Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy

Transcription

1 Buro Happold Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy Final Report - October 2008

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3 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Contents Executive Summary Foreword Steering Group Members 1 Setting the Scene 2 The Vision 3 Challenges 4 A Question of Scale and Emissions Savings 5 Creating a Market for Decentralised Energy 6 Implementation 7 Blueprint for Decentralised Energy Schemes 8 The Action Glossary Appendix A: Appendix B: Appendix C: Appendix D: Appendix E: Appendix F: Appendix G: Report Scope and Participating Organisations Economic Modelling Methodology Business Models and Funding Review Case Studies Carbon and Energy Balance Workshop Notes Bibliography

4 Executive Summary London First and its members recognise the imperative to address climate change and support the need to generate more of London s energy from decentralised sources. We believe that the 25% decentralised energy target by 2025, set out in the Climate Change Action Plan, whilst challenging, can be achieved through collaboration between the Mayor, boroughs and business. Much work has been undertaken by the Greater London Authority, London Development Agency, London Climate Change Agency and others in this area and significant progress has been made; this work must be built on, with a focus on strategic planning and project delivery. The facts Decentralising a quarter of London s energy would save 3.5 million tonnes of carbon dioxide a year. This is equivalent to the annual emissions from heating 1.1 million homes In the UK we waste enough heat in central power stations to heat all the buildings in the UK There is no silver bullet for delivering decentralised energy in London but this report provides a set of recommendations for implementation to unlock the investment and potential carbon savings Meeting the target will require combined heat and power plants with an electrical generation capacity of around 1800MW and a heat output of around 3400MW. This is equivalent to the output of around 170 schemes of the scale being built for the Olympic Park. The Report This report is the result of extensive consultation and discussion with over 90 key stakeholders from the public and private sector. The recommendations we make would not only support carbon reduction and mitigation of climate change, but also the delivery of new housing which is urgently needed in the capital, as low carbon buildings could be delivered at lower cost. The recommendations To unlock this potential we recommend: 1 Economic incentives which recognise the carbon savings from decentralised energy We recommend an incentive for combined heat and power such as an obligation or minimum floor price for electricity output or support for low carbon heat supply. We welcome the ongoing work by OFGEM and BERR in this area and in particular on the distributed/decentralised generation review, the renewable energy strategy and the heat strategy. 2 Decentralised energy at district scale, where it is most efficiently delivered Whilst small scale low carbon and renewable energy sources have a role to play in providing decentralised energy the greatest potential lies in using the waste heat from power stations energy from waste plants and new dedicated combined heat and power plants. Critically this would also serve existing buildings which is fundamental to meeting the 25% target. Existing buildings also act as anchor loads and are most energy inefficient, resulting in higher carbon savings. 3 Establishment of Energy for London (EfL) within the London Development Agency (LDA) to deliver a strategic implementation plan for decentralised energy in London EfL would act as the public sector lead and set out a plan to meet the 25% target. 4 5 Working with boroughs, energy companies and developers, EfL would give the LDA, the boroughs and public sector bodies the expertise to develop decentralised energy schemes to serve the existing stock. Development of energy masterplans for each borough EfL and boroughs would map heat loads and assess where decentralised energy schemes should be built. Energy masterplans would identify specific decentralised energy projects (including sites for energy centres), and be incorporated into local development frameworks. A partnership approach between public and private sectors for project delivery Using project specific public private partnerships would ensure the ability of the public sector to unlock decentralised energy schemes was matched by the investment and expertise of London s businesses. This approach could deliver the 7 billion of private sector investment required to build the necessary infrastructure.

5 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Other recommendations in our blueprint to achieve 25% decentralised energy by 2025 include: Private sector energy companies to expand their current decentralised energy provision to meet this demand for investment, based on the improved business case Private sector developers to commit to connect developments to new decentralised energy systems The public sector to commit to connect anchor tenant heat loads to kick start build out of decentralised energy schemes and to address emissions from the existing stock. As large occupiers of commercial space public sector bodies have the potential to drive this market. GLA and borough planning policy and decisions to recognise near-site renewable energy provision with flexibility to connect post completion GLA to establish a Green Energy Fund to fund new near site decentralised energy infrastructure through section 106 development contributions (energy to be included in the Community Infrastructure Levy). Developers to commit to connect to new heat network infrastructure in order to meet on-site renewable energy targets EfL to establish London wide standards and technical specifications for heat networks Industry wide Code of Practice for heat networks which includes consumer protection agreements and guarantees of minimum service levels. OFGEM to oversee the appointment of a heat supply ombudsman as part of the Energy Ombudsman Longer term/policy/regulatory change Definition of zero carbon to recognise nearsite provision Decentralised energy network operators to be given statutory undertaker status We welcome the ongoing work by OFGEM and BERR 2,3 in this area and in particular on the distributed/decentralised generation review, the renewable energy strategy and the heat strategy. Decentralised energy supply licenses and short haul cost reflective distribution charges should be implemented as soon as possible Government to lift the restrictions on social landlords that prevent them recovering a proportion of the capital cost of decentralised energy schemes, which reduce tenant fuel bills, through increased service charges or equivalent. The Landlord s Energy Saving Allowance gives this incentive in the private sector EfL to work with banks and energy companies on innovative ways of securing funding for low carbon decentralised energy projects Government to provide sources of low cost, project specific borrowing towards the most strategic, capital intensive investments in heat networks 5

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7 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Foreword Steering Group Members Neil Pennell Chair London First Decentralised Energy Steering Group Head of Sustainability and Engineering Land Securities London business takes seriously the urgent need to mitigate climate change. As well as seeking to reduce its own impact and that of its activities, business wants to work with government; nationally, regionally and locally, to find innovative and effective ways to address the challenge. London First has brought together experts in different disciplines to find the best way of achieving the target of decentralising a quarter of London s energy by 2025; to reduce the carbon impact and improve efficiency of energy supply. We commissioned Buro Happold to assess the scale of the challenge, identify the barriers and work out how they can be overcome. They have done this by engaging the capital s and country s leading experts in the public and private sectors with support from PricewaterhouseCoopers on financing and business models. More than 90 organisations have been involved in this project. The work has been overseen by an expert steering group drawn from London s leading businesses. This report highlights what action should be taken by whom to meet the challenge. It is clear from the work undertaken that there is no silver bullet in climate change mitigation and that the issues are complex and involve many parties including government at all levels, public sector organisations and business. Business is ready, willing and able to play its part and to work with partners in the public sector to meet this target. In particular, we look forward to working with the new Mayor to ensure that London is the leading city in tackling climate change. The new administration has the opportunity to deliver on the ambitious targets that London has set for itself in the face of the climate change threat. London First and Buro Happold wish to thank the members of the steering group who oversaw the development of this report Argent Group Robert Evans Arup Chris Twinn BCO Jenny MacDonnell Biffa David Savory Bioregional Quintain Nick James British Land Adrian Penfold Buro Happold Rod Macdonald CHPA/LEP Michael King Climate Change Capital Gareth Hughes Crest Nicholson Wayland Pope EdF Energy Angus Norman Greater London Authority Shirley Rodrigues Grosvenor Michael Baker Hammerson Paul Edwards Land Securities Neil Pennell London Development Agency Malcolm Ball Norton Rose Nicholas Pincott PwC Richard Gledhill Quintain Estates Nigel Hawkey RPS Group Danny Clark Peabody Trust Stephen Howlett Veolia Paul Levett Neil Pennell 7

8 1 Setting the Scene Primary Fuel input Separate heat and power system 6 Electric Network loss 100 Electric 124 Waste heat 12 Waste heat 76 Heat 46% electrical efficiency, UK average for gas power station A rated gas boiler 86% efficient = 60 units carbon to give the energy output Primary Fuel input Waste heat Combined heat and power 100 Electric 76 Heat 46% electrical efficiency 65% of waste heat used = 41 units carbon to give the same energy output CHP gives 32% reduction in carbon emissions Figure 1 Combined heat and power gives 32% reduction in carbon emissions vs central power 7 Heat network loss The target, the carbon savings and the challenge 1.1 What is Decentralised Energy? Decentralised energy is a broad term but, for the purposes of this report, the emphasis has been on CHP plants linked to modern efficient community heating networks. It is recognised that micro generation can and will contribute a small part of the 25% decentralised energy target. However, this report focuses on the most cost effective and largest potential carbon emission savings from decentralised energy, which are from CHP plants. CHP plants which use biomass or waste to generate power and supply heat to buildings are also counted as decentralised energy in the report. Figure 1 shows how this delivers primary energy savings and hence carbon savings. 1.2 The Target The Climate Change Action Plan 1 targets: 25% of London s energy supply to be decentralised by 2025, moving to 50% by The Carbon Prize This level of decentralised energy supply amounts to a reduction in carbon dioxide emissions of: 2.7 million tco 2 /annum savings from gas fired CHP, rising by a further 0.8 million tco 2 /annum by use of renewable fuels such as waste and biomass. Appendix E to this report shows the carbon and energy savings from our proposals. 1.4 The Policy Background Policy promoting decentralised energy in London is driven by a response to climate change: decentralised energy can significantly reduce carbon emissions. The main savings come from making use of waste heat from electricity generation. High efficiency gas fired CHP schemes making use of otherwise wasted heat can reduce emissions by around 30% (Figure 1). Supplying power locally also reduces transmission losses. Heat networks are the best way of using sources of renewable energy at an efficient scale, which also allows better air emissions controls. Even greater reductions in carbon emissions are possible through supplying heat networks with renewable energy sources.

9 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 At the same time decentralised energy improves energy security and reduces the burden on the electricity transmission system. The former is a key aim of the government s Energy White Paper, whilst the latter could offset significant investment. At a time of heightened security awareness a more distributed energy infrastructure can mitigate the effect of attacks on our energy networks. Climate Change Action Plan 2007 The Climate Change Action Plan seeks a 60% reduction in CO 2 emissions on 1990 levels by Decentralised energy is a key part of the reduction. The targets for decentralised energy are summarised in section 1.2 Government in London has set the pace with respect to introducing policy to deliver on commitments to cut emissions. Much has been achieved, particularly in raising the profile of this important issue. London First welcomes the Mayor s continued commitment to reducing emissions and the lead London is taking. The policy background is in place, action is now required to deliver decentralised energy. The policy is clearly defined in London; nationally it is reinforced by the Energy White Paper (2007) and is backed up by improvements to building energy efficiency standards and the Code for Sustainable Homes. To deliver the reduced emissions we must ensure that the planning framework supports efficient implementation of the policy and lobby national government to ensure the right economic incentives and regulatory environment are in place to develop a market in decentralised energy supply and deliver the Climate Change Action Plan target. 1.5 The Potential The potential for the provision of decentralised energy in London has been investigated through various studies. These set out both the potential for CHP in London, and the resulting carbon emission reductions. This report does not set out to duplicate this work but key conclusions are listed below: 4 A Defra study identifies a capacity of 2,026MW of potential for CHP linked to community heating in London (at a discount rate of 6%). This potential falls to 85MW at a discount rate of 9% showing the high risk, low return nature of these schemes. Based on the Defra report we calculate emission reductions of around million tco 2 /annum, or 5-6% of London s total emissions, could be made. This is equivalent to a reduction of 8% against the current carbon emissions from London s building stock. Around a further million tonnes of carbon savings could be made annually by utilising biomass and waste as fuels in CHP plants. The joint Mayor of London / Greenpeace report Powering London into the 21st Century, which identifies around 2,400MW of gas fired and 100MW biomass or waste fired decentralised energy capacity. Carbon savings of around 15% from this plant are stated 5. 6 The London Carbon Scenarios work by SEA/ Renue identified around 3,650MW of CHP based decentralised energy systems including gas, biomass and waste heat. These schemes claim to deliver carbon savings of over 9 million tonnes CO 2 /yr (20% of 2006 total) for London (although they use higher carbon displacement factors). 7 A report commissioned by Siemens estimated that around 2.1 million tco 2 /annum could be saved by implementing CHP in London, at a cost of around 4 billion. Clearly there is significant potential for decentralised energy to produce large reductions in London s carbon footprint. All of these studies identified district scale CHP (> 1MWe, around 1,500 homes) as providing the majority of carbon savings. 1.6 Planning and Regulation The current planning framework is leading to small scale schemes being approved on a site by site basis. These schemes are based on new development and tend to be driven by requirements to deliver a percentage of renewable energy rather than overall carbon reduction targets. Whilst there is some merit in such schemes they cannot deliver anything like the level of decentralised energy required to meet the 25% target (see Section 3.3). Whilst the planning framework does not preclude larger strategic and more efficient schemes such schemes are not currently being implemented on the scale required. The current regulatory environment, in the form of the electricity market and the absence of adequate recognition of the carbon benefit of decentralised energy at district scale, is not providing the economic stimulus necessary to drive investment. Section 3 examines the reasons decentralised energy schemes are not being delivered at the scale required to meet the Climate Change Action Plan target 9

10 2 The Vision The 25% decentralised energy target requires nothing short of a new strategic energy infrastructure for London Meeting the 25% target requires the development of a new energy infrastructure serving high density areas of the capital. Large investments in heat networks, connecting new and existing sources of waste heat into these networks and extending the networks to serve customers, particularly in existing buildings, are needed. Meeting the target means: 3.5 million tco savings by 2025, or 10% of emissions from buildings (including 0.8 million tco 2 from biomass or waste, see appendix E) Investment of up to 7 billion in capital, much of which can be delivered by the private sector with potential for a viable rate of return Meeting the 25% target translates into combined heat and power (CHP) plants with a total electrical generation capacity of around 1800MW and a heat output of around 3400MW 8, compared to a current capacity of approximately 200MW in London. This level of generation is equivalent to the electricity demand of around two million homes, or the energy output of 170 of the decentralised energy schemes being built for the Olympic Park. Cities such as Copenhagen have exceeded this level of penetration but it has taken over 30 years with strong backing from central and local government This decentralised energy plant includes: Connection of the existing power stations in London to heat networks, enabling them to provide 300MW of electrical power and 1300MW of heat. Many of those opportunities were identified in the GLA Community Housing Development Study (2005) 9 Development of new low carbon generation assets including around 1,000 MW of gas fired CHP plants of various scales Development of a further 240 MW of renewable and energy from waste CHP Development of heat networks in areas of high heat demand. Initially the emphasis must be on linking anchor heat loads but these networks can extend over time to connect surrounding buildings Connection of existing buildings in areas of high heat demand including all large public sector buildings and large multi-residential buildings Retrofitting of existing buildings to be compatible with connection to a heat network New development connected into heat networks or being built so as to allow future connection Lower grade fuels could be used at larger more efficient plants which can be fitted with more robust emission reduction and air quality monitoring systems From the initial systems, which may be relatively limited in extent, larger heat networks could be developed over time Eventually individual heat networks could be interconnected by heat transmission lines capable of delivering heat over large distances, including from power stations outside London. A wholesale market for heat could develop with competition between heat producers driving down heat costs for consumers. Figure 2 compares a centralised and decentralised energy system. The decentralised system shows a large dedicated energy centre supplying heat and power to new and existing buildings on an efficient scale.

