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The Political and Financial Challenges for Rural Electrification

This is the third article in the series published by the Alliance for Rural Electrification, an international business association that provides efficient renewable solutions for rural electrification in developing countries.

The first political challenge is to identify rural electrification as a key priority for development. Often, countries with highly under-resourced energy sectors and low electrification rates do not even highlight energy as a political priority. The fact that access to energy is not one of the Millennium Development Goals (MDGs) also does not help in moving governments to understand how power improves job creation, universal education, gender equality, and health.

Rural electrification should follow a coherent long-term strategy, especially including attractive policy/financing incentives for the private sector. This is important, as rural electrification projects have to be designed and financed for an extended period – for approximately 15-20 years. The long-term perspective is also a crucial challenge for development cooperation, which generally operates under much shorter project cycles and in many cases require short-term financing, where loans must be repaid under a shorter duration.

Policy frameworks

There are two ways of promoting renewable energy (RE): First, governments can stipulate that utility companies are obligated to produce a specified share of their output through RE. Or alternatively, governments can create financial incentives that promote private investment in RE. Since private investment is limited within many poor countries, this scheme lends itself to increase desperately needed private capital.

State run monopolies and regional concessions limit competition and innovation. Particularly in developing countries, empowering communities and private initiatives are indispensable ingredients for progress. Decentralized planning, which is closer to the consumers and adapted to local circumstances is key for furthering rural electrification. Moreover, local ownership and the willingness to pay largely depend on whether the communities are assuming responsibility. This is unlikely when an installation has been planned, designed, built and operated by a state company. Thus, the legal framework must allow for private and local initiatives. Monopolized power generation and distribution can hinder accelerated rural electrification.

In most countries, energy prices are heavily regulated. Developed countries tend to levy taxes for environmental reasons on electricity, whereas developing countries heavily subsidize energy consumption for social reasons. These subsidies can lead to distortions, which hinder the adoption of efficient and environmental technological solutions. Subsidies are recognized as essential in the practice of extending the grid and are furthermore commonly used to support the purchase of fossil fuels (such as kerosene for cooking or gasoline). In 2006, the World Bank found that two-thirds of developing countries impose price controls and subsidies on fossil fuels. Thus, subsidies for fossil fuels must be contained as they hinder the deployment of RE.

The Indian government is making energy security a primary issue for the next fifty years, but is stressing energy interdependence instead of independence. This is apparent in the joint collaboration with European countries in producing RE. Obtaining start-up help from abroad is important, but companies must be able to stand on their own to eventually be able to invest in RE projects in other countries as well. One example is the Indian company Suzlon Energy Limited, which has acquired a Belgium-based wind company in its expansion. The private sector will only get involved if the potential market size is large, if profit will be made, if the risk involved is marginal, if insurance is available for the risks, and if there are minimal government regulations.

Table 1. The following chart shows important project categories for rural electrification and their advantages and shortcomings

Financing Schemes

The financing schemes which fund an electrification project is a key factor in setting the right conditions for successful implementation, especially throughout the entire lifecycle of a RE project. It is essential that there are economic incentives to maintain and operate the systems, as frontloaded financing schemes run the risk that systems collapse due to insufficient maintenance and a lack of resources for repairs. Legal obligations (command and control legislation) to operate and maintain systems are inferior to clear-cut market-based economic incentives, as contract enforceability is a large problem in many developing countries.

Some development institutions follow the principle that the operation and maintenance of rural power systems are to be financed exclusively by the electricity consumers. This approach ignores the fact that rural power supply is comparatively expensive compared to urban areas and income levels are significantly lower. If consumers restrict their consumption in order to remain able to pay, they aggravate the situation further since there are fewer resources available for operation and maintenance.

The problem with subsidies is that they are needed to spur investment in RE, but they also decrease the sustainability of RE financing over the long-term.  For example, after nearly two decades of subsidies for RE development in India, one might conclude that this would have led to rapid growth and advancement of the technologies; however, this has not occurred. High costs and the perception of heavy government subsidies usually hinder RE project implementation. Although the high initial costs are true in most cases, without a competitive energy market, costs are even higher. Even though the “low fuel costs, low operation and maintenance costs and low polluting potential” are significant advantages for RE, it has been difficult for these technologies to significantly penetrate the overall national energy scene.

Table 2. Financing schemes

The Way Forward
According to the economist Jeffrey Sachs, “the market cannot be counted on to make up for the failure of the state to deliver decent governance. The state has to get better”. Developing countries will need to pioneer RE to accommodate the needs for the majority of its people, thus adapting to local needs and global trends. The recent major cost decreases of RE is opening up market niches; utilizing the full potential of these niches must be realized.  For example, in 2006 the RE market in India was valued over US$2.2 billion, and is growing at 15 per cent every year.

However, the financial incentives currently provided for RE cannot compete with the large subsidies that already exist for fossil fuels.  International lending organizations, such as the World Bank and Asian Development Bank are still greatly needed for RE implementation. The Banks can help create the right environment for the private sector to invest in RE technology, implementation, and maintenance in terms of procurements for large-scale RE deployment and encourage developing country governments the importance of shifting to these technologies.

The authors Simon Rolland and Aneri Patel work for Alliance for Rural Electrification. The next article in this series will focus specifically on rural electrification within India.

Image(s) Courtesy

Timitrius

References:
http://www.ruralelec.org.
World Bank, Financial and Private Sector Development Vice Presidency, August 2006.
Ravindranath, N.h., K. Rao, Bhaskar Natarajan, and Pradeep Monga. Renewable Energy and Environment: a Policy Analysis for India. New Delhi: Tata McGraw-Hill Company Limited, 2000. 1-208. 
Ibid, 2000.
Sachs, Jeffrey D., Nirupan Bajpai, and Ananthi Ramiah, “Understanding Regional Economic Growth in India” Asian Economic Papers, Vol. 1:3 Summer 2002. 
Bakshi, Rakesh. "Development of Renewable Energy in India: an Industry Perspective." Renewable Energy Policy and Politics: a Handbook for Decision-Making. Ed. Karl Mellon. London: Earthscan, 2006.