The BUSINESS CASE
If there is no requirement for mandatory hook-up in your area, then developers and property managers will not join your project unless you have a better business case than the status quo. Learn about the many facets of developing a winning business case, such as building a financial model, assessing risks, selecting potential business models, marketing, procurement and operation and maintenance.
Build a financial model
Overall, the cost of project development can amount to a significant proportion (between 10% and 20% depending on project size) of the total capital cost of delivering the project. The capital costs required for the development and delivery of the project can include, but are not limited to, the following:
- land for plant utility;
- the plant, including:
- Generating capacity sized to meet base load;
- back-up and peak boilers to meet peak load; and
- pumps and ancillaries;
- pipes for distribution network;
- consumer hydraulic interface units for bringing heat from the distribution network into the building (not including internal heating system);
- soft costs including engineering permitting, land-use approvals, and rights of way;
- construction and installation costs.
All costs associated with the operation of the project over a 25-year term include:
- input fuel (natural gas, oil, and/or biomass);
- electricity for lighting and pumping;
- billing and revenue collection, including bad debt provision;
- operational management;
- customer care, including emergency cover;
- capital interest and repayments;
- property and income taxes;
- contributions to sinking fund for replacement of the system at the end of its life. To ease the financial burden, this may be introduced after senior debt has been discharged;
- legal and financial advisor fees.
The various sources of capital to help finance your project could come from capital contributions such as debt, equity, grants, connection charges, and land availability.
Using robust financial models that illustrate a positive cash flow, loans could be acquired from provincial infrastructure funds, which are then repaid using revenue. Long-term contracts can be used to secure competitive interest rates. Interest payments may be tax-deductible, whereas equity payments are not. It is important for project proponents to seek advice from the appropriate financial experts.
Municipalities may consider forming private corporations which allow them to carry debt. For example, Markham District Energy is a private corporation and the City of Markham is the sole shareholder.
Equity may be acquired from a range of stakeholders with a direct interest in the project to remote investors, and may vary in form, such as assets or cash. You may choose to use equity for the initial phases of the project to create stable cash flow and then explore debt financing options.
There are a number of grant opportunities for clean energy projects across Canada. For the latest news and updates join the QUEST District Energy Working Group or sign up to the QUEST Newsletters.
Buildings that connect to the district energy system will not have the expense of installing their own on-site system. Property developers are then able to contribute to the cost of connecting to the district energy network. To stay competitive, you may have to set rates lower than the on-site alternative.
To evaluate the economics of connecting new customers, you can start with a hurdle rate analysis. First, determine the minimum acceptable rate of return on equity needed for the system to be financially sustainable. Then if the connecting customer doesn’t meet this minimum, they can contribute to the cost of connection to compensate.
Land owners may offer up land for free or at a discounted market value, in return for an equity stake or a special purpose vehicle (a separate company set up to oversee all aspects of the system development).
Depending on your system, you could receive revenue from thermal energy charges, electricity revenues, maintenance charges and tax benefits.
Thermal Energy Charges
This is payment for the supply of thermal energy to customers via tariffs or service agreements. The two principal components are:
- Capacity charge: This charge is a fixed-cost (i.e. total capital investment over the asset life) to recover the costs associated with the plant, piping network, and customer interconnection. This amount billed monthly is typically determined based on the one-hour peak requirement of the customer.
- Consumption charge: This charge is a variable-cost to recover the direct expenses such as fuel and water. Typically it is recorded using a metering system similar to MWh for heating or cooling, and is also billed monthly.
This is only applicable in scenarios where a power-generation plant, such as Combined Heat and Power is included. Similar to thermal energy charges, the sale of electric energy and capacity may be another revenue stream.
These charges are designed to cover the cost of maintaining the system, and may include the maintenance of the plant, network, and customer equipment.
Check to see if there are credits, exemptions or accelerated depreciation that can reduce your tax exposure.
Assessing financial viability
To understand the financial viability of the project you can use a variety of methodologies. These may include payback, discounted cash flow, net present value, internal rate of return, operational costs, life cycle costing, future costs, and discounting costs. These explore methods for putting present-day and future project costs into present-day currency. Additionally, many of these methodologies can be adjusted to take a more environmentally and socially sustainable approach. For example, the discount rate could be lowered (or made zero or even made to be negative), and environmental and social externalities could be brought into consideration.
