Herein lies the prospective commercial

N O V E M B E R 2 0 1 7 Investing in Distributed Renewable Electricity Infrastructure in Emerging Economies: A Framework to Characterize the Investment Readiness Level (IRL) of a Geography By Cathy Zoi (Adjunct Professor and Precourt Energy Scholar) and B.A. Sechrist (PhD candidate, Civil and Environmental Engineering) Investment opportunity: delivery of a mature technology to a currently unserved global market of >300 million households and >30 million businesses located in economies with projected annual growth rates better than the global average; recurring revenue of more than $50-100 billion per year with an incumbency advantage amplified by a trajectory of increased sales. 1 Herein lies the prospective commercial promise of the rural electrification market opportunity (often referred to as off-grid ) in emerging economies it is big, has significant growth potential, possesses little technology risk, and is largely untapped. It is also complex and unfamiliar to most investors, in terms of geographies and the customers within those geographies. Deploying distributed renewable energy systems to serve rural communities most of which are quite poor in sub-saharan Africa and south and southeast Asia is an undertaking in its infancy. Thus from an investor s perspective, there is limited aggregated data to benchmark and few commercial success stories to reference. However, with international pressure to address climate change and energy access increasing dramatically in the past several years, attention has grown on how to mobilize the capital necessary to electrify the 1.2 billion people without power and to do it without increasing greenhouse gas emissions. In 2015 the United Nations published a set of 17 sustainable development goals (SDGs) to end poverty, protect the planet, and ensure prosperity for all. 2 SDG 7 is to ensure provision of affordable clean energy for everyone by 2030. The multi-lateral Addis Ababa Action Agenda, also agreed in 2015, outlined the need to direct finance toward achieving the sustainable development agenda. And perhaps most widely discussed across all sectors around the world, the Paris Climate Agreement crafted cooperatively by 195 nations explicitly acknowledges the need to promote universal access to sustainable energy, particularly in Africa. 3 1

POWER (AND ASSOCIATED CAPITAL) NEEDS IN EMERGING ECONOMIES Over 600 million people in Africa and over 500 million in South Asia are completely without access to electricity. 4 Another billion people have frequent and extended power outages. Without reliable access to light, electric machinery and motors, office equipment, and connectivity, citizens living and working in these energy-impoverished communities have considerable limitations on economic growth. Notable electrification progress has been made in several countries in recent years. Afghanistan stands out as a shining example: in 2000 there was virtually no access to power; by 2010 43% of the population had electricity; and by 2014 that number had reached 90%. The success has been primarily due to a massive rollout of off-grid solutions. 5 Capital requirements: Sustainable Energy for All (aka SE4All ), the UN body charged with overseeing delivery of SDG7, reports that the pace of electrification needs to increase by a factor of four in order to meet 2030 energy access goals. And to achieve these objectives at the UN s Tier 5 level of service (i.e., full grid-quality power, all day, every day) would require a five-fold increase in the level of investment, to $50B/annum through 2030. 6 Continued reliance on carbon-based generation? The IEA s 2016 World Energy Outlook (WEO) makes whole-of-economy energy forecasts (not simply addressing the segment of unelectrified communities in rural settings, which is the focus of this paper). With this larger frame of reference in mind, the WEO estimates that ~$240B/year will be directed into emerging economy power infrastructure through 2040, with a continued heavy reliance on fossil fuels: it projects that 56% of new generation in Africa will rely on coal, gas, or oil, 46% on those same sources in India, and 63% respectively in SE Asia. Further, about half of the overall expenditure would need to be applied toward transmission and distribution infrastructure. 7 Even with this level of power infrastructure investment, IEA expects that 780 million people would remain without power in 2030 and 520 million in 2040. 8 The upshot is that neither climate nor energy access goals will be met if this scenario is realized. There is little discussion in the 2016 WEO of the potential role for distributed and off-grid solutions. Perhaps recognizing this, the IEA initiated a first-ever dedicated report on energy access that will be released in October 2017 and be part of the 2017 WEO. If the IEA s new attention on mini-grids and solar home systems is indicative of a shift in large institutional thinking, we should expect increasing attention on the importance of distributed energy solutions, both for addressing climate change and energy access needs efficiently and cost-effectively. ROADMAP FOR AN ALTERNATIVE FUTURE: CAPITALIZING ON ENERGY TECHNOLOGY PROGRESS AND THE DIGITAL REVOLUTION TO ACHIEVE UNIVERSAL ACCESS Energy technology progress: The range of choices, their durability, and the costs of the technologies well-suited to meet the needs of rural communities in emerging economies have improved dramatically over the past five years. Photovoltaics and associated component costs have declined by 80%. 9 Battery choices are more diverse and the costs of lithium ion offerings are down by 80% as well. 10 Small-scale biomass, wind, and hydropower systems now have operating track records in remote communities. And ultra-efficient appliances and machinery from LED lights to 15-watt flat screen TVs to variable speed, softstart motors for grain milling are allowing generation plant capacities to be reduced (thus reducing CapEx) while fully meeting rural community needs. With the improved techno-economics of distributed power systems (either in the form of mini-grids or standalone solar home systems), it is now possible to meet community energy requirements without investing in grid extension an effort that itself has proved to be both time and resource intensive, and hence often been waylaid in emerging economies. Which technology solution makes sense for a particular area is a function 2

