1 5 1 \ | | __ V - ' - - ~~~~~~~~~~~No.1 5 THE WORLD BANK Oct 1998 Financing Decentralized Renewable Energy: New Approaches Douglas Barnes, Karl Jechoutek, and Andrew Young 26344 Renewable energy is a feasible technological The message is becoming clearer; success takes option in sustainable energy. Rusting monu- time and demands the patient laying down of an ments to past failures attest that this institutional groundwork to support innovative "autonomous" technology must operate within a delivery mechanisms. frame of sustainable energy development where - many systems interact - the power sector, finan- F' cial markets, social systems, institutional struc- tures, policy frameworks, business climates, _ political environments, service infrastructures, I X cultural settings and so on. In the matter of financing renewable energy, a novel approach is needed. Unique financial instruments are required to complement new scale economies, cost profiles, risks, and benefits. The World Bank Group is reflecting that shift in perspective - ;* through its new renewable energy operations, the Solar Development Corporation, the Renewable Energy and Energy Efficiency Fund, - 2' E and other mechanisms. At the sectoral level, _ sustainable renewable energy development - demands a return to basics. Sound sectoral reform and rational incentives are necessary to make the power sector a friendly environment for renewables. It is in these areas that the World Bank can make its most important contribution Community biogas digester providing methane to run an electricity generator for lighting and water supply in a villoge to sustainable energy. neor Bangalore, India. The World Bank Group * Energy, Mining & Telecommunications * Finance, Private Sector and Infrasturcutre Network Douglas Barnes is an Energy Plannler in the Energy, Mining and Telecommunications Department of the World Bank. He joined the Bank in 1988 and has worked in the areas of energy and poverty, renew- able energy rural energy, and household energy. He is a Task Manager for ESMAP projects such as; India Rural Energy Study, India Urban Energy Study, Benefits Assessment of Rural Electrification, and Best Practices in Rural Electrification. Karl Jechoutek is Senior Advisor in the Energy, Mining and Telecommunications Department of the World Bank. He joined the Bank 1977 as Energy Economist in South Asia, where he task-managed rural energy projects. Since then he has held a variety of Bank positions including that of Sector Manager in the Energy Mining and Telecommunications Department. kI Andrew Young is an Operations Analyst in the Energy, Mining and Telecommunications Department. men 2 Financing Decentralized Renewable Energy: New Approaches Lessons Learned Commercial banks in developing countries can be The poor are willing and able to pay for reliable an important constituent in the sustainable "mix" energy services. This is the kernel of decentral- of supporting infrastructure for renewable energy. ized renewable energy's prospects for financial But these potential partners are risk averse, and success in the developing world. To date, the therefore require specialized training, persuasion, biggest market for solar photovoltaic (PV) equip- and risk sharing to equip them to support renew- ment has been government and donor programs, able energy development. Greater financial which are typically equipment-oriented, short- sophistication is needed to enhance energy ser- lived, and undermine the private sector. Give- vice, choice, and access in rural areas. Capital away programs and market distortions lower the markets should be capable of providing a broader value consumers place on a product or service, base of financial resources that respond to the and extinguish the incentives for local entrepre- needs of rural electricity services markets. In neurs. To avoid this, governments, donors and Indonesia, the World Bank/Global Environmental the private sector must work together to ensure Facility's Solar Home Systems (SHS) Project is coherent, market-expanding interventions which helping to establish a means to provide loans to complement a country's rural development strate- buyers of SHS equipment. It is anticipated that as gy. Any planning process should be demand dri- experience and confidence grows, banks will be ven, transparent, and governed by practical eco- willing to accept an increasingly large share of nomic considerations where meeting basic needs accounts receivable as security, and that second has first call on scarce resources. Life-line ser- tier lenders will buy off these accounts receivable. vices for the poorest are also important, but spe- cial attention is required to create market incen- Appropriate legal infrastructure and enforcement tives for equipment care and rational energy use. mechanisms are also essential if renewable ener- gy businesses are to thrive. Legal mechanisms Renewables have become an increasingly viable must protect the viability of credit, businesses, business in the 90s. Consumer's willingness to and foreign investment, and safeguard the rights pay for lighting services has been the factor sus- of all players in the market. An effective, fair taining their expansion in the fastest growing legal framework lowers risks and their associat- markets. Credit for renewable energy is an ed costs for everyone. unknown concept in many rural areas, so credit channels must be developed in parallel with Renewable energy development should be inte- development of projects in order to tap the full grated with energy strategies and reform efforts to potential of rural markets. Delivery networks to support economic efficiency and development connect rural consumers are also vital-Kenya, effectiveness. Power grid expansion plans must the Dominican Republic and South Africa are be credible, transparent, and public to allow exceptions among developing countries in having remote power markets to respond effectively. this infrastructure. It has also been observed that Vacuous government promises of future grid nascent renewable energy businesses can more electrification thwart the renewable energy mar- easily take root in already thriving retail networks ket as do low (often subsidized) energy prices that not least because the latter absorb some fixed dis- favor conventional energy, or very high import tribution costs. duties on renewable energy