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Step 2 - Recommendations for using subsidies smartly

Subsidies: this refers to any investment to directly support any function of an energy market system with funding that does not need to be repaid at market rates. Subsidies cover a wide range of types and can come from a wide range of sources (although are often linked to public funding), such as asset transfers, sharing costs of inputs, delivering services including training, providing marketing assistance and grants for innovations and piloting.

In the past, interventions for overcoming market barriers have often involved the use of some form of subsidy. Whilst the use of subsidies has had mixed results in supporting lasting impact at scale in a range of sectors, including energy access, experience has shown that it can be a powerful instrument in achieving sustainable changes in an energy market system. Particularly when it is used in a targeted way as part of a strategic facilitation process, such as follows:

  • Financing the demonstration of innovative new business models.
  • Reducing the risk for poorer market actors or building their capacity, such as empowering women to become energy technology sales agents.
  • Increasing access to critical inputs, services and finance.
  • Supporting the development, and adherence to, quality control regulations – this is becoming increasingly important for a range of energy products and services.

When subsidies are used in a broad way, or to support market actors or end users who don’t need them, they can undermine the efforts of the facilitator to achieve growth without distorting the energy market. This can create significant risks for the sustainability and the potential for impact at scale of the roadmap process.

As the use of subsidies are very common for funding interventions to overcome market barriers, it is useful for the facilitation team to start to identify when, and what types, of subsidies should, and shouldn’t, be used in the next steps of the roadmap. The facilitation team can use the template in Annex 7 to start to assess whether a subsidy should or shouldn’t be used for each potential interventions already identified. It is very important to carry out careful design and planning to ensure that any subsidy that the facilitators consider applying is used smartly, following the following 3 principles:

  • Keep them Minimal +

    • Don’t use subsidies and direct delivery unless you have to.
    • Always look to use the minimum level of subsidy.
    • Are there any market actors who have the incentives to invest and support the intervention in question?
    • Could you facilitate these market actors to address the market barrier themselves?
  • Be Strategic +

    • If you choose to use subsidies and direct delivery, be strategic about them.
    • Be clear about their purpose and the objective of their use.
  • Be Cautious +

    Be aware of the risks of using subsidies and direct delivery of market functions and mitigate risks as much as possible if you do choose to use them.

    It is useful to use the examples in Table 3 to select activities to include in the next steps of the roadmap, including the budgets to implement them.

    Table 3Common Risks of Using Subsidies and Ways of Mitigating Against Them

    Risks of subsidies

    Description

    Mitigation Activities

    Dependency on time-bound resources If market actors internalise a subsidy, using it as part of their business plan, this creates a dangerous dependency that can harm them more than it helps them when the funding ends.Communication: Be clear to market actors exactly how much subsidy they will receive, for what and for how long. Help them plan their business models and livelihoods after the end of the subsidy.
    Not scalableNew business models and innovations that require subsidies to get off the ground are always more difficult to replicate and copy, reducing the likelihood they will be scaled up into system-wide change.Partnering: While financial institutions may not be willing to finance research and development into new business models, they may be willing to finance market actors who want to copy or adapt an innovation that has been tested and demonstrated. Financial institutions can be strategic actors to help scale initially subsidised innovations.
    Addressing symptoms rather than causesSubsidies can be used to plug gaps in a market system. It is tempting and easy to use them as a temporary aid rather than seeking the root cause of the market failure and facilitating the market actors to work to overcome it.Systemic Planning: By carrying out systematic and careful analysis of the energy market system it is possible to identify the underlying market barriers and planning interventions that don’t rely on long-term direct subsidies.
    Distortion of existing marketsSubsidised goods and services can severely distort existing supply markets by temporarily deflating demand for the energy products and services and providing uncompetitive advantages to participating market chain actors.Coordination: Analyse energy market chains to identify the existing market actors. Use short term, targeted subsidies, such as Results-Based Finance (RBF) voucher schemes to encourage the market actors to develop better relationships with their end users, and work with existing, ideally marginalised, market actors.
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