The Critical Link Empowering Utilities for the Energy Transition © 2024 International Bank for Reconstruction and Development/The World Bank 1818 H Street NW, Washington, DC 20433, Telephone: 202-473-1000 www.worldbank.org This report was prepared by a World Bank Energy and Extractives Global Practice team led by David Loew and Tatyana Kramskaya under the strategic guidance and general direction of Guangzhe Chen, Stephane Straub, Demetrios Papathanasiou, and Ani Balabanyan. Core World Bank team members from the Energy and Extractives team included (in alphabetical order) Rafael de Sá Ferreira, Selena Jihyun Lee, Takeshi Mori, and Tom Remy. The ndings, interpretations, and conclusions expressed in this work do not necessarily re ect the views of The World Bank, its Board of Executive Directors, or the governments they represent. 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Fax: 202-522-2625; email: pubrights@worldbank.org The Critical Link: Empowering Utilities for the Energy Transition CONTENTS Executive Summary IV Section 1: Introduction & Methodology 1 Section 2: Historic and Current Global Utility 5 Performance Section 3: New Challenges and Opportunities 14 for Utility Performance Section 4: Empowering Utilities for the Energy 28 Transition and Universal Access Bibliography 39 I The Critical Link: Empowering Utilities for the Energy Transition FIGURES Figure 1: Sustainable utilities for the energy transition and universal access VII to electricity Figure 2: Number of utilities in the UPBEAT database by country income and 3 ownership (left), and geographic distribution (right) Figure 3: Number of utilities according to the share of variable renewables in 4 their country s generation mix (left), and change in their country s electricity access rate (right) Figure 4: Share of utilities by country income that are fully recovering both 6 their operating and debt service costs (green bar), their operating costs only (orange bar), and neither their operating nor their debt service costs (red bar) Figure 5: Utility cost recovery over time by income (left) and ownership 7 (right) Figure 6: Share of utilities by cost of supply and country income 8 Figure 7: Median distribution losses (left) and transmission losses (right) 9 Figure 8: Median age (in days) of utility receivables (left) and payables (right) 9 over time Figure 9: Utilities that do not recover costs are more likely to receive 10 subsidies Figure 10: Utility indebtedness is relatively low across the board, with little 11 di erence by country income or utility ownership Figure 11: Liability composition for the median utility (left), and the impact 12 of including non-debt liabilities in measures of utility indebtedness (right) Figure 12: Share of utilities by e ective interest rate (left) and spread of the 13 e ective interest rate against the sovereign rate (right) Figure 13: Utility cost recovery by proportion of liquid fuels in the national 20 generation mix Figure 14: Impact of a fossil fuel price shock on utility cost recovery, with 22 and without the energy transition Figure 15: Share of utilities by electricity demand growth 23 Figure 16: Number of utilities that could achieve cost recovery by 34 addressing key performance challenges Figure 17: Share of utilities reporting basic e ciency and reliability 35 performance metrics II The Critical Link: Empowering Utilities for the Energy Transition BOXES Box 1: Simulating higher capital intensity for a hypothetical utility 16 Box 2: Higher utility capital intensity and vulnerability to shocks 18 Box 3: HFO dependence and operating expense volatility in Western Africa 20 Box 4: The impact of a fossil fuel price shock on utility performance with 21 and without the transition Box 5: DERs and utility performance challenges in Jordan 24 Box 6: Enhanced utility service o erings for DERs and peer-to-peer 26 electricity trading in India Box 7: Utility performance and the push toward universal access in Kenya 27 Box 8: OFGEM RIIO (Revenue = Incentives + Innovation + Outputs) in Great 33 Britain Box 9: How much concessional capital? And at what price? 37 TABLES Table 1: Demand, supply, transmission intensity, and cost structure for the 17 hypothetical utility without and with the energy transition Table 2: Impact of interest rate, asset impairment, and demand shocks on 19 cost recovery for the hypothetical utility, without and with the energy transition III The Critical Link: Empowering Utilities for the Energy Transition Executive Summary The energy transition and universal access to electricity cannot be achieved without well-performing power utilities. As the stewards of the world's power grids, 40 percent of utilities are able to collect enough utilities will be at the heart of e orts to revenue to meet their annual operating and debt decarbonize electricity supply and electrify service costs the bare minimum for nancial energy demand (referred to jointly in this sustainability. This situation is especially bleak paper as the energy transition ). Utilities will for utilities in LICs and lower-middle-income need to signi cantly increase the share of countries (LMICs), where high costs of supply, renewable energy in their generation mixes, low tari s, operational ine ciency, and poor modernize networks to integrate these sector planning and procurement often create variable power sources into the grid, and persistent cycles of underperformance. manage the ever-more varied and complex Technical and commercial losses in power power needs of industry, households, and distribution hover between 12 and 15 percent transportation. In addition, utilities will need for the median utility in LICs and LMICs, where to be at the forefront of an accelerated push over half of utilities also have outstanding to provide electricity access to the nearly 700 customer payments equivalent to more than million people who still lack it today. Meeting ve months of revenue. Utilities that are unable these demands while ensuring reliable and to recover their costs have to make up the a ordable electricity service will require well- shortfall in other ways. Often this results in performing, nancially sustainable utilities underinvestment in critical maintenance, that i) are able to access inexpensive long- upgrades, and system expansion, and increased term nancing; ii) are viable o -takers for dependence on government subsidies. Utilities private power investors; iii) make e cient use in LICs and LMICs are more likely to rely on such of any public nance they receive; and iv) have subsidies, adding scal burdens to the the technological and managerial capacity to governments that can least a ord to pay them. harness the opportunities created by an The data paint a bleak picture and present a increasingly modern, distributed power stark warning: many utilities are ill-equipped to system. Although no two countries will be ful ll their role in achieving the energy transition impacted in exactly the same way, these and universal access. changes will transform power sectors in low- income and middle-income countries (LICs The energy transition and the push to and MICs). universal access will create new challenges for utilities, further threatening their However, utilities around the world are performance. For many utilities, achieving the already struggling to deliver a ordable and energy transition and universal electricity reliable power. A new World Bank database access will require massive upfront capital that tracks the nancial and operational investment. performance of more than 180 utilities in over 90 countries shows that fewer than IV Executive Summary The Critical Link: Empowering Utilities for the Energy Transition For instance, suitable sites for renewable The changing power sector landscape will energy sources such as wind and solar are also create new opportunities to improve often far from cities, requiring longer utility performance, but utilities that already transmission lines to deliver their power to perform well will be best positioned to seize demand centers. Modeling in this paper shows them. Many utilities, particularly in LICs, are that decarbonizing a hypothetical utility s highly exposed to uctuations in the prices of power supply mix by 2050 could increase the fossil fuels, which can make costs even harder required intensity of its transmission network for utilities to manage. Substituting generation by 30 percent. Much of this additional capital from liquid fossil fuels with renewable will need to come from the private sector, but generation in line with least-cost planning can many utilities in LICs and MICs have limited help create longer-term price stability for access to private nancing and its costs are utilities and their customers. DERs and new often prohibitively high. Though a reduced business models can also create opportunities reliance on fossil fuel power can decrease a for proactive utilities to better manage power utility s operating costs over time, these ows and expand their service o erings to reductions take time to materialize and are customers. National and international often not su cient to o set higher upfront commitments to decarbonization can create capital costs. Furthermore, the shift toward additional momentum to lower political barriers greater capital intensity could make utilities to power trade and regional integration, helping more vulnerable to shocks, such as spikes in utilities reduce their costs and improve network interest rates. Rising access and resilience. However, these bene ts will not electri cation of transport and industry will materialize on their own. Attracting investment mean that some utilities will also have to for new renewable energy sources and for contend with rapidly rising demand, which transmission and trade infrastructure requires may exacerbate their existing liquidity nancially viable utilities that are credible challenges and make their networks more contractual counterparties. To integrate new complex to manage. For other utilities, a customer-facing technologies and business growing number of customers using models, utilities need the necessary technical distributed energy resources (DERs) such as and managerial capabilities. At present, too rooftop solar could make it more di cult to many utilities in LICs and MICs are falling short. recover increasing capital costs. Building sustainable utilities to navigate changing power sector landscapes will require concerted e orts from policymakers, regulators, development nanciers, and utilities themselves. 01 Governments Governments have a crucial role in lowering the costs to utilities of achieving the energy transition and reaching universal access. They need to create robust policy and legal frameworks that reduce private investors risk and develop new infrastructure based on least- cost planning and transparent procurement. V Executive Summary The Critical Link: Empowering Utilities for the Energy Transition Governments Governments can also minimize complexity in permitting, including for land use for renewable generation and transmission infrastructure. In power sectors that rely heavily on fossil fuels, it will fall to governments to manage sensitivities around phasing down fossil fuel generation and phasing out distortionary subsidies. Public policies and incentives focused on energy e ciency can help mitigate some of the impacts of rapidly growing demand. 02 Regulators Regulators need to ensure that utilities are able to recover reasonable costs through tari s, including the costs of achieving universal access and the energy transition. They will also need to adopt innovations in tari design that e ciently and fairly allocate these additional costs between utilities and their customers. This includes adopting two-part tari s that enable utilities to recover xed and variable costs, which will become increasingly important as power sectors become more capital intensive and as more utility customers adopt DERs. Compensation for these grid-connected DERs must re ect the value they add to the system. 03 Utilities and Utility Managers Utilities and utility managers need to translate sound policymaking and regulation into sustainable operation of their networks. This will require them to improve their service delivery, reduce their losses, improve their billing and payment collection, maintain and modernize their infrastructure, manage administrative and workforce costs, and invest in managerial systems and capacity. The opportunities presented by the changing power sector landscape will not materialize on their own but must be proactively sought out and developed by utilities. This requires professionally managed, commercially oriented utilities that are governed according to principles of e ciency, transparency, and accountability. To maintain trust and credibility with customers and nanciers, utilities need to improve their public communication, including publishing nancial statements and operational data in a timely manner. 