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By Dominic Barton, Metropolitan Infrastructure Ltd.
District energy is a proven technology, with more than 2000 networks already in place in the UK. The recent injection of substantial Government loan funding for the public sector to encourage the development of district energy is expected to deliver £2billion of new heat network infrastructure. Many local authorities and other public-sector organisations are consequently considering implementing this energy solution by taking advantage of the funding and support available through the Heat Network Investment Project (HNIP), Heat Network Development Unit (HNDU) in England and Wales, and the District Heating Loan Fund (DHLF) and Low Carbon Infrastructure Transition Programme (LCITP) in Scotland.
Implementing district energy demands a long-term commitment – a well-designed network can be expected be in operation for up to 60 years, with plant needing replacement every 15-20 years. Successful district energy networks are assets that can generate income and deliver sustainable, affordable energy for end customers. It is vital therefore that organisations developing new heat networks establish appropriate ownership models and governance structures to ensure their district energy networks deliver the required outcomes over their lifetime.
They will need to plan, design, build and maintain these networks either on their own or in partnership. Developing new heat networks involves significant capital outlay and requires an appreciation of unique investment risks that need to be appropriately managed.
De-risking the process
For a district energy network to become a well-run, income-generating asset requires detailed, multi-disciplined experience at the planning stage. Successful schemes need to have robust business cases, with clear direction on how the network is to be commercialised. This is essential if investment is to be attracted, from the Government or the private sector, by demonstrating a realistic return on investment (ROI). Crucially, too, the business plan will set out the future ownership model for the network and choosing which model to embrace is one of the most important decisions to be made.
There are a number of models which are available to the public sector, each delivering a different balance between control and risk. Public-sector organisations need to assess the level of risk that they can tolerate and the extent to which they are prepared to be directly involved in, and therefore liable for, each network.
- Wholly-owned by the local authority, housing association etc. Here the assets are owned entirely by the council or other public-sector organisation and they must bear all the risks of network operation such as design, performance, replacement of assets, debt and energy procurement. Typically, a number of sub-contractors will be appointed to design and build and then operate the various aspects of the network: the energy centre; the underground heat network; secondary heating networks; and metering and billing. Examples of networks operating under this model include those in Gateshead, Bristol and Leeds and the London boroughs of Camden and Southwark.
- Wholly-owned separate company created by local authority In this model, the design and operation of the network is undertaken in a similar way but the risks are placed more at arms’ length from core council activities. This is the model operated in Nottingham, Pimlico and Aberdeen.
In these first two models, there is a heavy demand on internal resources to bring schemes forward and all the operating risks are borne by the council. Capital funding needs to be raised by the council themselves either by accessing EU grants or loans or through the Public Works Loan Board. This works well for organisations wanting to generate revenue directly and retain full control of, and responsibility for, the network.
There are, however, additional risks to be factored in beyond the initial design and building of the network. External contractors’ priorities will be different to those of a council, for example. For the contractor, their responsibility ends when the network is installed and becomes operational and they have no reason to concern themselves over whether the network is over-engineered or running inefficiently. In contrast, the local authority must take a long-term view. A heat network that functions inefficiently will be more expensive to run and will cost more over its lifetime than a system that has an optimal design. The consequence of getting this wrong can mean that councils are left with systems that do not generate the anticipated financial returns, which in turn can impact the heat prices that residents have to pay. Maintenance of the network is another area where problems can occur. Budget pressures can lead to cuts in maintenance expenditure resulting in breakdowns on the network, interruptions to heat and the delayed replacement of plant due to the lack of identified capital funding. Realistic, forward-planning for the lifetime of the network is required to mitigate these risks.
There are, however, alternative models available which reduce the exposure to risk.
- Concession. In this scenario, the local authority grants a concession to a private-sector entity to develop and operate a heat network for a defined period of time. Typically, the concession holder takes the majority of the risk and therefore also the majority of the rewards. The local authority can receive discounted energy costs for their buildings connected to the networks and the assets are handed back to the council at the end of the concession period. Networks in Birmingham, Sheffield and Leicester are operated on this basis.
- Special-Purpose Vehicle (SPV). Here, the local authority creates a new company with a private-sector partner to jointly develop and operate heat networks. The council is able to generate a return on investment and to define the level of risk it is comfortable with, having secured a private-sector partner willing to assume the remainder. A number of councils are currently considering this option. Alternatively, the local authority may choose to procure a private-sector partner to install, maintain, fully own and operate the network, reducing all commercial risk to the council.
These two options allow councils to transfer operating and financial risk to third parties. In the concession model, this is more complete but with the consequence that the council only benefits from cheaper energy rather than an income stream. The SPV model enables the council to share the risk and also generates a revenue stream. Private companies that enter partnerships to develop and operate networks bring a wealth of experience to projects, ensuring that networks are developed in an optimum way. Invested for the long-term, they have as much interest as the public-sector partner in the efficient running of the network and the lowest associated life-cycle costs.
King’s Cross – an SPV in operation
Metropolitan’s district energy network at King’s Cross is an example of how an SPV can work in practice. A fully-managed energy services company (ESCo) runs the network and provides professional metering and billing services to householders. The lead developer, Argent, owns a majority share in the ESCo, and the remaining share is owned by Metropolitan. This means that both Argent and Metropolitan will continue to have a mutual interest in the success of the development, managing the customers’ needs, long after the construction phases have been completed. Customers’ interests are further protected by the scheme’s membership of the Heat Trust. Metropolitan was one of the first to register a district energy scheme with this industry-led, self-regulatory initiative which recognises best practice for heat customers; fault and emergency reporting; billing and payment arrangements; support of vulnerable customer and complaint handling.
The energy centre at King’s Cross meets 99% of the current development’s heat demand with a saving of 50% in carbon emissions over traditional utility solutions whilst achieving a 5% reduction in residents’ fuel bills. Indeed, the King’s Cross scheme has delivered heating generation efficiencies in excess of those planned – achieving a CHP Quality Assurance Certificate with a QI score of 116.46, 10 points above the expected level (CHP Quality Assurance is a government initiative which monitors energy efficiency and environmental performance). It has been shortlisted by ADE (Association for Decentralised Energy) to be named District Energy Scheme of the Decade.
Real benefits for communities
Whichever ownership framework is chosen, the benefits of district energy are clear. With heating accounting for 40% of the UK’s carbon emissions and more than two million households in fuel poverty, the challenge to provide low-carbon, affordable and secure heat supplies has never been greater. The twin benefits of low-carbon emissions and reduced fuel bills are the key drivers behind Government support for district energy. As infrastructure projects, too, they generate jobs, both in building and maintaining networks. The flexibility of district energy networks means these advantages are not restricted to new developments; adjacent older buildings can be retrofitted as their heating systems require replacement, extending the energy network and its benefits into more of the local community.
Local authorities and other public-sector organisations understandably want to secure these benefits for their communities and to take advantage of the newly-available Government funding. They must, however, ensure that they consider the longer term and take clear-headed decisions now about how they will build and operate the networks.