The Critical Factors
- Micro hydro programmes and projects need clear objectives. Is the project or programme:
o A programme to sell as many micro hydro schemes as possible (regardless on the users' needs); and
o To create small profit making enterprises that are financially self-sustaining.
- Financially self-sustaining projects have cash generating (usually day time) end-uses to produce cash flow and increase the use of the plant (load factor). Lighting-only systems will have the greatest difficulty in achieving financial sustainability.
- Subsidies are likely to be necessary if micro hydro schemes are to substantially improve the access of poor people to electricity.
- The cost of micro hydro plants is dependent on location and standards although effective management can contain this.
- The form of ownership of micro hydro plant is probably less important to success than creating an effective business-like style of management.
- Selecting and acquiring micro hydro technology that is appropriate to the location and task remains a necessary condition for success (wrongly sized plant and inappropriate standards remain a constant threat).
- It is easier to make a profitable micro hydro plant socially beneficial than to make a socially beneficial plant profitable
- Profitable end-uses are difficult to develop because of the limited size of the local market and the general difficulty of small and micro enterprise development in remote locations.
- Financial institutions willing to finance micro hydro should consider funding associated end-use investments in order to build profitable load.
- It may well be that micro hydro should be promoted for its role in securing livelihoods, or developing small enterprises, rather than as an ‘energy programme’.
- The choice of end-use can affect those who benefit from micro hydro and will therefore effect the poverty and gender impacts, even if not all the community has direct access to the energy.
- The financial performance of all micro hydro plant could be improved if the average tariff was kept in line with local inflation.
- Life line tariffs under which the richer consumers cross subsidise households that cannot pay will spread the poverty reducing benefits of micro hydro - as long as the total revenue is adequate.
- While there is clear evidence that demand is sensitive to the tariff charged (many potential users would be excluded by full cost covering tariffs in many locations), there is also evidence that the ability of some people to pay is higher than originally thought.
- Governments need to assign clear responsibilities for micro hydro development and the development of the necessary ‘enabling environment’. Best Practice suggests that this would ideally be part of assigning more general responsibilities for the provision of decentralised energy services to rural (or marginalized).
- Governments need to treat all energy supply options equally (‘offer the full menu of options’) and to favour what best meets the needs of the consumer in different locations.
- Governments need to ensure fair competition between competing supply options and provide equal access to aid and other concessional funds, subsidies, tax breaks and support.
- Plans for the expansion of the electricity grid should be rule based, and in the public domain to reduce the uncertainty about when the grid will reach a particular location. Clear rules should be published regarding the actions the grid supplier must make to compensate micro hydro owners when the grid arrives (either to buy out the plant at written down costs or to buy the hydro electricity produced).
- While government finance tends to favour large scale energy investments (in say power or fossil fuels), micro hydro has the opportunity of utilising local capital (even the creation of capital through direct labour to build civil works) and it is part of the new trend towards ‘distributed’ power with much reduced costs of transmission.
- Regulation should aim to produce a structure of incentives that result in the needs of consumers being met most cost-effectively. It should be technologically neutral, and at costs that are in keeping with the scale of the investment and the ability of the various parties to pay.
- Regulation should be transparent, stable and free from arbitrary political interference so as to foster competition between suppliers of technology, services and finance.
- Regulation should set standards that are appropriate to the project cost and the ability of the various actors to pay.
- Quality and safety standards should be enforced to prevent the users being exploited by shoddy equipment and installations.
- Regulations should be designed so that they do not merely increase the opportunities for “rent seeking behaviour" of officials.
- Regulations should be set so that: independent power producers can supply power to the grid at ‘realistic’ prices; and connection standards are appropriate for the power to be sold. Rules should be transparent and stable.
- Best practice suggests that the expansion of micro hydro will continue to need both ‘soft funds’ and funds at commercial rates, particularly if micro hydro is to meet the needs of people with low money incomes.
- Funding will be needed to cover capital costs, technical assistance and social/organisational ‘intermediation’.
- Micro hydro development will need to leverage funds from many sources including those for small enterprise development, livelihood development, technical assistance social infrastructure, as well as the more usual energy and environment sources.
- Micro hydro will need to widen the menu of financing options for acquiring both debt and equity, including leasing, novel forms of debt guarantee, and novel forms of collateral (e.g. in Peru the hypothecation of the cash flow from energy end-use, and municipal loans guaranteed by ‘intercept’ on revenues from Central government).
- Loan conditions should be simplified, and collateral conditions modified to suit local conditions for asset (land, equipment) ownership.