04 Development Financiers Even if governments, regulators, and utilities all play their part, achieving the energy transition and universal access will create incremental costs for some utilities. Modeling in this paper suggests that a typical utility would require a 1.2 percentage point decrease in its cost of capital to o set the incremental costs of decarbonizing its power supply. Development nanciers play a key role in o setting these costs to keep the energy transition and universal access a ordable for LICs and MICs. They can scale up concessional capital that o ers longer tenors or lower interest rates compared to commercial nancing. And they can reduce private sector investment costs through concessional risk mitigation instruments. At the same time, development nanciers need to ensure that any concessional nancing is linked to progress by governments, regulators, and utilities in improving the performance of their power sectors. Figure 1 summarizes these actions. VI Executive Summary The Critical Link: Empowering Utilities for the Energy Transition Figure 1: Sustainable utilities for the energy transition and universal access to electricity Sustainable utlities DEVELOPMENT FINANCIERS can:  Scale up UTILITY concessional MANAGERS can: capital to o set Utilities in LICs and MICs often do not  Deploy e cient the residual costs REGULATORS can: recover costs, su er investment plans of the energy  Ensure that  Modernize grids transition & from high power Utility performance utilities can and reduce losses universal access losses, and are not GOVERNMENTS recover the costs  Improve billing  Provide support attractive targets for can: of operating and payment for policy, private investment  Reduce private power systems collection regulatory & investor risk that are  Invest in technical utility Power sectors are  Follow least- decarbonizing and and managerial strengthening undergoing rapid cost planning expanding capacity to  Facilitate dialogue transformation, principles  Maintain navigate new between energy and many utilities  Foster robust a ordability for technologies and sector are ill-equipped to procurement vulnerable business models stakeholders adapt to new practices consumers electricity  Strengthen  E ciently allocate demand and commitments new costs and supply patterns to power trade sources of risk Achieving the energy transition & universal access to electricity The longer these e orts are delayed, the unpredictable political and regulatory harder it will be for utilities to provide environments that are subject to arbitrary a ordable, reliable, and sustainable interference, and that lack the necessary managerial and technical capabilities, will electricity to their customers. Well-run, struggle to maintain a ordable and reliable well-regulated utilities that operate in service. These utilities will not only see their transparent, supportive policy environments performance deteriorate further but will will be best placed to mitigate the challenges jeopardize national and international targets for and seize the opportunities presented by a decarbonization and universal access. To date, rapidly transforming power sector landscape. the goals of the energy transition and universal These utilities will thrive as they provide clean, access have received more attention than the secure, and a ordable electricity to meet the importance of utilities in achieving them, demands of a growing base of customers with especially in LICs and MICs. Filling this gap, this increasingly sophisticated needs. They will paper aims to serve as an urgent call to action also have better access to investment, and at for policymakers, regulators, utilities, and a lower cost. By contrast, utilities that are not nanciers. able to recover their costs, that operate in VII Section 1 Introduction & Methodology As the conduit between power demand and supply, the utilities that operate the world's transmission and distribution networks will be the critical link in the energy transition. 1 Section 1: Introduction & Methodology The Critical Link: Empowering Utilities for the Energy Transition As the conduit between power demand and standalone (unbundled) utilities that are supply, the utilities that operate the responsible for the transport of bulk power on world's transmission and distribution high-voltage lines ( transmission ); the utilities that are responsible for carrying power to end- networks will be the critical link in the consumers ( distribution ); and the vertically energy transition. Utilities will need to integrated utilities (VIUs) that also own and expand and modernize their networks to operate power generation assets.2 These integrate variable renewable energy sources utilities ensure that generated power nds its and meet growing demands for cleaner and way to the residential, municipal, commercial, more exible power. According to the and industrial uses of power that underpin International Energy Association (IEA), the modern economies. They are responsible for equivalent of the entire length of the world's planning and investing in grid and grid-related grid networks will need to be added or infrastructure; they ensure the system's smooth refurbished by 2040 if countries are to functioning and reliability by maintaining a achieve their energy and climate goals.1 As the constant balance between power supply and o -takers of power generation, utilities need power demand; they serve as o -takers for to be nancially viable to enable the coming power generation; and they act as the interface massive scale-up of investment in renewable between the power sector and consumers, energy projects and grid infrastructure. providing customer connection, billing, Utilities will also need to lead the way in metering, and payment collection services. For providing access to electricity to the nearly this paper, collectively, these utilities are 700 million people who still lack it today, referred to as network utilities, power mainly in Sub-Saharan Africa. In addition, utilities", or just utilities. utilities will need to serve consumers with ever-more varied and complex power needs and an increasing range of distributed The analysis and recommendations in this generation options, such as rooftop solar. In paper draw extensively on new data in the short, power utilities will be the critical World Bank s Utility Performance and enablers of the energy transition and achieving Behavior Today (UPBEAT) database. UPBEAT 3 universal access. This paper aims to place the is a unique database that captures the nancial need for sustainable utilities in lower-income and operational performance data of over 180 countries (LICs) and middle-income countries utilities in over 90 countries around the world (MICs) at the heart of the energy sector from 2012 to 2022 (Figure 2).4 Forty-one of dialogue. these utilities (or about 25 percent) are privately owned. A total of 112 utilities are in LICs and The focus of this paper is on the utilities lower-middle-income countries (LMICs) and 70 that manage power transmission or are in upper-middle-income countries (UMICs) and high-income countries (HICs).5 distribution grids. This includes the 1 - IEA. 2023b. "Electricity Grids and Secure Energy Transitions: Enhancing the Foundations of Resilient, Sustainable and A ordable Power Systems." 2 - This excludes utilities such as state-owned generation enterprises or private independent power producers (IPPs), whose sole commercial activity is power generation. 3 - The full UPBEAT database can be accessed at utilityperformance.energydata.info. 4 - Utilities were selected based on data availability and the presence of past or ongoing dialogue with the World Bank. Therefore, the database does not purport to be representative either at the national or the global level. 5 - To mitigate small sample sizes, much of the analysis in this paper groups LICs with LMICs, and UMICs with HICs. 2 Section 1: Introduction & Methodology The Critical Link: Empowering Utilities for the Energy Transition UPBEAT processes the nancial and One persistent performance challenge is that operational data published by utilities, nancial statements and annual reports are regulators, and other energy sector entities often published several years after the close of into a set of standardized indicators. This the nancial year, if they are published at all. enables UPBEAT to provide utilities, Thus, unless otherwise speci ed, analysis in this policymakers, nanciers, investors, and paper considers the most recent available data researchers with uniquely detailed insight into point from 2020 onwards. power utility performance across the world. Figure 2: Number of utilities in the UPBEAT database by country income and ownership (left), and geographic distribution (right) 90 80 24 Number of utilities 70 60 14 50 40 30 65 1 48 20 10 22 2 0 6 IBRD 48053 | APRIL 2024 LIC LMIC UMIC HIC Public Private One utility Multiple utilities This paper builds on previous World Bank in Sub-Saharan Africa and found that only one e orts to measure and understand utility in three utilities were able to recover both their performance. The 2019 report, Rethinking operating and debt service costs, even when Power Sector Reform in the Developing World, accounting for operating subsidies utilities which examined utility performance in 17 received from their governments. Most recently, developing countries, found that many utilities the World Bank's 2023 paper, Scaling Up to were operating in countries with weak Phase Down: Financing Energy Transitions in the regulation, inadequate provisions for tari Energy Sector, identi ed utilities as potentially adjustments, no technically grounded plans the weakest link in the energy transition. for generation expansion, weak contractual frameworks for power purchase agreements In most LICs and MICs, the energy transition (PPAs), and high system losses. These utilities is still at an early stage. Very few of the were struggling to recover their costs, and utilities analyzed for this paper operate in they were often forced to adopt a range of countries where variable renewable energy suboptimal coping strategies, including taking sources such as solar and wind already on high-cost, short-term commercial debt, or constitute a large share of the generation mix. falling into arrears with their upstream While many more countries have reached suppliers of fuel or power. Building on these universal access than have met their ndings, the World Bank's 2021 study, Utility decarbonization goals, this was often achieved Performance and Behavior in Africa Today, decades ago or over a long period. undertook a comprehensive survey of utilities 3 Section 1: Introduction & Methodology The Critical Link: Empowering Utilities for the Energy Transition Figure 3 shows that only a few of the utilities illustrate the prospective future impacts of the in the UPBEAT database operate in countries transition on utilities, this paper complements with a variable renewable energy (VRE) share the historical data from UPBEAT with forward- that is greater than 10 percent6 or that have looking simulations and country examples. achieved high growth in their electricity access rates between 2015 and 2020. To better Figure 3: Number of utilities according to the share of variable renewables in their country's generation mix (left), and change in their country's electricity access rate (right) 80 100 8 70 90 11 80 60 Number of utilities Number of utilities 3 70 50 14 38 0 60 2 40 80 50 72 30 40 54 43 30 61 20 20 43 10 10 0 0 LIC & LMIC UMIC & HIC LIC & LMIC UMIC & HIC LIC & LMIC UMIC & HIC 2015 2020 Change in access rate (2015 2020) Electricity produced from VRE <10% >=10% -1 5% 5 20% 20 100% This paper Section 2 provides an overview of current and historic utility performance is organized challenges in LICs and MICs. It argues that many utilities are struggling to as follows: operate sustainably and are poorly prepared for the demands of the energy transition. Section 3 explores how the changing power sector landscape will present new challenges and opportunities for utilities and utility performance. Section 4 discusses the actions that policymakers, regulators, development nanciers, and utilities can take to build resilient utilities able to navigate an evolving power sector landscape. It also provides a rationale for additional concessional nance for utilities. 6 - As generation data were not obtainable at the utility level for a su cient number of utilities, this paper considers generation data at the national level, which were drawn from the IEA World Energy Balances database. 4 Section 2 Historic and Current Global Utility Performance Utilities around the world are underperforming, especially in LICs and LMICs. 