What policies create a supportive investment climate for mini-grids?

In many countries, laws either prohibit or fail to address private-sector distribution and/or sale of electricity to the public. Under Liberia’s Energy Law, for example, only the national utility could supply electricity. Private investors couldn’t legally supply power until Liberia’s senate passed the Electricity Law in 2015.

Without a clear legal basis to operate mini-grids, developers cannot secure licenses to generate and distribute power. Without licenses, private investors have no legal protection in case of dispute, and they often cannot apply for loans. While investors may still develop projects in this unclear context, they will choose smaller and less-efficient investments with poorer economies of scale. Clearer regulatory frameworks provide developers the confidence to think big, and in the energy sector, bigger projects produce better economic returns. To mitigate risk, project developers may install second-hand diesel generators and temporary distribution networks that they can easily sell or move.

In some countries without legal frameworks, companies still have invested in mini-grids powered by renewable energy. The company PowerGen, for example, has developed commercial solar micro-grids in Kenya and Zambia despite the lack of laws governing mini-grids. In fact, most countries with active mini-grid sub-sectors have only recently established legal frameworks to govern them. As of 2016, Kenya has one of the most robust mini-grid markets in Africa, but the government had only just begun to work with donors to create a legal framework.

Legalizing privately operated mini-grids can spur additional public investment along with private-sector investment. India’s Electricity Act of 2003, for example, opened the door for private developers to build, operate and maintain mini-grids without licenses in designated rural areas. The Electricity Act of 2003 not only encouraged private developers to set up and operate mini-grids, but also opened the way for national and state-level programs to promote mini-grids in regions not selected for grid extension. Following passage of the Electricity Act of 2003, India’s Ministry of New and Renewable Energy (MNRE) added mini-grids to the Remote Village Electrification Program. Under the Energy Security Program of 2005, MNRE provides subsidies for biomass-based generation for village electrification. The Jawaharlal Nehru National Solar Mission, launched in 2010, aims to install 3,000 MW of off-grid solar, including mini-grids, by 2022.

Mini-grids are only financially sustainable if project developers can set tariffs that reflect costs. Generation and distribution costs are generally higher in remote, off-grid areas. When the government requires private operators to set tariffs too low, investors cannot recover their costs. A persistent challenge is that consumers and local leaders in remote communities often expect to pay the same tariff as customers served by the national grid.

In many African countries, such as Namibia and South Africa, new national electricity laws allow tariffs that reflect actual costs, but off-grid customers object to paying more. Off-grid customers compare their tariffs with those of urban customers, and demand grid extension instead of mini-grids. In Mali, the national utility ended up extending the national grid to seven mini-grid sites located close to the utility’s concession area.

Communities are often willing to pay higher tariffs once they understand the quality of services they can expect to receive from the mini-grids. Remote communities in many parts of the world already pay more for poor-quality energy services. In Sub-Saharan Africa, for example, consumers in unelectrified rural areas are willing to pay about $0.50 per kWh, depending on location and perceived alternatives. This rate is significantly higher than the tariff on most national grids.

When creating tariff policies, governments need to weigh fairness for customers against the value of private sector investment. Tariff flexibility encourages mini-grid investment, but rural customers will likely pay more than grid-connected customers. The EU Energy Initiative Partnership Dialogue Facility (EUEI PDF) Mini-grid Policy Toolkit calls for national consensus on cost-reflective tariffs for mini-grids.

Governments can subsidize tariffs for mini-grid power by providing partial grants and concessionary loans to private developers and communities. The governments of Mali, Senegal and Tanzania, for example, provide subsidies and performance incentives for mini-grid developers to enable them to reduce tariffs for their consumers.

Tariff flexibility alone is not enough to attract large-scale private-sector investment in mini-grids. Developers also need access to the country’s plan for expanding the national grid to specific areas within a specified timeframe. Transparent grid expansion plans give project developers the confidence to invest in mini-grids in areas that won’t be served by the national grid. Without transparency, developers run the risk of building mini-grids in areas scheduled for grid expansion, thereby losing their investments.

Transparent grid expansion plans can also increase consumers’ willingness to pay higher tariffs. Once communities understand that they will not gain access to the grid for many years, they become more willing to pay cost-reflective tariffs to small power producers (SPPs).

The national utility and government must communicate transparently with citizens in rural areas about when they can expect grid service and what alternatives they have until then. Otherwise, communities are apt to wait for the grid rather than work with mini-grid developers.

Unfortunately, governments are often unwilling to say that there is no immediate plan to extend the national grid to particular districts or villages. Politicians may run for office promising to bring electricity to certain areas. Clear messaging, however, can help rural communities understand that off-grid systems supply high-quality energy services equivalent to grid-based electricity.

Government policy must establish what will happen if the national grid arrives in an area served by a mini-grid. Ideally, the grid should only arrive after mini-grid operators have recovered their investments. Otherwise, mini-grid investors lose money when the national grid takes over. Rwanda and Tanzania are two examples of countries with clear rules of engagement.