of load requirements and distance from the existing main grid (see Figure 1). Digital Technology Progress: Characterizing the improved techno-economics of distributed renewable systems would be incomplete without mention of the role of digital technologies as an enabler. Smart meters, device connectivity, mobile money, cloud-computing, and data-analytics are all critical elements supporting the performance and cost-effectiveness of today s distributed energy systems. The other side of the techno-economics equation is the customers ability to pay (or not). This has been a chronic concern in development circles for decades. Recent successes in adjacent sectors, however, demonstrate that business models designed for emerging markets and the communities within them, enabled by advances in digital tech-nology, can provide reassurance on revenue streams even from extremely poor customer bases. The most compelling example of cash-poor customers ability to pay may be the rapid uptake of cellphones in sub-saharan Africa, where since 2002 market penetration went from near zero to 65-89% (depending on the country). 11 Mobile phone industry pioneer and now billionaire Mo Ibrahim said, Celtel established a mobile phone network in Africa at a time when investors told me that there was no market for mobile phones there. 12 The combination of pre-payment schemes and mobile money (enabled by the digital revolution) made it possible for businesses to offer a service that low-income customers desperately wanted at a reduced commercial risk. The lessons from the cellphone industry in emerging markets are being used by the pioneers in rural electricity provision today. FIGURE 1: Rural Electrification Solution Applicability Source: Cathy Zoi/Emily McAteer, Odyssey Energy Solutions/Axess Energy A mini-grid deployed in rural Tanzania or India using current technology is equipped with smart meters that communicate via cellular or wifi networks; a solar power plant that is connected to the cloud so that a network operations center hundreds or thousands of miles can monitor operations; and consumers pre-pay for electricity via mobile money on their cellphones and receive text messages when their balances get low. Current Situation: The distributed generation sector in emerging markets is in its relative infancy. Most of the commercial enterprises are small, with the exception of several European utilities and energy companies who have engaged in exploratory development projects. Over the past two years institutional money was put to work in several solar home systems and microgrid companies working in sub-saharan Africa and India, but it is still too early to evaluate the commercial success of those investments. At the same time, there is significant interest in the distributed generation sector from mission-driven inves- 3

