Making rural minigrid economics work for investors

This is the second article in a two-part series on building and financing minigrids in energy-poor rural areas. Read the first piece here.

Minigrids are stand-alone systems that provide electricity to communities not connected to the central grid, primarily via solar PV. They have the potential to bring electricity to hundreds of millions of people living without it today. But whether that comes to pass will depend on the development of financial structures that will allow investors to back them at the same scale as massive power plants and other major grid projects.

That’s the opportunity that prompted Humphrey Wireko to join CrossBoundary Energy Access, a mission-driven investment firm and platform that directs large-scale financing to minigrid development. A long-time utility industry expert with stints at the Public Utilities Commission of Ohio and Boston Consulting, Wireko was familiar with the microgrids typically used to back up hospitals and other critical sites.

He was also aware that the rapidly falling cost of solar panels and batteries, as well as improvements in technologies to operate them as stand-alone systems along with backup generators, were putting minigrids within reach for a much wider group of people — including his own relatives back in Ghana.

Knowing ​“the challenges with infrastructure, and specifically electricity, that I had seen at, for example, my grandmother’s house, I always wondered, what…a minigrid [would] look like in Africa,” Wireko said in a recent interview. His family emigrated from Ghana to Canada, where he was born, and then moved to the United States, where Wireko grew up. When the opportunity arose to join a fund investing in minigrids in Africa, he said he ​“was definitely a bit surprised. I didn’t think that there were people really doing that.”

But since joining CrossBoundary Energy Access shortly after its 2018 inception, Wireko has seen the power of its financing approach play out at scale. CBEA’s $18 million pilot fund dating from early 2019 focuses on projects in Nigeria, Tanzania and Zambia, including the largest project financing of its kind to date in Nigeria: 28 minigrids being developed by PowerGen Renewable Energy, the leading minigrid developer in Africa, that together will bring high-quality electricity to 55,000 people.

CBEA is looking to raise $150 million in its second platform of blended finance by the end of 2021. That money will be put toward a larger-scale version of what it has done in Nigeria thus far: marrying the imperatives of project finance with the realities of on-the-ground minigrid developments.

CBEA has published an open-source document detailing its approach to raising capital and investing in minigrids. Working with collaborators including minigrid developers PowerGen and Standard Microgrid and investors including Renewable Energy Performance Platform and The Rockefeller Foundation, it plans to release standard term sheets and template project finance models, in hopes that others will make use of what it has developed so far.

“In order for this model to work, we need a lot of folks essentially doing this and doing it at scale, which was part of the motivation for taking the work that we’ve done to date and putting out this critical information,” Wireko said.

Minigrid economics 101 

All member countries of the United Nations adopted the 17 Sustainable Development Goals in 2015. Sustainable Development Goal (SDG) 7, which calls for universal access to affordable, reliable and modern energy for all by 2030, caught my eye. I grew up in Nigeria and was born in a hospital without electricity, so it’s easy to understand why.

An estimated 770 million people do not have access to electricity today, according to the International Energy Agency’s 2020 report on progress toward SDG 7, and 75 percent of them live in sub-Saharan Africa. The agency’s 2017 World Energy Outlook states that minigrids are the most cost-effective way to provide power to at least 260 million people in Africa, many of whom live in remote areas that are hard for centralized grids to reach.

The market for minigrids in Africa and Asia has the potential to grow to the multibillion-dollar range. Off-grid solar providers and developers such as Powerhive, Husk and PowerGen have raised tens of millions of dollars or have been acquired by international energy companies such as Engie seeking pathways into new markets.

The economics of building minigrids have improved significantly over the past decade, driven by major declines in the cost of the technologies that go into them, greater visibility and control for remote operators, and innovations in mobile payment methods that have stabilized operating costs.

Despite the momentum in the sector, however, minigrid companies have only managed to raise $350 million in equity over the last eight years, according to CBEA. This is less than 0.1 percent of the $187 billion of public and private capital the International Energy Agency forecasts needs to be mobilized into the minigrid sector to achieve universal energy access by 2030.

What’s holding the sector back? Primarily, it’s the fact that while minigrids are more affordable to build than large-scale power grids, they are more difficult to finance.

“Typically, for the main grid, it might cost upward of $2,000 per connection to bring power to rural communities,” Wireko said. ​“Given their locations and often being in marginalized sections of the country, many of these customers don’t have a high ability to pay for electricity. High costs, low revenue — that is quite a challenging business model.”

A minigrid, by contrast, ​“can typically go out and connect the same customer for half the cost, or less than $1,000 per connection,” he said. Imagine a rural community with 300 homes without access to electricity from the main grid. Developers come in and build a minigrid — typically comprising solar panels, batteries for storage and a backup diesel generator to make sure the community has 24/7 access to power — along with the power poles and lines to distribute that power and smart meters to measure consumption at each customer location.

The estimated cost to finance this 300-home minigrid project is roughly $300,000. That’s a drop in the bucket compared to the tens or hundreds of millions of dollars invested in infrastructure assets such as bridges and roads.

