For energy projects, concessional finance has always tended toward public sector led grid extension programmes that emphasise the number of connections made and the deal size. As a result, the success stories of individual business are prioritised to the detriment of more rural projects developed by Decentralised Energy Service Companies (DESCOs), the latter naturally have much quicker development timelines. Co-ordinated efforts to build national distributed generation (DG) markets where power is consumed closer to where it is produced are therefore unwittingly side-lined.
It is not just development finance initiatives (DFIs) who find difficulty in transferring traditional project finance methods onto smaller assets, the same can be said for private equity and commercial banks. That being said, it is also the case that new financing instruments and methods are constantly being devised and adapted to cater to a variety of market failures. To create scope for the right kinds of financing tools and debt products that African entrepreneurs need, DFIs need a change of approach to DG to one that directly addresses the barriers to uptake.
The Miller Centre for entrepreneurs estimates that universalising access energy access in SSA will need c.20,000 local energy enterprises. The critical question then becomes, how do we build institutional lenders support for localised enterprise in less high-density population areas where: the end users are less credit worthy, the technology is more expensive, and the administrative costs and foreign exchange risk remains the same? In policy circles, an approach that tackles these issues is coined as one that is ‘bottom-up’. Broadly speaking, bottom-up approaches employ reward metrics that shift the emphasis away from deal size toward the development impact on end-users.
In principle, a bottom-up approach means three things for DFIs: first, they need dedicated teams proactively aggregating distributed generation opportunities. Not least because in the long-term, larger aggregated portfolios of small-scale microgrid projects represent securitisation opportunities. In solar securitisations, investors purchase bonds that are repaid via the cashflows of the underlying assets. Aside from the obvious benefit that no single asset can significantly affect the debt repayment profile of the wider portfolio, an in-direct benefit of asset backed securities is the development of debt capital markets in the SSA more broadly.
Project aggregation requires dedicated teams within DFIs proactively engaging local government, national government, project developers, and regulatory authorities. Financial modelling and reporting that reflects the more complex risk profile of aggregated portfolios can only come from increased stakeholder coordination. DFIs could look at proposing new internal incentives that encourage bank staff to participate in deals that demand that they navigate the challenges faced when financing DG.
Secondly, financing distributed generation warrants different kinds of capital allocation. DESCOs are often smaller companies with high upfront working capital needs. When starting out, most DESCOs are tasked with quickly scaling operations to a size whereby they can demonstrate the likelihood of profitability in the long run to potential investors, this is capital intensive in the immediate term. Foundation partnerships are a good example of a potential remedy to this issue. 2011 saw a partnership between the OPEC Fund for International Development (OFID) and the Shell Foundation, together, they made a USD $2M revolving working capital facility available to eligible DESCOs who needed financial support to import solar products and up-skill their workforce.
DFIs also need to explore funding models that offer more patient capital to DESCOs. Some experts have proposed tiered capital structures that blend impact investors, DFIs, commercial funders, philanthropic capital in a single facility where proportionately higher returns are offered to participants who make longer commitments. Apart from incentivising lenders to commit to longer facilities, such a structure would allow for philanthropic capital to serve as an initial cushion for the entire syndicate and guarantee that each investor had the flexibility to tailor their liability according to their risk appetite.
Thirdly, there is some need to manage DFI expectations with respect to the credit performance and return expectations of DESCOs. Large publicly traded energy companies like E.ON, General Electric, and EDP receive billions in government subsidies from donor organisations every year, is it imprudent and incoherent for DFIs to hold DESCOs to the same standards of commercial profitability at such a nascent stage in the growth of the DG sector.
DESCOs have finite operational and financial track records. If these companies are also offering PayGo Solar services, they are addressing the needs of communities who have hitherto been excluded from financial systems and therefore have little or no credit history whatsoever. At present, the financing conditions imposed on DESCOs due counterparty credit risk is unrealistically strict, interest rates for DG projects can be as high as 20-30% in the worst cases.
Taking a step back, you could ask the question: is it really DFIs who need to change? Or conversely, do the fulfilment of many of the tasks set out above represent of a market opportunity for new project incubation vehicles serving as intermediaries between lenders and developers to catalyse the flow of institutional capital in the direction of DG? Incubation vehicles can concretise new market practices for DG in a connected financing ecosystem by facilitating increased stakeholder coordination. Market incubators are important because above all else, we must be better collectors and communicators of historical data that can provide institutional investors with the confidence that the financial projections made by developers is consistent with the realities of the market.
