariffs: financial sustainability vs. cost reflectivity
Initial reactions to the title of this blog? Surely we can talk about financial sustainability and cost reflectivity interchangeably, right? Why the “vs.”? Well, a lot of the time that might be fair, but in our work we’re seeing cases where this is not always true.
Off-grid electricity access solutions are playing an increasingly important role in extending access to clean, affordable, and sustainable energy. We increasingly hear that regulations for cost-reflective tariffs are needed to support some of these solutions. But targeted and well-designed subsidies and cross-subsidies could be used to reduce the cost of some of these solutions for the poorest communities, to ensure that we achieve sustainable energy for all. Kuungana recently co-authored a paper exploring these issues (attached below) with Tearfund. We believe that innovative solutions will be needed to achieve universal access, like those presented in our paper, and like those proposed by organisations such as the African Mini-Grid Developers Association.
This might deviate from a paradigm of pure cost-reflective tariffs, but could still be structured to be financially sustainable, for governments, utilities, and the private sector companies driving innovation in the sector.
We can also be more innovative in the on-grid sub-sector. There are a growing number of utilities in sub-Saharan Africa for example where there is a surplus of generation capacity, and where this is putting upward pressure of tariffs. In some countries tariffs are already high, but they are not sufficiently high to recover all costs. In this case cost-reflective tariffs might undermine financial sustainability, by driving load away from the grid, reducing the utility’s charging base, resulting in a further increase in tariffs: a positive feedback loop.
In some of these countries, perhaps we could create the equivalent of a ‘utility bad bank’ where stranded costs are stripped out of the utility bill? The liability does not disappear; it still needs to be financed; but tariffs could be set at a level that reflects the long-term costs of funding the sector.
In both cases we need to be clear on what we are trying to achieve. Cost-reflective tariffs are promoted for two main reasons:
To ensure the sector and companies operating in the sector are financially sustainable.
To drive an efficient allocation of resources through the value chain.
Normally cost-reflective tariffs are absolutely the best option for achieving these objectives, but sometimes we might better achieve our objectives by moving away from pure cost-reflectivity. Where we find specific contexts where this is the case, we need to ensure that generally applicable principles don’t stand in the way of an innovative solution that might better suit our context.