5 Section 2: Historic and Current Global Utility Performance The Critical Link: Empowering Utilities for the Energy Transition Most utilities do not recover their operating and debt service costs; utilities in LICs and LMICs perform signi cantly worse than utilities in UMICs and HICs. Financial viability is a challenge for most utilities, worldwide, that recover their operating utilities, with less than 40 percent7 and debt service costs (green bar), that recover recovering both their operating and debt only their operating costs (orange bar), or that 8 cannot even recover their operating costs (red service costs. Low cost recovery is often at bar). Overall, 39 percent of utilities are able to the heart of a vicious cycle of utility recover both operating and debt service costs, underperformance: insu cient recovery of another 18 percent are able to recover operating costs deprives utilities of the funds they need costs only, and over 40 percent do not recover to invest in infrastructure and maintenance; their operating costs. Utilities that do not this, in turn, leads to higher system losses and recover costs present greater risks to investors, more frequent and longer outages; and will face higher nancing costs, and will struggle declining service quality may make regulators to attract nancing at the scale required to and policymakers less willing to adjust tari s, achieve the energy transition and universal further depriving utilities of the funds they access. need. Figure 4 shows the proportion of Figure 4: Share of utilities by country income that are fully recovering both their operating and debt service costs (green bar), their operating costs only (orange bar), and neither their operating nor their debt service costs (red bar) N=159 N=95 N=64 100% 90% 28% 80% 39% 70% 55% Share of utilities 60% 19% Recover operating and debt service costs 50% 18% Recover operating costs only 40% Do not recover operating costs 17% 30% 53% 20% 43% 28% 10% 0% Total LIC & LMIC UMIC & HIC Utilities in lower-income countries are The UPBEAT data show a striking di erence in signi cantly less likely to recover their utilities abilities to meet their nancial costs than utilities in higher-income obligations, depending on the income level of the country where they operate. countries. 7 - Statistics on utility performance in this paper refer to the utilities included in the UPBEAT database. 8 - Cost recovery here refers to the extent to which the payments a utility collects from its customers cover the costs it reports in its nancial statements, compared to, say, e cient costs determined by a regulator. 6 Section 2: Historic and Current Global Utility Performance The Critical Link: Empowering Utilities for the Energy Transition More than half of utilities in LICs and LMICs left-hand panel). Between 2014 and 2020, the included in UPBEAT do not collect enough median utility in UMICs and HICs consistently revenue to recover even their operating costs, recovered both its operating and its debt- and only 28 percent are able to recover both service costs, while the median utility in LICs their operating and debt service costs. and LMICs recovered less than 90 percent of its Conversely, 55 percent of utilities in UMICs debt service and operating costs.9 The data also and HICs recover both their operating and show that private utilities slightly outperform debt service costs, and another 17 percent public utilities, though the di erence is small recover at least their operating costs. These (Figure 5, right-hand panel). di erences are persistent over time (Figure 5, Figure 5: Utility cost recovery over time by income group (left) and ownership (right) 115 115 110 110 Operating and debt service Operating and debt service 105 105 cost recovery (%) cost recovery (%) 100 100 95 95 90 90 85 85 80 80 75 75 2014 2015 2016 2017 2018 2019 2020 2014 2015 2016 2017 2018 2019 2020 LIC & LMIC UMIC & HIC Public Private Utilities' poor cost recovery results from their costs being too high, the tari s they charge being too low, high losses in transmission and distribution, and poor collection of customer payments. Cost recovery requires a utility to generate Many utilities face a mismatch between their enough cash from electricity sales to meet costs of supplying power and what they are its costs of supply. Three factors determine able to charge customers. Utilities' costs of its ability to do this: i) the magnitude of its supply may be inherently higher in some operating and debt service costs relative to countries due to di ering natural endowments the tari s it can charge; ii) how much of the in generation resources, but in LICs and MICs, electricity it buys or generates it can bill to this is often exacerbated by poor planning, customers compared to how much it loses in uncompetitive power procurement practices, transmission and distribution lines or to theft high and volatile costs of imported fuel and and poor metering practices; and iii) its ability other inputs, administrative ine ciencies, and to collect payments from its customers. high capital costs. Utilities in LICs and MICs often underperform on all of these factors. 9 - In general, this paper presents data on median values only up to 2020. This was necessary to avoid panel balancing issues, as utilities with more recently available data tend to perform better on nancial indicators. 7 Section 2: Historic and Current Global Utility Performance The Critical Link: Empowering Utilities for the Energy Transition In poorer countries, these elevated costs can larger share of their household budget, despite be particularly di cult to pass on to consuming very little. Figure 6 shows that customers, many of whom cannot a ord to utilities in LICs and LMICs are more likely to face pay much for electricity. These customers also high costs of supply of over 20 cents per kWh.10 tend to be those for whom electricity is a Figure 6: Share of utilities by cost of supply and country income11 N = 43 N = 35 100% 90% 28% 31% 80% Share of utilities 70% 60% 50% 42% 40% 51% Cost of supply 30% >0.2 $/kWh 20% 30% 0.1 0.2 $/kWh 10% 17% <=0.1 $/kWh 0% LIC & LMIC UMIC & HIC Many utilities' ability to recover costs is further diminished by power lost in network components (technical losses) or lost to theft and poor metering and billing practices (commercial losses). Even for utilities that are able to charge cost- HICs. Losses are lower across the board in re ective tari s, cost recovery still depends transmission due to the technical nature of on how much of the power they buy or high-voltage power transport and the lower generate reaches and is billed to end potential for theft or underbilling, but are still consumers. The UPBEAT data show that signi cantly higher for utilities in LICs and utilities in countries of all income levels lose LMICs (Figure 7, right-hand panel). High signi cant portions of their power, especially transmission losses are typically the result of in distribution, where the median utility lost underinvestment and overloading of around 12 percent of its power between 2014 transmission lines, and may present signi cant and 2020 (Figure 7, left-hand panel). Such bottlenecks to the greater power ows that losses are particularly a challenge for utilities utilities will need to handle under the energy in LICs and LMICs, where distribution losses transition. are signi cantly higher than in UMICs and 10 - Dollars and cents in this report are United States dollars. 11 - This excludes transmission-only utilities, many of which do not include generation in their costs. 8 Section 2: Historic and Current Global Utility Performance The Critical Link: Empowering Utilities for the Energy Transition Figure 7: Median distribution losses (left) and transmission losses (right) 16 16 Transmission losses (%) Distribution losses (%) 14 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 2014 2015 2016 2017 2018 2019 2020 2014 2015 2016 2017 2018 2019 2020 LIC & LMIC UMIC & HIC All utilities LIC & LMIC UMIC & HIC All utilities Finally, cost recovery requires that utilities growing over time (Figure 8, left-hand panel). convert electricity bills to cash by Poor collection performance, especially by collecting payments from customers. Few distribution utilities, is often felt across the power sector because poor collection means that utilities are able to do this e ciently, and as a less cash is available to pay upstream generation result, they have high levels of uncollected and transmission utilities. Accordingly, the customer payments. Over half of utilities in UPBEAT data show that over 60 percent of LICs and LMICs have outstanding customer utilities in LICs and LMICs have outstanding payments (receivables) equivalent to more than payments to suppliers (payables) equivalent to 150 days of revenue,12 compared to only 20 over 150 days of costs.13 For many utilities, these percent of utilities in UMICs and HICs. Delayed payables include delayed payments to or inconsistent payments for electricity by independent power producers (IPPs), which often public sector customers, such as government result in penalties or costly contractual disputes o ces, publicly owned mines, or water utilities, and act as a deterrent for future investment. As often make up a disproportionate share of with receivables, the payables of utilities in LICs receivables. Concerningly, the receivables of and LMICs (Figure 8, right-hand panel) have been utilities in LICs and LMICs have been steadily increasing. Figure 8: Median age (in days) of utility receivables (left) and payables (right) over time 250 250 Age of receivables (days) Age of payables (days) 200 200 150 150 100 100 50 50 0 0 2014 2015 2016 2017 2018 2019 2020 2014 2015 2016 2017 2018 2019 2020 LIC & LMIC UMIC & HIC All utilities LIC & LMIC UMIC & HIC All utilities 12 - This can be understood as the average time it takes a utility to collect payments from customers, weighted by the amount of the payment. 13 - This can be understood as the average time it takes a utility to pay its suppliers, weighted by the amount of the payment. 9 Section 2: Historic and Current Global Utility Performance The Critical Link: Empowering Utilities for the Energy Transition Public nance is often used to cover gaps in cost recovery, but public investment may be more e ciently spent on improving utility performance. Poor cost recovery has implications beyond Governments may choose to subsidize electricity a utility's nancial performance, especially tari s using public funds because consumers are in LICs and LMICs. Utilities that struggle to often highly sensitive to uctuations in electricity prices, which are immediately recover their costs are more likely to receive noticeable. In contrast, the speci cs of how government subsidies, which often place a governments allocate public budgets to these signi cant burden on public nances. Figure 9 subsidies are less visible and may draw less shows the impact of government operating public scrutiny. However, these subsidies often subsidies on utilities ability to recover their perpetuate utility ine ciency.15 They can also be costs.14 In general, operating subsidies are more regressive in countries with low access to likely to be reported by utilities that do not electricity, where poorer taxpayers who are not recover their costs, and these utilities are connected to the grid may subsidize the power predominantly in LICs and LMICs. Thus, the consumption of the more a uent consumers countries that can least a ord it are the ones who are. that are most likely to be using public nances to make up for their utilities revenue shortfalls. Figure 9: Utilities that do not recover costs are more likely to receive subsidies LIC & LMIC UMIC & HIC Median Utility Median Utility 140% 140% Operating and debt service cost recovery Operating and debt service cost recovery 120% 120% Recovers costs Recovers costs 100% 100% 80% 80% 60% 60% 40% 40% 20% 20% 0% 0% 20% 20% Costs covered by revenues Additional costs covered by reported operating subsidies 14 - Utilities receive government subsidies in a variety of ways, including direct transfers from government, government- nanced reductions in the cost of fuel or other inputs, favorable tax treatment, or vouchers or transfers to consumers to pay for electricity. This analysis only considers transfers from governments reported in utility nancial statements. 15 - For instance, research suggests that utilities in some cases may prefer revenue from subsidies to revenue from sales, and that subsidies disincentive utilities to improve operational performance (McRae, 2015). 