Catalog

	Table of Contents
p. 7 of 21 BACK | NEXT Introduction: Looking ahead Past policies and operations Changing context of the policy review Poverty reduction Private sector participation and sector restructuring Regional and global environmental impacts Regional cooperation Impact of the financial crisis Future assistance in the changing context Conclusions

Energy 2000: Review of the Energy Policy of the Asian Development Bank : Changing context of the policy review

---

Poverty reduction

17. In Asia close to 900 million people are poor. About a third of the rural population lacks access to modern forms of energy. The priority for the poor is the satisfaction of basic human needs, such as food security; productive employment; and access to health services, education, housing, clean water, and sanitation. As the basic needs get satisfied, access to modern forms of energy becomes important due to the beneficial direct and indirect impacts, and the actual level of energy consumption is influenced by the available rural energy services and their affordability. Pro-poor energy supply implies that the focus is on maximizing impact rather than output. The challenge is to do it in a cost-efficient way.

Impact of energy services on the poor

18. There is substantial and consistent empirical evidence that economic growth is a necessary but not sufficient condition for the reduction of both absolute and relative poverty. In general, there is broad agreement on the links between energy and poverty reduction, but hard data on the absolute or relative magnitude of the welfare impacts of different kinds of interventions in the energy sector are not available. Electricity is the most convenient form of energy for most applications other than transport, and even small quantities dramatically improve the quality of life. However, the consumer-supplier links at the point of delivery are notional, which makes it difficult to identify direct project beneficiaries (except for projects extending supply only to new consumers such as rural electrification schemes). Further, when various sectors of the economy use electricity and other energy resources as essential inputs to produce goods and services, a second tier of beneficiaries is created, but they are not always linked to the power or energy project. The lack of analytical work in assessing the impact of such projects on poverty reduction points to the need for building a body of evidence and experience with future ADB operations.

19. Improving access to and broadening the choice of energy sources for households and rural communities may affect welfare among poor households in several ways. It allows them to shift from biomass fuels to kerosene or gas for cooking, install electric lighting in homes and schools, and use refrigerators in community health clinics. Such interventions may enable households to use more energy services, either because the access is provided for the first time, or because it reduces prices when compared with cash and noncash costs of traditional energy sources. Greater use of energy services may result in other benefits, particularly better health and education, higher productivity of labor, and the poor having easier entry in labor markets. Access to modern forms of energy may have other direct welfare effects on poor households in terms of time and effort because of a reduced need to gather biomass and other traditional fuels, and by extending productive activities to evenings. This allows diversification of household labor and results in increased individual labor productivity. While the diversification of labor allows households to reduce risk exposure and vulnerability by increasing the number of household income sources, increased labor productivity is directly income enhancing. As income rises above subsistence levels, energy for lighting, refrigeration, and productive activities bring possibilities for introducing more advanced welfare-enhancing measures in education, health, and communication. Use of even small quantities of energy can have substantial effects on household welfare and the ability for coping with disasters.

20. There are some indirect effects of improved energy services, which generally arise from two sources: improved efficiency of the sector resulting in larger national wealth, and savings from cuts in poorly targeted, nontransparent subsidies. Their impact on the poor depends on the way the benefits will be distributed. Potential beneficiaries can be divided into three groups: (i) those who benefit directly from the wealth effect, at times through increased employment in the organized sectors; (ii) those who benefit from the use of the improved facilities available to all (broadcasting, transport, education, and health services), including those who obtain employment in the informal labor market that flourishes with better infrastructure; and (iii) those who benefit from well-targeted subsidies. The poor households are usually among the second and third beneficiary groups.

21. Initially poor households face the obstacle of high upfront costs of connections, fixtures, and appliances in switching from traditional to modern forms of energy. Once households gain access, their energy consumption depends on affordability. The pricing of fuels influences the amount consumed and the share of income it absorbs. Energy consumption and income are positively related, but while energy spending rises with income, it generally does so less than proportionately. The poor generally spend a much higher portion of their income on energy than the rich do. Use of instruments to defray the upfront costs and well-targeted subsidies can help mitigate this disproportionate cost burden.

22. The delivery of basic human needs—potable water, sanitation, primary health, and basic education—and improved employment opportunities are commonly pursued for poverty reduction. They benefit the poor and disadvantaged directly by strengthening their capacity to earn more and withstand misfortunes. However, delivery and monitoring of these poverty reduction measures are positively influenced by the availability of modern forms of energy, particularly electricity. Piped water, refrigeration, electric lighting, and telecast educational programs have a positive welfare impact on communities.

