No Easy Answers: Financing Distributed Power Generation
by Johannes Urpelainen, originally published in The Energy Collective
Last week, the United Nations’ Sustainable Energy for All (SEforAll) published a new report called Energizing Finance to compare actual investment in energy access with the estimated USD 45 billion a year that would achieve universal electrification by 2030.
One of the main messages of the report was that the annual investment in distributed power generation, such as solar home systems, was only USD 200 million per year – 1 percent of total investment in electrification. As Rachel Kyte, CEO of SEforAll, put it, “we urgently need targeted, refined strategies to increase investment in integrated electricity solutions.”
Why has financing for distributed power generation been such a disappointment? One explanation is that investors simply do not understand how scalable or economically viable distributed power generation is. The CEO of Practical Action, Paul Smith Lomas, said as much: “We have long argued that financial systems are skewed; the amount of finance directed towards decentralized energy technologies, like mini-grids and stand-alone systems, remains tiny in comparison to investments in national grids. This is despite decentralized energy technologies being the most economical solution to meet the needs of the majority of unconnected people by 2030.”
My own view is different; even though distributed power generation holds promise, it is a fundamentally challenging business that still faces major obstacles. There are no easy answers to the problem of financing distributed power generation. Until we find effective solutions to the core challenges of distributed power generation as a business, financing will remain a headache.
Both refereed research and practitioner experience show that affordability remains a fundamental obstacle to distributed power generation. Whether decentralized systems are more affordable than grid extension is beside the point as long as prospective customers are unable to afford the systems even considering government and other subsidies. One simple explanation for the lack of financing to distributed power generation is that few companies in this sector deliver large returns or have scaled beyond a certain extent.
Another problem is the small size of the projects. When investors do their due diligence and negotiate contracts, small projects present a challenge because their transaction costs per project are very high. Most distributed power generation do not invest billions of dollars at the time, but instead implement small projects in difficult conditions. For a financier, small projects mean lots of work for at most limited returns and a much higher perceived per capita credit risk.
While the SEforAll report is correct to point out weaknesses in existing financial models and policies, the challenge we face is much more fundamental. Is there a case for large-scale financing for distributed power generation? Does the distributed energy industry have the technology and business models to support scalable financing?
Investors do not care about nominal targets such as universal electricity access by 2030. They care about financial returns or, in the case of the public sector, social benefits. Therefore, expanding the financing of distributed power generation is ultimately a question of developing business models that generate concrete gains to investors, users, and the society more broadly.
The fundamental challenge for SEforAll and others active in this space is to demonstrate that distributed power generation can generate either large profits or social. Until someone makes this case, energizing finance shall remain an elusive goal.