10 Section 2: Historic and Current Global Utility Performance The Critical Link: Empowering Utilities for the Energy Transition Utilities have relatively little debt on their books and often nance themselves through other liabilities, which suggests that many utilities face capital constraints. Utilities carry relatively low levels of formal greater nancial discipline, and may be more debt on their books. For the median utility, likely to be part of holding company structures only about 20 percent of the assets on its that hold debt on behalf of subsidiary utilities. books are nanced with debt, with the Public utilities, in turn, may have easier access to remainder coming from equity or other nancing in LICs and MICs through sovereign liabilities (Figure 10). There is relatively little borrowing. Some utilities in LICs and LMICs may di erence in median indebtedness between require additional debt to make up funding public and private utilities and between utilities shortfalls; they may have greater relative in di erent country income groups. Public investment needs to meet rising demand; or they utilities and utilities in LICs and LMICs, may have more debt denominated in foreign however, are more likely to have large amounts currency and thus be more vulnerable to of debt on their books (but also more likely to devaluations that increase their debt burdens. have very low debt). This could have a range of Utilities in LICs and LMICs also face more explanations. Private utilities may have better expensive debt, even though they are more often access to equity nancing, may be subject to publicly owned. Figure 10: Utility indebtedness is relatively low across the board, with little di erence by country income or utility ownership 1.5 1.2 Debt to assets ratio 0.9 0.6 0.3 0.20 0.20 0.17 0.20 0.19 0.0 Total LIC & LMIC UMIC & HIC Public Private Utility data Median However, formal debt may be banks, or other credit facilities accounts for underestimating utilities' indebtedness. around 35 percent of the liabilities on the balance sheet of the median utility (Figure 11, Debt from commercial lenders, development left-hand panel). 11 Section 2: Historic and Current Global Utility Performance The Critical Link: Empowering Utilities for the Energy Transition The remainder comes from other liabilities such utilities' books. Taking these additional liabilities as unpaid nancial obligations for taxes or into account suggests that many utilities' power, unrendered services for payments e ective level of indebtedness may be higher received (for example, taking a long time to than what is implied by their loans alone, connect new customers even after they pay especially in LICs and LMICs (Figure 11, right- their deposits), or longer-term liabilities such as hand panel). While it is di cult to identify pension obligations or leases. These liabilities absolute thresholds for what constitutes too can behave almost like debt as they constitute much or too little debt, almost a quarter of future payment obligations in some cases utilities in LICs and LMICs have liabilities that with interest-like costs or penalties attached exceed their assets, meaning they have negative to them but are not classi ed as debt in equity and are balance sheet insolvent. Figure 11: Liability composition for the median utility (left), and the impact of including non-debt liabilities in measures of utility indebtedness (right) 100% 100% 2% 2% 3% Median utility liability composition 4% 90% 25% 90% 24% 20% 17% 30% 24% 80% 80% Share of utilities 70% 11% 70% 60% 18% 60% 43% 50% 24% 50% 67% 40% 19% 40% 77% 69% 30% 30% 20% 41% 20% 25% 32% 10% 10% 14% 7% 0% 0% LIC & LMIC UMIC & HIC Debt-to- - Liabilities Debt-to- - Liabilities assets to-assets assets to-assets Other current liabilities Trade payables LIC & LMIC UMIC & HIC Other non-current liabilities >1 0.66 1 0.33 0.66 0.0 0.33 Debt When they do carry debt, many utilities, LMICs face higher costs of debt (Figure 12, left- especially those in LICs and LMICs, already hand panel), they also bene t from greater bene t from some concessionality in loan discounts on their debt compared to sovereign 16 rates (which are typically higher in lower-income pricing. This concessionality could result countries due to higher perceived credit risk). from several factors, including access to Over half of the utilities in the UPBEAT database development nance or other concessional have e ective interest rates that are below capital, public ownership, or public backing of estimated sovereign rates (Figure 12, right-hand utilities that allows them to borrow at, or near, panel).17 sovereign rates. While utilities in LICs and 16 - Concessionality in this case is determined by the di erence between the e ective interest rate a utility pays on its debt, and the pricing of the country's sovereign debt. Sovereign nancing costs are estimated using United States Treasury rates and country risk premiums (source: Country Risk Determinant, Measures and Implications, Stern School of Business New York University). 17 - E ective interest rates are calculated as a utility's interest expense divided by its stock of debt. 12 Section 2: Historic and Current Global Utility Performance The Critical Link: Empowering Utilities for the Energy Transition Another 20 percent of utilities report nancing utilities are struggling to access or a ord costs that are less than 400 basis points above non-concessional loans. These capital sovereign rates, which in many cases may still constraints do not bode well for utilities ability be well below their commercial borrowing to access new debt to nance capital costs. Utilities in countries of all income levels expenditures in renewable energy generation, bene t from concessionality, but utilities in grid expansion and modernization, and other LICs and LMICs are more likely to report infrastructure investments that will be required e ective interest rates that have the highest by the energy transition. Conversely, utilities that degree of concessionality. are able to mobilize additional private capital for transition-related investments may see The relatively low levels of debt on utilities' signi cant increases in their costs of capital if books and the widespread presence of they have relied heavily on concessional nancing in the past. concessional nancing suggest that many Figure 12: Share of utilities by e ective interest rate (left) and spread of the e ective interest rate against the sovereign rate (right) N=92 N=59 N=92 N=59 100% 4% 5% 100% 90% 5% 90% 14% 15% 26% 80% 25% 80% Share of utilities Share of utilities 70% 70% 29% 29% 13% 60% 60% 50% 50% 28% 40% 40% 39% 64% 30% 30% 51% 20% 20% 33% 10% 10% 19% 0% 0% LIC & LMIC UMIC & HIC LIC & LMIC UMIC & HIC E ective interest rate Spread to sovereign rate >20% 10 20% >=400 bps 400 0 bps 5 10% 0 5% 0 400 bps < 400 bps 13 Section 3 New Challenges and Opportunities for Utility Performance Upcoming changes to the supply and demand of power will disrupt decades of business as usual for network utilities in LICs and MICs. 14 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition Upcoming changes to the supply and access but progress toward these goals, and demand of power resulting from policy new trends in the power sector landscape will, in choices and technological developments turn, present new challenges and opportunities for utility operations and utility performance. will disrupt decades of business as usual This section highlights some of the most for network utilities in LICs and MICs. Well- important new forces that will a ect utility performing utilities will be critical for performance in LICs and MICs, speci cally: achieving decarbonization and universal  Increased utility capital intensity as a result of VRE integration and network expansion  Reduced utility operating cost volatility as a result of declining shares of fossil fuel power in generation  Changing demand patterns resulting from higher electricity consumption and the greater availability of alternatives to grid power  New business models and digital tools for utilities to better manage their grids and expand their service o erings These trends will not impact all utilities facing increasing incentives to decarbonize; equally or at the same time. Decarbonization distributed energy resources (DERs) will be an and electri cation of demand may, at least attractive alternative to grid power both for initially, be more pressing concerns for utilities consumers in more a uent countries who want in countries with well-developed power sector to achieve cost savings, or improve their carbon infrastructure, while utilities in countries with footprint, and for consumers in poorer countries extensive power infrastructure gaps may who need alternatives to unreliable grid service; prioritize reaching universal access. and transmission investments to integrate VRE, Nonetheless, the e ects described are and distribution investments to add new relevant for utilities across geographies and connections, will both require utilities to take on levels of development: utilities in LICs are also additional capital. The shift from fossil fuels to renewable generation and the push to universal access will increase utilities' capital intensity, exposing them to new risks. Maintaining service quality amid dramatic transmission networks. The variable and shifts in the demand and supply of power uncertain nature of wind and solar energy will require utilities to make massive new means that more installed generation capacity and more associated network infrastructure are investments. Integrating geographically required to deliver the same amount of power. dispersed renewable energy sources will require investing in larger and more resilient 15 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition This is because land-use constraints often quality. In LICs, achieving universal access mean that developable solar and wind targets will require utilities to nance additional resources are located farther from load connections and strengthen their transmission centers, so more lines must be built to and distribution networks to support a growing transport a given amount of power. Increasing grid. Investment will be required not just to power consumption due to the electri cation address these impacts, but also to ensure that of energy demand in industry and transport new and existing infrastructure is resilient to will require further investments in climate shocks such as forest res, storms, and transmission and distribution capacity to oods. Box 1 shows the e ects of this increased avoid grid congestion and maintain service capital intensity on a hypothetical utility. BOX 1 Simulating higher capital intensity for a hypothetical utility The impacts of the energy transition on utility capital intensity are simulated here for a hypothetical utility. This utility is based on a stylized composite of utilities in LICs and MICs. The utility is assumed to be vertically integrated (responsible for generation, transmission, and distribution) and operating in a well-functioning regulatory environment that allows the utility to recover its costs through annually updated tari s. As a result of the energy transition and increasing access to electricity, the hypothetical utility needs to: i) deal with higher demand; ii) build and integrate into the grid a greater amount of generation capacity to meet this higher demand; and iii) reduce the share of fossil fuel plants in its generation mix in favor of renewable technologies. The energy transition leads to a signi cant increase in the capital intensity of the hypothetical utility. Table 1 shows the evolution of demand and supply for the hypothetical utility (Table 1, rows 1 and 2), both of which are signi cantly higher in the with-transition scenario than in the without-transition scenario. The supply mix in the with-transition scenario includes a higher share of VRE, notably wind and solar, which is characterized by higher upfront capital costs but lower ongoing operating costs when compared with fossil-fuel-based generation. The higher share of wind and solar energy in the generation mix also leads to a need for more transmission infrastructure to transport the same amount of demand. As a result, transmission intensity (measured here in kilometers of transmission line per unit of demand served) for the hypothetical utility is considerably higher in the with-transition scenario (Table 1, row 3). These factors cause the size of the utility s asset base to increase (Table 1, row 4). 