East Africa: An emerging microgrid hub

A report by TFE Consulting predicted that the global microgrid market might be worth $400 billion. In their report, “Kenya: The World’s Microgrid Lab,” lead authors Sam Duby and Tobias Engelmeier estimate the Kenyan microgrid market could reach 2,000 – 3,000 microgrids by 2021, up from the 65 microgrids between 5 and 100 kW currently operating. Sustainable Energy for All predicts that Africa will contain 35,000 microgrids – demonstrating the technology’s role as a key provider of electricity access. Recent policy changes and funding programs have increased developer and investor interest in the market, as governments in east and west Africa have created policy for issues such as tariff setting and the arrival of the national grid. Governments have also put in place subsidy schemes to get microgrid projects off the ground.

Sam Duby, the Africa Director of TFE Consulting, told pv magazine: “Slowly national governments are waking up to the opportunity microgrids provide. The sector is a true win-win-win scenario providing economic, social, and environmental benefits. Microgrids are a way for citizens to see their governments working for them.”

A lack of financing remains one of the key challenges in the microgrid market, though this lack of financing is in part due to the industry’s nascent stage.

Alexia Kelly, CEO of the Microgrid Investment Accelerator (MIA), a new energy access financing facility that is raising its first round of investment, explained that “the main challenges that developers face in obtaining financing are microgrid’s size and scale, tight project economics, merchant business models, and a lack of proven deployment track record.”

Microgrids offer the ability to provide grid-quality power in villages that cannot be economically serviced by the centralized grid.

Project size and scale

The relatively small size of many microgrid projects makes them difficult to finance through traditional donor funding mechanisms.

Kelly of MIA illuminated this point by saying, “The average microgrid we see across our target markets of India, Indonesia, and East Africa is around 29 kW, providing electricity to 200 households with a capital expenditure of approximately $150,000. Accessing concessionary capital though large development finance institutions (DFI) is nearly impossible for developers, as DFIs are looking for investments of no less than $5 million. The whole microgrid market operates at a scale that is too big for microfinance, but nowhere near the size of traditional donor financing.”

To better overcome the problem of size, MIA plans to aggregate microgrid projects to provide investors with pools of projects. For developers, MIA will combine donor and impact investor capital to provide more favorable investment terms. MIA is aiming to provide developers with long-term, patient debt with interest rates between 9% and 12%, and debt terms of 7 to 15 years.

Eventually, MIA will pool projects across developers and regions. In the early years, they will finance the project pipelines of individual developers, as is happening in the solar home system market. Mobisol, a solar home system company, recently announced an eight figure debt facility with ResponsAbility, a financing company focused on the developing world.

Enhancing project economics

Despite the best efforts of financiers to better meet the needs of microgrid developers, if project economics don’t work, nothing will be built. As developers gain experience, best practices for creating commercially viable off-grid microgrids are emerging.

Having some sort of commercial load is a must. Residential customers often do not buy sufficient amounts of energy and are unable to pay high enough prices to be the only customers on a commercially viable microgrid. Anchor tenants or commercial customers within the village that buy large quantities of electricity enhance project profitability.

A joint white paper with Vulcan Impact Investing, a microgrid developer, and SteamaCo, smart metering company, finds that the top 10% of ­customers generate 40% of their microgrids’ revenue and purchase around 50% of the power.

To increase commercial activity, developers should foster entrepreneurial efforts within the villages. Duby of TFE Consulting said: “Often the most profitable village businesses are the ones developers don’t expect. One of the unexpected findings we had from all the work we did in Kenya, for example, was just how profitable hair salons were.”

In addition to fostering local entrepreneurship, developers are also testing models that rent access to appliances and equipment. The up-front cost of many appliances remains a barrier to villagers. Certain equipment may not be fully utilized by a single family to justify a purchase; however, if developers finance the equipment and sell access to the Internet and computers, power tools, or cooling at a communal refrigerator, the developers can diversify their revenue streams and provide the community with greater access to productivity-enhancing equipment. Trey Jarrard, CEO of Renewvia, a U.S.-based microgrid developer, told pv magazine that in their “microgrids near Lake Victoria, [they] have focused on providing water pumping and treatment as well as ice making and cooling services for the fishing communities. The access to refrigeration will keep the fish cool and allow villagers to get a higher price for their catch.”

Beyond business model innovation, a critical part of project viability is appropriately sizing the microgrid to meet local electricity demand. Ensuring the microgrid is being fully utilized is made more challenging by the lack of information on customer usage and repayment.

In fishing villages, like Mageta Island in Kenya, electricity from microgrids can power ice making and refrigeration to preserve the catch providing fisherman with higher prices and reducing food waste.

Customer engagement

If developers overestimate the demand for electricity, they will have expensive equipment sitting idle. If they underestimate demand, they cannot provide adequate service and must resort to rationing electricity or suffer chronic brownouts and blackouts.

That is why Andrew Githaiga, Head of Regional Lending in East Africa at Sunfunder, an off-grid solar finance business, always checks to see if the developer has done a proper feasibility study.

Developers need to effectively engage with the community to ensure their model will work with local customs. Each village is unique and while it is expensive to do a project design tailored to each village, the cost of not understanding the nuances of the village is even more costly.