11 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October Natural Gas Network Central Power Station Waste Heat 4 Energy Centre 5 Centralised System-bottom right 6 Decentralised System-top left Heat Network Electricity Network 2 Gas Network 3 4 CHP 6 Figure 2 - Decentralised versus centralised energy supply 5 11

12 3 The Challenges Energy Consumption (GWh/yr) Energy consumption (GWh/yr) Potential Potential for decentralised for decentralised energy energy from from new development new development ( ) versus ( ) total energy versus consu total energy consumption for existing for buildings existing buildings Total energy requirement for London s existing residential and non-domestic buildings Total predicted energy consumption new build in London % decentralised energy target Figure 3 New development cannot meet the 25% target The vision has been set and policy targets are in place but we are still a long way from achieving the 25% decentralised energy target The challenges to delivering the 25% target are significant. The most important of these are set out below. Whilst much important work has been done to set policies and targets without addressing these challenges progress towards achieving the 25% decentralised energy target by 2025 will be very difficult. This evidence is based on the case studies and workshop notes presented in Appendices D and F respectively, as well as experience from project work. 3.1 Strategic nature of intervention required The target is extremely ambitious and will require large investment in energy plant and networks There is not a long term strategy for delivering the 25% target though the need for this is being recognised. The target translates into a very large capacity of decentralised energy plant 8. An estimated 7 billion of investment is needed to build this capacity of plant and networks, though some plants may be existing e.g. SELCHP, reducing the level of investment required. With a viable business case much of this investment could come from the private sector. There is little recognition of the cost and strategic nature of the heat pipework infrastructure necessary to deliver decentralised energy at the scale required. Historically utility build of this nature has either been undertaken by the public sector or regulated to de-risk investment by the private sector. Whilst this approach may not be the answer now the high capital cost, natural monopoly involved and low rate of return has much in common with municipal water supply networks. The investment cycle for heat networks is long with a forty year asset life and at least ten years to reach a positive cash flow. Large decentralised energy schemes which were identified by the GLA Community Heating Development Study 9 have not been developed further. The exception to this is the Barking Power Station project which is being developed by the LDA. 3.2 Economic incentives Current incentives do not provide a sufficient return on investment from building decentralised energy systems An economic case for gas fired CHP decentralised energy schemes is marginal with current incentives despite being a well proven method of emissions reduction. New build schemes are part funded by developers to gain planning permission. (See Appendix B) Business will not invest the large amounts of capital required to deliver the decentralised energy target without a viable return on investment. The existing market framework and regulatory environment does not adequately reward the carbon emission reductions from decentralised generation and supply investors with a firm carbon price signal. Carbon savings from gas fired CHP are not recognised financially, in the way that Renewables Obligation Certificates (ROCs) reward renewable electricity provision. Incentives such as the Climate Change Levy have not proved to be effective at promoting decentralised energy. The EU Emissions Trading Scheme only applies to larger schemes and the level of support is small compared to, for example, ROCs. Electricity exports from decentralised energy schemes reduce losses from the distribution of electricity but are still subject to the same charges as central generating plants. Current OFGEM proposals may change this. 3

13 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 The market for trading electricity disadvantages exports from decentralised energy as participation costs are high and low prices are available for the relatively small amounts produced compared with large central plants. Proposals made by OFGEM may address this barrier which are welcomed. The Carbon Reduction Commitment may offer an incentive to connect existing buildings but the strength of this incentive is unclear and it won t start until 2010 Increasing spark spread (the difference between gas and electricity prices) improves the viability of CHP plants but volatility in energy markets discourages investment. 3.3 Planning and existing buildings Connecting existing buildings to heat networks must be addressed as they have the greatest potential for carbon savings and provide anchor heat loads Even if all new development built by 2025 has 100% of its energy needs met by decentralised sources only 5% of London s energy supply, or a fifth of the target, would be decentralised. ( See Figure 3) London Plan policies 4A.4 and 4A.5 on energy assessment and heating networks do not adequately address the issue of connecting existing buildings to decentralised energy supplies. Schemes built to serve new development can serve nearby buildings but this depends on project specific factors, and the window of opportunity to design in this provision in a development programme is limited. Whilst at GLA level there is a more strategic understanding of how planning guidelines should be implemented to develop more efficient decentralised energy schemes, this is not happening in practice. Encouraging new and existing developments to connect to each other cannot deliver larger district scale systems without detailed planning. Land is required to accommodate decentralised energy systems, this is a particular problem in London where land prices are high. Innovative design is required to maximise use of space. Larger plants can be located further from load centres and hence on lower value land. Local development frameworks may need to be altered to include sites for decentralised energy plants. There is a potential conflict between the requirement of planning authorities to enforce the delivery of carbon reduction measures by the time a building is completed and the timeframe over which heat networks are built out. Buildings which could connect to future heat networks may instead be required to invest in on-site measures which provide lower carbon emission reductions but allow a planning authority to say that targets have been met. Social landlords are restricted by Housing Corporation regulation from recouping investments in decentralised energy systems, which result in lower energy bills for tenants, by commensurate increases in rent. This limits the potential for investment in heat networks for large parts of the existing building stock most suited to decentralised energy. The higher level targets set by the Code For Sustainable Homes 10 for carbon emissions reductions, particularly Code Levels 5* and 6* lead to the need to use renewable fuelled CHP in urban environments. Biofuel has uncertainties over long term sustainability of supply but wood or waste fuelled CHP plants require a minimum scale of plant to be viable. Decentralised energy can complement carbon saving through energy efficiency, but both approaches are needed to achieve high levels of carbon reduction New Development While decentralised energy schemes can be viable in new development there are limitations to how much provision can be based on new development Decentralised energy systems are often uneconomic for small development schemes, particularly if private wire solutions can t be used. The need to negotiate with energy services companies, each with a different offering, adds significant uncertainty to development and can delay delivery of housing schemes, including affordable elements. The Energy Service Company (ESCO) market is still evolving, there are currently only a small number of players, and little competition 12. Historically developers could reasonably expect that a utility would provide ongoing services to occupants in a manner that all parties could understand. With decentralised energy it is unclear who has ultimate responsibility for ongoing service provision, again increasing risks for developers. New development has very low heat demand reducing potential heat sales and making decentralised energy less viable as an investment. Build out risk and phasing are likely to reduce decentralised energy provision in the current housing market. 13

14 3.5 Decentralised Energy Project Delivery Delivering decentralised energy is well understood where the buildings to be connected are known and signed up. This is rarely the case when developing district scale schemes for a number of reasons Significant expenditure and time can be invested in developing schemes which do not prove to be viable investments. This early stage of project development needs to be supported financially. For new development developers meet this cost but other sources of funding are required for developing decentralised energy systems to serve existing buildings. In order for multiple new developments and existing buildings to be connected to larger more efficient district scale heat networks a level of co-ordination and planning is currently missing. The time window during the development design process when one development can commit to serving others with heat is very limited. In other utility services the network provider undertakes the role of long term planning and system integration. Lack of certainty of future heat load connection leads to a risk averse approach to design and construction of heat networks, to avoid stranded assets. This can result in less flexible and lower efficiency technical solutions limiting the potential for larger systems to develop. Low financial returns over long timescales mean increases in construction cost or delays to programme risk can reduce returns on investment to zero or worse. Again flexibility for expansion tends to be designed out. Often multiple stakeholders are required to approve and support decentralised energy schemes. This process can be very difficult to manage and requires political engagement, resulting in high development costs. Whilst in general the areas most suited to heat network provision have been identified in previous studies 9 there is a limited amount of information available in terms of detailed mapping of heat loads, sources of waste heat and locations of existing or proposed heat networks. Without this information larger more efficient decentralised energy schemes cannot be developed. Public sector bodies often lack the capital funding and specialist expertise internally to enable the delivery of decentralised energy schemes on an efficient district scale. The private sector can provide capital investment and delivery expertise but only where an economic return exists, balanced with an acceptable level of risk. Whilst improved incentives would mean larger scale schemes had viable returns on investment the level of risk involved in developing such schemes is very high. A lack of transparency in how connection charges and tariffs are determined can lead to a break down in trust between heat consumers and energy companies. 3.6 Streetworks Digging up streets is expensive and disruptive London is a dense city. The issues involved in digging up streets to install heat networks cannot be underestimated. There are cross boundary issues between boroughs as well as the need to involve Transport for London, all of which can add cost and programme delay to decentralised energy schemes. Installing heat networks in existing streets significantly increases the cost of the network. Costs are often double that of installation in new build developments. Streetworks are not co-ordinated 3.7 Consumer Attitudes Historically heat networks in the UK have been associated with unreliable supply and poor control Community heating does not have a good reputation in the UK. Persuading consumers to connect will not be easy, as there may be limited incentive to connect and alternative choices available. Although consumers are interested in green issues, there is as yet little evidence to suggest that they will pay more for them 13. This adds to the difficulty in making an economic case either for retrofitting or for new development. Consumers require long term certainty, also described as covenant, that infrastructure will be maintained and operated in the long term. Perceived risk attached to energy supply reliability must not affect property value or liquidity. Large commercial operators demand high levels of resilience and may require on-site heat only boilers to back up heat networks, increasing the total installation cost. This report sets out a series of recommendations to overcome the challenges noted above and focus on the delivery of decentralised energy and heat networks in order to meet the 25% target by 2025

15 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October A Question of Scale and Emissions Savings % electrical efficiency Figure 4 Electrical efficiency of gas fired CHP units vs output 35% 30% 25% 60% 50% 40% 30% 20% 10% Electrical efficiency of CHP units 0% Rated output, kw Carbon savings vs. grid factor 0.43g/kWh Carbon savings vs. gas factor 0.37 g/kwh Gas fired CHP carbon dioxide savings vs. scale compared to long term grid average and gas produced electricity Economies of scale and efficiency mean larger schemes deliver higher emission savings and better long term investment returns The appropriate scale of decentralised energy systems is an important issue. Smaller scale systems in new development cannot deliver the amount of decentralised energy required. Existing buildings must be connected to heat networks to meet the decentralised energy supply target of 25%. Smaller scale systems have lower efficiencies and higher relative transaction costs to establish them. Even if smaller systems were capable of meeting the target the resulting carbon emission savings would be lower than for larger decentralised energy schemes supplying the same amount of energy. Larger schemes also have improved economics over the long term (see box out: small vs. large scale CHP) 4.1 Economies of Scale Transaction and development costs to establish a decentralised energy scheme are similar once a certain scale has been reached. This tends to make smaller schemes less viable as legal, procurement and compliance costs are proportionally higher. Energy services companies tend to focus on larger schemes for this reason. Capital and maintenance costs per unit output fall with increasing scale, resulting in smaller total investment to supply a given amount of energy. However, larger systems require a proportionally higher investment in heat networks, often as up front costs. Economies of scale can also be achieved operationally both in terms of purchasing power for fuel and materials, but also for trading in electricity and carbon markets. 4.2 Efficiencies of Scale Decentralised energy schemes benefit from improved electrical efficiency of larger scale CHP units (see Figure 4). Since electricity sales drive the economics of decentralised energy larger schemes with higher electrical output give better returns on investment. New buildings have low heat demands and so higher electrical efficiencies also deliver better heat to power ratios, minimising the need to dump heat. 4.3 Improved Carbon Savings Figure 5 clearly shows the improvement in carbon emission savings with increasing scale for gas fired decentralised energy. This is linked to electrical efficiency. When linked to heat networks this is enhanced by an increased proportion of total heat supply from CHP, due to improved load diversity found in larger schemes. This is reinforced by the results of our modelling shown in Figure 6. 20% 15% 10% 5% 0% Scale of CHP plant, kw 1,000 10, ,000 Figure 5 Improved carbon emission savings with scale of CHP plant 15