16 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition Table 1: Demand, supply, transmission intensity, and cost structure for the hypothetical utility without and with the energy transition Parameter 2025 2050 Base Without transition With transition 1. Consumption (TWh) 100 185 275 2. Share of generation from VRE 15 percent 25 percent 85 percent 3. Transmission line intensity (length of 100 105 130 line per unit of demand, normalized to 100) 4. Size of asset base (normalized to 100) 100 190 270 These investments will make utilities more The investments required to decarbonize capital intensive, thereby altering their generation will a ect even network utilities exposure to certain performance risks. In that do not own generation assets. Network the near term, one of the main challenges for utilities will need to invest in additional utilities in LICs and MICs will be to access transmission and distribution capacity to su cient a ordable nancing for these integrate VRE, as discussed above. But network investments. However, even if su cient public utilities will also feel the e ects of increased and private capital is made available to these capital intensity in power generation, even if utilities, as it will have to be for the energy they do not own any generation assets transition to succeed, an increase in capital themselves. Network utilities that buy their intensity could exacerbate utilities exposure power from unbundled generators often do so to several sources of performance risk, through long-term PPAs. To mitigate the risks including i) higher costs of capital as utilities to IPPs, these PPAs are often structured to that have depended on concessional capital in ensure a minimum return to IPPs through the past take on more private nancing; ii) mandatory payments that apply whether or not greater exposure to long-term volatility in the utility uses the power produced (typically in costs of capital; iii) a move toward longer-term the form of capacity payments that are based and thus, typically, more expensive debt; iv) on installed capacity or deemed energy less exibility in utilities cost structures as payments that are based on generation). In their share of xed costs increases, which these cases, IPPs will require compensation for may, for instance, make it more di cult for any additional risks resulting from higher capital utilities to deal with short-term demand intensity through higher contract values. shocks; and v) a greater value of utility assets Similarly, unbundled generators that sell their that may be at risk of impairment for power to network utilities in wholesale markets example as a result of policy changes or will pass on any additional risks resulting from changes in consumer behavior (see Box 2 for a higher capital intensity through their short-term simulation of the impacts of selected shocks prices. on utility performance). 17 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition BOX 2 Higher utility capital intensity and vulnerability to shocks Interest rate shocks: The hypothetical utility above is more vulnerable to interest shocks in a with-transition scenario. If interest rates increase, the utility s actual cost of capital increases immediately, but the regulated cost of capital that the utility is permitted to pass on to consumers, which is set by regulators based on historical averages, takes more time to adjust. Thus, the increase in interest rates causes the hypothetical utility s actual cost of capital to exceed its lagging regulated cost of capital. The negative impact of this interest rate shock on the utility s cost recovery is higher in the with-transition scenario, in which the utility has a higher share of capital costs (Table 2, row 1). Reducing the lag between actual and regulated tari s would reduce the impact on the utility s cost recovery, but would make consumer tari s more volatile. Asset impairment shocks: The exclusion of certain assets from a utility s regulated asset base is a risk for utilities operating under so-called rate-of-return regulation, under which a utility s allowed revenues are determined in part by the value of its assets. Regulators may exclude assets that no longer serve the core business of the utility or that no longer align with the government s policy goals. An asset impairment shock reduces the hypothetical utility s cost recovery, as its allowed revenues decrease but its costs remain unchanged. The e ect on cost recovery is considerably more pronounced in the with-transition scenario, in which the utility is more asset-heavy (Table 2, row 2). Demand shocks: A sudden drop in demand may result from an economic crisis or an extraordinary event such as a pandemic. In the with-transition scenario, the utility has a higher share of xed costs in its cost structure and will not be able to reduce its costs in response to negative demand shocks as easily. A drop in demand will therefore cause the utility s cost recovery to deteriorate more in the with-transition scenario (Table 2, row 3). 18 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition Table 2: Impact of interest rate, asset impairment, and demand shocks on cost recovery for the hypothetical utility, without and with the energy transition Shock Short -term impact on cost recovery Without transition With transition 1. Interest rates rise by 3 percentage points Cost recovery reduced by Cost recovery reduced by over 4 years 19.5 percent 21.5 percent 2. 25 percent of assets are impaired over a 5- Cost recovery reduced by 2.5 Cost recovery reduced by 4.0 year period percent percent 3. 10 percent reduction in demand in one Cost recovery reduced by 5.0 Cost recovery reduced by 7.5 year percent percent Decarbonizing the power supply can reduce utilities' exposure to liquid fossil fuel's cost volatility and create additional momentum for regional power trade. Reducing their dependence on liquid fossil produced at the country level from liquid fossil fuels presents a signi cant opportunity for fuels. A share of liquid fossil fuel generation of utilities in LICs and MICs to lower their over ve percent of the total generation mix is associated with lower cost recovery. costs. In countries where poor planning or Importantly, high shares of generation from insu cient investment mean that utilities short-term liquid fuel sources often re ect the cannot keep up with growing demand, they capture of energy sector decision-making by often resort to generating power from liquid commercial interests more than they re ect fossil fuels (such as diesel or heavy fuel oil sound technical and economic planning. Utilities [HFO]) as their primary or backup power can signi cantly lower their costs by reducing source. This power is often obtained from the their dependence on liquid fuels and taking private sector on short-term contracts. These advantage of lower-cost renewable energy arrangements have the advantage that they alternatives, especially when this is combined are quick to install and contract and are fully with appropriate system planning and dispatchable, but often come at signi cant procurement policies. cost to utilities. Figure 13 compares utility performance with the amount of power 19 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition Figure 13: Utility cost recovery by proportion of liquid fuels in the national generation mix N=48 N=17 1 00% 90% 24% 80% 48% 70% Share of utilities 24% 60% 50% 40% 19% 30% 53% 20% 33% 10% 0% <5 % >5 % Proportion of electricity from liquid fossil fuels BOX 3 HFO dependence and operating expense volatility in Western Africa Many countries in Western Africa are heavily reliant on diesel and/or HFO for power generation, resulting in costs of supply that are more than double the average of those in OECD countries. For instance, until recently Sierra Leone and Liberia were almost entirely dependent on liquid fossil fuel generation during the dry season (December to May), while Chad's entire N'Djamena power system is fueled by diesel and nearly half of Togo's installed capacity uses HFO. In 2021, the region's costs of electricity supply increased signi cantly when oil prices started to rise. In Sierra Leone, the average cost of HFO power from IPPs went up from historical values in the range of 16 to 18 cents per kWh to 22 cents per kWh in March 2022, and further to 27.4 cents per kWh in June 2022. These rising costs have signi cantly impacted the viability of utilities in these countries. Unable to pass exorbitant power purchase costs on to consumers, utilities have had to defer paying their suppliers, resulting in load shedding and large arrears on utility balance sheets. Many utilities have also turned to governments for nancial support. To reduce the region's dependency on liquid fuels and exposure to associated price shocks, a new regional World Bank project is supporting the rapid installation and operation of approximately 106 megawatts (MW) of solar energy with battery storage, 41 MW of new hydroelectric capacity, and electricity distribution and transmission interventions to deliver this power to consumers. 20 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition Reducing their dependence on liquid fossil unpredictable costs prevent utilities from fuels can also help utilities reduce their e ectively allocating resources. This can disrupt exposure to uctuations in international essential maintenance and expansion projects and reduce the reliability and resilience of the commodity prices. Many utilities in LICs and power grid. Also, utilities that have volatile MICs su er from signi cant volatility in the operating costs are riskier prospects for costs of their inputs, especially from volatility investors, which makes it even harder for in the prices of oil and natural gas. This utilities to nance new projects at a ordable problem is especially pronounced for utilities terms. Box 3 illustrates how dependence on that rely heavily on a single generation source HFO has impacted some utilities in Western for their energy needs and have little in uence Africa. over the costs of their inputs. This is the case, for example, in power sectors where imported fossil fuels make up a large share of Having a larger share of renewable energy generation and are purchased predominantly sources in a utility's generation mix can help in short-term markets. Unpredictable and reduce the impacts of commodity price often steep swings in costs create challenges volatility. First, diversifying generation can for utilities, independently of absolute cost reduce the e ect that uctuations in the price levels. Consumers value predictability in power of a particular fuel or power source can have on pricing, and signi cant short-term rises in a utility's overall costs. Second, procuring tari s to accommodate uctuating fuel costs renewables with competitive, long-term can be politically challenging to implement, contracts provides utilities with a degree of even if tari s are low. Regulators and price predictability over extended periods, which policymakers are therefore often reluctant to facilitates both country-level power sector allow utilities to pass on volatile input costs to planning and utility-level budgeting. their customers. As a result, utilities may be Competitively priced renewable energy can left grappling with these cost uctuations and therefore help mitigate the nancial shocks see their nancial sustainability further associated with volatile operating costs. Box 4 eroded. Volatility in operating costs makes it shows the bene ts of reducing fossil fuel challenging for utilities to plan for long-term dependence for a hypothetical utility. infrastructure investment, and uncertain and BOX 4 The impact of a fossil fuel price shock on utility performance with and without the transition The higher share of VRE under the energy transition makes the hypothetical utility analyzed above less vulnerable to uctuations in fuel prices. The utility is assumed to purchase all of its fuels in short-term markets, either in the spot market or via short- term contracts. The fuel price shock a ects the utility's actual fuel prices immediately, but the shock's impacts on regulated costs are delayed as there is a lag in the regulator's reaction to cost uctuations. In the with-transition scenario, which has a higher share of VRE, the utility experiences less severe swings in cost recovery as a result of the price shock (Figure 14). 21 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition Coal & gas prices (as % of 2025) Figure 14: Impact of a fossil fuel price shock on utility cost recovery, with and without the energy transition Decarbonizing generation also o ers a manage the variability of renewable energy signi cant opportunity for utilities and sources, further diversify generation sources, countries to realize greater gains from and balance networks by channeling excess energy to other countries with higher demand. interconnection and cross-border power This, in turn, can reduce the need for costly local trade. Commitments to achieving the energy solutions to manage variability. As a result, transition can provide the necessary impetus power trade can improve reliability and service to accelerate the physical and regulatory quality, lower both the magnitude and variability integration of power systems, which is of utilities' operating costs, and reduce the need necessary for power trade to function for capital expenditures across the trading e ectively. Increased trade between countries region. For many utilities, integrating power or power systems o ers utilities a number of sectors and boosting power trade could provide potential bene ts. By drawing on a greater the most cost-e ective way to meet range of generation sources spread across a decarbonization targets while also maintaining a broader geographic area, trade can make secure power supply. power supply more secure, make it easier to Demand for electricity will grow but may become increasingly supplied by DERs. The drive to universal access to electricity across which to spread their xed costs, which in LICs and electri cation of transport and might therefore be easier to recover. On the industry in some LICs and MICs could other hand, rapid growth could also create new administrative and nancial challenges as result in rapid rises in demand for many utilities will need to upgrade and expand their utilities. On the one hand, this means that management systems and capabilities to utilities would have a higher demand base accommodate a higher level of activity. 