The challenges faced by rural electrification funds

René Massé

Rural electrification funds (REF) serve as intermediaries between the institution financing these funds and the beneficiaries of their services, the rural electrification operators, and even credit institutions. Therefore they have to be set up in a way that enables them to respond quickly to the evolving needs of the operators and the banks and to the requirements imposed by donors.

The following is a non-exhaustive list of the challenges the REF face:

1. Constraints imposed upon REF by donors

Apart from basic requirements like good management and transparency, the international financial institutions have specific requirements regarding REF, notably:

• Control of financial flows

International financial institutions demand the traceability of the funds they grant as well as precise reporting on the progress of their financial commitments. The Global Environment Facility (GEF), for example, only finances programs that implement renewable energies. Other institutions of bilateral cooperation may require that the funds given to REF are only used for electrification in a specific region. The procedures of involvement, follow-up and reporting must therefore allow and guarantee this traceability.

• Avoid the dependence of concessionaires on Subsidies

International financial institutions (IFI) fear to start on a process which might entangle them in ever multiplying financial needs of a RE development program. In particular, when it comes to subsidizing a RE program, they take care that the way the RE program is financed does not leave the concessionaire in a situation of dependence on subsidies. The sustainability of access to electric services in rural areas must in the long term be based on the commercial viability of the business of RE services.

The REF will be able to, for example, I) provide subsidies only for partial financing of investments, II) reduce the share of investment subsidies for already established concessionaires, or III) require conditional repayment of the subsidy when the exploitation of the RE service becomes durably profitable.

• Ensure the continued existence of the resources of REF

The need for financing by the REF will persist, especially as for some rural areas, electrification may be particular difficult and expensive. From the start of the REF, it is important to think about possible new financial sources that can supplement the initial donors.

The REF may, for example, I) seek the involvement of the local banking sector, by implementing a partial guarantee to share their risk, II) envisage total or partial repayment of the subsidy for the investment, once the RE exploitation is durably profitable. International financial institutions in particular will be sensitive to whether there is lasting support on the national level: for example, a tax on kWh levied on the customers of the national grid, will be a very positive signal for these IFI even if it will not raise that much money during the first few years.

2. Constraints imposed on REF by the financial needs of rural electrification operators

Rural electrification is not a profitable market for the private operators; therefore these public programs have to be subsidized. However the procedures of allotments and payouts of these subsidies will have an impact on the type of operator and the sustainability of the business. This is why it is important from the conceptualising of the REF onwards to take into account certain constraints that the operators will be familiar with over the course of an RE endeavour. The following list of constraints is obviously not exhaustive.

2.1. Reconciling financial resources and spending of concessionaires

Throughout the establishment of an electric business venture, the RE concessionaire will need to spend (“Spending” in the illustration) successively to pay for the preparation of the offer, the technical studies, the promotion of electric services in the villages, the consultations of suppliers and subcontractors; then, he will pay a first instalment of equipment cost when the supply contracts are signed, then make an intermediate payment, and a last payment when he finally receives the installations.

In the face of this schedule of costs, the concessionaire has to have financial resources ("Resources" in the illustration) at his disposal: the REF will ask him to first use his own funds before he will be able to use the subsidies (in tranches). However as an important part of the subsidy (22.5%) will only be paid out to him after he has connected all the customers (in accordance with the Output Based Aid procedure– OBA) and the direct contributions of the customers (5%) will only be made once the supply with electricity is working, the concessionaire will lack the funds to manage the last two payments… If the concessionaire is a large international company of the energy sector, it will be able to pay the advance from its own capital, or even arrange for a short term loan from a commercial financial institution. But if the concessionaire is a small local company, it is likely that it will be able neither to self-finance nor to borrow the resources needed to bridge the gap.

If the REF does not want to marginalize national companies, it has to find a solution to make the resources correspond with the spending needs, throughout the construction phases of an RE venture. Therefore the REF has to involve itself closely with the financing plan and establish financing tools that are adapted to the volume, but also to the schedule of costs.

2.2. Financial needs during construction

It is important to look at the precautionary measures taken before the investment subsidies are paid out and the financial contributions of the customers are released.