16 4.4 Conclusion Previous research, the outcomes of working groups and case study evidence point to larger district level CHP plants and heat networks as being the most economic way to achieve large scale carbon reductions through decentralised energy supply. Our economic modelling reinforces this. Figure 6 shows the relative economic performance of several different scales of decentralised energy scheme; the larger schemes outperform the smaller schemes over the long term. The best returns are for systems serving existing buildings which are built out quickly, assuming various risks can be mitigated. See Appendix B for full details. The results of economic modelling and the workshops held indicate that a system serving around 1,500 residential units (~1MWe) in a new mixed use development approaches commercial rates of return if some of the retail value of electricity sales can be captured. See Figure 7. Below this some schemes may be viable but they would have to rely on private wire systems capturing more of the retail value of electricity sales or additional revenue sources such as telecoms. Alternatively an incentive for decentralised energy is required The evidence clearly shows improved carbon savings and returns on investment from larger decentralised energy systems. These are also required to deliver the scale of the proposed 25% target. Whilst a mix of project scales will be required, particularly away from areas with high densities of heat demand, connecting fewer, larger plants to extensive heat networks will provide the most effective carbon emission reductions. Policy, economic incentives and regulation must work together to enable delivery of larger scale decentralised energy projects. Box out: Small vs. large scale CHP A comparison of distributed CHP/DH with large scale CHP/DH, IEA, 2005 This report compares different scales of decentralised energy schemes, specifically various scales of CHP plants against building by building approaches. The results show that for dense city centre areas larger plants give better economic performance and higher carbon savings. London Carbon Scenarios, LEP, 2006 This study identifies large scale gas fired CHP plants as the most economic method of delivering carbon savings in London through changes to energy supply. London Community Heating Development Study, GLA, 2005 A number of large CHP schemes are identified, each serving several thousand households and large anchor tenant heat loads. The most economic are all above 10MWe in electrical output. Time to take a fresh look at CHP, CHPA 2006 This report examines the relative carbon savings between a variety of CHP systems including large scale combined cycle plant and micro-chp. Large scale CHP delivers the highest carbon emission savings per unit of installed electrical output.

17 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October % % NPV 000s % 10% IRR% 5% 0% Discount rate -5% Electricity price /MWh Figure 6: Returns associated with gas fired CHP/ district heating schemes at different scales, with and without an anchor heat load Figure 7: Sensitivity of gas fired CHP/ district heating schemes to changes in electricity export price. 17

18 5 Creating a market for decentralised energy key Text Text Text Stick Planning Policy Building Regulations Code for Sustainable Homes Carbon Reduction Commitments National Policy Present Present but not sufficient Not present Funding Regulation Integrator De Project Consumers Networks Energy centres Fuel Supply Chain Standards Contractual Carrot Economic incentives Strong carbon price CHP/Low carbon heat incentive Improved market for decentralised power production Consumer demand Decentralised energy electricity highly regulated favours big players incentive for renewables carbon regulated but much uncertainty gas regulated heat unregulated Capital investment on the scale required to deliver London s decentralised energy vision requires clear price signals, regulatory certainty and long term time scales. In short a new design of market is required 5.1 Overview The most significant barrier to the development of efficient decentralised energy schemes in the capital, at the scale and build out rate required, is the lack of a strong price signal which recognises the carbon benefit of decentralised energy. Establishing this price signal is a fundamental requirement to deliver 25% of London s energy from decentralised sources by Figure 8 Decentralised energy market showing missing factors Figure 9 Uncertainty over regulation In addition to an economic incentive to develop decentralised energy, certain other changes are required in order to underpin a market for decentralised energy. In particular consumer protection and guarantees of service level need to be provided. The missing factors are highlighted in Figure 8. Many of the sticks are in place, significant carrots are not. We call for action at national Government level, and by the electricity and gas market regulator OFGEM, to ensure an economic incentive exists within a regulatory environment which supports decentralised energy.

19 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October Regulatory Issues Decentralised energy is complex due to the many markets with which it interacts. It is affected by electricity, gas, heat and carbon markets, as well as waste and biomass supply chains. Each sector has a different regulatory environment (see Figure 9). Heat networks share many similarities with public water supply due to the nature of the product and network. Excessive regulation could kill off a fledgling market; proposals for regulation should be proportionate. Consumer protection Effective consumer protection is the main objective for regulation of decentralised energy. This should cover guaranteed service levels and some form of protection from excessive prices. Currently each decentralised energy project must negotiate service level agreements between the energy company and the consumer. This process could be speeded up and could provide consumer confidence if common standards were agreed by the industry. These are in place for regulated utilities. Establishing a London wide standard for customer service levels and supply resilience, via a standard Service Level Agreement for heat would promote confidence and accountability. This should address issues such as minimum response times and reliability of supply. Some price protection is afforded consumer through competition law, as heat networks are natural monopolies, they should therefore not cost more than the alternative. However, enforcement of this could currently require recourse to the courts. In the absence of a mature regulatory framework heat suppliers should agree in principle to price heat sales on an avoided cost basis, with prices limited to being no higher than the cost of owning and operating a conventional gas heating system. Options for flexibility could be preserved for project specific changes. Whilst the market is small and growing excessive regulation should be avoided, with any intervention being light touch. This light touch regulation could be overseen by OFGEM with complaints handled through a heat network ombudsman, possibly part of the Energy Ombudsman. More formal regulation would only be required as higher levels of market penetration are reached. Level playing field for decentralised energy The current electricity market was designed for large central power plants. Decentralised energy is disadvantaged as it is generated in low volumes and can attract low prices for exports. We welcome the attempts by OFGEM to rectify this through their proposals for distributed generation. Many smaller decentralised energy schemes take advantage of the private wire limits which allow exemption from holding an electricity distribution licence below a threshold. The key advantages to this approach are the lack of customer churn, and exemption from regulated costs. The latter allows a greater margin to be earned on the electricity generated, whilst the former provides revenue certainty. A recent court case indicates that networks must allow third party access to their systems, reducing the advantages of a private wire system 14. To guarantee fairness to decentralised energy generators three measures are recommended. These support the recommendations of the LDA in response to the OFGEM consultation 36 : OFGEM should establish a dedicated and simplified market for decentralised electricity trading avoiding the high costs for participating in the current system. This market would help meet demand for low carbon electricity sources Decentralised electricity supply licences should be established with light touch regulation for schemes under a 50MW (electric) threshold A short haul distribution charge should be established to be cost reflective of the reduced use of the distribution system. 19

20 5.3 Economic Incentives The most consistent issue raised during the project was the lack of an economic incentive to invest in developing decentralised energy schemes. A variety of suggestions are available, with calls for action to establish an incentive by government and regulators being a key outcome Economic Incentives - the need Almost all new decentralised energy schemes in London are being developed in new build to comply with planning policy and obtain planning permission. Systems serving existing buildings are not being developed at the scale needed to meet the 25% target as there is a low return on investment for decentralised energy schemes. The low returns contrast with the high risks for decentralised energy developers, particularly when trying to connect existing buildings all with different owners and building designs. A number of incentives are in place but they are currently insufficient to encourage investment in decentralised energy. In the longer term and for larger systems, above 20MW, a firm carbon price could reward carbon savings from decentralised energy. However in the short to medium term an incentive that recognises the carbon savings from decentralised energy and provides a strong price signal for investment is required. The incentive must be guaranteed for an initial period of at least ten years to support investment. Box out: Incentives Case Studies The Netherlands In 1972, CHP capacity in the Netherlands stood at around 11% of total national capacity. By 2001 CHP supplied around 38% of the power capacity, the highest proportion in Europe. This has been achieved by various interventions including: discounted gas price for CHP; obligation for electricity suppliers to purchase electricity from CHP at a minimum price; creation of an Office for CHP Promotion in government. Belgium Since 1999 Belgium has introduced a market system to encourage CHP based on presenting certificates for CHP electricity, a similar principle to the Renewables Obligation in the UK. Regional targets have been set and a regionally varying buyout payment is required from electricity suppliers if they fail to meet these targets. Due to scarcity, certificate values are close to the buyout payment levels and capacity is expected to double for the decade from Existing Economic Incentives Climate Change Levy: The CCL is a tax on electricity and gas for non-domestic consumers. Good Quality CHP is CCL exempt, meaning operators do not pay the levy on gas usage and customers do not pay the levy on electricity purchased. A Parliamentary report on CCL stated that it had little effect on construction of new CHP plant and domestic customers do not pay CCL. 22 Estimated value per 1MWh electricity generated by a CHP plant 5. European Union Emissions Trading Scheme (EU ETS): EU ETS can provide an incentive to Good Quality CHP plants with a thermal input greater than 20MW as the emission cap they receive is such that they could have surplus carbon credits to sell to raise revenue. However, the quantum of allowances granted and relatively low price of carbon leads to a marginal incentive for CHP investment. Estimated value per MWh electricity generated by a CHP plant is around Carbon Reduction Commitment (CRC): The CRC is a new cap-and-trade scheme to be introduced in 2010 aimed at large non-energy intensive organisations in the public and private sector. Participating organisations will have their emissions capped. This could provide an incentive to connect to low carbon heat networks, but uncertainty over the value of the CRC means that it provides no economic incentive to schemes being planned at present. Renewables Obligation: The Renewables Obligation was introduced in 2002 to incentivise renewable electricity generation. The Obligation is on suppliers to obtain a rising percentage of electricity from renewable sources by presenting Renewables Obligation Certificates (ROCs). Currently one ROC is issued for every MWh of accredited renewable electricity generated; the certificate can be traded. Gas fired CHP is not eligible for ROCs. These incentives have not been sufficient to catalyse investment in decentralised energy schemes in London outside of new development Possible Economic Incentives London First calls for a new economic incentive for decentralised energy schemes to ensure delivery on an efficient scale and of a sufficient level to realise the Climate Change Action Plan proposals. Reward for Low Carbon Heat Supply: A Low Carbon Heat Obligation/Incentive would reward the carbon savings made by supply of low carbon heating, with rewards proportionate to the quantum of carbon saved. A Renewable Heat Obligation/Incentive is being considered as part of the BERR Renewable Energy Strategy 15. We recommend that this is expanded to reward all forms of low carbon heat supply, including CHP, and based on the carbon savings achieved.

21 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Feed in Tariffs that Reward Decentralised Energy: Feed in tariffs have not been developed in the UK, in contrast to other EU member states where roll out of renewable and low carbon energy sources has been more rapid. A previous study identified a feed in tariff of around 10-15/MWh above the market price for electricity as making a majority of CHP schemes in the study economic. 17 This measure has the disadvantage of rewarding low carbon heat supply indirectly but has proved successful elsewhere in Europe (see Case Studies box). CHP Obligation for Electricity: Similar to the Renewables Obligation suppliers would be required to provide a certain percentage of their power from decentralised CHP plants. This would have the advantage of being analogous to the Renewables Obligation in terms of operation, however this may prove more expensive than a feed in tariff. Exemption from the Renewables Obligation Base: Exempting Good Quality CHP from the base for an electricity supplier under the Renewables Obligation would deliver income for nonrenewable decentralised energy. The value of this to a supplier would be around 3/MWh which is unlikely to offer a sufficiently strong price signal. Floor Price for CHP Electricity: Feed in tariffs can distort the electricity market, but a similar effect could be achieved by providing a floor price for decentralised energy. This would reduce as the spark gap increased. Initial value would be similar to a feed in tariff of 10-15/MWh above the market price at which decentralised energy schemes are viable. This level would reduce as wholesale electricity prices increased. Floor Price for carbon: To give a bankable investment securing a minimum price for carbon could de-risk investment in decentralised energy schemes. This could operate in a similar manner to a floor price for CHP electrical output but would not discriminate against other carbon reduction options. Our modelling (see Appendix B) indicates an incentive of around 10-20/Mwh of electrical output is required to make all but the smallest scale CHP schemes viable. This is consistent with other research by Cambridge Econometrics 16 and AEA Technology 17. Whilst the detail of incentive design is outside the scope of this study, one of these measures must be implemented to catalyse investment in decentralised energy schemes otherwise the 25% target will not be met 5.4 Low Cost Borrowing for Networks The high capital costs of heat networks represent a barrier to establishing decentralised energy systems. A way of financing heat networks using low cost borrowing could provide a mechanism for the development of decentralised energy supply, where energy centres were financed separately from the pipework infrastructure. Various options are available including grant funding, soft loans and revolving investment funds. In particular the public sector has access to the lowest cost sources of borrowing. Work currently being undertaken by the LDA/GLA on the Barking Power Station scheme may inform this option. See Appendix C for a detailed analysis of funding options. Enabling local authorities to borrow to fund heat networks and recouping this investment by charging for heat distribution could enable development of decentralised energy schemes. We recommend that this option is considered as part of the BERR work on heat strategy. 5.5 Recommendation - Action by Government We recommend the following actions to incentivise decentralised energy development: 17 Recent studies and experience from other European countries (see box out) indicate that some form of support for electricity export prices is a viable way of ensuring a business case for decentralised energy from CHP. A CHP Obligation or floor price for export power from CHP are recommended as the preferred mechanisms for supporting decentralised energy. The latter would require rates for schemes to be set, with higher levels of incentives for smaller scale schemes supplying heat networks. A floor price for carbon would also have a similar effect but would not be technology specific. An incentive level of 10-20/Mwh is recommended, subject to further detailed research. Any incentive or obligation for heat supply should include all low carbon energy sources not just renewable energy. We would welcome detailed proposals from BERR on this form of incentive which could obviate the need for a CHP Obligation or floor price as recommended above. Options for funding heat networks through low cost borrowing or grants should be established. Detailed studies by OFGEM and BERR would be required to determine the exact nature and level of support and the effects on energy markets and other impacts. This should inform the ongoing work on distributed generation, heat supply and renewable energy 21

