What financial instruments are available to cover the costs of building a mini-grid?

Short Answer

Working in concert with more conventional grants, debt, equity and mezzanine finance, some mini-grids have been funded by the following techniques and instruments:

Project-based Financing
Loans or other debt provided based on a project’s perceived risks and expected future cash flows. Usually, the project developer creates a special-purpose vehicle (SPV) whose sole assets are the project itself. This protects the project’s parent company should the project fail. Lenders can seek repayment from the SPV, but have limited or no recourse to seek funds from the parent company.
First-loss Loans or Other Guarantees
A form of credit enhancement in which a third party agrees to cover a certain amount of loss for an investor. By improving balance sheets and decreasing risk, first-loss loans encourage investors to fund riskier projects than they otherwise would. If the project fails, the first-loss loan provider is the last to be repaid, making it more likely that other investors recoup some of their capital. The World Bank, Asian Development Bank and other multilateral development institutions offer this financial instrument.
Renewable Energy Funds
Sources of concessionary loans and grants specifically for clean energy and/or green mini-grids.
In-kind or Cash-equity Contributions from Project Beneficiaries
Contributions of in-kind labor, local materials and/or cash that decrease outside financing requirements giving beneficiaries have a sense of ownership and vested interest. Contributions include in-kind labor, local materials and cash.

Further Explanation of Key Points

Project-Based Financing

In renewable energy, project finance is often associated with larger projects, particularly those that sell electricity to the grid under power purchase agreements (PPAs). Project-based financing uses the project’s projected cash flows as the basis for loans. Developers seeking project-based financing may use prepaid metering to ensure a more reliable cash flow and decrease banks’ concerns about risk.

Project-based financing doesn’t require cash collateral, so it’s appealing for village-scale mini-grids. Traditional financing, on the other hand, is based on the overall finances (balance sheets) of a project sponsor or developer, and it requires collateral.

In response to this challenge, some development banks, microfinance institutions and pioneering commercial banks have pursued project-based financing for village-scale mini-grids, despite the small scale of these investments and the challenges in guaranteeing predictable cash flows.

For example, the World Bank-supported the Sri Lanka Energy Services Delivery Project and the follow-on Renewable Energy for Rural Economic Development Project, which used project-based lending together with targeted grants to co-fund 260 community micro-hydropower projects. Commercial banks initially became involved on a small scale, funding community micro-hydropower projects as part of corporate social responsibility measures. When they found that default rates were well below industry standards, they grew more comfortable with this type of lending, and loans to communities for micro-hydropower projects are now an ordinary part of these banks’ portfolios.

First-loss Loans or Other Guarantees

Some donors offer first-loss loans instead of (or in addition to) grants. If the project fails to generate sufficient revenue to cover loan payments, a first-loss loan absorbs the loss and leaves other investors protected. Many first-loss loan providers invest in projects that achieve social or environmental goals in addition to returns. These lenders are willing to take on greater risk in order to advance social or environmental objectives. Having a first-loss loan or similar guarantee can be instrumental in attracting capital from more risk-averse lenders.

USAID’s Development Credit Authority (DCA) provides loan guarantees to local banks. The DCA covers 50 percent of any losses the banks realize on new lending in the sector for a specified period. USAID is increasingly leveraging its credit authority to promote mini-grid implementation. These efforts include a $75 million grant made in 2016 through Beyond the Grid to stimulate off-grid projects such as mini-grids. The DCA also generated significant impact through the Uganda Kalangala Infrastructure Services project. For this project, USAID co-guaranteed a credit that enabled the private sector to provide several important infrastructure upgrades, including water filtration, ferry service, and electrical service.

Renewable Energy Funds

Renewable energy projects face high initial costs, and project developers often lack capital. Carbon funds like the Green Climate Fund in Africa provide upfront payments for the carbon-emission reductions the project will generate over its lifetime. These payments can count as equity toward a bank’s equity requirements for loans. Mini-grid developers interested in the Green Climate Fund should approach one of the accredited entities that channels its resources to projects and programs.

Green Mini-Grids £30-million Support Facility, a new fund from the Agence Française de Développement and UK Department for International Development, will soon support green mini-grids in Kenya.

Contributions from Project Beneficiaries

Contributions from project beneficiaries are particularly appropriate for community-owned projects or community-owned portions of projects when ownership is shared. Equity contributions can take the form of in-kind labor (sweat equity), local materials (sand, gravel, or wooden poles) or cash. Besides helping meet capital requirements, community contributions (particularly labor) help build a sense of ownership.

Some mini-grid projects can readily use community labor, greatly offsetting costs. Micro-hydropower, for example, requires significant labor, and the local workforce may have the necessary construction skills. Solar panels, on the other hand, might require technical expertise lacking in the local community, so in-kind labor contributions on a solar project might be limited.

In Thailand, for example, beneficiaries of dozens of micro-hydropower mini-grids contributed significant amounts of labor and local materials. Every day for a year, each community supplied 15 village residents to help build their mini-grid.

Putting it Into Practice

Project developers will need to explore innovative financing mechanisms as well as more conventional sources of funding such as grants, debt and equity. A multi-year project cash-flow model can help developers identify appropriate funding sources. Developers will need to understand financing requirements to ensure their projects are eligible for funding.

Relevant Case Studies

Hydropower in Tanzania’s Rural Highlands. The Mwenga Hydro Generation and Rural Electrification Project in Tanzania’s Iringa region provides electricity to more than 2,200 households in 17 villages, a local tea and coffee factory and the national grid. The Rift Valley Corporation installed the 4-MW facility in 2012 with funding from the Africa Caribbean Pacific-European Union Energy Facility and Rural Energy Agency.

Resources

Global Impact Investing Network (2013). Catalytic First-Loss Capital.
This website describes the benefits and risks of catalytic credit enhancement tools such as first-loss capital, which lowers risk and incentivizes investment in socially beneficial enterprises.

World Bank (2012). Toolkit on the appraisal of small renewable energy projects: Tanzania case study.
Chapter 3 of this toolkit provides information on the financial structuring of small power projects.

Last updated: February 14, 2018

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