58599 November 2010 Note Number 39 Output-Based Aid and Energy: What Have We Learned So Far? | Geeta Kumar and Yogita Mumssen W orldwide, nearly 1.4 billion people live without access to electricity and nearly 2.7 billion people use traditional biomass fuels for cooking (IEA/ UNDP/UNIDO, 2010). One challenge to increasing reliable energy access for the poor is their limited ability to pay the up-front connection fees for electricity and natural gas. Output-based aid (OBA) approaches--in which subsidy payments are linked to prede ned outputs, such as instal- lation of a working household connection or solar home system--o er a potential solution that has increased energy access for more than 6.8 million poor bene ciaries. A recent World Bank review of OBA concludes that there is a case to adopt OBA more widely, where there is an enabling environment (Mumssen, Johannes, and Kumar, 2010). is Photo by Richard Hosier (World Bank) note discusses lessons learned and best practices in imple- menting OBA in the energy sector. investment is needed to ensure universal access to mod- ern energy services by 2030. This figure is far above the current levels of investment. Neither developing country Low access in the energy sector stems from both de- governments nor donors have sufficient resources to mand and supply side issues. On the demand side, high close the financing gap. Hence there is an urgent need to up-front connection charges are a barrier to connecting encourage private sector investment and to use existing the poor. Even though energy expenditures are typi- public resources effectively. cally less for electrified households, the connection fee prevents the poorest from switching to this lower cost Output-based aid in the energy sector source (World Bank, 2008). On the supply side, low cost recovery and the resulting inability of utilities to spend OBA approaches are currently being implemented in the on capital investments contribute to low access. Most energy sector to help improve access and targeting for the electricity utilities charge tariffs substantially below full poor. A recent World Bank review of OBA (Mumssen, cost recovery and many charge tariffs that do not even Johannes, and Kumar, 2010) identified 30 OBA energy cover operating and maintenance costs (Foster and oth- schemes in the World Bank Group (WBG), including ers, 2005). Thus subsidies are pervasive in the energy three GPOBA projects under design (see Figure 1). Sev- sector, but often are not targeted to the poor, result- eral additional schemes have been identified outside the ing in unnecessary leakage of scarce public funding. WBG, including projects funded by the Dutch Director- A common attempt to target utility subsidies is to use ate-General for International Cooperation through the quantity-based tariff subsidies that charge lower tariffs Energizing Africa Initiative. for lower quantities of electricity. However, such subsi- dies usually lead to regressive targeting, as many poor households are often not connected to the network in Geeta Kumar is a consultant in the Global Partnership on Output- the first place. Based Aid. Yogita Mumssen is a Senior Infrastructure Economist The International Energy Agency (IEA/UNDP/ in the World Bank's Finance, Economics, and Urban Development Department. UNIDO, 2010) estimates that US$36 billion a year in Supporting the delivery of basic services in developing countries Figure 1. Regional Distribution of World Bank collection records. The OBA subsidy is generally used Group OBA Energy Projects to buy down the capital cost to make access affordable and is paid once installation is verified. In addition to a) By value of subsidy one-off capital subsidies for access, transitional and (Total=US$175.5 million) ongoing output-based subsidies have been used in grid-based schemes, such as the Pamir Private Power SAR, 18% AFR, 33% Project in Tajikistan. Explicitly targeting subsidies LCR, 30% to the poor EAP, 13% The World Bank review concludes that OBA provides ECA, 6% a strong platform from which to target subsidies. b) By number of projects (Total=30) · Nearly all the energy projects (28 out of 30) involve one-off capital subsidies enabling initial access, AFR, 30% which is inherently more pro-poor since the poor SAR, 23% are usually not connected in the first place. · Most OBA energy projects use a blend of geo- graphic targeting (selecting poorer locations LCR, 20% where subsidies should be channeled) and self- EAP, 17% selection targeting (subsidizing outputs that the non-poor are less likely to use, such as smaller ECA, 10% SHS) (see Box 1). AFR = Sub-Saharan Africa; EAP = East Asia and Pacific; · The most precise way of targeting involves assess- ECA = Europe and Central Asia; LCR = Latin America and Caribbean; ing household income (means testing) or using SAR = South Asia Region. indicators to estimate household wealth (proxy Source: Mumssen, Johannes, and Kumar (2010). means testing). Means-tested targeting is more common in projects located in middle-income countries, as it requires more advanced adminis- trative systems. The use of OBA is most widespread in individual · Output verification helps check the accurate target- off-grid systems for rural electrification. Public fund- ing of subsidies and is