Financing and de-risking mechanisms to enable solar mini grid investments in fragile contexts

Over 685 million people worldwide still lack access to electricity, with the vast majority of them living in situations affected by fragility, conflict, and displacement. Solar mini grids offer the potential to reach unconnected populations in challenging environments – they are modular and incremental, they draw on locally-available renewable energy resources, and they pose less of a target for sabotage in incidents of conflict than large-scale, centralised infrastructure. 

In addition to being more resilient, the input costs of solar mini grids are becoming more competitive due to notable price declines in solar panels and storage batteries in recent years. However, affordability remains a key constraint when expanding solar mini grids in low-income and fragile settings. To reach populations who otherwise won’t be able to afford solar products or services will require leveraging traditional and innovative financing mechanisms and de-risking tools. 

Through numerous efforts from development finance institutions, impact investors, philanthropic and bilateral funders, energy organisations, and private sector developers, the evidence base is growing on what financing and de-risking approaches work in fragile contexts. A new policy toolkit, Financing and de-risking tools and approaches for solar mini grid project in fragile contexts, takes stock of this evidence base and highlights financing arrangements that hold the most promise for challenging environments. This is a part of our State Fragility initiative’s set of publications on key aspects of scaling up solar mini grids in fragile settings. 

To overcome the myriad of investment challenges associated with fragile settings, financing that is flexible, patient, and risk-tolerant is needed. Specifically, this would include a significant portion of project funding comprising grants (especially for early-stage project development) and highly concessional loans, to lower the cost of finance. Additionally, several tools have emerged that distribute risk and return between parties to make investments more attractive for private capital. We outline some of the more impactful approaches in this blog. 

Blended finance for tailored financial solutions

Blended finance is the combination of concessional (below market terms) public funding and private investment, with different financiers (often with varying agendas) working together to progress a common venture. There are three characteristics of blended finance: impact, leverage, and returns. 

In the case of solar mini grids, the concession funding would typically come from public finance sources in the form of grants (where there is no expectation of repayment) and low-interest rate financing. The provision of concessional funding is based on mutual impact being created between funders and the mini grid developer.

Concessional finance acts as a de-risking mechanism from both a commercial and technical perspective – the commercial model’s viability becomes more favourable, and the technical capacity of the delivery team is more evident. This leverage allows private investors to invest on de-risked terms – a share of the risk is absorbed through the grant, thereby lowering private investors’ exposure to risk and raising investment attractiveness. 

This combination of public and private funding, which supports the developer at different stages of their funding journey, generates both financial and impact returns. In fragile settings, these blended finance arrangements are context specific and offer a tailored way to support developers to design financing solutions that best meet their funding requirements.

Concessions to motivate both the private and public sectors

Concessions are contractual arrangements from public sector authorities that facilitate private sector participation in the energy sector. Although the exact contractual arrangements differ for each agreement, concessions are typically a way for the public and private sectors to partner together. Under concession arrangements, private sector entities generally receive exclusive rights to implement and operate mini grids within a defined geographic service area for an agreed period. 

Concessions tend to be structured to motivate the private sector to take on the responsibility of ensuring operations meet targets around generating and distributing electricity, while the public sector focuses on ensuring an enabling regulatory environment and compensating the developer for results achieved. The exclusive rights that developers receive under concessions and the public support the arrangement entails, gives investors greater confidence that their investment will reap a return. The success of concessions is determined by 1) financial viability, 2) pre-investment support, 3) clarity on rights and responsibilities, 4) detailed contracts, 5) reasonable cost of compliance, and 6) timely payments for services provided. 

Impact investing for social, environmental, and financial results

Impact investing aims to utilise investment capital to achieve positive social or environmental results, as well as financial returns. The spectrum of instruments used for impact investing varies vastly across industries and countries. In fragile settings, it is important to craft instruments that take into account stakeholders’ preferences. For example, impact bonds can provide upfront funding for a solar mini grid project, while allowing an investor to reap returns from the project if the project achieves a pre-defined outcome. This arrangement brings together different stakeholders, including mini grid developers who implement projects, impact investors who make upfront financing available for project development, and outcome funders who pay out impact investors if projects’ pre-defined results are achieved. In fragile settings, outcome funders may be a combination of government and development partners. Each stakeholder involved in impact investing takes on some level of risk to achieve the result they mutually aspire to. 

Diaspora investments, guarantees, and local currency financing as additional financing tools

In blended finance, concessions, and impact investing, it is also important to work with non-traditional development investors, which may include a country’s diaspora. Diaspora investment offers untapped potential, and the patriotism of diaspora investors makes them ideal candidates to invest in projects with development potential in their home countries.

Additional tools that can be leveraged to raise the financial viability of mini grid projects in fragile settings include guarantees, which involve a third-party undertaking to compensate investors if a mini grid developer defaults on its loan repayment obligations. Guarantees are not always called upon; however, the existence of the guarantee lowers the risk that lenders face, making them more willing to support mini grid projects.

More broadly, increased use of local currency financing is also needed to lower the currency risk that mini grid developers face. Mini grid developers generate revenues and have their cash flows in local currency, yet much financing for clean energy projects is provided in hard currency from foreign lenders (such as USD). If mini grid developers shoulder this currency risk, local macroeconomic instability or currency depreciation (which are relatively common in fragile settings) may cause their hard currency loan obligations to balloon in local currency terms. This could imperil the financial viability of mini grid projects in countries experiencing macroeconomic stability. Therefore, local currency financing, which removes the currency risk from developers, is essential for the financial stability of developers – and the financial resilience of the renewable energy sector as a whole – in more fragile contexts. 

Fragile settings need greater attention if there is to be progress on achieving SDG 7 (access to affordable and clean energy) in these contexts. However, making mini grid projects investible in these settings requires effective risk allocation. Fragile settings are often seen as some of the riskiest settings to invest in; therefore, mitigating the real and perceived risks around these projects necessitates concessional and private funders, public authorities, developers, and non-traditional stakeholders (such as diaspora investors) to come together and apply these mechanisms as appropriate in their settings. 

To learn more, read our policy toolkit, Financing and de-risking tools and approaches for solar mini grid project in fragile contexts and three case studies focused on different examples of financing and de-risking tools in action: Blended finance in fragile settings: P-RECs and the P-REC Aggregation Facility, Harnessing capacity building to improve leverage: AECF and REACT SSA Somaliland, and Concessions: Nuru’s experience in the DRC’s electricity sector.