Tariff Reduction Innovation Insight – Crossboundary Innovation Lab
Mini-grids are self-sufficient electricity grids that serve households and businesses isolated from or integrated with the main grid. CrossBoundary’s Mini-Grid Innovation Lab estimates they are the cheapest way to deliver power to at least 100 million Africans. However, rural mini-grid customers typically pay much higher electricity tariffs (price), and consume much less energy, than rural main grid customers. Private rural mini-grid companies must charge their customers tariffs that reflect the full costs of providing power. Public utility-run main grid rural customers typically pay much lower tariffs as their cost of power is subsidized by the utility’s higher consuming urban or industrial customers.
The electricity tariff (price) is therefore one of the major drivers of the mini-grid business model, for both the mini-grid operator and the customer. The price of electricity directly determines a mini-grid’s revenues, and how much energy a customer can afford to consume. If the price is too high, customers can’t afford to buy enough power. If the price is too low, mini-grids sell power below their cost of delivering energy, harming the commercial viability of the project.
Setting the right tariff is an important business model decision for a mini-grid developer. It is a delicate balance between customer needs, developer economics, and the requirements of the regulator. To help mini-grid developers get this decision right, the Innovation Lab is running a Tariff prototype to test the impact of reducing the tariff on the mini-grid business model.
Early results from the Lab’s Tariff prototype show that rural mini-grid customers are extremely price sensitive – they are ready to consume much more power than they can afford at current tariffs. In May and June of 2018, the Innovation Lab supported two mini-grid developers in Tanzania to significantly reduce their cost-reflective tariffs on two small, rural sites – by 50% on one site and 75% on the other.
Customers reacted immediately. For every dollar they saved on price, they spent $0.93 on increasing their energy consumption. Therefore, despite massive price reductions, developers saw revenues fall by only 7%.
We can make two significant observations from this initial data:
- Reducing tariffs has an immediate and strong effect on rural customers’ use of energy. Rural customers are budget constrained.
- Mini-grid developers may be able to charge lower tariffs and achieve the same or similar revenue.
However, consumption is not free. It requires investment in generation and storage, which means added costs to serve the increased demand. A tariff that is too low could be below the levelized cost of energy of the system. We therefore don’t know how lowering tariffs impacts the business model until we have a complete picture of the associated costs. The Lab will present this analysis in the next release of this paper. While the initial results are promising, neither developer could have reduced their tariffs without funding support from the Lab in the form of a tariff subsidy.
It’s important to emphasize that this initial data represents actionable intelligence rather than scientific evidence. The data sets are small (128 customers across two sites), customers at both sites are low consumers relative to other mini-grid customers, and the prototype is only nine months into its five-year life. These are preliminary results and may change with more data over time, or more data from additional sites and from other markets. However, the Lab will soon add a third site, bringing total connections under the prototype to 332. The Lab is working with mini-grid developers and funders to further prove the level of tariff reduction that will fully unlock customer demand. The Lab will test tariff reductions on sites in new countries in Africa, with different types of customers, different tariff structures, and different grid sizes.
Why we’re doing this: tariff is a major driver of both mini-grid revenue, and how much energy customers can afford
The Tariff prototype tests the impact of reducing the tariff on the mini-grid business model. The Lab expects reducing the tariff will impact electricity consumption, either because customers can afford to use energy in new ways (appliances) or they can afford to use energy for longer, whether in the same or new forms (hours).
To test this prototype, the Lab provided a subsidy that allowed developers to reduce tariffs at two mini-grid sites in Tanzania. At one site, with 63 total connections, the Lab reduced the tariff by 50%. At the other, with 65 total connections, the Lab reduced the tariff by 75%. The tariff reductions were chosen so the price change was significant enough to change customer behavior, while mini-grid operators were able to recover enough of their costs to ensure their sustainability of their business model.
After community engagement, the mini-grid developers implemented the reductions on a single day, dropping the price per kWh of power offered to all customers on site by 50% and 75%, respectively. The Lab collected consumption and payment data from each site on a monthly basis, and conducted two customer surveys to collect demographic, socioeconomic, and user experience data.
More details on study methodology can be found in the Study Design, available here.