providing early evidence ing is often needed as grid expansion costs are typi- that OBA schemes are reaching the poor. In the cally high in rural areas, as demand tends to be small Armenia Heating and Gas project, for example, and widely dispersed. The "output" in an off-grid proj- output verification involves checking whether the ect is usually the installation of a functioning off-grid beneficiaries of the subsidy are registered in the unit, such as a solar home system (SHS). Fifteen of country's official social protection program for the WBG projects use SHS and one uses household- low-income households. sized biogas plants. Most OBA projects use the "dealer model" whereby private dealers sell systems in the open market. A third-party financial institution, such Shifting performance risk as a microfinance institution, may provide household to providers credit for the initial down payment. Consumers own the stand-alone systems and are responsible for main- Compared to input-based schemes, OBA shifts per- tenance, following the warranty period. formance risk to service providers, since payments to OBA for grid-based extensions is also being used them are made only after verified delivery of access in a few projects (including a couple of GPOBA and service. How much performance risk is borne by projects under design) to expand access to the urban the OBA service provider depends on the definition and peri-urban poor. The "outputs" in grid-based of outputs and the extent of phasing-in of subsidy systems typically are verified working connections to payments, as well as the service provider's ability to the network, but could also include a specified period prefinance the investments and services until sub- of service delivery, demonstrated through billing or sidy payments are made. In the Colombia natural gas November 2010 Note Number 39 Box 1. Nepal's Biogas Support Program: Grid-based OBA schemes leverage private capital Geographic Targeting plus Self-Selection mainly by working with private concessionaires. Such Targeting investments are viable only if tariffs for OBA benefi- ciaries cover ongoing costs and pay back investments. The Biogas Support Program successfully combines Thus private capital leveraging is wholly related to carbon finance with output-based subsidies to tariff reform. In Senegal the Government, with sup- provide affordable household-size biogas plants port from the Public-Private Infrastructure Advisory to rural families in Nepal. The subsidies vary ac- Facility (PPIAF) and other donors, developed a rural cording to the plant's size and location. Smaller plants, used by poorer families, receive relatively electrification program that combines privately oper- higher subsidies than larger plants. Biogas plants ated concessions with output-based subsidies1. Under in remote mountainous regions, where the popula- this program, the rural concession of Dagana-Podor tion is poorer, receive a higher subsidy than biogas was awarded to the Office National de l'Electricité plants in the Terai lowlands, where the population (ONE), Morocco's electricity utility, in 2007. ONE has is better off. As of July 2010, 10,868 biogas plants committed to make long-term investments of approx- had been installed and verified under a GPOBA- imately US$10 million that it plans to recover through funded component. The World Bank's Community Development Carbon Fund is purchasing emission customers' monthly payments. reductions generated by substituting biogas for In cases where the OBA subsidy recipients ben- traditional fuels such as wood and kerosene. efit from social tariffs--which do not fully cover investment and/or running costs--the provider will need to cross-subsidize these new poor users with higher tariffs for industrial customers and wealthier households. For example, in Colombia, under a project, the entire output-based subsidy was paid after government cross-subsidy initiative, poor residen- the households had obtained (and paid for) service for tial customers receive a 40 to 50 percent discounted at least three months. This was possible because the tariff for the first 20m3 of natural gas consumed. Gas service provider, Promigas, is a large private company distribution companies recover these subsidies from and has the financial muscle to take on increased a surtax charged to high-income residential and performance risk. industrial users. In the case of mini-grids, up-front capital expen- In the case of off-grid energy schemes, dealers are ditures as a percentage of total costs are high and typically small- and medium-size service providers. service providers are typically small. Thus a larger There are identified cases where dealers could not fraction of the subsidy must be paid up front to avoid scale up business volumes rapidly because of difficulty increasing the financing costs and hence the subsidy in accessing finance. However, there is some evidence levels. For instance, Nicaragua's off-grid rural electri- that larger dealers are taking risks in OBA schemes. fication project (PERZA) disburses 70 to 80 percent In Sri Lanka's RERED project, three SHS dealers have of the subsidies against construction milestones and each made investments of up to US$1.5 million to the remaining 20 to 30 percent against