In countries without rules of engagement for grid arrival, project developers may invest in remote mini-grids far from areas slated for grid expansion. While this approach may protect the developer’s investment, it greatly reduces the number of communities who gain access to electricity.

Concession and license terms can reduce risk for mini-grid investors. Government concessions can dictate that if the grid takes over distribution before the end of the concession, the developer will receive compensation. In Senegal, for example, the government has awarded 15-year concessions for developers to electrify rural areas in specific zones. The concessions guarantee compensation in the event that the grid extends to these zones earlier than planned.

Public-private partnerships using a split-asset model can help offset the risk of grid arrival. The German company, Inensus, for example, invests in mini-grid generation equipment where governments invest in distribution networks. Under this model, the government can connect the distribution network to the grid when it arrives, and the private developer can transfer the generation technology to a new location. In addition to decreasing risk for investors, this approach creates distribution infrastructure for future grid expansion.

Some utilities have begun developing strategies for working with SPPs in areas of grid expansion, allowing SPPs to switch from power production to power distribution. Under this arrangement, SPPs can continue supplying electricity at a lower cost than the grid. In Cambodia, for example, the regulator has authorized more than 170 rural electrification entities operating mini-grids to become small power distributors once the grid arrives.

Mini-grid developers cannot afford the lengthy, expensive approvals process that regulates larger independent power producers (IPPs). In Senegal, for example, the government issues smaller concessions, known as locally initiated rural electrifications (ERILs), to companies to electrify individual remote communities. These companies, however, must follow the same regulatory tariff review process as larger concessionaires. ERILs have attracted much support from bilateral donors and the country’s Rural Electrification Fund. However, Senegal's regulator is obligated by law to apply the same due diligence process to small ERIL projects as to multi-million dollar investments; only one ERIL has successfully received a concession since 2008.

Total deregulation, on the other hand, risks multiple claims to the same service area. Governments can use “light-handed” regulations to discourage frivolous applications while keeping transaction costs affordable for serious developers. Several countries have set minimum thresholds for licensing. In Nepal, South Africa and Tanzania, producers operating mini-grids smaller than 100 kW do not need licenses. In Mali, the cut-off is 20 kW. As banks generally prefer to lend to licensed developers, the national regulator may need to provide documentation of a company’s electrification agreement instead of a license.

Governments have handled regulatory approval for mini-grid tariffs in different ways. In Mali, Agency for Domestic Energy and Rural Electrification (AMADER) serves as de facto regulator for mini-grid tariff approvals, and it provides financial assistance to SPPs. In Tanzania, projects smaller than 100 kW do not require licenses. The government regulator, Energy and Water Utilities Regulatory Authority (EWURA), will review a tariff if 15 percent of consumers complain. EWURA uses same the cost-of-service model used to determine maximum revenue for larger systems.

To attract private investment in mini-grids, government electrification plans generally use some combination of three approaches:

• Promoting mini-grids as an option in large electrification concessions
• Encouraging SPPs to invest in stand-alone mini-grids to supply individual communities
• Enabling IPPs to supply the grid as well as neighboring communities

Mini-grids in Concession Areas

The large concession approach to electrification can use mini-grids to meet isolated demand in remote areas, but governments must promote and incentivize mini-grid development. In the concession approach, a government unbundles the power sector and bids out concessions to companies to distribute power to a region over a set time period. In Mali, Nigeria, Senegal and several other countries in Sub-Saharan Africa, national governments have taken this approach.

Efforts to expand mini-grids through large concessions have not often succeeded. Concession programs tend to attract large private companies that function as utilities and provide electricity to large populations in contiguous regions.

Governments can encourage concessionaires to use mini-grids to meet their coverage obligations, either by developing their own mini-grids or by partnering with SPPs. In Brazil, concessionaires receive incentives to invest in mini-grids and other off-grid solutions to electrify remote areas where grid expansion isn’t economical. Companies typically offset mini-grids’ higher operating costs with sales in more profitable parts of their concessions.

Mini-grids for Individual Communities

Alternatively, national electrification programs can promote stand-alone mini-grids to serve individual communities. Many governments attract investment through competitive grant programs.

In Mali and Senegal, most new mini-grids supply power to communities outside the large concessions. In Mali, AMADER has awarded grants to private investors and communities to establish more than 160 mini-grids through smaller concessions. In Senegal, ASER has invested in dozens of private mini-grids for individual communities through a small concession program, ERIL.

Independent Power Producers Electrifying Neighboring Communities

As a third approach, governments can provide incentives to IPPs to sell surplus power from mini-grids to the national grid.

In Tanzania, IPPs that sell power to the grid receive performance-based incentives to use part of the power they generate to electrify neighboring communities via mini-grids. Up through 2015, Tanzania’s Rural Energy Agency awarded $500 per connection under the Tanzania Energy Development and Access Project. This strategy works well for independent hydropower producers in rural areas with communities located along the transmission line that connects the power project to the national grid.