But this relatively small scale of investment is actually a barrier to attracting infrastructure investors, Wireko said. It’s hard for an investor to justify the risk and complexity of investing in dozens or hundreds of small-scale projects when larger-scale investments can be closed in almost the same amount of time. That’s where groups like CBEA come in. 

Aggregate and conquer 

The challenge is to find ​“capital that matches these assets,” Wireko said. Minigrids typically have a payback period of about seven to 10 years and generate steady returns over a period of 10 to 20 years or more. In other words, they ​“have long-term, inflation-linked cash flows, and they need long-term, low-cost infrastructure capital to match that.”

“Historically, there hasn’t been that type of capital in the sector,” he said. Infrastructure assets such as minigrids require project financing, which stabilizes and secures risks and cash flows over a project’s lifetime.

CBEA has incorporated these ideas into its own innovative approach to project-financing minigrids. The approach has three components:

• Isolate: The firm exposes itself only to the risks related to the specific set of minigrid assets it buys, not the risks of a developer’s other businesses or activities.
• Allocate: All revenue, costs and risks are allocated through long-term contracts.
• Aggregate: CBEA aggregates minigrids into portfolios and then aggregates those portfolios into a much larger funding mechanism.

Aggregation is the key to scaling up minigrid investment opportunities to the level that can attract infrastructure funding. The 2018 report Derisking Renewable Energy Investment from ETH Zurich and the United Nations Development Programme identifies aggregation as a method to help unlock the ​“patient capital” that minigrids require in order to scale.

“Due to their capital intensity, solar [minigrids] are penalized in high financing cost environments,” the report states. ​“Developing countries often exhibit high financing costs for renewable energy due to investment risks that can exist in early-stage markets.” The report goes on to note: ​“As solar [minigrid] markets mature, an opportunity also exists for diversifying risk through aggregation of multiple [minigrid] assets.”

The power of aggregation to reduce financing risks is also highlighted in a 2019 report from the International Institute for Environment and Development:

“Energy access funds and financial intermediaries are attracting investors with structured funds. By offering different levels of return for comparable risk, structured funds can link investors with different risk appetites. The underlying assets for these funds are bundles of smaller decentralized systems and companies, which spreads risk, lowers transactions costs, hones expertise, and standardizes processes.”

Wireko highlighted the intersecting roles for minigrid developers, government agencies, utilities and private financing parties in accomplishing these tasks. Developers are the ones ​“actually finding these minigrid sites, working with governments to get the necessary permits, working with communities to get a land lease and to get their permission to come out there and actually build a minigrid within their community,” he said.

Government entities ​“are the ones [that] hold the keys to the permitting processes in each individual country or state or local area,” he said. They also set rates for these customers, a critical consideration for a minigrid that must charge its customers based on cost-recovery structures that are very different than those that apply to typical large-scale grid projects. At the same time, government entities are also ​“outlining what happens when…the main grid [could potentially arrive] five or 10 years down the road,” he said.

Aligning these complexities in a way that can give project finance investors the confidence to sink their money into them is a challenge, Wireko said. Minigrid projects ​“are a bit more hands-on than, let’s say, a wind farm in the U.K. which doesn’t really require the hands-on customer management” of billing and payment processing for thousands of different customers. CBEA plays a role in monitoring minigrid performance and enforcing contracts to help manage the risks involved.

CBEA is also managing complexities on the financing side of the transaction, he noted. ​“We’re blending debt and equity and concessional capital.” The latter term refers to funding from international financial development entities or charities, which tends to come with more lenient terms than traditional project finance.

CBEA’s first financing in Nigeria shows how these complex interdependencies can be worked out among multiple participants. Oikocredit, Triodos IM and EDFI ElectriFi are providing $9 million of financing for the construction phase of the project. Once operational, CBEA will purchase the portfolio, becoming the long-term owner of the systems and providing the construction financiers with an exit. PowerGen will build the systems and continue to act as the long-term operator of the project after the transfer to CBEA.

These are more complex transactions than single-source funding from government or charitable groups, but they are seen as critical steps in engaging private capital in projects that can prove their long-term value for customers and investors alike. Minigrid development has been largely dominated by nongovernmental organizations and international financing programs — both of which have a less-than-stellar track record for making the best use of dollars spent. According to a 2020 report from the Mini-Grids Partnership published by BloombergNEF and Sustainable Energy for All, only 13 percent of the development finance institution money committed to African minigrids had been disbursed to on-the-ground projects.

As William Brent recently reported for Canary Media, government-owned or -backed utilities have also struggled to extend service to rural communities, even though countries are investing billions of dollars in expanding grid service.

But the decentralized approach — building thousands of clean minigrids — has enormous potential to bring electricity to unserved populations. The falling cost of solar and batteries can be expected to drive even more dramatic cost advantages — if the financing structures to support the sector’s growth can be unlocked.

“We think that through project finance, we can bring capital at scale into this sector,” Wireko said. ​“And that’s what we’ve been working on doing ever since [CBEA was launched].”