22 6 Implementation Risk of non-delivery Point where risk vs. reward acceptable to attract private sector investment Meeting the target for decentralised energy not only requires schemes to be of an efficient scale and to be economically viable, but also having a strategy for effective delivery. A combination of public and private sector involvement for project delivery is recommended approach capitalises on the ability of the public sector to unlock private sector investment and catalyse the development of heat networks by derisking the initial stages (see figure 10). These partnerships would act as integrators overcoming the barriers to delivering larger scale, more efficient approaches to decentralised energy delivery at the level of individual projects. 6.1 Implementation and Project Delivery The role of Green Energy Fund could help enable delivery of heat networks at a more efficient scale. Total energy supply (GWh) Expenditure on Development Activities Figure 10 Risk versus cost for development of decentralised energy projects Potential for Microgeneration Shortfall CHP Potential Energy From Waste Proposed New Build Development with CHP Potential CHP from Existing Power Stations Existing CHP Losses from distribution (heat and power) 25% Target We call for a strategic implementation plan to be developed which sets out how to achieve the 25% target. Together with addressing the fundamental need for improved economic incentives this plan would set a roadmap towards greater decentralised energy provision in London. Case studies show that the only way to deliver high penetration levels of decentralised energy is by strategically planning heat networks. A partnership between London Government and the boroughs is required to develop this strategic plan. At borough level we propose the development of energy masterplans mapping heat loads and networks to show the areas where decentralised energy projects are viable. In lower density areas other low carbon solutions will be more suitable. Figure 12 shows the parties involved in planning and delivering decentralised energy in the capital from a strategic plan level down to individual decentralised energy projects Figure 11 Proposed Decentralised Energy Mix 2025 Once decentralised energy projects have been identified specific project level partnerships between public and private sector are proposed as the best way to deliver these schemes. This

23 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October Strategic Implementation Plan A strategic plan would set out a route map to meeting the 25% decentralised energy target The scale of the target, the duration of investment required to produce returns and the need for new strategic infrastructure, together with evidence from case studies such as Copenhagen, indicate that only with a strategic city wide plan can the 25% target be delivered. The outcomes of the project workshops and seminars highlight that a key role must be played by the public sector to direct the strategic approach to delivering the 25% target. Other infrastructure has been developed on the basis of achieving a strategic goal, particularly existing gas and electricity networks which were planned and developed pre-privatisation by the public sector. Whilst a different approach is required now the role of planning the areas suitable for decentralised energy systems is an activity which must be led by the public sector. There is a clear role for London Government to develop such a strategy, working in partnership with the boroughs. Whilst a number of bodies exist at this level working on energy issues we believe a dedicated group is required. This group, which we have called Energy for London should sit within the LDA as it has the objectives, powers and funding required to drive delivery of decentralised energy. The strategic plan should set out a road map for the roll out of decentralised energy projects across the capital. We have developed a possible route to deliver the 25% target see Figure 11 and Appendix E. A strategic plan would deliver significant benefits which are described below: Prioritisation of the most economically and environmentally viable projects. This would ensure that the whole life cost per unit of carbon reduction is minimised. Projects should be judged by this pound per tonne of carbon indicator. Co-operation across borough boundaries. A long term approach would ensure that the most efficient outcomes, environmentally and in terms of investment, were reached through the use of larger systems. Larger systems are more economic and deliver higher carbon emission reductions but are more challenging to develop. Systems would be specified to be capable of expansion and interconnection to accommodate future growth, new technologies and take advantage of economies of scale. Disruption in the form of streetworks could be co-ordinated and minimised. Co-ordination with waste policies and activities would deliver carbon reductions and economic advantages by utilising residual waste and biomass as a fuel source. NEW STRATEGIC INFRASTUCTURE: The conversion to natural gas In 1967 the Government initiated a rush to gas as natural gas was discovered in the North Sea. This required huge levels of investment to create a national gas infrastructure some 3,000 miles in length; these pipelines ran the length of the country. Town gas appliances of some 13 million domestic, 400,000 commercial and 60,000 industrial customers were converted over a period of ten years. This process was overseen by the then nationalised Gas Boards and subsequently British Gas Corporation. Other utility networks were similarly installed with state funding. Copenhagen Following the fuel crisis of 1973/74 and onwards the Danish Government established strong policies promoting CHP and heat networks. Strategic planning of heat supply was undertaken in cities on a least cost basis. Areas for heat networks and gas networks were zoned. Although this established heat supply monopolies different fuels were able to compete to supply heat at lowest cost and heat networks were required to operate as not for profit organisations. In Copenhagen around 96% of buildings are heated from heat networks. Transmission mains link large scale CHP plants and energy from waste plants. These plants allow the use of low grade fuels such as biomass and peat (where emissions to air can be treated efficiently). 23

24 6.3 Energy Masterplans Each borough should develop an energy masterplan to ensure that efficient district scale projects are delivered which serve existing buildings as well as new development The strategic plan would be informed by borough level energy masterplans developed as part of the Local Development Framework and based on heat mapping. Each borough s energy masterplan would identify zones for decentralised energy systems based on the densities of heat demand, location of existing heat networks, location of key existing building anchor tenant heat loads and land to locate energy centres. The energy masterplans could be part of the requirement for boroughs to plan infrastructure under Planning Policy Statement 12: Local Spatial Planning (PPS12). Developers would pay a connection charge to connect to these schemes, or contribute to their future development via a Green Energy Fund (see Section 6.5). Renewable energy would be provided through the heat network in addition to heat from CHP plants. We recognise that some boroughs may lack expertise to undertake energy masterplanning work in house but propose that EfL would act as a central pool of expertise able to undertake or commission this work, in partnership with the borough. Funding for this work could come from the Green Energy Fund, described below, or from EfL. The energy masterplan would build into a project brief, or series of briefs, within a borough. This approach ensures planning policy support for decentralised energy systems. Areas designated for decentralised energy projects could also be classified as Low Carbon Zones (formerly Energy Action Areas), an approach which has been successful at Elephant and Castle and Barking. Within these project areas new buildings should be required to commit to connect to the decentralised energy heat network. In return connecting to the heat network would satisfy the on-site renewable energy requirement, even where the heat network was not yet established.

25 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October Project Delivery We recommend public private partnership, to drive project delivery with investment by business Having identified specific opportunities for decentralised energy projects, project specific public private partnerships offer the most effective way to lever private sector investment and expertise whilst capitalising on the long term approach of the public sector. The long term commitment of boroughs and their climate change duties adds covenant to individual projects as well as the elements described below. With the right level of incentives most of the investment required to meet the 25% decentralised energy target could be delivered by business but only if the public sector can provide the right framework. The areas selected as suitable for decentralised energy provision would feature many of the key elements required for successful decentralised energy systems. Many of these key elements are in the gift of the public sector, including: anchor tenant heat loads, such as civic centres, swimming pools and hospitals; land for energy centres; the ability to grant statutory undertaker status and undertake development and procurement activities. By connecting to existing buildings revenue streams immediately start to repay initial capital investment. Schemes can then be expanded to connect other existing buildings and link to new development. The case study evidence examined from schemes such as Barkantine, Southampton and CITIGen show that the role of a project integrator is key to enable larger systems to be successfully delivered. In these cases the public sector was heavily involved in the initial development of such schemes, with delivery and operation of the energy systems typically being undertaken by the private sector. The private sector will not undertake the initial project development activities at risk (see Figure 10) but investment can be de-risked if the public sector undertakes this work. This development activity would vary by project but could include undertaking feasibility studies, assembly of heat loads and testing of the business case viability. Once sufficient development work has been undertaken to identify a viable scheme private sector investment can be attracted. This approach has been successful for the Olympic park/stratford City decentralised energy scheme. It was also recommended for several projects in the GLA Community Heating Development Study 9. The exact structure of the partnership can vary considerably in formality and balance between the public and private sectors. The project delivery partnership would act as an integrator fulfilling the role played by statutory network operators for other utilities. Section 7 sets out how this approach would work for a particular project blueprint Southampton City Centre Initially based on a geothermal borehole the success of the Southampton City centre decentralised energy scheme is centred on a partnership between public and private sectors. The City Council originally procured the energy services company, provided the initial heat customers at the Civic Centre, leased the land at minimal cost and sponsored the scheme. The Council are able to provide the covenant on which investment can be made and supplies guaranteed. Utilicom directed investment and expertise to deliver a system which has successfully grown to serve a mixture of public, commercial and residential buildings. Barkantine The Barkantine decentralised energy scheme was established as a public private partnership between the London Borough of Tower Hamlets and utility company EDF. Tower Hamlets committed to connecting social housing and a leisure centre and to providing land and a building to house the energy centre. EDF developed and designed the scheme which was financed using Private Finance Initiative credits. 6.5 Green Energy Fund A Green Energy Fund could support the development of decentralised energy systems where it is less effective to deliver on-site solutions in new development Within areas designated in energy masterplans as suitable for decentralised energy, developers would contribute to the future build out of heat networks through a Green Energy Fund. This funding could be collected through section 106 agreements 20 (or Community Infrastructure Levy 19 ) and ring fenced for delivering decentralised energy projects. New development should also be required to connect to the heat network when built. For new development away from wider district level decentralised energy projects a pragmatic approach to delivery should be adopted: For larger developments, such as mixed use schemes with around 1,500 residential units where decentralised energy schemes should be viable decentralised energy should be a requirement. Boroughs should promote such schemes by providing delivery of land for energy centres, additional heat loads from existing adjacent buildings and by their involvement covenant for consumers. These projects would then integrate into the borough s energy masterplan 25

26 For smaller schemes developers should be required to test the viability of decentralised energy provision. Where these are not viable energy efficient buildings with community heating systems and future connections to heat networks should be provided. Rather than investing in small inefficient systems a funding contribution towards the development of local heat networks through the Green Energy Fund could be made. National Government London Government Policy Planning Implementation CO 2 reduction targets OF GEM electricity review CHP/Low carbon heat incentive Capital/grant funding CO 2 reduction target Decentralised energy target Mayor s Energy/Strategy Mandate local regional Government Code for sustainable Homes definitions improved Allow near-site renewable energy or CHP schemes Allow phased implementation of above None - only to ensure long term certainty LDA Strategic Decentralised Energy Delivery Plan Project Portfolio The Green Energy Fund should be ring fenced for development of heat networks and where possible spent locally. If no local projects are being developed EfL could direct the funding to other schemes. The GLA is currently working on a Green or Renewable Energy Fund for developer contributions. The JESSICA 23 fund being developed by the LDA could provide investment for low/zero carbon projects in the form of loans, equity or guarantee and would complement the proposed Green Energy Fund. Local Government - London Borough Energy Companies Energy Policy Green Energy Fund Commitment to decentralised energy Energy Masterplan Heat planning/mapping Scheme Promoter Covenant Land Planning permission Heat loads Statutory Undertaker rights Project selection Project Integrator Development Feasibility Heat load assembly Output specification Procurement Special Purpose Vehicle/Public Private Partnership Business plan Network plan Commercial / contractual Funding Design Build Operate Maintain Public Sector Building Policy to connect to decentralised energy and heat networks Heat load Connection charge Energy Revenue Private Sector Development/ Building Connect to heat networks in return for planning permission Heat load Connection charge Energy Revenue Figure 12 - Strategic Implementation Plan

