Microfinance as a Pathway to Meet Future Energy Demand in Developing Economies

Image Source: World Bank

A large portion of Earth’s population lives in developing economies that currently do not consume much power. As the GDP of these developing economies increases, their energy demand will too. The United States Energy Information Administration (EIA) estimates that total world energy consumption will increase by 28% between 2017 and 2040. The majority of this increase in energy consumption will come from non-OECD countries, the bulk of which are developing economies:

Image source: EIA

Meeting Increased Demand

In order to address the forecasted 28% increase in demand for energy in developing economies, a significant amount of new electrical generation capacity will have to come online:

Image Source: EIA

Based on the EIA’s prediction for this growth, it is clear that the majority of this new generation capacity will be in the form of renewables or natural gas. However, this growth of natural gas and renewables is predicated upon continued investment. Recent improvements to hydraulic fracturing technology have led to an increase in the supply and a decrease in the cost of natural gas, and analysts are able to forecast short to mid-term natural gas investment with a moderate degree of confidence. However, as evidenced by the Bloomberg New Energy Finance Clean Energy Investment End of Year 2016 report, there is a significant amount of volatility in the clean energy investment sector.

Despite the volatility, the trend is clear: investments in clean energy research, development, and implementation have been increasing year-to-year and are likely to continue to increase. This investment is vital if renewable energy generation is going to more than double by 2040. The majority of this investment will likely be in large, utility-scale projects with attractive ROIs and long-term financing agreements. These utility-scale projects will allow the electrical grids in developing economies expand, and subsequently the portion of the population with access to energy will increase as well. However, this expansion is likely to be primarily in urban and suburban areas that are in close proximity to planned or existing transmission lines. Though there will be domestic economic migration within developing economies as their GDPs increase and centers of industry are built, the decentralized population bases that do not live near transmission are unlikely to benefit from increased utility-scale generation capacity.

For the uninitiated, microfinance is a type of banking service that is provided to unemployed or low-income individuals or groups who otherwise have no other access to financial services. It is a common mechanism utilized by NGOs, national development agencies, and finance organizations to encourage small-scale economic growth in developing economies. There are countless microfinance success stories, and it can be a particularly effective tool for fostering growth in a targeted sector.

Microfinance is playing a pivotal role in developing economies by filling the gap between urban grid growth and energy access for rural population bases. Issues associated with access to lighting at night, cooking fuel, and reliable electricity sources for home or small business use are major hurdles to overcome in developing economies and can severely hamper rural economic growth. This has been well documented, and a 2009 study by Rao et al. posited that the “lack of energy-finance options is hampering the “quality of life” of the [below-poverty line] community”.

Interestingly, in 2012, Chris Neidl, the South Asia Project Manager for Arc Finance stated in an article, “…a number of quality product suppliers and MFIs [microfinance institutions] have explored potential partnerships and initiated pilots, but often the distribution and after-sales service gap could not be fully be bridged by either or both partners. These experiences have further contributed to the sense that energy and microfinance simply cannot mix. However, this perspective does not adequately take into account the dynamism, growth and change that have characterized the rural energy sector in recent years, and mistakes capacity limitations symptomatic of the sector’s youth for inherent, permanent limitations.”

Reassessing where we stand today, there are many microfinance organizations actively involved in energy access in developing economies. The IFC, kiva.org, greenmicrofinance.org, pamiga.org, and the USAID REMMP are just a few examples of the organizations that have filled the need for energy access microfinancing in recent years. However, while there are several organizations that track broad microfinance data (CGAP is one example), finding specific metrics that provide past or present data on energy-specific microfinance is difficult. While a 2014 article by Richard Ottinger and John Bowie claims that, “microfinance in off-grid rural applications…[is] rapidly aiding growth in the renewable energy market”, given the quantitative nature of the finance industry, the lack of accessible data regarding energy access microfinance raises some questions regarding the current viability of the industry.

From one report that does provide relevant data, “despite their positive trends and high potentiality, MFIs products’ outreach for RE [renewable energy] and EE [energy efficiency] remains still limited in LAC [Latin America and Caribbean] with on average only few hundreds of loans disbursed per MFI per year and a total portfolio between USD3.5 million and USD15 million in 2014. Other kinds of green microcredits supporting sustainable practices such as agroforestry and recycling seem to have better outreach. Various challenges are at stakes among which the lack of clear understanding of the economic opportunity of green products, and of sound business models for RE and EE lending. However, in presence of good strategies, partnerships and products, the potential microfinance market in LAC for climate change adaptation and mitigation can be estimated at various hundreds of thousands of clients and hundreds of millions of dollars.”

Looking Forward

In a World Bank paper discussing financing instruments for renewable energy, three cons for microfinancing are listed:

  1. MFIs may not exist or may be unwilling to lend for purchases of RET [renewable energy technology] hardware, as loan terms are longer than typical MFI loans and repayment is dependent on household incomes rather than revenue generation.
  2. Transactions costs are high, although MFIs are able to reduce these compared to alternative financing arrangements.
  3. Microfinancing still requires RET developers to find significant working capital to fund initial purchases of RET systems ahead of first sales.

Taking these cons into consideration, as well as the limited MFI outreach mentioned above, the future for the microfinance energy access sector may see uncertain. However, the paper in which these cons were listed was written in 2011, and there has been a significant amount of growth in the MFI and RET hardware sectors since then.

Indeed, the World Bank now has an online tool for assessing the clean energy needs of low-income countries, and one of the options it suggests is microfinance. However, this tool is not going to bring microfinance, or energy access, to developing economies on its own. Chris Neidel further expands upon his analysis of the role that microfinance is playing in expanding access to clean energy, and asserts that as more funds, time, and talent are applied to the sector, “a clearer business case for greater MFI engagement in clean energy finance is beginning to emerge, driven by high levels of transformation occurring in the rural clean energy sector. As this trend continues, the argument will only become stronger.” Whether it’s a question of simply applying current microfinance pathways and infrastructure to the energy sector, or altering the fundamental way that MFIs conduct business and target potential lessors, is the question.

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