22 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition This includes keeping up with growing utilities experiencing the highest growth in workforce requirements via new hiring and demand are predominantly in LICs and LMICs, training or managing a larger number of which already struggle disproportionately with suppliers and lenders. As shown in Figure 15, cost recovery. Figure 15: Share of utilities by electricity demand growth N=12 N=21 N=11 N=34 100% 1 5% 80% 36% 67% Share of utilities 60% 92% LIC & LMIC UMIC & HIC 85% 40% 64% 20% 33% 8% 0% 0% 0 10% 10 20% >20% Rapid increases in power sales could also additional needs and cause additional cost increase working capital needs or the costs pressure if these are not provisioned for in retail of interest during construction, which tari s. utilities are not always permitted to pass on to consumers. Around 65 percent of the Even as overall electricity demand increases, utilities analyzed in Section 2 of this paper the energy transition will also bring new reported having receivables days that alternatives to grid power that could exceeded their payables days that is, they diminish interest in utilities traditional grid take more time on average to collect services. DERs such as household rooftop solar payments from their customers than they will o er increasingly attractive alternatives to have time to pay their suppliers. For these the grid for some utility customers. This could utilities, demand growth under the transition be the case, for instance, if governments o er will increase this working capital gap. To nancial incentives to promote DER adoption or incentivize e cient collections and payment in systems where power service is unreliable. practices, some regulatory regimes do not Under traditional volumetric tari approaches, allow utilities to nance working capital from where customers pay only for the amount of tari s. Similarly, to incentivize utilities to power they consume, decreased grid electricity avoid delays or cost overruns, regulators may consumption due to higher penetration of DERs restrict them from including interest costs means that a utility s past and future xed that are related to the nancing of an asset costs (including from investments to support that is still under construction ( interest the energy transition) will have to be spread over during construction ). Rapid demand growth a smaller demand base. under the transition may increase the amount of nancing that utilities require to meet these 23 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition To compensate, utilities may need to raise the customers who consume the most power tari s and thus further increase customers have the strongest incentive to reduce their grid incentives to shift from grid power to DERs. power consumption. In many systems, these This utility death spiral will be especially customers account for a disproportionate share pernicious under progressive block tari of utility revenues, and utilities can least a ord structures, in which customers tari s to lose them. Box 5 illustrates some of these increase proportionally to the amount of challenges in Jordan. power they consume. Under these structures, BOX 5 DERs and utility performance challenges in Jordan By the end of 2022, self-generation from household solar amounted to more than 1,070 MW of installed capacity in Jordan, or 42 percent of total renewable generation capacity in the country. This resulted in a noticeable reduction in the demand for grid power during the day (when rooftop solar systems were generating), followed by a sharp increase around sunset (when solar systems stopped generating). Jordan's net metering allowed self-generators to sell their excess electricity to the grid at retail prices and deduct this from their power bills. This created nancial challenges for NEPCO, Jordan's single o -taker and bulk power supply utility, because the net metering policy did not recognize di erences in the marginal costs of power between when it was abundant (during the day) and when it was scarce (during the evening peak), and this overcompensated self-generators for the power they injected into the grid. To address this problem, the Jordanian regulator now stipulates that households that self-generate must pay monthly network usage fees that are proportional to the amount of self-generating capacity they have connected to the grid. As a next step, the regulator plans to switch from its net metering policy to a net billing policy that sets prices closer to marginal costs. This will ensure a more balanced treatment as self- generators will contribute to the costs required to enable them to provide electricity to the network. 24 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition New business models and digital tools create opportunities for network utilities to better manage grids and expand their service o ering to customers. The transition will introduce new tools for Utilities can draw on new business models to managing demand and supply and expand their service o erings and their value improving service reliability. New digital propositions to consumers. On their own, or tools, technologies, and business models will through third parties, utilities could o er allow consumers to deliver electricity services to customers in their service area who produced by their DERs to other consumers, or would be willing, for example, to deploy to store it for later use, for instance in distributed solar on their premises. Utilities' batteries or electric vehicles. These systems services could then comprise the design, could store excess energy from renewable nancing, installation, operation, and sources, which could then be discharged maintenance of these DERs. Utilities could also during peak times to ful ll demand. Industrial leverage their technical competence by customers could adjust their energy usage in providing associated project management response to power system constraints services to customers, including specifying ( demand response ). This would allow utilities equipment standards, developing and vetting to even out temporary peaks and valleys in project design, and standardizing contracts for daily demand instead of varying supply by DERs. In addition, utilities could improve their turning power stations generators up and customers access to DERs by providing low- down. Residential customers could participate cost nancing or including repayments for DER in utility-funded energy e ciency programs equipment nancing in customers power bills that install energy-e cient lighting, (Box 6 illustrates how utilities in India were able programmable thermostats, and equipment to take advantage of some of these new such as smart power strips,18 and, in turn, help business lines). This approach could be utilities to achieve their annual energy savings particularly bene cial in countries that su er targets. These rapidly spreading innovations from damaged infrastructure and unreliable could help to make sure that networks are run power supply due to fragility, con ict, and more e ciently; ensure the smooth coupling violence. In these countries, utilities could use of the electricity, e-mobility, and heating DERs to provide stable and independent power sectors; reduce the costs of asset sources directly to consumers, which would maintenance and equipment failures; optimize avoid the vulnerabilities of a central grid. This the operation of grid-connected generation; strategy could help to build utilities resilience, defer distribution and transmission capacity as well as strengthen relationships with their investments; and mitigate grid congestion and customers. technical and commercial losses. 18 - Smart power strips are designed to reduce the amount of energy used by consumer electronic devices by shutting o the supply of power to devices that are not in use. 25 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition BOX 6 Enhanced utility service o erings for DERs and peer-to-peer electricity trading in India Tata Power, India s largest power company, provides electricity distribution services in North and North West Delhi. The company allows customers to use electricity generated from rooftop solar systems to o set their power bills, with two additional features. First, Tata Power o ers several di erent nancing arrangements in conjunction with local banks to help customers purchase rooftop solar systems, while also o ering maintenance services for installed systems. Second, all customers are charged a two-part retail tari , with xed charges based on capacity and variable charges based on the energy they consume. This model means that Tata Power can manage the revenue risk from DERs through the two-part tari while also bene ting from additional revenue streams from the sale and maintenance of solar systems. This arrangement was expanded in 2021 when Tata Power and the Australian technology company Power Ledger, in collaboration with the India Smart Grid Forum, introduced a trial of a peer-to-peer energy trading system based on blockchain technology, which enabled the direct trade of over 2 MW of solar PV among customers in North Delhi. Customers could choose whom to buy their electricity from, and the blockchain audit trail of energy transactions provided quick settlement and full transparency. These kinds of trading platforms provide a market-based alternative to dealing with surplus energy under net metering and net billing arrangements, while also creating incentives to install storage and provide other forms of exibility. New tools and business models could also be mitigated by least-cost geospatial planning help to better target grid expansion e orts, tools that are now available to help utilities and reducing the nancial burden to utilities governments identify which connections are most economically served through power grid from growing their networks. Historically, expansion and which are more e ectively government universal access programs in LICs reached through o -grid technologies, such as and MICs have often required utilities to pay mini-grids or solar home systems. New for the capital costs of grid extension as well approaches to electri cation, in which utilities as cover any operating losses resulting from partner with nanciers and appliance serving what are often remote, low-demand distributors to stimulate the adoption of new customers. Some governments have income-generating appliances ( productive use ) committed to compensating utilities for these can also help improve the nancial case for grid shortfalls, but this compensation is often electri cation. Box 7 describes some of these insu cient or delayed. These challenges can trends in Kenya. 26 Section 3: New Challenges and Opportunities for Utility Performance The Critical Link: Empowering Utilities for the Energy Transition BOX 7 Utility performance and the push toward universal access in Kenya Kenya has undergone one of the most dramatic energy access expansions in recent history, having increased its electricity access rate from 25 percent in 2010 to 75 percent in 2019. A large share of this increase in access came from new connections to KPLC Kenya s power distribution and retail utility. Recognizing that the new connections would be in rural areas with predominantly low-volume household consumption, the Government of Kenya instituted a last-mile connection policy through which KPLC s connection costs, and revenue shortfalls from servicing these connections, would be covered by public funds. In practice, the government s scal constraints meant that compensation for last-mile connections was often delayed or did not materialize. However, KPLC continued to connect new last-mile customers. This has caused signi cant nancial di culties for KPLC as well as deteriorating service quality as KPLC has not been able to mobilize su cient funding to accompany grid extensions with the investments needed to strengthen its network. As Kenya embarks on its nal push toward universal access, KPLC is drawing on more streamlined, cost-e ective approaches to last-mile electri cation that are based on new technologies, planning tools, and utility business models. These include geospatial electri cation planning to identify whether new connections can be most economically achieved through grid extension or o -grid technologies such as solar home systems and mini-grids; using demand and network data to better target electri cation on technical and economic grounds; and working directly with nanciers and appliance distributors to mainstream the use of income-generating appliances and stimulate electricity demand in newly electri ed areas. 