Reference no: EM13971117

Many farming households in the developing world use traditional biomass, kerosene and liquefied petroleum gas (LPG) for cooking and lighting. Domestic biogas – generated from the dung of farming animals – has the potential to replace other fuels for meeting basic energy needs. However, high-quality systems such as fixed-dome plants1 can be relatively expensive – especially if constructed in remote areas, where not all building materials are readily available, and where perhaps no skilled masons are located. Farmers might not have either the required capital for cash purchase, nor the required income or creditworthiness for raising – and paying back – a credit.

A current debate – particularly in international development cooperation – deals with the question of how local financial institutions (FIs) can be integrated in the financing process. It is debatable, and it may differ from case to case, if lending for biogas is a viable business (and FIs have not yet realised the market potential), or if the lending potential is limited and an involvement of the private financial sector is rather more wishful thinking than a realistic option.

There have been several attempts for introducing local FIs to biogas finance. Besides technical assistance (such as trainings, capacity building, business development support), different financial support mechanisms have been considered for making the investment affordable for the farmer, and for introducing local FIs to biogas lending. This assignment should assess if and under which conditions i) a biogas plant is a financially viable investment; ii) local FIs can be involved in the development of a sustainable biogas market.

BASIC ASSUMPTIONS

• A 6m3 fixed-dome biogas plant (size for a small farmer family) costs 660 USD, and has a 15 year economic life-time;

• By using biogas instead of kerosene and LPG, and by using the resulting bio-slurry to replace chemical fertiliser for agricultural needs, a farmer can save on average 147 USD p.a. (given fixed prices);

• Interest rates for annuity loans under 1,000 USD are 36 percent p.a. (monthly equal instalments); the loan tenor is 12 months.

QUESTIONS[1]

What are the internal rate of return (IRR) and payback period of the biogas investment – considering the savings on kerosene, LPG and fertiliser as revenues (i.e. positive cash flow)? How do you interpret the results with regard to the investment’s overall attractiveness and financing requirements for the farmer? (approx. ½ page) (15 points)

Assuming a positive net present value (NPV) of the investment, the initial capital expenditure (CAPEX) is often not affordable for small farming households. A bank loan could help the farmer to purchase the biogas plant. It is initially assumed that there is no down-payment (equity contribution) from the borrower, and no subsidy from third parties – i.e. the CAPEX has to be fully covered by the loan.

What is the monthly installment (repayment and interest) to pay back the annuity loan?

What is the total (accumulated) interest amount paid after 12 months?

How does the total payment over 12 months (initial loan amount plus accumulated interest) relate to the annual savings the farmer can generate from not anymore using kerosene, LPG and chemical fertiliser (again considering these savings as revenues, and having in mind that farmers perhaps do not have regular monthly income)? (approx. ½ page)

3. Given the high interest rates (36 percent p.a.), an international donor institution temporarily offers an ‘interest softening’ mechanism, reducing the interest for ultimate borrowers substantially to 9 percent p.a.[2]In turn, local FIs expand the loan tenor to 3 years (still monthly equal installments).

a. What impact do these new loan conditions have on the farmer’s annual installments? [3]How much household income (in addition to fuel and fertilizer savings) would be required per year for paying back the loan?

b. How much would the donor contribute to financing of the biogas plant, both in absolute terms (USD), and relative to the initial investment costs (CAPEX) of the plant?[4] What could be the concerns of subsidising a large share of the investment costs through this interest softening mechanism? (approx. ½ page)

c. In what way does the interest softening mechanism, combined with the extended loan tenor, improve the farmers’ access to finance, and justify the involvement of the financial sector? (approx. ½ page)

4. Given the high demand for domestic biogas plants, and assuming that – even with interest softening and tenor extension as described under task 3 – still many farmers cannot afford a loan, the same donor institution decided to additionally provide a 30 percent CAPEX subsidy.

a. What impact does the CAPEX subsidy have on loan amount, annual instalments, required household income, and the donor’s contribution to financing of the biogas plant?

b. What are the pros and cons of providing a one-time (up-front) subsidy payment? (approx. ½ page)

5. The donor institution offers both support mechanisms – interest softening and CAPEX subsidy – only temporarily. What could be the reasons for the temporary nature of these interventions, and what positive effects does donor presumably aim for after withdrawing from the market? (approx. ½ page)

[1]It is recommended to use MS Excel for calculating IRR, annuity, installments etc. For arithmetical tasks, please outline your approach (e.g. formulas, basic calculations) and provide a brief written analysis of your results. Small graphs and short tables can be included in the text; large graphs and extensive tables should be attached as an Annex.

[2]In this context, interest softening is defined as a subsidy payment on the interest of each individual loan (or each individual installment, respectively) – not as a subsidized, interest-reduced credit line (so-called concessional finance, typically applied by development banks).

[3]Bear in mind that – for an annuity loan – repayment amount and interest payment change over time, resulting in different annual installments for each year.

[4] Bear in mind that the donor subsidizes the interest payment every month over the entire loan tenor.