27 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October Blueprint for Decentralised Energy Schemes The need for economies of scale, economic incentives, a strategic plan for London, energy masterplanning and public private partnerships at project level have been set out. What does this mean in terms of a decentralised energy project? 7.1 How do our proposals work in practice? This section summarises how a decentralised energy scheme for a series of existing buildings might look, as shown in Figure 13. The approach set out is specific to a dedicated scheme built to serve mainly existing development but the general principles are valid for schemes built to serve new development or heat networks built out from existing or new waste heat sources (power stations, energy from waste plants, industry). This approach is based on identifying the key success factors of existing decentralised energy schemes from the case study evidence and analysing the barriers to implementation for new schemes. 7.2 Models for decentralised energy schemes We envisage three main models for developing decentralised energy schemes The development of decentralised energy schemes can be split into three main types described below. Although there will be many variations in terms of detail these categories cover the main types of heat networks. Previously identified studies and findings on potential from new development (section 4) mean that this order also reflects the potential for decentralised energy supply and hence carbon savings. Main types of decentralised energy scheme: Heat networks from existing or new standalone power stations or energy from waste plants (e.g. Barking Power Station) Public sector led schemes serving mainly existing buildings (e.g. Barkantine) New development led schemes (e.g. Olympic Park/Stratford City) Each different type of scheme will require a different approach to project delivery. With reference to Figure 10 it is also clear that the different stages of development will be undertaken differently for each type of scheme. Table 1 sets out a possible approach to undertaking the main development activities for each type of scheme (also see Figure 12), and subsequent scheme delivery. Procurement of a private sector energy company partner (or equivalent) could occur at various stages. (indicates procurement stage) Activity Type of scheme 1. Heat networks from existing or new standalone power stations 2. Public sector led schemes serving mainly existing buildings Heat mapping Borough with support from EfL Borough with support from EfL Developer Energy masterplan Borough with support from EfL Borough with support from EfL Developer Pre-feasibility Borough / EfL Borough with support from EfL Developer 3. New development led schemes Feasibility studies Borough / EfL Borough with support from EfL Energy services company Business plan Borough / EfL Borough with support from EfL Energy services company Output specification Borough / EfL Project specific PPP Energy services company Funding Project specific PPP + low cost loan/grant Project specific PPP Energy services company + Developer Design and build Project specific PPP + contractor Project specific PPP + contractor Energy services company + contractor Operation Project specific PPP + service contractor Table 1 - Development of decentralised energy schemes Project specific PPP + service contractor Energy services company + service contractor 27

28 7.3 Project blueprint example We describe a blueprint for a specific public sector led scheme serving mainly existing buildings (See Figure 13). The approach would vary by type of scheme Project development The following key features of the project development process ensure a successful decentralised energy scheme. Much of the project development would be initiated by the borough with specialist support from EfL. Project identified under the borough energy masterplan in conjunction with EfL Initial stages of project development reveal that a scheme is viable. At this stage limited expenditure is incurred Initial development work includes assembly of heat loads, providing certainty of heat load connection, encouraging a long term approach to design and construction of heat networks and avoiding the risk of stranded assets De-risking the project delivery by undertaking the critical development work at the initial stages minimises the risk of increases in construction cost or delays to programme reducing future financial returns. The public sector can recoup the development costs through a profit sharing arrangement, but the initial involvement enables the private sector to invest with confidence A business case for the scheme is developed including preparation of a detailed financial model Private sector energy partner is procured by a competitive tendering process to ensure transparency and value Private sector partner is responsible for tasks such as developing a detailed business plan, undertaking design development, obtaining a funding package, design and build of the system as well as ownership and operation over the project lifetime Partnership with the private sector has the advantage of using private sector capital investment and delivery expertise with minimal public expenditure The public sector, through the borough, provides several of the key elements to ensure a viable decentralised energy scheme. These include land for energy centres, anchor heat loads, support through the planning system, acting as scheme promoter and sponsor and assistance with access to alternative funding sources such as EU grants The ability of the boroughs to deal with multiple stakeholders ensures a shorter project development period. Without political and stakeholder support it would be impossible for businesses to deliver a scheme Public sector bodies should commit to connect their buildings to the heat network Businesses in the area should be encouraged to connect their buildings to the heat network Risk can be apportioned and understood by using an industry standard risk schedule. The public private partnership approach allows risks to be allocated to either the public or private sector, depending on which is best placed to manage a given risk Contractual agreements can be simplified with reference to a contract checklist Consumer connections Key features of consumer connections are described below: Anchor heat loads with long term energy supply agreements provide bankable revenue streams against which investment can be made. Existing buildings are connected to provide revenues from the first year of operation Consumer protection is in place through a Heat Ombudsman ensuring industry standard customer Service Level Agreements are upheld Heat prices to consumers are based on an avoided cost basis and linked to prices for alternative heating systems New development is required to connect through the use of a special planning zone (similar to a Low Carbon Zone) in the Local Development Framework. Funding towards development of the system is delivered through the Community Infrastructure Levy into a Green Energy Fund Covenant for the long term reliable operation of the system is provided by the involvement of the host borough in the project delivery public private partnership Sufficient customer connections of different types are planned and built to ensure high levels of load diversity and base load

29 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October Energy networks Key features of the energy networks for the scheme are described below: Network operator has statutory undertaker status, granted by the local borough and streetworks are co-ordinated with Transport for London EfL or the borough helps access low cost borrowing for establishing heat networks where these would otherwise be uneconomic. The Green Energy Fund is used to extend the networks to otherwise uneconomic connections Networks link large heat loads, such as large public sector buildings. Network extensions are developed after the system is established and extended to new development and neighbouring buildings. Confidence in the system and operator develops with time, encouraging further connections This process is overseen by the public private partnership which acts as an integrator, connecting buildings or providing a timetable for future connection and planning for the long term The electricity generator pays only short haul distribution charges for electricity sold locally to customers using a decentralised electricity supply licence. This improves the economic return Energy island Key features of the energy island including features of the plant are described below: Revenues for the scheme are increased by an incentive for decentralised energy (such as a CHP Obligation or floor price for CHP electricity exports) ensuring that operating the decentralised energy generation plant is economic and provides sufficient return on investment to attract private sector capital Power is exported via a licensed distribution network either to nearby buildings or into a decentralised energy market. This market, together with the incentive, ensures an economic price for exports is available Modular configuration of heating plant gives resilience. The diversity gives a high base load allowing at least 75% of heat to be supplied by CHP, maximising carbon savings. CHP units with capacities of at least 1 MW ensure high electrical efficiencies and high carbon emission reductions Low grade fuel burning plant can be fitted with efficient air emissions treatment systems to reduce NOx and particulate emissions The energy centre is located on low value land granted to the public private partnership on a long term low cost lease by the borough or other public sector body. This separates ownership of buildings and energy infrastructure ensuring liquidity of property assets Fuel supply Key features of the fuel supply are described below: A proportion of renewable fuel, usually biomass, is used to meet the on-site renewable energy requirements of the London Plan Low carbon fuels such as biomass and waste are considered as fuel sources where sufficient sources and suitable plant locations are available Fuel price risk is mitigated by hedging or an other trading mechanism by the energy company operating the plant This blueprint captures the application of our proposals and how they overcome barriers to implementation of decentralised energy at a project scale. Clearly much detailed work on an overall strategic plan and developing individual projects remains to be done 29

30 Buro Happold Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy June 2008 Blueprint for Decentralised Energy Schemes Fuel Supply Energy Island Energy Networks Consumer Connections Barrier Fuel price risk Mitigation Hedge full prices or secure long term fuel supply contracts Barrier Lack of certainty over long term requirement of Code for Sustainable Homes Mitigation Clearer definition of carbon reduction requirements by DCLG Barrier Mitigation Land is expensive and return from Public sector to grant low energy centre is low yield cost land for energy centre Barrier Mitigation Lack of firm price signal recognising carbon benefit of CHP provision No price signal recognising lower transmission and distribution cost for decentralised energy Economic incentive. CHP Obligation; or Low Carbon Heat Obligation; or Floor price for CHP export electricity Short haul distribution charge for decentralised energy electricity generators Barrier Mitigation Pipe network is expensive Statutory undertake status to be granted to due to high cost of network operator Co-ordination of utilities work streetworks to minimise disruption and trenching costs Barrier Mitigation Site by site approach will not Role for strategic project developer INTEGRATOR meet targets and does not deliver Flexibility in planning system to allow 10% maximum carbon savings or renewables to be achieved by future connection to economic scale of CHP plant heat network Contribution by developer towards Phasing of developments needs to funding development or build of a heat network be exactly aligned to manage risk with commitment to connect in future of 3rd party connection Barrier Mitigation High initial capital investment needs Anchor heat loads with long term contracts immediate income stream to ensure provide bankable income for third party adequate business case. Particular funding. problem in phased new development. Immediate revenue stream from existing Energy companies require build out building anchor loads enables scheme to guarantees for new development grow from initial size. Soft loan or revolving to invest in most efficient long term fund investment in heat networks recouped as technical solutions connections increase New build Carbon benefits Offsite power top and spill High density residential Fossil Leisure Centres Electrical network, licensed wires Biofuel/Biomass Heat network, flow and return Heat network, flow and return Civic Centres Residual Waste Streams Social Housing Hospitals Barrier Developers required to provide renewable energy (10% rule) and CHP making cost of development high Mitigation Energy centre fuel supply to include 10% renewable component. E.g large biomass boilers with air emissions control equipment Figure 13 Blueprint for decentralised energy scheme Barrier Scale of projects being delivered not adequate to meet Climate Change Action Plan targets Barrier Low prices available for export of power to wholesale market due to small volumes versus central generation Barrier Transaction costs are high and not dependent on scale of scheme Mitigation Strategic plan for delivery required across London. London boroughs to partner private sector to deliver schemes at efficient scales Mitigation Dedicated trading market for decentralised energy linking consumer demand for lower carbon supply to decentralised generations Mitigation Legal checklist to ensure consistent approach. Stimulus to supply of projects will iron out problems here. Transparency between energy companies and developers Barrier Mitigation Risk of stranded assets for Long term connection energy service companies. agreements with covenant Long periods of return on from public sector. Incentive to investment with relatively connect for building owners/ low yields Currently a low occupiers. Special planning yield high risk investment. zones (expand scope of Low Most utilities networks Carbon Zones) to encourage are low risk, low return connection to heat network. investments due to In return developer can defer regulation. Historically achieving 10% renewable utility networks built by requirement until this state owned utilities and connection is made. then privatised Public sector backed investment in networks. Regulation to be light touch and proportionate. Strategic plan for build out of decentralised energy across London. Barrier Consumers not protected from high energy costs and risk of energy supplier insolvency Barrier No incentive for building developers or owners to connect to existing buildings unless close to existing network Public sector anchor loads Hotels Mitigation Light touch regulation for consumer protection Ombudsman. Covenant from public sector as heat supplier of last resort. Industry agreement on Customer Charter detailing Service Level Agreement Mitigation Incentive to connect for building owners/ occupiers possibly as planning requirement relaxation on 10% renewables requirement Carbon Reduction Commitment may influence this but currently not clear

31 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October The Action To meet the target for decentralised energy and deliver the potential carbon savings, coordinated action is required 8.1 National Government The primary role for National Government is to incentivise decentralised energy Introduce an adequate long-term economic incentive for CHP that values the carbon savings in a manner comparable to ROCs. A CHP Obligation or floor price for CHP electricity exports is recommended based on overseas experience. However a heat based incentive would also be welcome provided it applied to all low carbon heat sources not just renewable energy. An incentive of around 10-20/Mwh is required to make most schemes viable. Grant funding for retrofitting existing public buildings to heat networks to be made available over the long term (at least 10 years). Some form of low cost borrowing support for heat networks may be required to overcome high initial capital costs, this could be recouped from profit sharing arrangements. Soft loans or a revolving investment fund could provide this requirement. Allowing boroughs to raise dedicated finance for heat networks could enable investment in heat networks. We welcome the OFGEM review of energy supply licence arrangements, particularly on the need for decentralised energy supply licences and short haul cost reflective distribution charges 3. An electricity market for decentralised generators should be established to reduce costs for participation and capitalise on demand for low carbon electricity. Ensure the new generation of large scale power plants are built as CHP units and equipped to supply their waste heat via heat networks, with reference to Section 36 of the Electricity Act Review the definition of zero carbon in the Code for Sustainable Homes to allow use of near site decentralised energy schemes which can use existing or new licensed electricity networks to connect to new development. Take steps towards light touch regulation of heat networks, initially by providing consumer protection through an industry standard service level agreement that can be referenced in contracts with ESCOs, and which includes heat supply tariffs based on an avoided/ alternative cost basis for heat. Additionally an ombudsman for heat networks should be established through the Energy Ombudsman to administer complaints, overseen by OFGEM. The establishment of a heat supplier of last resort should be included in the Service Level Agreements, though further work is required to establish where this liability lies. Under the New Roads and Streetworks Act (1991) allow heat network operators to be statutory undertakers. Revise Housing Corporation regulations that prevent social landlords from recovering a proportion of the capital cost of decentralised energy schemes, which reduce tenant fuel bills, through increased service charges or equivalent. The Landlord s Energy Saving Allowance gives this incentive in the private sector. 31

32 8.2 London Regional Government Primary role for London Government is in strategic planning and building borough capacity to deliver projects At London Government level we recommend that Energy for London or a similar body, within the LDA, is tasked with developing a detailed Strategic Implementation Plan to roll out decentralised energy projects across the capital. EfL should act as experts ensuring the public sector is equipped with the capabilities required to deliver the initial project development activities. Projects included in the plan should be selected based on borough level energy masterplans, with EfL overseeing strategy and cross boundary links. LDA funding should be prioritised to equip EfL with more energy experts, procurement specialists and project managers capable of providing technical backup to the borough level projects. The Strategic Implementation Plan for decentralised energy should include specific projects and a routemap to delivering the targets. This should include work already underway such as Barking Power Station and Albert Basin, new development led schemes and schemes to serve existing development. The latter should include opportunities identified in the London Community Heating Development Study 9 such as Tower Hamlets biomass project and SELCHP. The Plan should ensure long term provision is co-ordinated and can be interconnected. Develop a Green Energy Fund where new developments contribute funding towards new low carbon energy networks and associated activities required to establish them, in return for exemption from onsite renewable energy commitments where these are not viable. The renewable energy requirement would be delivered by future connection to these decentralised energy schemes. Under this proposal once connected to a heat network the near site renewable energy would be counted towards the on-site requirements. Planning policy should recognise that below a certain scale decentralised energy schemes are less economic and carbon savings are reduced. By ensuring that all new build includes community heating and provision for future connections to larger scale decentralised energy schemes at plot boundaries, heat networks can begin to be established. Larger new developments and public sector backed schemes can create nodes for decentralised energy generation from which new buildings and existing stock can connect as and when economically viable. These schemes connecting existing stock would act as a catalyst to wider delivery of decentralised energy. Introduce planning flexibility which recognises that within a mixed use scheme around 1,500 dwellings are required to ensure a decentralised energy scheme is economically sustainable in the long term. Developments below this size should be required to contribute to funding off-site decentralised energy schemes in the area, to which they could later connect, through Section 106 (or the Community Infrastructure Levy). Develop and publish technical specifications to ensure that networks can be linked in the future. Include heat networks in the Enhanced Capital Allowances scheme for energy efficient products. Co-ordinate waste and energy policy such that new waste to energy facilities, based on appropriate and economic technologies, can be used to contribute towards the 1 million tco 2 /annum emission reduction proposed from waste and biomass. Promote and facilitate cross border cooperation where necessary. Work closely with Transport for London to coordinate and facilitate streetworks. Liaise with UK Green Building Council, the Carbon Trust, Energy Watch and other bodies to develop an effective consumer education campaign on the merits of decentralised energy.