tors, including major development finance institutions (DFIs), impact funds, foundations, and family offices. The kind of capital potentially available from these entities spans the spectrum: patient equity (corporate and project), concessional or patient debt, convertible notes, grants in numerous forms, and short-term loans to support working capital needs. Given the nascency of the sector and the distance between the markets and where most investors are based, along with the very unfamiliar operating circumstances in those markets, prospective investors would benefit from tools to evaluate which geographies are best suited to their risk/ return appetite. The Investment Readiness Level (IRL) framework outlined here aims to demystify the off-grid opportunity assessment process for investors, by helping to characterize markets where a significant portion of the population has little or no access to electricity. A USEFUL ANALOGOUS FRAMEWORK: TECHNOLOGY READINESS LEVELS (TRLS) The United States Department of Defense (DoD) is frequently tasked with assessing the maturity of critical defense-related technologies. DoD developed a framework of technology readiness levels (TRLs) as a helpful shorthand for evaluating technology maturity and associated risk 13. The TRL framework proved so useful it is applied across many government departments and labs and in industries with sophisticated technology research agendas. The TRL framework is a nine-level taxonomy, denoted by TRL1 through TRL9, encompassing the entire spectrum of technology readiness from laboratory research to full deployment. TRL1 is described as the Lowest level of technology readiness. Scientific research begins to be translated into applied research and development. Examples might include paper studies of a technology s basic properties, while TRL9 is described as Actual application of the technology in its final form and under mission conditions, such as those encountered in operational test and evaluation. Examples include using the system under operational mission conditions. The concept of a multi-level taxonomy for assessing readiness is applicable beyond technology evaluation. A potential investor in off-grid energy must assess the suitability of the overall investment environment in addition to evaluating the skills and track record of the prospective investee before making a decision to allocate capital toward a project. While readiness in the TRL framework is based on technological development and deployment, evaluating investment environments in rural electrification requires the consideration of both techno-economic and policy-regulatory factors. The Investment Readiness Level (IRL) framework proposed here is designed to help investors evaluate the off-grid investment environment in a geography of interest. 14 INVESTMENT READINESS LEVELS (IRLS) Financiers develop risk/return profiles to decide whether to make investments and to establish terms and conditions associated with those investments. The investment community is diverse, with highly varying appetites for risk and expectations for returns. In mature markets the criteria for establishing the inputs for developing risk/return profiles are well-established. This is not the case in emerging markets, and more particularly so in off-grid energy infrastructure. The IRL framework will help investors characterize the risk/return profile of a particular geography for offgrid energy investment across two key axes: technoeconomics (TE) and policy-regulatory settings (PRS). TE considerations include technology risk, costcompetitiveness with current and future technologies, market size and scalability, data availability, and consumer affordability. PRS considerations include sector-specific factors such as market access, price 4

restrictions, incentives, the siting and commissioning processes, and grid extension provisions; and macro factors such as government effectiveness and political stability. The notion is that a combination of strong technoeconomics and supportive policies creates a favorable investment environment (and the converse creates an unfavorable one). The premise of the framework is that supportive policies can, in many cases, offset more challenging techno-economics. Likewise, if technoeconomics are very strong, the relative importance of policy measures may be less. Fig. 2 is a schematic of the relationship between investment readiness levels and the strengths of the associated techno-economics and policy-regulatory settings. The IRL taxonomy comprises six levels IRL1 through IRL6 with IRL1 signifying the lowest level of investment readiness and IRL6 the highest. A potential investor can use the IRL as an indicator of the overall investment readiness of a geography, or can drill down to view the scores of individual criteria for a more detailed perspective. Both the TE and PRS categories contain 10 specific criteria to be scored. The 20 criteria were developed based on synthesizing first-hand experience (of one of the authors); dozens of meetings with relevant industry practitioners in project development, finance, and policy; and from key reference materials from the UN and the World Bank Group. 15 Each individual criterion is evaluated under a 0-1-2 scoring system. Tables 1 and 2 list the TE and PRS criteria, respectively, along with the associated scoring standards. The individual criterion scores are summed to yield TE and PRS category totals, which are then plotted on each axis to produce an IRL. Since both the TE and PRS categories contain 10 criteria, the maximum total score in each category is 20. FIGURE 2: Schematic of investment readiness level (IRL) as a function of techno-economics and policyregulatory settings. Higher levels represent greater investment readiness. 5