27 Section 4 Empowering Utilities for the Energy Transition and Universal Access Utilities cannot navigate the shifting power sector landscape alone. 28 Section 4: Empowering Utilities for the Energy Transition and Universal Access The Critical Link: Empowering Utilities for the Energy Transition Utilities cannot navigate the shifting power require a major departure from their standard sector landscape alone. The challenges and operations, with signi cant nancial downsides. opportunities discussed in the previous In all cases, concerted action will be required section will impact utilities in di erent ways, from policymakers, regulators, nanciers, and depending on each utility s technological, utilities themselves to ensure that: i) utilities are political, and economic context, as well as its prepared to manage a rapidly evolving power capacity and capabilities. For some utilities, sector; ii) policy-level and utility-level incentives the goals of the energy transition and are properly aligned; and iii) additional costs to universal access already closely align with utilities and their consumers arising from their corporate and nancial objectives. For decarbonization and universal access are other utilities, meeting these objectives may managed and appropriately compensated. The role of governments Governments can reduce the costs of the transition to utilities by reducing private sector risk. While the costs of energy access expansion and transition will in part be determined by exogenous factors such as the price of solar panels and other materials, a considerable share of the costs will depend on energy investors' perception of sector- level risks. By providing stable, predictable, and transparent laws and policies, governments can help to reduce the risk premiums that investors require and, thus, the costs for utilities and consumers of private capital. This includes developing transparent frameworks for public-private partnerships (PPPs) and creating clear rules concerning permitting, grid access, and power dispatch. In areas where the siting and permitting of transmission and distribution lines require action by many di erent authorities that govern access to public or private lands, governments need to ensure good coordination and e ciency by setting clear expectations and predictable timelines and processes. Similarly, a procurement framework based on fair and transparent bidding and selection can help drive down costs compared to negotiated contracts or feed-in- tari policies. Where markets are not yet su ciently mature for open competition, non-competitive procurement should still be based on rigorous and transparent technical and commercial criteria. Reducing sector risk through sound policymaking and robust procurement practices are among the most e ective tools that governments have to minimize the costs of the transition. This will be especially critical for utilities that have heavily relied on concessional nancing in the past, and whose nancing costs will rise as they mobilize greater amounts of private capital. When setting transition targets and formulating power sector plans, governments should consider all related costs and their impact on utilities. Policymakers should consider the full impact that policies will impose on utilities and make sure that utilities are not burdened with excessive or hidden costs. Regarding decarbonization, renewable energy targets should take the full costs of achieving them into consideration, including the costs for transmission and distribution grid investments that are required to integrate new renewable generation. 29 Section 4: Empowering Utilities for the Energy Transition and Universal Access The Critical Link: Empowering Utilities for the Energy Transition The role of governments Planners must also ensure that policies that incentivize the rapid development of new renewable energy projects include careful monitoring of overall system needs and that they avoid committing to increases in generation capacity beyond what utilities and consumers can absorb. Regarding e orts to increase access to electricity, least-cost access expansion planning can ensure that the grid is only extended to areas where it is economically e cient to do so when compared to o -grid alternatives. Where grid extension is least-cost, or other options are not available or politically desirable, governments need to ensure that the commercial performance of utilities does not su er as a result of implementing socially motivated connection expansion campaigns. This could entail, for example, providing utilities with adequate compensation for serving low-consuming customers in remote areas, and keeping loans used to nance non-commercial access investments o utilities books. In addition, promoting policies and incentives focused on demand management and energy e ciency could help mitigate the challenges of rapidly growing demand and reduce the impact of decreasing subsidies on consumers. Governments should remove subsidies that do not support the goals of the transition or universal access, and ensure that their own obligations to utilities are paid. Creating a level playing eld for renewables will require governments to remove distorting fossil fuel subsidies, but to do so in a way that is sustainable for both utilities and consumers. In many LICs and MICs, subsidies for fossil fuels make fossil fuel power arti cially attractive. This creates strong disincentives for utilities to increase the share of renewables in their generation mix and for consumers to accept the potentially higher prices of unsubsidized power. While phasing out these subsidies will be fundamental for a successful energy transition, this will require a concerted e ort by utilities and policymakers to devise phase-out strategies that do not create overly abrupt changes in utilities' and consumers' costs. This could involve introducing compensatory incentives to make renewable energy adoption more appealing for utilities as subsidies are phased out. Also, some of the funding spent on fossil fuel subsidies could be reallocated to mitigate the nancial impacts on utilities and consumers. Finally, since governments are often among the largest utility customers, they can further help utilities by paying their own electric bills on time. 30 Section 4: Empowering Utilities for the Energy Transition and Universal Access The Critical Link: Empowering Utilities for the Energy Transition The role of regulators Utilities need to be allowed to recover reasonable costs, including costs incurred as part of achieving their government s energy transition or electricity access goals. Sustainable nancial performance of power utilities can only be achieved if the revenues they bill and collect are su cient to cover their costs of operation. This requires that regulators be free to set tari s based on clear, transparent methodologies without ad-hoc government interference. When governments keep tari s low for certain customer groups for political or strategic reasons, cross- subsidies from other tari categories or scal transfers need to make up for any shortfalls. Regulators also need to be able to monitor performance e ectively and react to utilities' tari lings in a timely, transparent, and accountable manner. Innovations in tari setting may be required to manage new volatility in utilities' costs. Although the principles underpinning cost recovery will remain as important as ever to ensure utilities' sustainability during the energy transition, the transition's demands may create new pressures on cost recovery even for utilities that are currently well-regulated. As some utilities incur greater capital costs to nance transition-related infrastructure and experience rapid growth in demand, regulators may need to explore options for dynamic tari -setting mechanisms that are more responsive to external shocks. This could include more frequent tari reviews or the provision of additional pass-throughs for transition-related costs that cannot be reasonably controlled by the utility (for example, costs arising from interest rate shocks, which may be ampli ed for utilities that have borrowed to undertake large infrastructure expansion programs). Regulators that do not already allow utilities to include working capital, interest during construction, and other nancial costs in their revenue requirements may need to consider accommodating these. Of course, preserving utility cost recovery under the transition will need to be balanced with keeping tari s predictable and a ordable for consumers to reduce the risk of political backlash. This will require greater transparency from regulators and utilities in determining and communicating the allocation of costs between utilities and their customers. New tari -setting approaches will be required to deal with the impacts of distributed energy resources. Most of the challenges linked to higher penetration of DERs among utility customers are pricing-related and will require appropriate regulatory responses to manage. Regulators will need to ensure that the grid customers who adopt DERs continue to pay their fair share of the network and generation capacity costs that are required to ensure their continued connection to the grid. The use of two-part tari s with both a component based on ongoing consumption and a component based on maximum demand can help address this. The prices paid to DERs for supplying energy to the network should re ect as closely as possible the value to the power system of that energy at that time. Time-of-use tari s, which are particularly useful when there are large di erences in the costs of service delivery between peak and o -peak hours, are one way of helping to achieve this. 31 Section 4: Empowering Utilities for the Energy Transition and Universal Access The Critical Link: Empowering Utilities for the Energy Transition The role of regulators Regulations will need to be adapted to help utilities manage upcoming changes to the nature of supply and demand. Traditional approaches to balancing supply with demand by ramping up or reducing dispatchable sources of generation will become less e ective in systems that have large additions of renewable generation. New grid technologies, however, o er new sources of exibility by targeting both supply and demand. Policies and regulations should, therefore, provide incentives for utilities to invest in innovative infrastructure and digital tools that can better leverage supply and demand data to improve system exibility. This includes smart meters and smart grids, cogeneration, demand response, energy e ciency, and electricity storage, as well as incentives to extend the useful life of assets to avoid unnecessary investments. Often this will require removing outdated legislation or technical regulatory requirements, such as those that preclude peer-to-peer trading of electricity among DER providers or that arbitrarily exclude the participation of unconventional resources such as battery storage. Encouraging additional energy solutions to enter power systems and augmenting the available power supply requires strong regulatory frameworks that provide metering data standards, proper wheeling tari design, and ensure that utilities, DER resource aggregators, and mini-grids all face the same set of responsibilities for maintaining the grid's exibility. Box 8 discusses regulatory innovation in Great Britain. 32 Section 4: Empowering Utilities for the Energy Transition and Universal Access The Critical Link: Empowering Utilities for the Energy Transition BOX 8 OFGEM RIIO (Revenue = Incentives + Innovation + Outputs) in Great Britain To encourage e cient investment, the RIIO framework of OFGEM (Great Britain s electricity market regulator) rewards the three British companies that it regulates for innovations to better meet the needs of their network users and consumers. To make sure that investments provide value for customers, and that network companies deliver on the performance targets and commitments outlined in their business plans, OFGEM sets cost and quality incentives that are based on reviewing exactly how much each company can spend, and on what. If OFGEM determines that a proposal is closer to e cient costs, the company will receive a higher incentive. Thus, if a company spends less than the amount allowed by OFGEM, it can retain a portion of what it saves (the incentive). This motivates utilities to invest in innovation and customer service. In addition, OFGEM s regulations focus on TOTEX (total expenditures) so that utilities are nancially incentivized to reduce their total costs by making tradeo s between their operating costs and capital costs. The RIIO framework, which was introduced in 2015, has been credited with enabling British utilities to reduce their carbon footprint by over 49 percent. The RIIO framework has also helped to improve the reliability of utility grids, as the number of power cuts has fallen by a fth, and the average length of interruptions has fallen by 15 percent. The role of utilities While good policies and regulations create the foundation for a sustainable energy transition, utilities must also play their part. Even in countries that have adopted sound policy and regulatory principles, it will ultimately be up to utilities to determine to what extent they are able to turn a favorable operating environment into long-term nancial sustainability. Utilities responsibilities include keeping the costs that are under their control such as administrative costs and, to some extent, nancing costs to reasonable levels. Poor operational and nancial performance makes utilities a riskier target for private investment, raising utilities costs of capital or deterring some private investment altogether. Twenty-seven utilities included in the UPBEAT database could achieve cost recovery by improving their collections and reducing their system losses and costs of supply to below benchmark levels19 (Figure 16). This would require utilities to implement e cient investment plans and programs to sustainably reduce technical and commercial losses, as well as revenue protection plans to improve customer billing and payment collection. 