33 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Indicative existing major decentralised energy schemes or power plants in London Low carbon energy centres established at major anchor heat loads and public sector estate. Heat networks built from new energy centres and existing power plants. Large new developments connected Networks extended to include further buildings and smaller new development for which on-site decentralised energy schemes are not viable Figure 13 London needs a strategic plan to deliver the scale of decentralised energy required to meet the 25% target 33

34 8.3 London Local Government Primary role for boroughs is to develop local energy masterplans and where viable develop public partnerships to deliver private sector investment into decentralised energy schemes serving existing buildings Each borough to develop an energy masterplan which maps heat loads and identifies decentralised energy project opportunity areas. The energy masterplans should identify zones for decentralised energy systems based on heat densities and anchor tenant heat loads and include planning policy support within Local Development Frameworks for such systems. Funding should be made available for this work and for dedicated carbon/energy officers in each borough. Initially this funding could come from the Community Infrastructure Levy via the proposed Green Energy Fund or LDA funding. Boroughs to identify sites and grant land for energy centres and to promote the development of heat networks, including providing anchor tenant heat loads for new projects. Heat loads could include civic centres, leisure centres, high density social housing and other public sector estates. Boroughs should include decentralised energy plants within their waste strategies where appropriate. Boroughs to grant statutory undertaker status to decentralised energy project companies lowering the cost of developing systems and helping to ensure faults can be swiftly repaired. Boroughs should include decentralised energy infrastructure in the infrastructure plans they will be preparing as part of their Local Development Frameworks (under changes to PPS12). Working in conjunction with EfL boroughs should undertake the development and feasibility activities to determine whether decentralised energy systems could be established in their borough. Where feasible schemes are identified the boroughs should form public private partnerships with energy companies to deliver these schemes. The combination of private sector investment and expertise, with the public sector s ability to unlock and de-risk this investment through the actions set out above, would enable the delivery of decentralised energy systems at an efficient and economic scale. Unlocking the development of decentralised energy schemes is compatible with boroughs duties under Planning Policy Statement 1: Delivering Sustainable Development (PPS1) 21 climate change policy and through Local Area Agreement National Indicators NI185 and NI186 to reduce carbon emissions from local authority activities and within the borough area. Potentially provide access to sources of low cost borrowing or grant funding for the initial development of heat networks. 8.4 Public Sector Organisations Public sector organisations can provide anchor heat loads by connecting to new heat networks Commit to connecting their building stock to new or existing heat networks supplied from low carbon heat sources. This to include prisons, hospitals, schools etc. Establish minimum standards for buildings which they occupy which include provisions for reduced carbon emissions. Registered Social Landlords to include provision of decentralised energy in their minimum standards for housing stock upgrades. Reflect the need to reduce carbon emissions in their energy procurement decisions. Make land available for decentralised energy systems which can be expanded to serve the wider surrounding area. 8.5 Private Sector Developers New development can deliver decentralised energy schemes, on-site where viable, or by connecting to new or proposed heat networks On sufficiently large projects (over 1,500 dwellings), commit to work with the LDA and boroughs to deliver low carbon energy schemes and heat networks, including linking to existing buildings, or other new development, across site boundaries. Funding from the Green Energy Fund should be made available to de-risk connections, and opportunities for using public land nearby should be reviewed. On smaller schemes, to agree to connect to existing, or future, heat networks and to contribute to their funding, via the Green Energy Fund, in return for being able to meet on-site renewable energy requirements through future connection to these heat networks. The latter point to be recognised through the planning system. All new schemes should be developed to be community heating compatible and to include connection points to future heat networks at plot boundaries. Commit to long term energy supply contracts for low carbon energy sources where appropriate.

35 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October Energy Companies and Utilities There is a clear opportunity for energy companies and utilities provided the right incentives are established and project opportunities can be developed and de-risked Commit to invest in new development and public sector led decentralised energy schemes where a viable investment case is on offer over the long term. Sign up to an industry wide Code of Practice for heat networks which includes consumer protection agreements and guarantees of minimum service levels (via standard service level agreements), and ensure that all contracts are backed by a heat supplier of last resort. This to be agreed with OFGEM, EfL and the GLA. A complaints ombudsman for heat networks should be established via the Energy Ombudsman and overseen by OFGEM. Whilst service level agreements could be varied, starting from acknowledged best practice would help ensure consumer confidence and fairness. Commit to transparency in the development of bid proposals and pricing based on open book capital costs where forming public private partnerships. Base heat price on an alternative heat source basis with transparent provisions to pass through increases in energy costs (e.g. linking to index of energy costs). Together with developers and the public sector, commit to undertake the development of a legal contract checklist and standard risk framework to speed up contractual negotiations and arrangements. In conjunction with the LDA and GLA, to agree and publish technical standards for community heating networks to be adopted by projects on a London wide basis. Where reinforcement is required to the electrical network design should allow for future accommodation of decentralised energy generation. Distribution Network Operators required to accept decentralised / distributed generation in a streamlined and fair way. To commit to sharing historical data to help support future investment decisions. Allow the use of land holdings which could be used for heat network routes at commercial rates. 8.7 Investors and Financial Sector As more decentralised energy schemes are developed more options for financing are likely to be forthcoming Develop financial tools for investing in low carbon energy systems, including aggregation of assets and trading of decentralised energy electricity products. Develop understanding of decentralised energy schemes and their risk profiles Investigate opportunities within existing funding strategies to invest in smaller scale projects through aggregation, with a view to developing asset portfolios and supporting liquidity in the market Lenders to review their internal team structures to reflect an evolving CHP market by combining skills from infrastructure and renewable energy project finance teams 8.8 Engineering and Professional Services Companies There is an opportunity for engineering and services companies to provide new services relating to decentralised energy Increase capability and skills to work with the private and public sector to deliver decentralised energy schemes, including scheme development, technical and engineering design, procurement processes and project management. This report sets out recommendations to overcome the barriers to delivering sufficient decentralised energy in London to meet the Climate Change Action Plan target. We have set out the potential for carbon reductions; the need for an efficient scale of system; how an economic incentive is required to deliver a business case for decentralised energy; the role of a strategic plan; and a blueprint for project delivery. We call for the actions set out above to be implemented as soon as possible to build on the work already undertaken by London government, BERR, OFGEM and others, and thus deliver large reductions in London s carbon footprint. 35

36 References Glossary 1 GLA, Mayor s Climate Change Action Plan, February BERR, Heat Call for Evidence, January a. Ofgem/BERR, Distributed Energy Initial Proposals for More Flexible Market and Licensing Arrangements, Consultation ref: 295/07, December 2007 b. Ofgem/BERR, Distributed Energy - Further Proposals for more Flexible Market and Licensing Arrangements, Consultation ref: 87/08, June 2008 c. LDA/GLA/LCCA, Response to the Ofgem Consultation on Distributed Energy, Defra, Analysis of the UK potential for Combined Heat and Power, October GLA/Greenpeace, Powering London into the 21st Century, London Energy Partnership, London Carbon Scenarios to 2026, EIU / McKinsey on behalf of Siemens, Sustainable Urban Infrastructure: London, Edition a view to 2025, June The figures are based on 25% of the total electricity and gas consumption of London in 2005 as given by DTI (now BERR) statistics and average power station operation. It assumes no increase in energy demand by 2025 due to the effective introduction of efficiency measures. 9 GLA, London Community Heating Development Study Summary, The Code for Sustainable Homes Code measures the sustainability of a new home against categories of sustainable design, rating the whole home as a complete package. The Code uses a 1 to 6 star rating system to communicate overall sustainability performance. For a Code Level 5 home, energy performance must be 100% above that calculated under building regulations and for Level 6 it must be zero carbon. 11 See (accessed July 2008) 12 The term Energy Supply Company or Energy Services Company (ESCO) is a broad one with no precise definition. For a useful review of procurement using an ESCO see London Energy Partnership / GLA, Making ESCOs Work: Guidance and Advice on Setting up and delivering an ESCO, February See for example, Savills Research, The Market for Sustainable Homes, The European Court of Justice ruling in the May 2008 on the Citiworks case held that there has to be so-called open third-party access to energy supply systems. Although a private wire system can be established that allows third party access, the benefits of locking consumers in and hence securing revenue are lost. 15 BERR, Renewable Energy Strategy: Consultation, June Cambridge Econometrics for Defra, An Appraisal of the Effect and Costs of Introducing a CHP Obligation, September See the Cambridge Econometrics study (ref 16) and also the AEA Technology report for Defra, Study of the economics of example CHP schemes, July DCLG, Planning Policy Statement 12: creating strong, safe and prosperous communities through Local Spatial Planning, The Government has introduced provisions in the Planning Bill for a Community Infrastructure Levy which will empower Local Authorities to raise funds from new developments in their areas to support new infrastructure delivery. At the time of writing, the Bill is currently under review in the House of Lords. 20 A s106 agreement is an agreement between a Local Authority and a developer in the context of gaining planning consent. The agreements are underpinned by section 106 of the Town and Country Planning Act 1990, hence their name. Essentially they are a way of making sure a new development is acceptable to the community in which it resides and oblige a developer to provide appropriate infrastructure and facilities such as open space provision, educational and community facilities or transport and travel plans. One of the main drivers over recent years has been the provision of social housing. 21 DCLG (published under former name, ODPM), Planning Policy Statement 1: Delivering Sustainable Development, House of Commons Select Commitee on Environmental Audit Second Report, Joint European Support for Sustainable Investment in City Area (JESSICA) is a new initiative developed by the European Commission in conjunction with the European Investment Bank and this allows Member States to use Structural Funds to finance urban development projects. In London, a 80m fund is being developed and this could lever additional public and/or private sector funding of around 160m to 320m. CCL CHP CHPA CHPQA CCHP DE ECA ESCO GLA GDP CEP LDA LEP kw MW kwh MWh RDA ROC Climate Change Levy Combined heat and power Combined Heat and Power Association CHP Quality Assurance Combined cooling, heat and power Decentralised energy the generation of electricity and heating (or cooling) locally Enhanced Capital Allowance Energy services company/contractor Greater London Authority Gross domestic product Community energy programme London Development Agency London Energy Partnership Kilowatt Megawatt Kilowatt hour Megawatt hour Regional Development Agency Renewables Obligation Certificate

37 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Cutting the Capital s Carbon Footprint - Final Report The recommendations in this report represent the views of the London First Steering Group. The views of individual members London First is a business membership organisation with a mission to make London the best place in the world in which to do business. We mobilise the expertise and experience of the capital s major businesses, universities and colleges to devise and promote practical solutions to the challenges facing London. or instructions commissioning it. The liability of Buro Happold Limited in respect of the information contained in the report will not extend to any third party. Designers of elegant, bold and sustainable engineering solutions for today s built environment Buro Happold aims to produce high quality engineering design in concept, in detail and in execution, on time, to programme and delivering excellent value for money. Our distinctive culture and ethos is still based on the same principles of care, value and elegance that were established when the practice was founded. Buro Happold is involved in delivering a number of decentralised energy solutions in London and provides procurement advice, technical and environmental consultancy and design solutions for low carbon energy systems. PricewaterhouseCoopers PricewaterhouseCoopers LLP (PwC) provides industry-focused assurance, advisory and tax services to public, private and government clients in all markets. Climate change has emerged as one of the most important political and business issues of our time. PwC has been working with policy makers and companies since 1997, helping to analyse issues and develop practical solutions for our clients. With a network of more than 200 professionals across Europe, the collectively guide clients through the complexities of climate change and emissions trading. 37