- Some financial institutions are likely to require training to understand the special needs and risks of micro hydro, or to build on analogous experience in other forms of rural investment.
- Subsidies should be designed to achieve clearly stated objectives and should develop rather than destroy markets.
- A particular problem with current subsidies provided by bilateral donors is that they have a tendency to ‘pollute the well’ – that is, they use their subsidies to spoil the market for others.
- Smart subsidies should:
o focus on increasing access by lowering the initial costs (technical advice, capital investment) rather than lowering the operating costs;
o Provide strong cost minimisation incentives such as retaining the commercial orientation to reduce costs;
o remain technologically neutral;
o cover all aspects of the project including end-use investments, particularly to encourage pro-poor end-uses; and
o use ‘cross subsidies’ within the project to pay for life line tariffs and other ‘propoor’ recurrent cost subsidies (e.g. enable transfer from richer sections of the community, and commercial users to marginal connections).
Best Practice for Donors
- Build programmes on a thorough understanding of what has already been tried before in the country and elsewhere.
- Adopt funding strategies that enhance (rather than duplicate or destroy) local capabilities including organisations, regulatory frameworks, and technical capacities.
- Maintain the ‘full menu’ of options, so as to give micro hydro the same chances for funding as other decentralised energy supply options.
- Ensure funds build markets rather than destroy them - apply the principles of ‘smarter subsidies’.
- Ensure funds are available for both micro hydro and associated end-uses. Give particular attention to the encouragement of pro-poor end-uses (and the views of women as major players in traditional energy systems).
- Ensure funds are available for all aspects of project development.
- Use soft funds to leverage access to large flows of more conventional loan and equity finance.
- Be transparent to make others aware of what you are doing and try to harmonise activities with other donors, partners, equipment suppliers, contractors, and government programmes.
- Project developers who have the skill and tenacity to put all the elements of a micro hydro plant together are crucial to the success of programmes, and are likely to be the main constraint to programme expansion, particularly if their costs cannot be covered by grants
- Successful micro hydro programmes will need to be sufficiently large to produce sufficient work for the project developers and to achieve economies of scale in the supply of such services - such as where there are a number of plant in the same area allowing for costs of site visits to be shared by a number of installations.
- Financial institutions and regulatory agencies need to strike a balance between their need for project developers they regard as credible (speaking English with formal qualifications in engineering and accountancy) and their cost. Best practice probably requires lower cost project developers with specific practical experience with micro hydro and the communities that use them.
- The costs of ‘intermediation’ in project development should be recorded, and attempts made to cover them directly with grant funding.
- Efforts should be made to estimate the realistic size of the market for micro hydro, taking into account, costs, alternatives, and the likely availability of finance, so as to determine whether the process of project development can be put on a more sustainable financial basis (including grants). Additionally the scale of project development capabilities should be increased sufficiently so as to reduce unit costs by capturing the economies of scale.
- Technical assistance services should be separated from credit functions to ensure that sound judgements are made about the financial viability of each project (with or without subsidies) and credit worthiness of project owners.
- Consideration should be given to productive end-uses from the outset, and treat micro hydro investment as a small enterprise (regardless of actual ownership structure).
- Endeavour to create a business like management structure, even if co-operative or other forms of joint ownership are used.
- Attempt to institute rules for tariff setting and for inflation adjustments that are technical and routine rather than arbitrary and politicised (e.g. link the price of electricity to some other freely traded commodity - such as a staple crop, kerosene, or candles).
- Successful programmes include activities that stimulate demand for hydro and the financial and other support activities that are available.
- Successful programmes include activities that lobby for changes in the ‘enabling environment’ created by government, financial institutions and donors. These are probably most effective when operating as an ‘Energy Forum’ combining the interests of all people interested in rural, ‘alternative’, or decentralised energy options.
- Project development would benefit from technical catalysts who can work in close proximity to villagers at relatively low cost.
- There would appear to be no short cuts in developing local capacities. The process takes a long time and is costly, but without such capacities micro hydro programmes cannot succeed.
- Local capacities to build micro hydro plants locally appear to substantially reduce costs
- Local capacities to manage, operate and maintain micro hydro plants are a necessary condition for success and resources will need to be devoted to building this capacity.
- Regardless of ownership structure, it would appear that the successful management of micro hydro plants requires a ‘corporate structure’ that minimises political interference (e.g. from municipal authorities or powerful community members) by providing clear delegated authority to a management to achieve clearly stated objectives related to profitability, coverage, and the quality of the service to be provided.