19 - Benchmark losses here are 2 percent for transmission losses and 10 percent for distribution losses; benchmark costs of supply here are 10 cents per kWh, which is roughly the median for utilities in HICs. 33 Section 4: Empowering Utilities for the Energy Transition and Universal Access The Critical Link: Empowering Utilities for the Energy Transition The role of utilities Better use of management information systems can help utilities manage and reduce interruptions; maintain voltage levels; record, bill and collect payments for electricity consumption; and manage corporate resources. Utility performance targets can be codi ed in concession agreements (for private utilities), in performance contracts, or as conditions for government guarantees for new utility nancing. Figure 16: Number of utilities that could achieve cost recovery by addressing key performance challenges Number of utilities that could 30 25 achieve cost recovery 20 15 27 10 16 13 5 8 0 By collecting By reducing By reducing With all all billed power losses cost of of the revenue to benchmark supply to preceding levels <10 cents/kWh Outdated management and governance practices contribute to poor utility commercial and operational performance just as weak infrastructure and regulations do. For utilities in LICs and MICs to thrive under the energy transition, they must not only be e ective transporters of electricity, but also competently managed, and have the technical skills and organizational agility to seize new commercial opportunities, and mitigate new risks. Utilities' technical departments will need to become experts on how changing supply and demand patterns will impact power network management and how to use a growing universe of IT systems for grid and customer management. Finance departments will need to develop the capabilities to source and manage capital that aligns with the long-term investments necessary for supporting the transition, as well as know how to tap into new international and domestic sources of climate and sustainability-linked nance. Procurement and planning departments need to prepare for the grid upgrades necessary for DERs, VRE integration, and improved resilience and energy security. All of this needs to be facilitated by a management approach that hires, compensates, and rewards employees based on performance, overseen by strong government-led transparency and accountability measures. 34 Section 4: Empowering Utilities for the Energy Transition and Universal Access The Critical Link: Empowering Utilities for the Energy Transition The role of utilities As the link not just between supply and demand but also between capital and consumers, utilities need to be able to communicate credibly with both their nanciers and their customers. Of the 182 utilities analyzed here, 23 had no nancial data available for the years after 2019. Only about half of utilities in the UPBEAT database make metrics for power losses publicly available, and fewer than half, even in higher-income countries, report standard reliability indicators such as SAIDI20 or SAIFI21 (Figure 17). Several utilities, particularly in LICs and LMICs, lack even the basic systems to measure operational indicators. Poor reporting standards may also extend to de ciencies in communicating tari changes to utility customers, which can undermine public perception of their legitimacy. If utilities are to continue to have the con dence of both nanciers and customers as they navigate the complexities of the energy transition, then transparency, accountability, and e ective communication must be among their top priorities. Figure 17: Share of utilities reporting basic e ciency and reliability performance metrics Share of utilities that have published data 100% 90% 80% 42% 38% 53% 54% 51% 70% 59% 60% 50% 40% 30% 58% 63% 47% 46% 49% 20% 41% 10% 0% LIC & LMIC UMIC & HIC LIC & LMIC UMIC & HIC LIC & LMIC UMIC & HIC Losses SAIDI SAIFI Have not published Have published The role of development nance and concessional capital Utilities will have little incentive to make the investments, manage the assets, and develop the business models needed for the transition's success if they are left worse o nancially as a result. The objectives of the transition are economic, social, and environmental in nature: governments and the global community have recognized the importance of providing universal access to electricity and mitigating climate change, and have set policy targets accordingly. The objectives of a utility are to deliver power to consumers, reliably and e ciently, while earning a reasonable return on investment. 20 - System Average Interruption Duration Index the average outage duration for each customer. 21 - System Average Interruption Frequency Index the average number of outages a customer experiences over a certain period. 35 Section 4: Empowering Utilities for the Energy Transition and Universal Access The Critical Link: Empowering Utilities for the Energy Transition The role of development nance and concessional capital There are no inherent reasons for these objectives to perfectly align, and utilities would not necessarily pursue the aims of the transition and universal access for commercial reasons. Decarbonization targets may require additions of renewable energy capacity that exceed what utilities would consider to be nancially optimal. The additional network infrastructure needed to absorb and transmit variable generation will also add signi cant costs. This will be true as well for publicly driven energy access programs if governments require utilities to nance grid expansions to remote, low- consuming customers, or if governments promote the adoption of DERs. While well- designed and well-enforced regulation can ensure that utilities are able to recover their reasonably incurred incremental costs by passing these on to consumers, there is a limit to the speed and magnitude of the tari increases that customers can bear. Private capital has an important role to play in energy transition nancing, but the additional costs of the transition will be felt by utilities regardless of how they are funded. Given the scarcity of public funding, private sector investment will be critical in mobilizing the nancing needed for the generation, transmission, and distribution infrastructure required to carry out the energy transition. This could either be in the form of PPPs where utilities pay private developers for electricity services or in the form of utilities raising debt and equity directly from private investors. Both approaches will require nancially viable utilities to act as credible o -takers and borrowers. However, from the utility s perspective, while signing contracts with private investors for the supply of power or network services can help spread costs over time, contracts with private investors that support transition-related goals will often still represent additional costs. In addition, as private capital is typically more expensive than public or development capital, raising new private nancing for the transition may also increase utilities cost of capital. Development nance and international concessional nance can therefore play a critical role in helping utilities and consumers in LICs and MICs manage the additional costs of the transition. Given the limited ability of many utility customers to pay for electricity, government budget constraints, and the global bene ts of decarbonization, there is a strong case for providing utilities with international concessional nancing to reduce the burden of the energy transition's incremental costs. Su cient amounts of concessional capital could, theoretically, leave utilities and their customers no worse o nancially when utilities make the investments needed for the transition. For example, the hypothetical utility modeled in Section 3 would require a 1.2 percentage point reduction in its cost of capital to o set the incremental costs of decarbonization. Box 9 explains this approach to estimating concessionality in more detail. 36 Section 4: Empowering Utilities for the Energy Transition and Universal Access The Critical Link: Empowering Utilities for the Energy Transition The role of development nance and concessional capital Concessionality could come in many forms, and not just as reductions in loan pricing. Many utilities in LICs and MICs lack access to long-term debt and are unable to reliably re nance short-term debt. Longer tenors can help reduce utilities annual debt service costs and better align the maturity of utilities debt with the long lifetimes of network assets. Concessional capital can also fund risk-sharing mechanisms, such as guarantees, that make utilities less risky counterparties for IPPs and private lenders. Utilities in LICs and MICs are often highly vulnerable to exchange rate uctuations as large shares of their power, capital, and other input costs are denominated in hard currency. For these utilities, risk-sharing mechanisms that mobilize local-currency private capital could be especially impactful. Concessional capital for utilities could also come from global carbon markets. These could provide utilities with grant-like capital that can be blended to improve the terms of other sources of nance, without imposing additional debt burdens. Whatever form concessional capital takes, development nanciers need to make sure that it is accompanied by appropriate conditions so that it does not disincentivize policymakers and utilities from making the reforms necessary to further reduce the costs of the transition. BOX 9 How much concessional capital? And at what price? Decarbonizing power systems will require utilities to add VRE generation to their supply mixes and expand and modernize their power grids. For many utilities, these investments whether they are nanced from utilities' balance sheets or through contracts with the private sector will impose additional costs that would not have been incurred without decarbonization targets. In many LICs and MICs, these additional costs stand in contrast to comparatively small contributions to global greenhouse gas emissions. Therefore, there is an argument for international concessional debt to help o set these incremental costs to utilities. One approach to estimating the required concessional debt is nding the reduction in a utility's cost of capital that would o set the additional costs of decarbonization. For the hypothetical utility examined in Section 3, a 1.2 percentage point decrease in its weighted average cost of capital (WACC) would equalize the present values of its regulated revenues with and without decarbonization. Reducing the utility's WACC in this way could be achieved by increasing the share of concessional debt in its capital structure and/or increasing the discount o ered on concessional debt, compared to its commercial debt. 37 Section 4: Empowering Utilities for the Energy Transition and Universal Access The Critical Link: Empowering Utilities for the Energy Transition The role of development nance and concessional capital Development nance also has an important role to play in strengthening the capacity of utilities, regulators, and other power sector institutions. This support can include strategies for integrating renewable energy sources into existing grids, balancing investments in distributed and grid-scale renewables, and establishing fair and transparent support mechanisms for new renewable energy. Also, dedicated capacity building will be required to help utilities manage increasingly complex network infrastructure. 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