equipment. Energy Issues 3 1i-~~~~~ 'A -~~ _ |- *m.f Solar PV panels 1 ; 1 . providing elec- I j . i , . tricity to a small i I . J I 4 1l r community in * I i I | s , s Gujarat, India. Good power sector reform is good renewable World Bank Strategies Respond energy development policy. The interplay to Change between renewable energy and energy sector Two recent World Bank papers reflect the reform can be mutually enriching in well changed emphasis of the Banks Groups' strategy. designed projects. Renewable energy, because it Local and global environmental concerns, falling is modular, less sensitive to scale economies, and costs, accumulated field experience, and new decentralized, is well suited to private invest- economic renewable energy applications have all ment and can serve as a base from which to been catalysts in shifting our approach. Fuel For implement reform. In Cape Verde, for example, Thought, the draft energy and environment strat- a World Bank financed solar electrification and egy paper for the Bank Group is introducing addi- wind power loan is helping to lead the reform tional commitments to the institution's work. process and introduce the private provision of Sectoral-level energy and environment reviews energy services in rural areas. Off-grid electrifi- will be undertaken as an advanced planing tool to cation concessions will be awarded to private guide energy sector development along the most sector entities and the public sector role will be efficient and environmentally sound path. The that of a customer, for example, as purchaser of Bank Group will mainstream environment- public lighting services. friendly technologies and practice into its opera- tions, and will apply new lending mechanisms to 4 Financing Decentralized Renewable Energy: New Approaches maximize learning and mesh the imperatives of * Implement good sector policies. Macro- new energy options with the financing required economic policies should not discriminate for their success. The Bank will improve analy- against rural energy. Governments should sup- sis standards for environmental problems, and port markets. monitoring of projects aimed at solving them. Climate change mitigation will gain a stronger World Bank Financing Options mandate, and the Bank Group will cultivate new For Renewable Energy Finance partnerships to address this issue. To help put The unique challenges of renewable energy have these objectives into practice, the Bank Group given rise to new Bank Group financial instru- will improve its specialized skill base in energy ments designed to lower transaction costs and and environment development, barriers to market entry, spread and absorb risks, build service networks in rural areas, and develop The approach set out in the World Bank's Rural specialized skills to manage local businesses and Energy and Development; Improving Energy credit mechanisms. Supplies for Two Billion People emphasizes a commitment to alleviating energy poverty and The Global Environment Facility (GEF) is one improving the quality of life in the rural develop- such instrument. It backs investment projects that ing world. This strategy is based on a number of provide global environmental benefits and local principles, development gains for developing countries. In the case of climate change, the GEF provides * Provide for consumer choice. A better choice roughly $1 billion in well-leveraged grant financ- of renewable energy sources should be provid- ing to mitigate greenhouse gas emissions. One of ed to rural consumers. Informed consumers the main focal points of this component is lower- will choose the most effective solution accord- ing barriers to the success of renewable energy ing to their own preferences. and energy efficiency technologies. * Ensure cost effective pricing. Distortions in The Solar Development Corporation (SDC) prices that are created by subsidies and taxes which is being established by the World Bank, the should be eliminated. They create a disincen- IFC, and four major foundations is a very differ- tive for entrepreneurial solutions to rural energy ent financing mechanism which is intended to supply, and give consumers the wrong signals. become a free-standing, commercial enterprise. Its primary objective is the development of * Overcome the high first-cost barrier. Credit viable, private sector business activity in the dis- mechanisms, lower-cost equipment, and lower tribution, retail and financing of off-grid PV service standards can all contribute to remov- applications in developing countries. ing this obstacle. The Energy Sector Management Assistance * Encourage local participation. Participation Program (ESMAP) is a global technical assis- of local communities, investors and consumers tance program jointly sponsored by UNDP, the in the design and delivery of energy services is World Bank and bilateral donors. ESMAP activ- essential. Decentralized approaches need to be ities have substantially expanded the range of part of the solution. renewable energy investment operations entering Energy Issues 5 the World Bank's project pipeline. They have sector renewable energy and energy efficiency in introduced innovations in renewable energy lend- developing countries. Now in fund-raising mode, ing such as the solar PV concession systems for the fund will provide $150-210 million of private Argentina. ESMAP-financed micro PV lantern and IFC capital for financing on/off-grid projects demonstration projects in Africa are successfully of less than 50MW. attracting private sector provision of energy ser- vices to the very poorest consumers. The Photovoltaic Market Transformation Initiative (PVMTI) is now in its first stage of The Asia Alternative Energy Program operation by IFC. This $30 million GEF fund (ASTAE) was established in 1992 to promote will be used to accelerate the growth of PV mar- renewable energy and energy efficiency in the kets in India, Kenya, and Morocco by providing World Bank's power sector lending operations in leverage to private companies on a competitive Asia. Since its inception, ASTAE has supported a basis. broad portfolio of alternative energy projects and activities throughout Asia. The cumulative Finally, the Small and Medium Scale pipeline of ongoing and prospective alternative Enterprise Program (SME) is a $21 million energy projects (FY93-00) is about US$1.2 bil- activity of IFC