23. In the context of employment and income-generation opportunities, the beneficial results of providing modern forms of energy are more visible. Agricultural implements, including pumped irrigation, help increase productivity and output, which potentially benefit both the owners and the poor farm workers. The availability of powered vehicles brings communities closer to markets. If a region has natural resources and other factors of production, the availability of electricity allows entrepreneurs to establish manufacturing facilities and provide formal employment to a larger number of people, which in turn brings more income-earning opportunities to the poor. The availability of electricity allows communities to develop cottage industries, like weaving using powered looms, for earning higher incomes. Electricity can also bring new opportunities at the household level, as lighting extends store hours, refrigeration allows stocking of a wider range of goods, and services like tire repair can be started. Electricity helps improve communications and media coverage that bring communities closer. In general, provision of electricity increases productivity, which is reflected as higher wages in the organized sector and in the cottage industries as higher household incomes. Further explanation of the links between energy services and poverty is given in Appendix 2.

24. New investments in energy sector projects on their own will not be sufficient to reduce poverty in the DMCs. Social efforts and investments other than in energy development are essential for removal of the causes of poverty, particularly abject poverty. However, should DMCs not have adequate resources to invest in their energy sector, there will be serious negative implications: (i) economic growth will slow down for want of energy, which will reduce the employment opportunities; (ii) shortages will create scope for corruption that will drive up prices; and (iii) power outages during the evening peak load time will curtail commercial activities, impair leisure activities, and have a negative impact on education by reducing study hours. Under such circumstances, poverty reduction programs could severely contract. Hence, there is a need for continuing ADB’s role in the development of the energy sector in its DMCs.

25. The energy sector is being restructured in many DMCs, consistent with overall macroeconomic and other reforms. This often involves rapidly unbundling government-owned utilities, increasing private sector involvement, and developing competitive markets. These changes will have repercussions on social, economic, and environmental aspects of the energy sector. In the long run, they will contribute to poverty reduction, enhanced private sector participation, and good governance. Such private sector participation in competitive markets leads to higher efficiencies and also reduces budget subsidies and the government’s capital investments, which will free up resources that can be allocated to poverty reduction. With the restructuring, new projects will tend to be smaller, and the energy sector will be more efficient and competitive. Projects will tend to be localized and the operations may have more grassroot-level participation.

Approach to rural energy services

26. A large percentage of the population living in the rural areas of the DMCs is poor. To improve economic opportunities for them and to slow down migration to already crowded urban areas, the government has a legitimate role in improving access to electricity and commercial energy supplies to such rural and remote areas. In the context of sector unbundling and privatization of energy entities, the government’s role in ensuring access has to be fulfilled in such a manner as not to dilute the commercial and financial discipline of the energy entities. Extensions of the power or gas distribution systems (using pipe network) to rural areas are generally not attractive to profit-oriented supply entities, as such extensions initially generate very low volumes of revenue in relation to their capital requirements. When delineating franchise areas for power and gas distribution companies, there could be a reasonable mix of profitable urban areas and less profitable rural areas, and the social obligation of having to extend the system to the latter and meeting rural demands could be made a part of the franchise conditions. Alternately, the rural franchise could be separated and competitive bidding used so that bidders compete to keep the cost of supply low. Regulatory provisions may allow a higher rural tariff, particularly for large rural consumers, to enable the utilities to recover the higher costs, or use less expensive design standards (without sacrificing safety standards) and lower quality of supply, appropriate to the nature of demand in the rural areas. Should the high rural tariff make electricity unaffordable for most consumers, the government can consider providing a direct subsidy to the franchise holder for meeting the social obligation, with the amount of subsidy determined through competition for the franchise.

27. It is important that rural expansions of energy supply be timed to coincide with implementation of integrated rural development projects covering water supply, irrigation, farm-to-market roads, sanitation and sewerage, agricultural processing facilities, and public health and education facilities, so that the synergy among these activities stimulates economic growth and reduces poverty while increasing the demand for energy and improving load factors¹⁰. Further, to facilitate access and improve effectiveness, the government may, through institutions like the Grameen Bank in Bangladesh, organize microcredit programs for consumers to undertake house wiring or to purchase household equipment to use electricity and gas and make initial deposits for electricity or gas connection. Studies have shown that such initial costs are key inhibiting factors for providing new connections.

28. Close attention should also be paid to ensuring that the distribution utilities are not compelled to expand the system unless such expansion proves to be a lower cost option than decentralized energy options, such as isolated mini grids using only small diesel generators or in combination with renewable energy options. The comparison should be made on the basis of life-cycle costs and internalizing all environmental effects. If the grid expansion option turns out to be uneconomic, then the isolated grid options and decentralized energy options should be pursued. In the cases when it is not sufficiently attractive for the private sector to provide off-grid electrification, nongovernment organizations (NGOs) or civil society could be directly involved. In cases where private sector sponsors are interested in pursuing off-grid electrification as a monopoly, they will need to be regulated.