Risk management has become a vital part of business project management and project development. Typically, risks are identified, analyzed, prioritized, and then adequate mitigating responses are designed, appointed and then implemented. Project risks to consider include:
- Engineering design
- Planning and permitting
- Input fuel pricing
- Energy rates (output)
Did you consider climate change risk?
Canada is facing the brunt of devastating climate change impacts. Temperature in Canada has increased at roughly double the global mean rate. Beyond the risks outlined above, climate change risk could be a significant risk for your project that would merit a formal assessment. Read more about how the changing climate risk and opportunity is upending urban infrastructure.
Allow time to iterate!
You may run into challenges that require you to either adjust or pivot your objective, proposed design, project partners, or financial model. This process of iteration will improve your chances of success but can also cause unexpected delays and incur increased project planning expenses, if unplanned for. So, make sure that you allow enough time to iterate!
Select a potential business and ownership model
At this early stage, it is also crucial to understand your project team’s exposure and attitude to risk. This determines the most appropriate business model in respect of the availability of capital (including the assessment of reasonable return) and of the operating risks. This, in turn, will provide the most appropriate method by which affordable energy can be delivered. Consider the different types of business or commercial models that can be put in place to take the project forward. The relationship with risk and control changes based on your approach, and this can impact the cost of capital.
There are four basic business models within the context of district energy projects:
- Private project development companies (PPDs),
- Public project development companies,
- Hybrid public/private partnerships (P3s), and
- Stakeholder-owned special purpose vehicles (SPVs).
Sources of finance, the roles required to deliver and operate a low-carbon energy project, and the proportion of private and public sector involvement must all be considered.
Marketing & Business Development
Once the general project has been defined, even with preliminary project schedules and maps, it is important to develop presentation materials and consistent content that describes the physical project, lays out preliminary project phases, and provides an overview of the features and benefits of a local district energy system.
Conceptual renderings, development maps, and system interconnection guidelines can be created. Depending on whether the project is a municipal endeavour, a public-private partnership, or a third-party private investment, customers in the marketplace will need to be informed and educated on the merits of the proposed project. Generic materials can be developed from resources provided by membership in the International District Energy Association (IDEA) (www.districtenergy.org), including PowerPoint presentations and community outreach.
Throughout the project development phase, it is important that potential end-users are identified and that a communications strategy is developed to cultivate buyer interest and identify critical customer locations. Very often, federal, provincial, and municipal buildings serve as anchor loads and their energy requirements need to be fully understood, including timing of major renovations, equipment replacements, or adaptive re-use. From the outset, market intelligence on the potential customer buildings is strategically important and should be a high priority for a professional business development specialist on the team.
- Private sector route
- In-house provision route
- Hybrid/special purpose vehicles route
- Stakeholder-owned route
As part of the negotiations with the preferred bidder, the parties will have set out a project delivery plan, summarized in a Gantt chart. Key milestones will have been set in the final contract. It is advisable to appoint a contract supervision officer to provide a focus point between the two parties, oversee the delivery of the contract, and deal with any problems that may arise. Additionally, project delivery will involve permits, rights of way, traffic planning, and street construction disruption, and it will be appropriate to appoint a community-relations or resident-relations officer.
For district heating and cooling distribution projects, you will need to open roads in order to lay the pipes. Powers to do this are generally defined in local franchise arrangements with the municipality. Disruption is inevitable and construction coordination and permits and approvals will need to be established with the appropriate local municipal department, such as Facilities, Public Works, and/or Highway Department. Very often, special permits define duration and nature of traffic patterns, safety, and signage. In urban settings, it is important to be mindful of a special events calendar that might cause traffic congestion, such as professional sports events or seasonal festivities that draw crowds.
Commissioning is often used to establish that the project construction has been completed and the equipment and systems operate to design standards. Pressure testing of underground piping can be accomplished through a series of inspections, non-destructive testing, x-ray analysis, and functional burst testing. Most piping components have a standard operating and pressure test in place for acceptance. Major plant equipment should be evaluated through a series of increasing performance standards, from operation confirmation, to delivery performance testing, to confirm that the overall system operates as designed. In a large district cooling system, it may be challenging to simulate a sufficient-size cooling load to evaluate system performance overall. Many large projects now budget a commissioning phase to test the individual components as well as the system performance overall to ensure return on investment and compliance with specifications.
Lastly, all new energy systems will go through a period of teething problems. These could take up to a year to settle down. It is important to be mindful of this fact and endeavour to take a long-term view.
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