• OBA (Output Based Aid) procedures: this measure has been imposed by the donor community to ensure good and proper use of subsidies. The reason for public authorities to subsidize RE programs is to have a certain number of clients supplied with electricity, and not simply to have a power plant and an electric grid constructed in a rural area. In other words, they do not subsidize the infrastructure, but the beneficiaries of electric services. To avoid any form of misuse, they have decided to only pay out a certain part of the subsidy after having verified that the consumers are effectively supplied with electricity, in a suitable quantity. As has previously been mentioned, as a matter of fact, this procedure requires the concessionaire to self-finance this part of the subsidy. This may discriminate against small companies, particularly national ones that do not have sufficient cash flow to self-finance and are ineligible for bank loans. The majority of REF have taken this into account by proposing a schedule for the payout of subsidies that corresponds more with the schedule of investment expenses of the RE concessionaire.

• Securing the deposits of the customers: upon signature of their contracts, customers have to pay a deposit intended to contribute to financing the RE investment. For reasons of security, the deposit (making up 5% of the total cost of investment) is blocked by the REF until the installations are finished. Just as with the OBA procedure, this constraint forces the concessionaire to self-finance this amount to finalize the investment, before he can benefit from subsidies. For the small concessionaires, who cannot depend on a contribution from shareholders, the REF can facilitate access to a bank loan by, for example, providing guarantee funds for lending institutions, or offering interest rate subsidies for construction bank loans (short-term bridgeloan).

2.3. Covering risks of delay or non-completion of construction

It is also important to anticipate a possible failure of the concessionaire before the service becomes operational, as well as overspending or any delay. Whereas in principle this falls into the concessionaire’s responsibility, as the REF is also involved in the operation, it has a vested interest in the success of the venture, and is thus defending the public interest.

The REF can set up an appropriate tool, for example a reserve to cover the risks of non-completion of construction. It can also encourage the banking sector to grant short term loans for construction by offering a guarantee to share the risks with them. It can finally insist in the concession contract that the shareholders of the RE concessionaire should cover possible construction costs that go beyond the original budget.

2.4. Sustainability of the installations

The continuity of electric services depends on timely maintenance and repairs of the equipment. Often the concessionaire has not reserves to buy spare parts when necessary or to replace equipment that has reached the end of its lifespan. This is not always due to bad financial management by the concessionaire: for example, in 2009 the concessionaires who were faced with the need to replace solar batteries ran into great difficulties because the price of solar batteries on the international market had more than doubled, due to a fast-rising lead price.

In order to assure the continuity of electric services it has subsidized to a great extent, REF can make arrangements to impose conditions on the concessionaire that require him to invest in renewal and upkeep of the installations and encourage the banking sector to get involved by offering lenders a partial guarantee on loans for equipment renewal.

2.5. Accompanying the development of the RE venture

To find a sustainable balance for the venture, concessionaires of RE have to pursue developing their venture for several years. They will therefore need new resources to make investments in expansion and to densify the access to the local grid. Small concessionaires, who cannot mobilize resources from shareholders or banks, cannot develop their venture. If, in addition, they progressively loose clients (those who do not pay their bill, those who move, those who die), they will see their returns diminish even if their prices are adjusted to inflation - until their income no longer covers the running costs of their business, and the venture fails.

Concerned for the continuity of electricity access for the population and for monetizing the public investment in the RE venture, the REF can become involve, for example by helping the banking system to cover the costs to replace lost clients, as well as investments in densification and expansion.

3. Constraints to the involvement of credit institutions

The involvement of local credit institutions is a very important objective of REF. REF thereby aim to:

• Professionalize the management of their resources: by leaving their funds with a selected bank and having them managed by the bank, the REF calls upon the financial expertise of the bank (an expertise that REF itself generally does not have) and ensures that its products are managed with prudence;

• Utilize its resources to gain leverage over the bank's own resources and to mobilise additional financial support: by involving the banks in the support of RE operators, the REF allows the banks to become familiar with them, to learn how to evaluate the risks of a new sector, and thus sets the stage for their future involvement in the financing of RE.

• Sustainably consolidate the resources of an RE program. The REF has to mobilize financial resources in the long-term; the funds of the banking sector are desirable resources.

However, the involvement of commercial banks may encounter other problems and obstacles, which the REF has to consider if it wants to involve them. In particular, African banks are not used to grant long-term credits, as they most often lack in long term reserves. In addition, they are subject to prudential rules that do not authorise them to give out long-term loans with their own short-term resources.

As a solution, the REF could, for instance, propose a model to help banks ease their long term refinancing.

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