This briefing paper explores how to design subsidies, as a form of public finance, for distributed renewable electricity and clean cooking, and how to deliver them effectively to accelerate universal access to energy. The paper draws on country examples of subsidy schemes and identifies the characteristics of effective subsidies that will catalyse a sustainable energy market delivering energy access for the long term. The paper aims to provide a discussion point for policymakers, particularly for multilateral development banks (MDBs), donors and governments, who are increasingly financing subsidy schemes.
Policymakers and investors need to step up significantly efforts to achieve universal energy access goals if the poorest and most remote communities are to be reached in the next decade. Access to affordable, reliable and clean energy remains one of the greatest development challenges for many countries, especially in sub-Saharan Africa. On current trends it is expected that 620 million people will remain without access to electricity in 2030, and 2.3 billion will have no access to clean cooking solutions. If universal access to energy is to become a reality in the next decade, additional efforts to increase public finance will be required. Making progress on energy access and transitioning to renewable energy should form a central part of countries’ recovery from the Covid-19 crisis. This will catalyse economic activity, build resilience and contribute to the climate change agenda by reducing emissions, air pollution and their associated health impacts.
Subsidies are necessary to achieve universal energy access. They are needed to bridge affordability gaps and the higher costs involved in ensuring that the poorest and most remote communities are not left behind. In rural areas especially, many communities cannot afford even the most basic modern energy services, especially if the full cost of those services is passed on to the energy user. The coronavirus pandemic has highlighted the importance of addressing these inequalities: the traditional fuels that many households use, such as firewood and charcoal, are linked with respiratory conditions that could put people at increased risk of serious illness from Covid-19. The private sector-led results achieved by the off-grid electricity sector in recent years have often been made in peri-urban and/or weak grid areas where the cost of serving customers is lower.
Policymakers and investors increasingly recognise that subsidy support from public finance will be required to reach more remote communities and achieve universal energy access. There have been numerous dialogues on the need for effective subsidies in recent years and a growing body of literature supporting this view, building on Tearfund’s 2018 paper, Transforming electricity markets to deliver universal energy access. The need for support is likely to be increased by the Covid-19 pandemic and the impact on communities. Emerging evidence suggests that renewable energy companies operating in the sector have been particularly badly affected by lockdowns.
There are many levers that can be used to ensure that subsidies are well designed. Once the requirement for a subsidy is identified, there are many complex and interrelated design decisions to make. It is important that a subsidy is tailored towards the specific market failure that it intends to address. For example, is the subsidy intended to address an affordability gap or differences in cost of service? Does it need to target upfront connections costs or ongoing operating costs? Other important considerations and trade-offs include the geographical and technological scope of the subsidy, how the subsidy is funded, and how the funds made available are allocated.
Subsidy schemes should be designed with a focus on sustainability from the start. To date, schemes for distributed renewable energy have often used short-term subsidies to address long-term challenges and so have not been sufficiently sustainable or scalable. This briefing paper reviews the experience of energy subsidy schemes that have been implemented, covering a range of technologies in various low- and middle-income countries.
This review shows that the most successful schemes have been long-lived and/or have been integral to the design and regulation of a country’s energy market. It is notable, and concerning, that many of the schemes targeted at the hardest-to-reach communities are tied to short-lived donor programmes. Even the latest wave of results-based financing (RBF) schemes do not appear to take on board the lessons from earlier subsidy schemes that have failed to achieve sustained results. Systems have fallen into disrepair and service providers have exited the market. It is important to define the end goal of a subsidy scheme and consider what subsidies a future sustainable energy market might need.
Lessons from the on-grid electricity sector show how sustainable subsidies and cross-subsidies can be used to achieve progressive policy objectives. There are many examples globally of subsidy and cross-subsidy schemes being used to redistribute resources to achieve access to affordable energy for all. Many of these schemes are in the on-grid electricity sector. This paper cites examples of countries that already redistribute hundreds of millions of dollars every year through applying an energy market design that is focused on achieving equitable and affordable access.
A three-phase approach can be used to transition towards a sustainable market to deliver energy access. In countries where it is not yet politically possible to charge tariffs that fully recover system costs, outright subsidy (in contrast to a self-funding cross-subsidy) will be required initially. This kind of scheme can be funded by donors, with the government taking on a funding role in a second phase, before eventually the scheme is funded through sustainable and customer-funded cross-subsidies. Adopting a subsidy that allows for such a phased transition assuages concerns that donors and/or governments could become locked into funding subsidies. Such a market design, combined with integrated energy planning, should also be blind to the technical mode of delivery and be designed to sustain the benefits of energy access over the long term.
