Over the last three decades or so, development finance institutions have approached energy projects in three different ways, reflecting the complexity of development challenges and changing energy systems.
In the 1990s, the priority was to demonstrate how energy projects would contribute to the national GDP in developing countries. The assumption was that energy supply was key to support economic growth, and economic growth would in turn solve most development problems.
By analogy, the issues in this decade were sort of a linear equation with one variable. In such cases, solutions were straightforward, driven by economies of scale and favoring large projects with high financial internal rate of return (FIRR). Examples of this trend included high-voltage transmission projects and fossil fuel-based power generation plants financed by the private sector through build-operate-transfer (BOT) schemes with government guarantees.
However, by the end of the decade the Asian financial crisis (with many debts caused by energy sector BOT projects) and widening income gaps shifted the focus to poverty alleviation. Project design required a vigorous “headcount” of how many poor people would benefit directly from project implementation.
To achieve inclusive economic growth, energy projects in the 2000s focused on the demand side, mainly expanding energy access through rural electrification. Projects had to make energy affordable for poor households, while maintaining their economic and financial viability.
Such requirements spurred policy support via subsidies and increased concessional financing for energy projects. Again, by analogy, the equation became nonlinear with two variables – much more difficult to solve.
In the 2010s, extreme weather events became more frequent, threatening particularly vulnerable developing countries, so the priority changed again to climate change mitigation and adaptation. Nowadays all energy projects must be designed to be economically sound, socially inclusive, and environmentally sustainable.
Typically, such projects include both supply-side renewable energy (wind, solar, hydro, and geothermal) and demand-side (industry, buildings, commercial) energy efficiency projects. They also have to demonstrate how much they will reduce greenhouse gas emissions; this is what we know as the Energy Trilemma, a nonlinear equation with three variables.
A nonlinear energy equation with three variables is very hard to solve, as different countries are at different stages of development and have different energy resource endowments. Solutions can only be found through technology innovations that can be categorized as the “3 Ds” of distributed, decarbonized, and digitalized energy systems.
- Distributed systems offer tailor-made energy supply solutions at the consumer level without relying on centralized national grids. Around 70% of the 1 billion people still without access to electricity—mostly residing in remote rural areas and islands—can be served with off-grid local micro- or mini-grids, much cheaper to install than connecting them to the national grid.
- Decarbonized systems are distributed systems based on renewable energy. They do not generate emissions and include energy battery storage, so the power supply is 24/7 despite the intermittency of solar and wind.
- Digitalized systems regulate and optimize the power supply with minimum human intervention and maintenance. For instance, deploying blockchain technology in micro- and mini-grids would turn rural consumers into “prosumers,” sharing their surplus production among the local community. Artificial intelligence can likewise help program and schedule energy use for maximum conservation and efficiency.
Technology innovations have great potential for developing countries to address the Energy Trilemma, but deployment and scaling up will not happen automatically. Beyond technology, these countries also need innovative business models, financing instruments, and procurement methods.
First, business models should incentivize developers, financiers, operators, local communities, and consumers, to maximize project benefits while sharing the risks in a fair manner. In this regard, governments should provide policy and regulatory transparency and certainty for businesses.
In the eyes of investors, the impact of policy intermittency is much more harmful to energy systems than the physical intermittency of solar and wind power.
Second, new financing instruments must be introduced to complement banks, mostly accustomed to financing large-scale energy supply projects with adequate FIRR, or providing concessional resources to socially oriented, government-subsidized rural electrification projects. However, financing micro- and mini-grids in remote areas is much more complex, as they involve innovative technologies and new business models yet are often relatively small in size and deal with multiple stakeholders.
Development finance institutions should design new instruments that can flexibly support such projects, and mitigate the associated risks.
Third, procurement methods that usually favor the lowest-priced bids should be enhanced to give more weight to quality and innovation in project design and specifications. High technology funds could be established to cover the viability gap when piloting innovative technologies for possible scaling up in future.
Furthermore, in identifying project cost and benefits, it is important to consider a “shadow carbon price,” or the social cost of carbon. The Intergovernmental Panel on Climate Change suggests a unit value of $36.30 per ton of CO2 for 2016 emissions (to be increased by 2% annually in real terms); this can encourage innovative projects that cut emissions, and discourage those that increase them.
As the focus of the global development agenda has shifted from economic growth to inclusive and sustainable growth over the last three decades, energy technologies have also evolved with increasing sophistication. Engineers have replaced supply-oriented, large-scale, fossil-based power systems with demand-focused systems characterized by the “3 Ds.”
To further scale up the deployment of such technology innovations, policy makers, regulators, investors, financiers, and other stakeholders must also innovate in business models, financing instruments, and procurement methods. This will bring a real chance for developing countries to overcome the challenges of the Energy Trilemma and leapfrog to secure, affordable, and clean energy systems.