final outputs develop a commercial distribution network (World such as new connections and service quality. In recent Bank, 2002). Although the amounts are small in ab- SHS projects, maintenance services are included in solute terms, the relative risks are substantial from the the output to shift greater risk to the provider. For dealers' perspective. example, in Bolivia's SHS project, the service provider Key to enhancing private sector finance and ex- is responsible for maintenance of the SHS during a pertise, especially when working with smaller provid- three-year service contract. ers, will be tackling the access-to-finance constraints for medium- to long-term financing. An IDA line of Mobilizing private sector capital credit is being used in Bangladesh, Ghana, Sri Lanka, and expertise and Uganda to provide long-term liquidity to partici- pating private rural banks and microfinance institu- OBA has been successful in mobilizing expertise tions. But in the Ghana case, the line of credit focuses and funding from the private sector to poor areas on household affordability; it is clear that dealer access they would not otherwise serve. All the energy OBA to finance will also need to be addressed. Carbon fi- projects involve private service providers (or public- nance may generate incremental revenues for renew- private partnerships), except one (the Ethiopia rural able energy projects and can thus alleviate some of the electricity access project). funding constraints (see Box 1). However, for OBA to grow to scale, the access-to-finance constraint will is also being used in grid and mini-grid schemes. Fur- need to be addressed more systematically. ther lessons are being learned and will inform OBA as it goes to scale. Conclusion References OBA is not a panacea. OBA schemes are only as sustainable as the environment in which they operate Foster, Vivien, Quentin Wooden, Kristin Komives, and cannot bypass the need for a strong regulatory and Jonathan Halpern. 2005. "Water, Electricity, regime. Ultimately, an output-based capital invest- and the Poor: Who Benefits from Utility Subsi- ment program is only part of a larger service delivery dies?" Washington, DC: World Bank. arrangement: in order to provide sustainable service IEA/UNDP/UNIDO. 2010. "Energy Poverty: How to over time, tariffs need to be at appropriate levels and Make Modern Energy Access Universal?" Special subsidies need to be minimized. early excerpt of the World Energy Outlook 2010 There are also additional costs associated with for the UN General Assembly on the Millennium implementing OBA. Monitoring and verification Development Goals. Paris: OECD/IEA. requires capacity and resources. Capacity can be an Mumssen, Yogita, Lars Johannes, and Geeta Kumar. issue in OBA schemes, especially with small and lo- 2010. Output-Based Aid: Lessons Learned and Best cal private providers. Successful projects, such as the Practices. Washington, DC: World Bank. Rural Electrification and Renewable Energy Develop- World Bank. 2002. "Renewable Energy for Rural Eco- ment Project in Bangladesh, tend to include extensive nomic Development." Project appraisal document capacity-building elements for the private sector. for the Rural Electrification and Renewable Energy Access to medium- and long-term financing is Development Project, Sri Lanka. Washington, DC: critical to enhancing private finance and expertise, World Bank. and determines how much performance risk can be ------. 2008. e Welfare Impact of Rural Electri ca- reasonably shifted to the service provider. To date, tion: A Reassessment of the Costs and Bene ts. An experience is limited on how best to mitigate the IEG Impact Evaluation. Washington, DC: Indepen- access-to-finance constraint with instruments such as dent Evaluation Group, the World Bank. guarantees. Despite these challenges, OBA has demonstrated advantages over traditional approaches in efficiently targeting subsidies and mobilizing the private sec- tor to serve poor households that would otherwise 1 PPIAF has provided technical assistance to the Government of go without improved service. In the energy sector, Senegal since 2000 to foster private participation in infrastructure. PPIAF also funded the market survey and pre-feasibility study of the OBA is becoming one of the more commonly used Matam-Bakel-Kanel-Ranérou concession in 2008. approaches for expanding rural off-grid access, and it About OBApproaches OBApproaches is a forum for discussing and disseminating The case studies have been chosen and presented by the au- recent experiences and innovations in supporting the delivery thors in agreement with the GPOBA management team and are of basic services to the poor. The series focuses on the provi- not to be attributed to GPOBA's donors, the World Bank, or any sion of water, energy, telecommunications, transport, health, other affiliated organizations. Nor do any of the conclusions rep- and education in developing countries, in particular through resent official policy of GPOBA, the World Bank, or the countries output- or performance-based approaches. they represent. To find out more, visit www.gpoba.org e Global Partnership on Output-Based Aid e Global Partnership on Output-Based Aid Supporting the delivery of basic services in developing countries