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39 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Appendix A: Report Scope and Participating Organisations The Project London First commissioned Buro Happold to undertake a focused study into the barriers to delivering the Mayor s target of decentralising 25% of London s energy supply by 2025 and to work with its members and other stakeholders to establish how these barriers might be overcome. While recognising the complexity of the issues, the extensive research already available, and the many steps taken by all levels of government towards this goal, this report specifically considers London. The project was overseen by an expert Steering Group chaired by Neil Pennell of Land Securities and benefitted from in depth support and input from PriceWaterhouseCoopers, particularly in relation to commercial and funding aspects. The project took a collaborative approach building on existing research and on the expertise of a wide section of the market such that: 34 one-to-one interviews were held with London First members and other key stakeholders 7 topic based workshops were hosted A seminar was attended by over one hundred people and together with workshop attendees 86 organisations were represented. We extend our thanks to all those organisations that participated in the research and consultation exercise. Organisations engaged during the research and consultation process: Argent Group Land Securities Fontenergy Arup Lend Lease Development Fulcrum Consulting Bank of Scotland London Borough of Barking & Dagenham Gerald Eve Berkeley Group London Borough of Camden Government Office For London Biffa Waste Services London Borough of Islington Greater London Authority BioRegional London Borough of Lambeth Grosvenor BioRegional Quintain Ltd. London Borough of Southwark Hammerson British Council for Offices London Councils Hoare Lea & Partners British Land Corporation London Development Agency Home Builders Federation Brodies London Energy Partnership John Lewis Partnership Buro Happold London ESCO KTI Energy Limited Canary Wharf Group London First CB Richard Ellis London Remade Ceres Power London South Bank University CIBSE Lovells Climate Change Capital Management Consulting Group Cogenco Morgan Professional ServicesCombined Heat & Power Association Morgan Sindall Communities and Local Government Nabarro Cory Environmental North London Waste Authority Crest Nicholson Norton Rose Dalkia Olympic Development Authority Dept for Business, Enterprise & Regulatory Reform Office Of Climate Change Drivers Jonas Parsons Brinckerhoff EDF Energy PBA Consulting Elementenergy Peabody Trust Energy for Sustainable Development PricewaterhouseCoopers Environmental Services Association PRP Architects E-On Energy Quintain Estates and Development Ernst & Young LLP Regen Fuels European Land and Property RPS Planning Transport & Environment EVONIK Power Minerals Scott Wilson ExCeL South Bank Employers Group FaberMaunsell Tesco Thames Gateway Executive Thames Water Utilities The Cooperative Bank The Moorfield Group Turner & Townsend Group Upstream Utilicom Veolia Environmental Services Vital Energi Zed Factory 39

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41 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Appendix B: Economic modelling 41

42 Figure 1: Small scale scheme Figure 2: Medium scale scheme showing anchor load 1. Purpose Economic modelling was undertaken to explore and illustrate the impact of both project specific and generic variables on the economic returns generated by a decentralised energy scheme. 2. Overview Six developments were modelled and tested for a range of sensitivities. In terms of project specific variables, one of the issues associated with schemes in London is their diversity no two projects are the same and there are a large number of variables in the project design that impact on viability. However, it has become clear throughout this study that two issues in particular have significant impact, namely, scale and the rate at which the heat load builds up. The scenarios selected have therefore sought to reflect these factors, ranging in size from small scale (200 units) to mixed use large scale (10,000 units) and showing the impact of incorporating a sizeable anchor load from day one. The models have been subjected to sensitivity analysis of generic variables, in particular power, fuel and carbon prices, to illustrate how these impact viability. The intention was to highlight where regulatory intervention by government might be most effective. 3. Methodology and assumptions Six developments were modelled (detailed below) using a specialist CHP package and financial modelling tool. 3.1 Modelled systems The scenarios modelled are described below with a summary of plant installed given in Table 2. Model 1: small scale A small scale new build residential development for which all the capital expenditure for energy plant is incurred in year 0 with build out occurring over two equal phases over two years. The model assumes two blocks of 100 units each, located in close proximity to one another and with the energy plant located in the basement of one block. Model 2 A & B: medium scale A medium scale new build mixed use residential development for which capital expenditure for energy plant is incurred over two phases and load builds up over four equal phases over four years. The model assumes 1,500 residential units in six equal blocks, 36,000m2 of office space in two equal blocks and 3,000m2 of retail space located at the base of each residential block. The buildings are reasonably dense and the energy plant is located in the basement of one block. Variant A has no anchor load and variant B includes an anchor load in the form of a 5,000m2 school connected from day one of the build out. Model 3 A & B: large scale A large scale new build mixed use residential

43 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Figure 3: Large scale scheme showing anchor load development for which capital expenditure for energy plant is incurred over four phases and load builds up over four equal phases over 16 years. The model assumes 10,000 residential units in 32 equal blocks, eight 30,000m 2 office blocks, two 10,000m 2 schools and 16,000m 2 of retail space. A separate energy centre of 2,500m 2 is required to house the plant. Variant A has no anchor load and variant B includes an anchor load in the form of a 100,000m2 hospital connected in phase one. Model 4: large, existing stock The final model assumes the same buildings, mix and layout as Model 3 (without the hospital as anchor load ) but assumes all buildings are existing. In terms of energy modelling therefore, the key difference from Model 3 is that the heat loads are higher as older buildings are less energy efficient than new ones. For the purposes of simplicity, it is assumed that all capital expenditure is incurred in year 0 and that all load materialises in year one. 3.2 Technical modelling The technical analysis software used calculates a number of outputs relating to the energy requirements of a scheme using CHP in particular annual fuel requirements and electricity generated, used on site and required as top up. Inputs required are: Load profiles: ambient temperature is an important factor as it has a direct effect on heating distribution with greater heat required in winter than in summer. A standard annual temperature profile for London was used together with load profiles for each type of building modelled. Operation strategy: due to the different tariffs that exist for day time and night time electricity the models have been run so as to maximise CHP output during peak periods. Fuel: the plants have been assumed to run on natural gas. Energy demands: annual energy demands for the different scenarios and building types were assessed using a benchmark approach, given in Energy units: the plant selected for the simulation was CHP and gas fired boilers. Characteristics were based on available products. Running hours: plants were optimised to maximise the scheme economics with running hours of 5,000 5,500 hours. 43

44 3.3 Economic modelling assumptions Table 1: Benchmarks Table 2: Plant summary input for each model Table 3: Total energy demand output for each model Table 4: Capital costs 000s Table 5: Operating costs and revenues used for each scheme The energy output generated by the technical modelling software (Table 3) was used to form the basis of economic models for each scenario, using a financial modelling tool. The economic assumptions used are outlined below Capital Cost Capital costs were estimated using cost plans from recent Buro Happold projects and information in the literature. The total capital costs for each development model are shown in Table 4. No allowance has been made for: internal building costs ie. the costs modelled include the pipe network up to the building boundary but no further; land costs for plant space either where it is within a basement or in a separate building Electricity The model assumes that all power generated by the CHP unit is exported at wholesale prices (ie. over a public network). On this basis, a figure of 45/MWh has been assumed as the baseline for the small and medium schemes with a slightly higher value of 47/MWh being assumed for the larger schemes reflecting the ability of these schemes to attract and negotiate higher prices in the marketplace. In terms of imported power, it is assumed that prices are slightly higher than export prices an important factor raised by respondents again a reflection of the reduced bargaining power of smaller participants in the market.

45 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Figure 4: Graphs comparing recent wholesale and retail electricity prices Figure 5: Non-domestic gas prices excluding CCL, source BERR statistics Gas The model assumes a range of baseline gas prices depending on scale. The values are taken from recent BERR statistics for non-domestic gas prices excluding CCL (see Figure 5). Carbon Modelling the impact of carbon prices is a complex process as it depends both on the value per unit and the design of the regulatory framework. For example, under the EU Emissions Trading Scheme the carbon price is only directly relevant for schemes over 20MWth and the number of allowances available to a scheme depends on the rules regarding new entrants. For the purposes of this exercise a simplified approach has been taken whereby the volume of CO2 savings achieved by each CHP scheme has been assessed against a baseline of conventional individual gas fired boilers and grid supplied electricity. The baseline case assumes zero value of carbon. Sensitivities are shown in figure 10. Maintenance Maintenance costs are based on project experience Financial and economic assumptions Inflation All scenarios assume inflation of 3% across all cost types and revenue streams. Discount rate All models are assumed to be 100% equity financed. Sensitivity to discount rate has been modelled across a range with 10% being considered a commercial target Internal Rate of Return (IRR) for a utility type investment. Project life A project life of 40 years has been assumed, with replacement of plant (excluding networks) after 20 years. 3.4 Results and Sensitivities The results are shown in Table 6 below. They clearly show increasing returns with scale this being a combination of higher relative capital and transaction costs for the smaller schemes, poorer electricity export prices and lower electrical efficiencies. For the medium size schemes, the impact of the anchor load is actually negative. This is because the model assumes that the same size CHP unit has been used for both scenarios. It has been assumed that it was not possible to invest in large scale plant on the basis of the additional load as this could not be guaranteed. This highlights the issue of optimisation and the complex interaction of factors that need to be considered. This process is time consuming and an expensive part of the project development process. For the larger schemes, the presence of an anchor heat load significantly increases returns. In this case the model assumes a larger CHP capacity to optimise the scheme. The model for existing stock demonstrates the potential viability of such a scheme however these results would clearly worsen if loads did not materialise in a reasonable timeframe emphasising the need for 45

46 Table 6: Modelling results Figure 6: Variation of NPV with discount rate and scale some incentive to connect. The model excludes the costs of conversion to communal heating systems for residential apartment type buildings estimated at around 3,000-5,000 per dwelling Discount rates The sensitivity of each scheme to discount rate was modelled to produce the NPV curves shown in Figure 6. The exercise clearly demonstrates the importance of discount rate to these capital intensive schemes. Given the high risk attached, rates of return required by investors / lenders are likely to be 10% or more, precluding many cheaper sources of finance. If these projects could be de-risked for example through local borough participation, more sources of finance could become available. These results support those of other studies. For example, the UK Potential for Community Heating and CHP by BRE calculates a UK potential of over 18GW at a 6% discount rate falling to less than 1GW at 12%. Figure 7 shows the NPV per MWhe generated, again highlighting the relative value of the larger schemes and the importance of discount rate at all scales Electricity, gas and carbon prices The sensitivity of each scheme to electricity, gas and carbon prices was tested. For electricity, the price of exported power was varied over a range, with the baseline being 45/MWh - 47/ MWh depending on scale. Imported power prices were left unchanged as the objective was to demonstrate the importance of an incentive for CHP generated power. The graph (Figure 8) clearly shows the importance of power prices to the level of return, this being more significant for the smaller schemes which are most disadvantaged by scale. Gas prices were modelled around a baseline case in the range 17.50/MWh - 23/MWh depending on scale. It was assumed that part of the heat income would be tied to gas prices thus part of any change in gas price could be passed through to consumers. As shown in Figure 9, all models are highly sensitive to gas price. It was beyond the scope of this study to undertake detailed gas and electricity price forecasting particularly given the current instability in the market. However, the sensitivities modelled here do show that both impact significantly on the viability of a scheme. This volatility will add further cost to a project where hedging instruments may be required to mitigate price risk. Modelling the impact of a carbon price depends both on the value per unit and the design of the regulatory framework. For example, under the EU Emissions Trading Scheme the carbon price is only directly relevant for schemes over 20MWth and the number of allowances available to a scheme depends on the rules regarding new entrants. The LEP study London Carbon Scenarios to 2026 calculated that for schemes above the threshold, the value of the EU ETS was of the order of 0.50/MWh.

47 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 For the purposes of this exercise a simplified approach has been taken whereby the volume of CO 2 savings achieved in each scenario has been assessed against a notional baseline of conventional individual gas fired boilers and grid supplied electricity. On this basis, the sensitivity of the schemes to changes in the carbon price is less marked (Figure 10) than it is for gas and electricity. Figure 7: Variation of NPV/MWhe with scale and discount rate Figure 8: Variation of IRR with electricity price Figure 9: Variation of IRR with gas price Figure 10: Variation of IRR with carbon price Conclusions Larger scale systems have improved returns both overall and per unit of output. Economies of scale mean that costs per unit are significantly lower for larger schemes. In particular, capital investment per tonne of carbon saved is lower for the larger schemes (see Table 4). An incentive for CHP generated output is required to improve returns and increase the level of investment by both equity and debt providers. This incentive needs to be of the order of / MWh, consistent with other studies (see those by AEA Technologies and Cambridge Econometrics for Defra, Bibliography references 2, 3 and 9). Systems built to serve existing stock where anchor heat loads can be connected early on in the project have better returns but carry higher costs. Schemes at all scales are highly sensitive to discount rate which will have an impact on the nature of the funding available. 47

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49 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Appendix C: Business Models and funding Review 49

50 Figure 1: Decentralised energy system The delivery of decentralised energy projects requires the commercial issues of risk, corporate structure and funding to be adequately addressed. Identifying, understanding and mitigating risk is a key element in project delivery and requires the apportionment of specific risks to those parties best able to manage them. Ownership and management structure is an important aspect of this and one in which the Energy Services Company (ESCo) model is becoming increasingly common. The availability and type of finance sought and the funding structure adopted will depend on how business structure and risk allocation is dealt with. This Appendix explores these issues in the context of decentralised energy projects suggesting ways in which each may be addressed to unlock the investment that is widely believed could be made available. 1.1 Risk Risk is a critical factor in project development, particularly in securing appropriate finance as it is responsible for unexpected changes in the ability of the project to repay costs, service debt and issue dividends to shareholders. The skill in structuring a project is to transfer or allocate specific risks to the parties best able to manage, absorb or mitigate them. Ideally only modest residual risk remains with the project. The three basic strategies to put in place to mitigate the impact of a risk are: Retain and manage the risk Transfer the risk by allocating it to one of the key counterparties Transfer the risk to professional agents whose core business is risk management (insurers) A delicate balance must be struck between the pressures from the financiers to minimise the risks retained within a project, and the costs of transferring risks out of a project to third parties. If the risks of the project are high, the costs levied by third parties to bear them may excessively reduce the expected returns that will be earned by the project. In the context of decentralised energy projects that involve a wide range of parties and, in many cases, represent new business models for participants, identifying risks in the first place is challenging and understanding them even more so. Key risks that are particularly relevant and/or unique to these projects are discussed below, categorised in the context of a decentralised energy system as illustrated in Figure Fuel supply Availability and price of fuel - whether conventional (gas) or alternative (biofuels, waste) - is a key issue for decentralised energy schemes.

