Financial Analyses of Municipal District Heating Options

USAID Regional Energy Security and Market Development Project

Workshop on Municipal District Heating Options

Obrenovac, November 14, 2012

Aleksandar Kovacevic

Contents

• General Municipal Heating Economics– Urban heating options

– Long term competitiveness of district heating (DH) option

– Key factors of competitive advantage for DH system

• Proposed Project Outcomes– Conversion of conventional DH system into sustainable

option

– Financial outcomes of intervention

– Risk and Sensitivity analyses

– Conclusions

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Urban Heating Options

• There are many urban heating options in use– Air source heat pumps– Ground (waste heat) source heat pump– Heat-only-boiler based central heating (building level)– Light heating stove – Masonry stove and other efficient stoves– Electrical thermal accumulation heaters– Electricity - Direct heating– District heating

• If security of supply is not sufficient, consumers combine more than one option

3

Comparative Cost Analysis

Calculate the cost of producing one megawatt-hour (MWh) of useful heat from various fuels using typical heat generation equipment and operational patterns in Serbia •Current fuel costs and equipment efficiencies•Current investment costs for equipment•Operation and maintenance costs

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Data and Assumptions for Comparative Analysis

• Heavy fuel oil and lignite fired boilers are traditional heat-only boilers (flue gas condensing not available due to the high sulfur content of these fuels)

• Natural gas boilers use advanced flue gas condensation but not full-scale condensing due to the requirements of temperature regulation in the networks

• Biomass boilers are based on full-scale flue gas condensing and advanced flow regulation

• Electricity is based on electric heaters with low investment cost that directly heat the living space (comfort might not be comparable with other options)

• Electricity (heat pump) is based on advanced split system air-to-air heat pump with inverter. The assumed price of electricity is based on day round use.

• Electricity (overnight) uses thermal accumulation heaters with partial uploading during the day (comfort might not be comparable with other options)

• Fuel wood is based upon traditional light heating stoves (no thermal mass, no turn-down-capability)

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Comparative Heat Production Costs

 Heavy fuel oil

LigniteNatural

gasBiomass Electricity

Electricity (heat pump)

Electricity (overnight)

Fuel wood

Measurement unit t t 000m3 t Mwhe Mwhe Mwhe t

Energy content (GJ)

39.98 8 37.578 14 3.6 3.6 3.6 14

Price per unit (Euro)

460 47 367 36 46 46 20 65.22

Boiler efficiency (%)

55 55 95 115 100 350 100 22

Cost of MWh of fuel

41.42 21.15 35.16 9.26 46.00 46.00 20.00 16.77

Cost of MWh heat produced

75.31 38.45 37.01 8.05 46.00 13.14 20.00 76.23

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Based on Current Fuel Costs and Equipment Efficiencies in 2011

Long-term Competitiveness of District Heating (DH) Option

• DH system requires minimum density of heat demand to be economical– Loss of customers (lowering density) increases cost to remaining customers

– Gain of density decrease costs per unit.

• High utilization rates require flexibility of supply and active demand side management to avoid demand peaks

• Combination of relative fuel price and efficiency of fuel use in the reality of actual heat demand should match the competitive threshold in long term perspective.

• Fuel mix should support local economic development and employment in order to facilitate affordability

• Quality and reliability of supply should be almost perfect in order to match security of alternative urban heating options

• Competitive threshold: Heat delivered to the customer by the DH system, should be competitive with available heat pumps and the best available fuel wood stoves in long term

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Key Factors to Competitiveness of Biomass DH System

• Biomass boiler economy of scale versus good quality wood stove

• High boiler efficiency and flexibility with low fuel cost and positive impact of fuel procurement to local economy versus available heat pump

• Fuel wood / biomass prices marginally dependent on prices of alternative fuels – electricity and natural gas

• Active forestry development policy is prerequisite to keep wood biomass abundant and prices stable

• Active demand side management is required to keep peak demand under control, ensure high utilization rates and minimize installation cap-ex and op-ex.

• Avoid any additional capital expenditure and keep it simple.

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Situation of Current Conventional DH Systems

• Current DH systems stressed by massive loss of density of demand including commercial demand

• Very low inherent efficiency (COP of 0.4-0.8)• Too low utilization rate (<1000 hours)• Inadequate reliability of supply• Decreasing barriers to entry of alternative heating options• Phase out of public subsidies but still some emergency /

reactive interventions and cross over subsidies• Poor quality of service (low comfort levels)• Loss of most potent and demanding customers• Price regulations, state aid and barriers to entry can

not keep conventional DH companies in business for long

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Conversion of Conventional DH System into Sustainable Option

Investments must be directed to change of fundamentals of the competitive situation•Minimize size of heat source (maximize utilization rates) by early introduction of energy efficiency, heat distribution management and demand side management•Capture economy of scale by standardization of boilers and substations and through mass procurement•Maximize part-load efficiency (and utilization rates) by use of condensing boilers •Implement heat network efficiency improvements to the grid and flow control focused to decrease return water temperature•Establish an ESCO fund to address energy efficiency of strategically located consumers •High quality installation to maximize residual value of assets and facilitate BOOT arrangement

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Projected Financial Outcomes

Institute of Economic Sciences developed a cash flow model of the project at the SDHIC, Municipal District Heating Company and ESCO levels

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0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Thou

sand

Eur

os

SDHIC Investments in MDHCs

Design & construction of newbiomass-fired heat supply systems

ECSO projects with customers

Operating start-up investments &Working capital

Advanced Heat NetworkManagement Systems

Proposed Investment Timeline

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Projected Revenues and Operating Costs

• Gross revenues are positive starting the first year the new biomass heat supply systems start operation

• Gross profit exceeds €10 million annually by year 10• Net cash flow and IRR have also turned positive by year 10

-70,000

-60,000

-50,000

-40,000

-30,000

-20,000

-10,000

0

10,000

20,000

30,000

40,000

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 10 Year 15 Year 23

Thou

sand

Eur

os

SDHIC Revenues and Operating Costs

Revenues from CERs

Revenues to MDHCs

Operation &maintenance

Biomass Supply

Gross Profit

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Risk Analyses

• Bankruptcy risk to current DH companies becomes critical if no intervention

• Risks considered in the scope of financial analyses – Regulatory risks – Institutional risks– Political risks – Financial risks – Technical and Managerial risks– Operational risks

• Knowledge intensive solution controls political risks

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Sensitivity Analyses Results

Proposed project is very robust due to strong economic fundamentals and links to local economic development

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Sensitivity analysis Impact on Projected Financial Outcomes

Decline of revenues and collection risks

very robust, sustains decrease of over 20% revenue reduction

O&M costs and fuel costs increase

very robust, minimal change in IRR +/-20% in biomass costs.

Change in interest rates robust

Non-performance of four citiesrobust but sensitive – economy of scale important

Demand Side Efficiency Intervention

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• Financial analysis showed the ESCO business component of SDHIC to have a compelling investment case due to – strategic targeting to high impact buildings– short pay back period– standardization of energy efficiency interventions focused

on peak energy demand and weather sensitivity

• Value of energy efficiency at the building level is only exposed if energy efficiency fundamentals are properly set at the DH system level.

Conclusions

• Bankruptcy risk motivates intervention• Phase out of state aid in the context of EU integration • DH companies exposed to competition while

extremely vulnerable• Diminishing regulatory barriers to entry of competitors• Dismantling of DH systems would represent a missed

opportunity for energy efficiency• Economical investment possible• Downstream opportunity to increase market share

and facilitate further local economic development

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ADD ON SLIDES

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Heat production cost comparisons

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Sample efficiency curve for biomass boiler

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