TABLE 1. Techno-Economic scoring criteria. Score = 0 Score = 1 Score = 2 1. Technology risk: is the technology proven, durable, and tamper/theft resistant? Technology unproven Proven but susceptible to damage or theft Proven and well suited to geography 2. Market size and scalability: is there a sizable market, and does the technology scale easily and economically? Limited scalability Small market or costly to scale Sizable market, easy scaling 3. Commercial data: are reliable data available to demonstrate commercial viability and associated best practices/standards? No data Limited and/ or unreliable data Extensive, reliable data 4. Opportunity assessment data: are reliable data available on demographics, infrastructure, and resources? No data Limited and/ or unreliable data Extensive, reliable data 5. Competitiveness with current technologies and/ or fuels: does new technology cost less than what it is replacing? 6. Competitiveness with grid electricity rates: can new technology be provided at lower cost than the (often) subsidized grid rate? 7. Competitiveness with grid electricity costs: can new technology be provided at lower cost than extending the grid to this location? 8. Consumer affordability: does new technology cost less than 10% of household expenditures? Costs more Similar cost Costs less Costs more Similar cost Costs less Costs more Similar cost Costs less Costs more Similar cost Costs less 9. Consumer credit: can consumers access credit? No access to credit Limited access Easy access 10. Consumer productivity: does new technology enable consumers to increase their incomes via power-using applications and services? No increase in income Small or unlikely increase in income Substantial increase in income 6

TABLE 2. Policy-Regulatory scoring criteria. Score = 0 Score = 1 Score = 2 1. Market access: can operator get explicit government permission to operate? Cannot get permission to operate Lengthy approval process Permission easily obtained 2. Project ownership: are there restrictions on foreign ownership of capital or land? No foreign ownership of capital and/or land Local partner required for foreign owners No restrictions on ownership 3. Price restrictions: does the operator have the ability to charge prices that could deliver a positive IRR and the freedom to change prices or utilize different tariff structures? Rigid price controls Limited price controls, difficult to obtain approval for price changes No restrictions on prices or tariff structures 4. Incentives: are there subsidies, tax breaks, or other incentives that materially improve project economics? No incentives Incentives are short-term or of little economic consequence Substantial long-term incentives 5. Siting and commissioning: is there a defined process for siting and commissioning approvals that is enshrined in legislation and/or regulation? Processes uncertain or undefined Processes defined but burdensome and/or inconsistently applied Processes well defined, consistently applied, and not excessively burdensome 6. Monitoring and reporting: is the monitoring and reporting process well defined and not excessively burdensome? Processes ill-defined or excessively burdensome Processes defined but burdensome and/or inconsistently applied Processes well defined, consistently applied, and not excessively burdensome 7. Grid extension: do regulations guarantee the project owner fair compensation? No guarantee Compensation guaranteed but less than fair value Compensation guaranteed at full book value 8. Government effectiveness: does the government formulate and implement sound policies and regulations, and does it commit to those policies? Gov t ineffective Inconsistent policymaking, middling public services Effective gov t with high-quality public services 9. Rule of law: are laws, contracts, and property rights consistently enforced? Lax enforcement, significant corruption Some inconsistency but trend toward improvement Consistent enforcement, little corruption 10. Political/Macroeconomic risk: are the government and economy stable? Unstable Currently stable but recent volatility or other signs of future instability Stable 7

THE IRL FRAMEWORK IN PRACTICE Following are two sample a pplications of the IRL framework to geographies that have been the focus of much off-grid development activity and are thus of high prospective interest to investors: Uttar Pradesh, India and Tanzania. Scores (on the 0-1-2 scale) for each criterion in the TE and PRS categories are illustrated in the spider web plots. Test Case 1: PV-Battery Minigrid in Uttar Pradesh, India For the Indian state of Uttar Pradesh (UP), the IRL framework was applied to minigrids consisting of solar PV and battery storage. Techno-Economics As a mature, scalable technology that enables increased customer productivity and costs less than the common kerosene lighting and pooled-household diesel generation, PV-battery minigrids score 14 points out of a possible 20 in TE. Policy-Regulatory Settings With well-defined processes for market access and monitoring, a lack of restrictions (unless the developer elects to receive a capital subsidy) on pricing or ownership, and a stable political environment, UP scores 16 points out of a possible 20 in PRS. Investment Readiness Level With a TE score of 14 and a PRS score of 16, UP minigrids fall on the boundary between IRLs 5 and 6. We have adopted the convention that any score falling on the boundary of two IRLs belongs to the lower IRL, so UP receives an IRL of 5. Fig. 3 shows the TE (x-axis) and PRS (y-axis) scores on the IRL diagram. 8

