Decentralised Dividends

Financing India’s off-grid market

Providing reliable power supply to India’s 73 million rural households is crucial for unlocking the country’s full economic potential. Households that do not have access to the electricity grid rely on inefficient and often dangerous alternatives such as kerosene lamps, candles, flashlights and car batteries. In this regard, off-grid power can play a game-changing role in improving access to basic electricity services.

Off-grid power is supplied through two main technologies – small energy grids (SEGs) and solar kits. SEGs comprise nano-micro- or minigrids. These are village-level micro-utilities that install a small power plant with a distribution system. Solar kits include portable solar lanterns and solar home systems (SHSs). These are small hand-held devices combining a solar panel with a rechargeable battery and an LED light.

As of now, solar kits are more successful, in terms of both capacity sold as well as the finances raised. This can be attributed to the fact that solar kits can be marketed directly to an individual customer and are often sold against cash. The financial risk is therefore more manageable. Consumers are also free to decide whether to buy a solar lantern, depending on their needs. On the other hand, minigrids need a critical mass of customers in any given village, making them more complex to finance.

SEG business models and financing avenues

There is no blueprint business model for an SEG operator yet. Even the most advanced companies are still amending their offerings and projects, trying out new services, improving their technology and taking up projects as and when they find them feasible.

The build-operate-maintain business model has emerged as the most popular way to roll out commercially viable SEGs. In this model, the operator maintains long-term ownership of the asset. It, therefore, ties the developers’ long-term interests to the local community as they only make a profit when the system remains functional and customers continue to pay.

SEGs have received limited financing up till now. The different types of investment that have come into the sector include debt from banks, venture capital and equity finance, as well as occasional funds from corporate social responsibility and crowdfunding.

A key reason stopping investors from investing heavily in SEGs is the fact that several factors need to be aligned to ensure successful installation of SEGs. There needs to be enough demand and ability to pay in a village. Further, houses need to be close enough together to keep the distribution grid economically viable. A willing developer needs to convince a bank that the asset will provide long-term returns. The bank requires a regulatory framework that ensures the electricity tariff that can be charged, as well as a guarantee that the grid will either not be extended to compete with the microgrid asset or that the developer will be compensated if it does.

Moreover, SEGs require long-term investments. The financiers recoup the investment by charging tariffs that are significantly above those charged by the national grid. This arrangement can work as long as an SEG can offer the cheapest and/or most reliable power. A successful grid extension that provides 24×7 electricity can quickly make the SEG uncompetitive, making it difficult for investors to recoup their investment.

The limited access to capital has significantly constrained the ability of SEGs to flourish. Going forward, it is imperative to reduce the various challenges impeding the growth of SEGs to attract long-term financing. The issue of grid arrival can be addressed through changes in the regulatory framework. Rules that determine potential compensation or exit options for minigrid investors following a grid extension are one way to address the financial uncertainty. Another option is to carve out small concession areas in which an SEG operator can establish a local monopoly with regulated tariffs.

Long-term viability of SEGs will also require technical changes. Building minigrids to the same standards as the national grid will make eventual integration a lot easier. This will both improve the service levels prior to grid arrival and ensure that the installed equipment can be used to plug directly into the grid once it arrives.

Financing solar kits

Solar kits have emerged as the most popular solution in the off-grid market, largely due to their low cost. In India, more than 90,000 SHSs have been installed and more than 5 million lanterns have been distributed during 2013-16.

The sale of solar kits has been driven by support from both government and non-government organisations (NGOs). The National Bank for Agriculture and Rural Development (NABARD) operates a lighting programme under the Jawaharlal Nehru National Solar Mission (JNNSM). Under this, a subsidy of Rs 160 per Wp is provided for systems up to 40 Wp and Rs 100 per Wp for systems between 40 Wp and 300 Wp. Systems above 300 Wp are not eligible for subsidy. It is only provided to a pre-determined list of eligible companies.

The government is also running the Million Solar Urja Lamp Programme.  The objective of this programme is to provide lamps to a million unserved or underserved students. Under this, a 1 W solar panel lamp costing around $9 is given to a student. The student has to pay around $1.8 as a one-time payment. The total cost of the lamp is recovered with support from philanthropic organisations and the National Clean Energy Fund established by the Ministry of New and Renewable Energy. As of November 2016, almost 0.8 million lamps were distributed.

However, government and NGO-driven efforts have not been able to reach all potential customers. The systems have also not lived up to customer expectations owing to inadequate after-sales service. Delays in the approval of loans, subsidy applications and system installation have also left potential customers unserved.

The gap has been filled by for-profit and social enterprises selling off-grid solar kits on a commercial basis. Most of these enterprises procure products from component manufacturers, assemble them and distribute them by developing networks in the villages. These companies focus heavily on product customisation and developing customer relationships. Some solar lantern companies design and manufacture their own products to achieve better flexibility to meet specific customer requirements.

Retail distribution is a key challenge in selling solar kits as off-grid households are mostly in remote areas. In order to address this, some companies create proprietary sales networks while others leverage existing channels. Many players have partnered with microfinance institutions to distribute lanterns and SHSs, often bundled with a loan.

More recently, some SHS companies have vertically extended their operations and are engaging more directly with microfinance institutions. For instance, some companies combine an SHS with a mobile phone connection, allowing customers to make small payments. If a customer falls behind, the SHS is automatically disabled until the balance is settled. Most solar kit companies require debt capital to maintain inventories and finance supply chains. However, as a small and unproven sector, it is often considered too risky by banks and investors and not given long-tenor loans without collaterals. At the same time, many companies have voiced scepticism over government product subsidies that are paid either late or infrequently.

Going forward, the government should consider converting subsidies for debt facilities that let companies compete on a level playing field while accelerating access to regular corporate loans. In addition, till the time the sector gains traction with commercial lenders, donors to off-grid companies can create a fund to minimise collateral requirements.

The way forward

The off-grid market requires a lot of upfront capital to function effectively. For SHSs and minigrids, the largely self-financed success seen in the rooftop solar segment cannot be replicated because they mainly cater to poor and cash-constrained consumers. Financing is, therefore, a crucial challenge for scaling up the off-grid business models.

Off-grid solar companies are usually not able to access commercial financing because they are unproven players operating in an unproven market. In order to overcome this challenge, there is a need for developing financial vehicles that can align well with the off-grid business models. Targeted government subsidies handed out for future projects rather than past achievements are one such possible vehicle. Asset structuring and, in particular, special purpose vehicles that offload outstanding consumer loans from the corporate balance sheet, can also play an important role in expanding the reach of consumer financing or minigrid investments. n

Based on the report, “Financing India’s Clean Energy Transition”, by Bloomberg New Energy Finance

By Puneet Kumar Arora

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