By Remy Dhingra for Yale Clean Energy Finance Forum. Read the original article here.
The world has made undeniable progress toward universal energy access by 2030, a target laid out by the United Nations in its Sustainable Development Goal 7. However, if the global energy landscape remains the same, 8% of the global population will still lack access to electricity by 2030, and a startling 90% of the un-electrified population will be living in sub-Saharan Africa.
Mini-grids are an attractive option for electrification in rural, hard-to-reach areas of Africa. These off-grid systems not only accelerate economic development but also tend to offer important benefits in the way of resilience and carbon emission reductions. There were over 2,000 mini-grids on the continent in 2018. However, the available funding sources for mini-grids are mostly limited to donors and developmental finance institutions (DFIs) — notably, private financing is rare. According to USAID, private lenders are partial to the lower apparent risk provided by on-grid rather than off-grid investments. The increased risk causes these private lenders to charge interest rates too high — 15-20%, as reported by the Rocky Mountain Institute — for most potential mini-grid projects to be economically viable.
Green Aggregation Tech Enterprise, a 2018 Global Lab instrument, a risk-pooling initiative aimed at removing barriers to private investment in mini-grids, was conceived a few years ago by Felix Brand (from Lion’s Head Global Partners), Ana Hajduka (Africa GreenCo) and Tinashe Makoni. The three proponents — Brand is an off-grid finance expert, Hajduka is a renewable energy finance entrepreneur, and Makoni is an experienced energy and Africa transactions lawyer — aim to prepare off-grid energy financing for a self-sustaining future in Africa that involves all types of funding, including commercial lending.
How Would GATE Work?
Why might a commercial investor consider mini-grids, particularly in Africa, an unattractive investment opportunity at present? The associated risks — from currency risk to regulatory risk to revenue risk — are significant. As a result, forecasting revenues and conducting diligence proves difficult for potential mini-grid investors. “The concept of GATE,” said Brand, a director at Lion’s Head Global Partners, “is to ensure to commercial lenders that there is some minimum level of revenue that they know will be sufficient to service their debt.”
GATE aims to target specifically revenue risk by addressing the implicit demand risk, resulting from the lack of data on mini-grid-level energy demand in sub-Saharan Africa, and payment risk, resulting from the lack of credit history for most customers on the continent that would use mini-grids. Imagine a mini-grid is built, but consumers’ energy demand was overstated — the grid is not making as much money as expected. The mini-grid company then faces a shortage of revenue, inadequate to compensate its lenders. Not only is the company in trouble, but investors are de-incentivized from investing in similar assets.
GATE promises to secure compensation for investors in such grids, opening up a pathway for commercial capital to safely enter the world of mini-grids in sub-Saharan Africa. To mitigate demand risk, GATE would provide revenue guarantees for mini-grids. Mini-grid operators would pay GATE a premium, and if a mini-grid’s revenue fell below the guaranteed threshold, GATE would pay the developer the difference between the actual revenues and the guaranteed threshold. The concept and structure of the GATE instrument is still being validated, with other forms of protection for commercial lenders being considered.
Last year, GATE was selected as one of the Climate Finance Lab’s class of promising early-stage investment vehicles poised to lead the transition into a low-carbon future. GATE’s proponents are currently working on establishing a framework to demonstrate proof of concept. Seeking partnerships and discussing the concept with DFIs are also on the agenda.
By collecting premiums from a diverse set of mini-grids, GATE’s portfolio could support the entities that end up facing revenue shortfalls. Investors would not have to worry about the possibility of a mini-grid being unable to fulfill its debt obligations.
Why Is GATE Important?
Commercial capital is a necessary, but difficult-to-obtain source of funding for mini-grids. Donor and DFI financing have proved immensely beneficial for both grid and off-grid power, but such capital has its limits. “DFI and donor budgets are finite,” said Felix Brand, “nowhere near big enough to reach universal electrification.”
According to a 2019 International Renewable Energy Agency publication, the mini-grid sector attracted $81 million of investment worldwide in 2018. But to achieve universal energy access by 2030, the mini-grid sector requires over $10 billion of investment per year, as reported by the International Energy Agency.
Experts seem to agree on the importance of increasing private financing. In 2015, PricewaterhouseCoopers conducted a survey of African power industry experts. By and large, the survey participants indicated that the most significant barrier to electrification in Africa is funding. With governments facing financial constraints and commercial banks from outside the continent facing an unfamiliar regulatory environment, electrification may depend on stimulating private investment in the African power sector. A vast majority of survey participants also agreed that the role of private sector will grow in the future.
Additionally, the Center for Global Development has laid out several difficulties that mini-grid developers face. In addition to low levels of financing, they must deal with a lack of nearby expertise and capacity and a lack of knowledge about energy consumers. GATE addresses the financing issue, but also aims to tackle the knowledge challenge; the guarantor would also gather data from mini-grid customers, which could be used to create accurate profiles of energy users and allow developers to more accurately assess the revenue-generating potential of a mini-grid.
Finally, under-electrification constrains economic growth. If GATE can help accelerate electrification in sub-Saharan Africa, it might contribute also to faster, more stable growth for the region.
What Would Success for GATE Look Like?
According to Brand, the key problem GATE could address is “commercial capital being unable to look at mini-grids as an asset class.” If the project is successful, mini-grids could become a far more common investment.
Right now, GATE is focusing on Nigeria, where several potential local lenders are already established, as a possible starting platform. Other pilot markets being considered include Kenya and Zambia. Additionally, the team has been in conversation with insurers and financial institutions to further develop the idea.
In moving forward, the initiative faces a few challenges. One, according to Brand, is that “GATE is trying to bring scale to the sector, but GATE also requires scale in order to succeed.” Additionally, dealing with local regulatory frameworks and finding suitable currency risk management solutions will be sources of discussion as progress continues. The affordability of power is also paramount — GATE proponents say they are working to ensure that alongside continued grant funding, a holistic financing package can be found that results in no or minimal increases in end-user tariffs despite the added cost of a premium payment.
GATE, too, would likely rely on donor and DFI capital in its initial stages to fund its operations. With diversification and risk pooling, however, the guarantor could obtain a credit rating. A rating would allow GATE to start leveraging its capital multiple times over to build further scale — this would increase returns, helping GATE to raise commercial finance itself.