supported by GEF. It finances lion in 31 Bank/GEF loans and grants in 10 coun- biodiversity and/or climate change projects car- tries. Renewable energy projects will involve the ried out by small and medium scale enterprises in installation of over 0.7 GW of environmentally GEF-eligible countries. Contingent, concession- sustainable electricity generation capacity, while al loans are provided to financial intermediaries ongoing and proposed energy efficiency projects (FIs). These FIs then finance the SMEs. Two PV will offset more than 0.8 GW of capacity. projects and one efficiency project have been approved to date. A post-Kyoto financing option, the Prototype Carbon Fund (PCF), is also under preparation New Approaches to Rural Renewable by the World Bank. The PCF will be similar to a Energy Delivery closed-end mutual fund. Its objectives are to sup- The traditional failed approach to promoting ply high quality carbon offsets at a competitive renewable energy is well known. A donor con- price, and to ensure that buyers and sellers of off- tacts a government with a proposal and money; sets receive a fair share of the value added. The the government selects recipient communities negotiated price of the carbon offsets would cover and the contractors; the contractors provide the cost of additional emissions reductions mea- installation and perfunctory training and then sures over the baseline technology as well as a return to the capital city; and the unserviced, margin representing equitable benefit sharing undervalued equipment fails or is sold. However, between the investor and host, of the gains from new strategies and modest successes have risen the offset. Final approval of the Fund will depend from these past gaffes. on the pace of the post-Kyoto discussions. In the new, market-oriented approach to RE The IFC's Renewable Energy and Energy development, consumer-side financing has gener- Efficiency Fund (REEF) is expected to be the ally depended on some form of cash sales, credit first global fund dedicated to investing in private provision, leasing, or fee-for-service. Such 6 Financing Decentralized Renewable Energy: New Approaches financing plays an important role in the develop- the provisions of their contract. Concessionaires ment of viable renewable energy markets, but this will be provided with partial financing of their is only one part of connecting consumers with start-up costs through the project. needed energy services. The small electricity retailer model is a new, com- Renewable energy development has grown in munity-based approach to renewable energy sophistication over the last decade and three com- delivery employed by the World Bank in projects mercial models (classified by intermediary) for for Sri Lanka and Laos. Under this model a com- delivering rural energy services have emerged. munity, organization, or entrepreneur develops a The dealer model is perhaps the most well- business plan to serve local demand for electricity. known, and depends on either cash or credit The plan is submitted to the project's offgrid elec- based sales. In Kenya, the market developed trification Committee and if approved, a loan is when PV dealers began selling systems through given. The retailer deploys the system and through existing small rural sales points such as general a fee-based service arrangement recovers the cost, stores. Now more than 100 thousand households repays the loan, and earns a profit. This approach use PV systems, usually purchased piece by piece ensures significant local involvement and con- and in low watt increments (12 watts is almost sumer choice. In this, as in the other models being standard) that lower the first-cost barrier. The pursued, a challenge is to keep transaction costs dealer model is also being pursued in the from escalating and to realize scale economies. Indonesia World Bank Solar Home Systems Project, although in this case, sales are credit Conclusions-the Right Mix based i.e. first costs are lowered and deferred Twenty years of experience with renewable ener- through a credit mechanism arranged for cus- gy development offer a simple but important mes- tomers by dealers through the banking system. sage;-there is no magic fix for the challenge of renewable energy finance. Responding to the The concession model for PV system delivery challenge involves patiently cultivating the right employs a very different set of incentives and is mix of supporting institutions, reforms, policies, characterized by a different risk profile. The markets, and infrastructure, based on the country model depends on regulation by contract more and circumstance. than market forces, but helps ensure that large scale-economies are achieved. In Argentina, for For renewable energy to succeed, broad institu- example, franchise rights for rural service territo- tional groundwork is needed including-good ries will be granted to concessionaires that offer pricing policies, efficient power sector manage- bids with the lowest subsidy to service rural house- ment, viable lending institutions, credible regula- holds and community centers. Concessionaires tory policies, and solid legal frameworks. can select from a range of off-grid technologies, Success will also depend on conducive frame- although solar PV is anticipated to be the most works for market and investment growth. cost-effective choice in the majority of cases. Renewable energy development must be Users pay a connection tariff and monthly service approached from a systems perspective because fee (set by the government), and a declining sub- it both contributes to and depends on the sidy is provided to the concessionaires based on effectiveness of the entire development process. Energy Issues 7 The greatest contribution the Bank Group can * removing price distortions make is in its policy and institution strengthening efforts. With these the Bank creates an enabling * instituting frameworks for credit, investment environment for renewable energy by: and capital market development * establishing rational, efficient reforms in the * promoting policy, institutional and technical power sector capabilities in developing countries 8 Financing Decentralized Renewable Energy: New Approaches Energy Issues is published by the Energy, Mining and Telecommunications Sector Family in the World Bank. 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