Duby of TFE Consulting emphasized this point. “Microgrid developers need to be wary of applying a one-size-fits-all, blunderbuss approach. The way communities behave is hard to predict. I have seen situations where villagers on one island preferred buying bundles, essentially larger volumes of electricity at a lower price; whereas, villagers on another island a few kilometers away were uninterested in the idea and preferred to buy power in tiny increments. The social and environmental conditions were nearly the same in each island, but their service preferences were not,” he said.

Limited project data

Limited project-level information across the industry presents a challenge to investors conducting due diligence. There are not enough projects to represent an industry standard for project costs and revenue assumptions. The shortage of project data is in part caused by the small number of off-grid microgrids and their short operating lifetimes.

“As a debt facility, we are looking for several years of operating experience across several projects,” said Githaiga of Sunfunder. The firm’s expectations are not unusual for investors, although they do present a sort of catch-22 for some developers. A developer needs financing to deploy projects, but to get financing, investors need a track record of operating projects. This is where equity and grant financing comes into play, and where MIA hopes to play a catalytic role in the market.

“MIA is positioned to take early developer risk and is committed to bringing along the next generation of entrepreneurs that are going to enable the microgrid market to scale,” Kelly of MIA notes.

Government support

The Green Mini Grid (GMG) subsidy program supported by the British and French development agencies has played an important role in providing much-needed support to the microgrid sector in Kenya and Tanzania. The GMG subsidy is a form of results-based financing where developers must reach certain milestones – like finishing construction of the microgrid – before subsidy payments are dispersed.

In Kenya, the GMG facility will soon be eclipsed by a new $150 million World Bank program called the Kenya Off-grid Solar Access Program (KOSAP) that will finance microgrids as well as standalone solar home systems in the north and northeast of Kenya. The KOSAP facility will provide a combination of results-based subsidy and debt financing.

Sunfunder is in the process of vetting microgrid developers to provide short-term bridge financing to meet the milestones in the GMG program. If a developer doesn’t have enough equity to reach a milestone, the developer may rely on a Sunfunder bridge loan.

Renewvia is developing 82 projects across Kenya, Nigeria, and Uganda. Renewvia was an approved U.S. contractor to receive grant funding from the U.S. Trade and Development Agency to perform feasibility studies for 33 microgrids. In Kenya, they are choosing to finance their first few projects with equity to demonstrate to lenders their ability to successfully implement projects. Once lenders see them finishing projects, the lenders will be more open to financing the remaining projects.

Transparent policy

Beyond providing a project subsidy, governments can better clarify policy in three key areas: tariff setting, the arrival of the national grid, and permitting. The big economies in East Africa – Kenya, Tanzania, and Uganda – all allow microgrid developers to set their own tariffs, though Kenya and Uganda lack clear policies on what will happen when the grid arrives. Uganda is unique in its slow permitting scheme. The 2016 Regulatory Indicators for Sustainable Energy report from the World Bank said it can take more than two years to set up a microgrid in Uganda.

Having the freedom for developers to set their own tariffs is critical to creating commercially viable microgrids. Given the high interest rates and short loan durations that microgrid developers face, microgrid tariffs will be higher than national tariffs in the short to medium term because of developers’ need to aggressively service debt.

Duby of TFE Consulting remarked that “tariffs are also higher than national rates, as national rates are often subsidized by governments, whereas microgrids are not. Another key point is that people are usually willing to pay more for electricity in rural areas, particularly if it is offsetting other forms of energy like kerosene or candles.” Research by Vulcan Impact Investing found that certain villagers were willing to pay up to $4/kWh for electricity demonstrating how valuable electricity is to those without access.

Microgrid developers need approval from national regulators on their tariff levels. What is less clear in Kenya, is how long those tariff levels will last. Having a tariff lifetime longer than three to five years is essential as investors may be scared off by the need to seek more frequent approval for tariff rates.

If tariffs needed to be approved more frequently, the government would need to transparently explain the tariff setting process and stick to that process to allow developers to access finance.

Having clear policies on what happens when the national grid reaches a microgrid is almost as important to tariff setting. Without a clear delineation of a microgrid’s rights, the arrival of the national grid risks making existing microgrids a stranded asset. There are different ways to set this policy such as providing microgrid operations an exclusive license to operate or having grid operators purchase the microgrid at a predetermined valuation when the national grid arrives.

Even if the government sets clearer policy, the uncertainty around how that policy will be enforced remains a persistent risk. Jarrard of Renewvia explains, “While the laws have been put in place, we are still waiting to see how they will be enforced.” Especially for policy around the arrival of the national grid and enforcement of exclusive service area concessions, microgrid developers and investors may need to wait several years or decades to see how that policy works out in practice.

The more clear and transparent the policy and the more uniform the policy enforcement, the lower the risk to the developer and the greater their access to finance.

As policies improve, new funding models are deployed, microgrid developers break ground, and the industry builds momentum. One sign of this momentum is the newly formed Africa Minigrid Developer Association (AMDA).

In the words of Sam Slaughter, CEO of PowerGen Renewable Energy, a microgrid developer, and a member of the AMDA, “AMDA provides a unified platform of some of the most experienced players in the sector who are trying to get the word out on how powerful a tool private utilities can be for solving energy access challenges in Africa while also building the smart grid of the future.”

Author: Dustin Zubke