Most mini-grids require some kind of grant or subsidy to be economically viable. These grants are typically for technical assistance or capital expenditure (capex), for example for mini-grid construction, connections or productive use appliances.
The grants and subsidies may be structured in different ways:
Up-front payment of grants or subsidies;
Public investments, usually in mini-grid distribution assets;
Payments based on outputs or results (results-based finance or RBF);
Competitive tenders, which include a public investment or grant element (the Pre-Developed Mini-Grid Tender or PDMGT);
Tariff subsidies to bridge the viability gap; and
Repayable grants which are repaid prior to distribution of dividends or sale of assets.
The grants and subsidies may be given as one-off subsidies for capex or ongoing tariff or operating expenditure (opex) subsidies. Funders need to calculate the overall cost of the support. For example, tariff or opex subsidies may not be feasible without cross-subsidies from grid-connected customers or taxpayers. Funders also need to consider the position of private investors. They tend to prefer upfront capex subsidies and may be reluctant to invest if they have to rely on potentially risky, long-term tariff payments from developing country governments.
The grants and subsidies, together with other regulatory measures, are designed to catalyse equity and debt investments in the mini-grids. However, further support is likely to be necessary in the form of concessionary loans (single digit rates if possible), longer-term loans (to allow time for demand to build up and to match the project payback period, which may be 7-15 years), local currency loans (reflecting the fact that the revenues are in local currency), and guarantees to de-risk projects. Another option is to index local currency tariffs to hard currencies, but this needs to be reflected in the tariff regulations.
Mini-grid tariffs are a highly sensitive political and social topic. The costs of generating, delivering and selling a unit of electricity to a remote mini-grid customer are much higher than those for a customer connected to the main-grid. However, unlike national utilities, there is limited scope for stand-alone private mini-grids to have cross-subsidies between urban and rural customers. As a result, they have to charge much higher tariffs than the main grid, which will limit demand if the tariffs are not affordable or acceptable for rural customers.
That is why financial support is important. The level of support should be high enough to make projects viable for investors and affordable for end users, while not too high, or broad in focus, that it crowds out private capital. The support should be flexible enough to meet the changing needs of developers, and easy to manage to keep down transaction costs. Ideally, grants and subsidies should also be available for expansion of existing projects (including hybridisation of diesel mini-grids), as well as for developing new ones.
Over the last few years, new capex subsidy models for mini-grids have been adopted. Revenue-based financing (RBF) is a tool that gives money to mini-grids based on certain milestones being met. It typically provides a fixed grant per customer connected to the mini-grid, with the amount depending on the quality of the connection. Under this scheme, mini-grid developers are in charge of selecting the sites, acquiring all permits and licences, establishing contact with the community, designing the system and implementing it. They may also need to raise bridge finance to cover the period before the RBF is paid out.
Under a PDMGT, the mini-grid sites are usually selected by the public partner of a Public Private Partnership (PPP), which also develops the project up to a certain level. This may include everything from demand assessments, the acquisition of permits and licences, and local community awareness campaigns, all the way through to partly or fully installed mini-grid systems. The private investor bids based on a proposed quality of service, business model and references. Tariffs are usually not one of the bidding criteria because they are set by the regulator based on tariff calculation methodologies after all cost have been projected or audited.
Mini-Grid Policy Toolkit: Policy and Business Frameworks for Successful Mini-Grid Roll-outs (2014)