Test Case 2: PV-Battery Minigrid in Tanzania The IRL framework was applied to PV-battery minigrids in Tanzania. Techno-Economics PV-battery minigrids are scalable, mature, productivityenhancing systems that are cost competitive with existing technologies, though there are concerns about affordability in rural villages and competitiveness with potential future grid expansion in some areas. The resulting score is 13 points out of 20 in TE. Policy-Regulatory Settings Developers in Tanzania benefit from well-defined market access and monitoring policies. The government provides substantial subsidies, but there are concerns over pricing interference and political stability. Tanzania scores 12 points out of 20 in PRS. Investment Readiness Level The respective TE and PRS scores of 13 and 12 place PV-battery minigrids in Tanzania within the IRL 5 band. Fig. 3 shows the TE and PRS scores on the IRL diagram. 9

Investment Readiness Levels of Two Test Cases FIGURE 3: Investment readiness levels for Uttar Pradesh, India (UP) and Tanzania (TZ), based on the test cases described above. Both UP and TZ are IRL5, though UP falls on the IRL5-IRL6 boundary. FURTHER WORK The next step in the development of the IRL framework is to workshop the criteria with both energy-access practitioners and academics. Once the criteria have been refined to the point where we are confident that they distill and capture the most important elements of an off-grid investment decision, we intend to apply the framework to a larger set of geographies, which will include the 20 countries identified by SE4All in sub-saharan Africa that account for 80% of the global population without electricity access. After scoring the individual TE and PRS criteria for these countries, we plan to make the information public, thereby giving potential investors a screening tool with which they can quickly assess and compare the investment environment across countries or regions of interest. Rather than simply publishing a list of jurisdictions with their IRLs, we will develop an interactive, web-based platform that allows a user to generate customized IRLs based on his or her preferred weighting of the underlying criteria. The IRL taxonomy is a simple tool for assessing off-grid investment readiness, but we expect that prospective investors will find it useful for their initial screening of potential investment opportunities. 10

(ENDNOTES) 1 Assumptions: 2.1 billion people with little or no access to electricity; average household size: 6 people; average monthly electricity spend/household: $8-14; number of households with businesses/pumping power needs: 10-20%; monthly business power spend: $40-60. 2 www.un.org/sustainabledevelopment/sustainable-development-goals/ 3 IEA WEO 2016, p.92 4 Ibid. p.93 5 UN SE4All, Electrification Heat Map, 2017 (http://www.seforall.org/sites/ default/files/electrification.pdf) 6 Ibid. 7 IEA WEO 2016, New Policies Scenario, p. 278. 8 Ibid, p. 264. 9 NREL, 2017. 10 McKinsey, 2017 11 Pew Research Center, Cell Phones in Africa: Communication Lifeline, April 15, 2015. 12 The Guardian, October 18, 2009. 13 www.army.mil/e2/c/downloads/404585.pdf 14 The IRL taxonomy is meant to be a screening tool for geographies and/or regions of interest. It does not attempt to cover specific issues of a prospective investee s track record or business model. 15 The World Bank Group s RISE 2016 report, Regulatory Indicators for Sustainable Energy: A Global Scorecard for Policy Makers is a useful reference. It considers policy factors in a broader context, examining regulatory settings in emerging economies for renewable energy, energy efficiency, and energy access. Within energy access, off-grid is an option that is evaluated. A number of the IRL framework s PRS criteria are also identified by RISE as key considerations, although given the slightly different focus of each of the analyses, there is not complete overlap. energy.stanford.edu/clean-energy-finance