29. The viability of rural electrification in DMCs is expected to be enhanced through decentralized small grids using “micropower,” i.e., the generation of electricity by small-scale fuel cells, gas turbines, and photovoltaic solar cells. While the appropriate technologies for micropower have been available, recent deregulation of the power sector in industrialized economies has attracted venture capital and a focus on their commercial application, mainly because (i) in the case of remote locations, local power plants offer cheaper options as transmission losses are avoided and surplus heat can be utilized; (ii) microgenerators are exceedingly clean; and (iii) supply reliability can be enhanced by offering users control over the operation. It is expected that, over the next 15 years, the cost of generation capacity for small sets in the kilowatt (kW) range could become comparable to pulverized coal plants, i.e., $1,000 per kW. This trend is apparent in the application of photovoltaic technology for less than 10 kW size, wherein the cost is a quarter of the 1970s levels. As fuel cells and microturbines also develop further, providing access to reliable electricity in remote regions of DMCs at reasonable costs becomes easier.

30. There has been a trend in recent years toward decentralization and devolution of responsibility for urban services, including infrastructure, from the central government to the local level. Decentralization and devolution cover the transfer of responsibility for planning, management, and raising and allocating resources from the central government and its agencies to regional and local governments, semi-autonomous public authorities, NGOs, and the private sector. Like other urban infrastructure services, responsibility for energy supply, particularly in off-grid areas, can be devolved to the local level. Technical and institutional support can be provided by the national or regional energy agencies. ADB will encourage market-based mechanisms to attract private expertise and investment for decentralized energy options, and will help identify appropriate forms of private sector participation and develop the necessary regulatory environment. ADB financing may be provided for decentralized energy systems to local governments/private sector providers/NGOs through appropriate development finance institutions.

Approach to subsidies

31. Subsidies have been extensively used by the DMC governments in the energy sector to benefit particular classes of consumers (such as the poor, rural consumers, and residential consumers), or activities (such as irrigation, fertilizer production, and goods transportation). Such subsidies have often (i) failed to benefit the target population¹¹; (ii) distorted the relative price of fuels, inhibiting fuel switching based on true economic costs, or using renewable energy options; (iii) sent price signals that promoted inefficient consumption; (iv) imposed a heavy burden on the supply system and environment; (v) eroded the ability of the utility to undertake system expansion and connect new customers without additional budget support; (vi) imposed a heavy and often unsustainable burden on the general tax revenues; and (vii) impeded the efficient development of indigenous energy resources. In DMCs where the electrification ratio is low and only a privileged part of the population has access to electricity and commercial fuels, the diversion of the state’s general tax revenues to subsidize electricity and fuel consumption raises troublesome moral and governancerelated questions.

32. In the power subsector, governments have traditionally subsidized the sector as a whole by (i) provision of grants and low-interest loans to the utilities; (ii) provision of excessive equity without dividend expectations; (iii) exemption of the utilities from corporate taxes, import duties, property taxes, and even value-added tax; and (iv) frequent rescheduling, and often cancellation, of debts owed to the governments by the utilities. Further, the governments have seldom allowed utilities to adopt tariffs to recover the full cost of supply, and in most cases required cross-subsidies from industrial to residential consumers, and from urban to rural and agricultural consumers. Instances of the utilities being compelled to supply electricity to certain classes of consumers free of charge or at a nominal insignificant charge are also known.

33. ADB’s approach has been to discourage subsidies given to the utilities that distort the market, such as concessional loans or grants, excessive equity, and tax exemption. These instruments erode the financial discipline of an essentially commercial operation. Internal cross-subsidies between different consumer categories must also be minimized or eliminated as they give the wrong price signals, which promote uneconomic consumption. At the same time, ADB is cognizant of the legitimacy of the government’s responsibility to provide access to electricity and commercial energy to those living in remote and rural areas¹², and to provide financial support for the minimum consumption of electricity by the poorest sections of the society, who cannot afford to pay the full price. However, these objectives should be achieved in a transparent and efficient manner, and when the subsector has been restructured to extend consumer choice, such subsidies should not create entry barriers. Use of a low lifeline tariff for a minimum consumption level by the poor is an acceptable option, and if the average electricity tariff does not allow full cost recovery, transparent budgetary support will be necessary. The use of budgetary support to meet part of the cost to extend supply to new regions is also justified as long as it removes from the existing consumers the burden of system expansion, which would inherently be inefficient during the initial few years.

Back Changing context of the policy review	Next Private sector participation and sector restructuring