Light the Way: Collaborative and iterative financing solutions are needed for off-grid solar’s next phase of growth in Africa
In most parts of Sub-Saharan Africa, reliable access to electricity continues to be a luxury. The problem is most stark in rural areas where the average electrification rate is a mere 16% and many households still resort to burning kerosene to light their homes.
Competing priorities on government finances compounded with a high cost per connection in rural areas—in Kenya it costs the government utility a whopping $1,435 per rural grid connection—have served to slow the advance of grid electrification outside of urban areas.
A standalone home solar home system installed in a rural African household. The system is inclusive of 4 LED lights, a radio, phone charging and a rechargeable torch.
Off-grid solar has proved to be a cost-effective alternative to the grid
The off-grid solar sector, which has grown rapidly over the last 10 years in Africa, has proved to be a cost-effective alternative for reaching these more rural households. According to the International Energy Agency’s (IEA) 2017 energy access outlook, “decentralized systems are the most cost-effective solutions for over 70% of those who gain access in rural areas.” What’s more, according to the IEA’s sustainable development scenario, which assumes universal electrification by 2030, decentralized systems will be the lowest-cost option for more than half of all new connections.
The outlook is certainly promising. But if off-grid solar is to play a significant role in Africa’s future electricity landscape, much more strategic finance from DFIs, donors, private investors and corporates will be needed.
Pay-go solar firms have so far received the lion’s share of investment in the sector
Within the off-grid solar sector, where the current product portfolio ranges from small lanterns to community mini-grids, pay-go solar has garnered the most attention, as well as the lion’s share of the $1B+ (debt, equity, grants) that has been invested in the sector to date.
Off-Grid Solar Funding 2012-2018 by investment type
(Source: GOGLA)
Pay-go solar’s lease-to-own business model, whereby customers make incremental payments over a period of 1-3 years for the use of systems (inclusive of panels, lights, phone charging and sometimes televisions) necessitates significant finance to fund working capital. As pay-go solar firms have grown, financing has had to keep pace. In the initial years, most firms were financing working capital with on-balance sheet financing. Thus, to grow their portfolios of customers, firms had to inevitably increase leverage ratios on their balance sheets.
To mitigate this risk the industry has moved towards conventional off-balance sheet securitization. In this arrangement, pay-go solar operators sell future receivables tied to customer contracts to a special purpose vehicle (SPV), which is typically formed as a limited liability partnership.
This transition has created a more standardized way of raising working capital finance, allowing pay-go solar firms to focus on their core businesses and to more easily and quickly scale up their operations. No doubt this has been a great step forward for the industry. But there’s still plenty of room to make access to finance easier and cheaper for firms operating across the region.
Blended financing and subsidy schemes are imperative for unlocking further capital and growth of the off-grid solar sector
The African Development Bank’s newly unveiled multinational financing program, which aims to work directly with local banks and distributed energy companies to promote securitization financing techniques to address barriers to accessing finance, is one initiative to achieve just that. Put simply, less than 20% of the capital invested in the sector has come from local financial institutions. This new program is an attempt to mobilize more local investment in the sector.
Beyond pay-go solar, such blended financing schemes are imperative for the development of renewable energy mini-grids, which have significant upfront capital costs and uncertain payback periods. Indeed, just last year a group of energy investors urged governments and donors to design a unified results-based financing (RBF) scheme to support the unlocking of private capital for the development of mini-grid projects.
In such a structure, mini-grid developers would essentially receive concessionary finance for delivering specific KPIs as outlined by the RBF guidelines, providing them with more predictability with regards to future cashflows—i.e. helping lower risk for private investors.
In short, without targeted subsidies most rural markets will continue to be uneconomic for pay-go solar and mini-grids firms. Indeed, given the challenges of connecting rural households, many firms have already shifted towards more peri-urban customers who are easier to reach and have higher and more reliable income streams. To incentivize firms to target poorer and more rural customers, more subsidy schemes such as Power Africa’s $1 billion beyond the grid fund will be needed.
How to achieve off-grid solar’s next phase of growth
Up until now, finance has been instrumental in the growth of the off-grid solar sector, from the provision of grants for market development to strategic equity investments from large corporates to support new product development and expansion. But for the sector to achieve its next phase of growth, there will need to be far greater deployments of strategic capital. Designing well-thought out blended finance and subsidy schemes, with the goal of unlocking further private capital, is one way of getting there.
A family holding a pay-go solar system commercialized by Tanzania based firm Trend Solar. A standard kit is composed of a solar panel, a smart solar battery, 4 LED lights, 5-1 USB charging cable and a rechargeable torch. (Photo Credit: Trend Solar Tanzania Ltd)
Finance also needs to focus on building businesses for the long-term. The Silicon Valley mantra “move fast and break things” simply does not apply to rural Africa. In the pay-go solar sector in particular, where customer repayments drive success, rapid increases in customer acquisition rates have often preceded periods of financial turmoil for firms. In essence, firms need to build models with profitable unit economics.
Let’s keep in mind that off-grid systems are attempting to provide a similar level of service that would be typically achieved by a transformer and power lines. In brief, scaling such a service nationally and internationally will take patience and a willingness to iterate and adapt.
Most of Africa still lives without affordable, reliable power. Patient and smart capital will continue to be instrumental in addressing this problem.
At ThirdWay Africa we are hopeful for the future of off-grid solar and are proud to be playing a role helping facilitate the deployment of finance for the sector. We are also committed to working towards closer collaborations between private investors, governments and multilaterals to co-ordinate advocacy and knowledge sharing initiatives to support the growth of renewables across the continent.