51 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 There are conventional and understood ways to manage these risks through appropriate contracts and hedging mechanisms although these are better developed for gas markets than for waste and biofuels. There are costs associated with such risk management which must be borne by the project. Companies with access to / experience of fuel markets (eg. waste companies and utilities) have an advantage Energy centre The construction, operation and maintenance of an energy centre is well understood and is something again that can be wrapped up in appropriate contracts such as the Engineering, Construction and Procurement contract (EPC contract) and a suitable Operations and Maintenance contract. There are however particular risks relating to decentralised energy that need to be addressed. The energy centre is not built in isolation and must link up efficiently with all the other aspects of the supply chain fuel deliveries, heat networks and customers. This puts particular emphasis on the design phase of the project in terms of optimisation of the scheme. One of the main challenges in designing an optimal scheme is forecasting heat and power loads and how these will materialise over time. In theory, in a new build situation this should be relatively straightforward to calculate based on design criteria of buildings in the development. In practice there can be a tendency to oversize plant leading to excess capital being tied up early in a project putting extra strain on project economics. Also, although there may be a phasing plan it may not be adhered to due to market conditions, again severely impacting viability. Development build out rate and risk of non-development is particularly real in the current uncertain economic climate. In terms of existing stock, the heat / power loads can be measured and the plant sized accordingly. For larger schemes with less certain connection rates, sizing is more complex and represents one of the main risks to development. In the ESCO model (see discussion under Section below), the risk of optimisation tends to lie with the ESCO which is tasked with delivering specified service levels, although it will seek to transfer the phasing risk to the developer as far as possible Networks / infrastructure Networks comprise both electricity and heat. Electricity networks are mature in terms of regulation, skills and capacity to construct. On the other hand there is relatively little experience of heat networks in the UK and no specific regulatory regime. They are expensive and disruptive to install with limited return in their own right representing a high risk element of a scheme. As with the optimisation of the energy centre, the risk lies in understanding and forecasting load uptake. Ideally a heat network developer would need firm customer commitments to build the network. Similarly a heat producer would require a guarantee of connection before converting their plant to operate in CHP mode. The development of heat networks in and around London requires strategic input from both the public sector to help mitigate the risk of stranded assets and to incentivise scheme expansion, and from utilities that have expertise in rolling out similar forms of infrastructure Connections / consumers The issues relating to connections and consumers from the perspective of the project relate again to timing and certainty: when will a consumer connect and what will their demand be? This impacts scheme optimisation as discussed above. From the consumer s perspective there is a risk of poor or at worst non performance by the heat energy supplier. This impacts on the energy supplier through a need to have in place adequate Service Level Agreements (SLAs) which can be relied upon. In the case of electricity supply such agreements and step in rights are covered by regulation. In the case of heat they are currently being developed on a project by project basis adding to transaction cost and risk. This report advocates standardisation and GLA / LDA support for such SLAs. 1.2 Ownership and structure Ownership and business structure are key variables in the delivery of decentralised energy schemes and are important in the allocation and mitigation of risk. Retaining liquidity of property assets is seen as a key issue. Before looking at specific business models for delivery, the following section discusses some of the issues to be considered arising from the various commercial and contractual - relationships that are involved. It then focuses on procurement and the involvement of the private and public sectors in this activity Commercial relationships The energy services provider is at the heart of a decentralised energy scheme and is the starting point for discussing the commercial relationships relevant to energy generation, distribution and supply. Figure 2 illustrates these relationships; numbered references on the diagram are discussed in the references 1. 51

52 Figure 2: commercial relationships relating to energy provision (see text for references) 1. Procuring Agency The procuring agent or sponsor will generally either be the property developer or the local borough. As has been discussed elsewhere in this report, property developers have been required to take on the role of procuring agent primarily as a consequence of planning requirements within London. In most of the case studies both in the UK and abroad however, procurement has been led by local government. This has been shown to be a key success factor of a number of schemes (see Appendix D: Case Studies). In the context of the relationship of the procuring agent or project sponsor to the project in the long term, this will depend upon the project specifics. Generally a local authority will take a long term interest, for example by becoming a shareholder in the ESCO or having a profit share agreement. For a developer this will be a more complex decision and will depend upon its core interests and long term business model. These issues are discussed further below. 2. Ownership A benefit of setting up a separate company for the project is that ownership can be varied according to the objectives of the various stakeholders. Thus ownership could extend to: A developer that wishes to retain some influence over the management of the scheme; The local authority; An energy utility; The community: in some smaller schemes where profitability is marginal, setting up a Community ESCO whose primary objective is to supply energy rather than make returns for shareholders may be more suitable. Overseas this has approach has been a success at this scale; Other private sector investors as appropriate. 3. Energy assets The energy generation assets may or may not be directly owned by the ESCO. Direct ownership is more straightforward and more common in existing schemes. Often the ESCO will have designed, built and financed the plant and all earnings will accrue to the owners of the ESCO. Alternatively, provision of the energy services fuel supply, operations and maintenance, customer billing etc could be separated from the ownership of the assets themselves. The driver for this approach is to make it easier for the ESCO to reach a more optimal scale. The ESCO

53 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 could extend its services to other sites / schemes (not necessarily in the same location) thereby benefiting from economies of scale such as group fuel purchase and dealing with the electricity markets. Meanwhile, ownership of the energy assets is then open to other, possibly specialist, investors who would earn an appropriate return from the ESCO. This could help unlock finance for schemes by lowering risk for the investor and increasing liquidity. In terms of the operations and maintenance of the asset, this can be undertaken by the ESCO or can be contracted out to a third party. Some equipment suppliers are moving into the ESCO market due to their expertise in operations and maintenance and hence their understanding of the importance of providing a reliable service to customers. 4. Electricity distribution network Access to a local distribution network is required to supply electricity to customers. There are a number of options for ownership / management of this network: Private wire : the network is owned and managed by the ESCO to supply a limited number of customers through a private wire. Such a network is restricted in scale under the current electricity regulations (Class Exemption Order 2001) but by being exempt, licensing costs are avoided and the ESCO can retain a higher proportion of the retail price of the electricity. It also means the ESCO can have greater certainty over revenues by restricting third party access and obliging customers to connect. The Citiworks case heard in the European Court of Justice in May 2008 will have implications for the use of private wire by insisting on allowing third party access. Ofgem s proposals for a virtual private wire are compatible with this outcome. Independent Distribution Network Operator (IDNO): the ESCO itself or an associated company could establish itself as an IDNO, operating under the electricity networks licensing rules. Returns on this activity are earned in accordance with these rules but do incur the relevant licensing costs. The benefit of this over a private wire is that it enables the ESCO to expand to neighbouring schemes relatively easily (under the private wire model above, scale and hence expansion, is restricted). Customers will then have the option to choose their electricity supplier, an important aspect of consumer protection. Should a customer decide to switch to another supplier, the IDNO can still earn some revenue from that supplier as a consequence of this electricity being distributed over its network. Another potential advantage is that costs may be lower than those levied by the incumbent DNO. Incumbent Distribution Network Operator (DNO): the ESCO can export via the incumbent DNO network. This is arguably the most straightforward and low risk approach however it captures less of the retail value of electricity sales for the ESCO. 5. District heating network Ownership and management of the district heating network is the most complex and immature aspect of a decentralised energy scheme. Again there are alternative ownership and management structures not all of which are seen in the UK. In many respects a heat pipe infrastructure is more akin to water infrastructure than electricity as customers cannot choose their supplier (although there is some competition in the form of the alternative heating solution of an individual gas fired boiler). For a contained scheme set up to service a single development, generally the ESCO will include the installation and maintenance of the pipe network as required by the scheme. As discussed elsewhere, this is a high cost, low return aspect of the ESCO s business and timing of installation and hence capital spend is critical to a scheme s viability. For schemes looking to expand whether from an energy centre built to service a particular development or from an existing power station such as Barking or SELCHP the issue of who pays for and owns the pipe work is more complex and arguably has yet to be resolved. In Copenhagen the heating networks are of a sufficient scale to be split into a transmission network and a number of local distribution networks. The transmission network is owned by two companies which cover two geographical areas. Balance of supply and demand is managed centrally in association with these companies. There are a number of local distribution networks which are owned by non-profit municipal cooperatives. London is a far larger city and is likely to have a number of disparate schemes for which a wider transmission network is not likely to be economic for many years to come. 53

54 6. Customer supply Where the ESCO is supplying heat directly over its own pipe work it will have a direct relationship with the customer so that customer billing and payment collection will be an integral part of its operations. Whether it also undertakes electricity supply will depend on the structure adopted with respect to a public or private wire and whether or not the ESCO is licensed. In the case of a utility led ESCO, the model is generally to sell electricity wholesale and supply to customers via the parent utility s supply license. In both cases, if there is a direct relationship with the customer, structures can be put in place to incentivise and encourage energy efficient behaviour. standard Service Level Agreements that could help the procuring agent and the energy services provider through the process. An overview of the key contractual relationships is given in Figure Contractual relationships Underpinning each of these commercial relationships will be a contract. The variety of new and potentially long term commercial relationships - between developer, energy suppliers and neighbouring developments is in part a reflection of the inherent complexity of decentralised energy as a concept and in part a result of the immaturity of the market. Both will take time to resolve, the former through greater understanding and skills development, the latter with experience and the establishment of models that are demonstrated to work. In the meantime, there is scope for the development of a legal and contractual tool kit or checklist backed up by

55 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 The critical contract is that between the ESCO and the procuring entity. This is generally known as the Project Agreement and is the main legal instrument around which the decentralised energy scheme is developed. It is not uncommon for a developer to take a year to agree a contract with the ESCO. In one case, where the critical issue was that of consumer protection, the developer wanted to mirror the regulated energy framework as far as possible so that there was little difference from the customer s point of view and hence the impact on property value and liquidity would be minimised. Figure 3: Contractual relationships surrounding an ESCO There are a range of areas that this agreement needs to cover. Two critical areas are the charging structure and performance issues: Charging structure: to ensure consumers are not disadvantaged by connecting to a district heating network, charging for heat delivery is generally done on an avoided cost basis ie. an estimate is made of what it costs to own and run an individual boiler and the ESCO will commit to charge no more than this. The price arrived at may not reflect the true costs of production for the ESCO which causes problems for its financial model. Some fuel price risk can be passed on to the consumer assuming consumer gas prices rise in line with wholesale prices where the ESCO price is revised say annually against domestic gas prices for running a boiler. The charging structure will generally comprise a fixed element associated with the capital cost/depreciation, operation and maintenance and availability of the scheme and a variable element that is related to usage. The fixed element may be charged through a service charge.with regard to electricity, unless supply is over a private wire, consumers are able to switch supplier. The ESCO can seek to incentivise uptake through price mechanisms along the lines of a dual fuel discount but otherwise has to take the risk of consumers switching. Performance issues: the principal risk associated with decentralised energy schemes is service failure. Generally this is dealt with through revenue deductions and other penalty measures following a defined period in which the ESCO has the opportunity to take remedial action. The drafting of these clauses is technically demanding and carries risk to the developer if the end result it not adequate. Generally, although the ownership of and responsibility for a scheme may lie with the ESCO, tenants will turn to the developer should anything go wrong and it is the developer s brand / reputation that is at risk Procurement: private and public sector involvement As noted above, procurement of an energy service in the context of London decentralised energy provision is generally undertaken by a property developer with or without input from the public sector. 55

56 Figure 4: Traditional model of infrastructure provision Figure 5: Illustration of the issues surrounding local energy provision

57 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 The issues relevant to both sectors are further discussed below. Private sector: Property developers Property development is undertaken in different ways depending on sector, investor profile, market conditions and location. As a consequence different developers have different business models. A key difference in the context of energy supply is that some build to invest and hence hold a long term interest while others build to sell. Another difference is that some see providing services and general urban infrastructure as an opportunity while others prefer to concentrate on their core business. This diversity within the marketplace means that there are a number of different models for energy provision being developed. One of the key issues is how the developer relates to the energy provider or ESCO in the long term and how risks are transferred or shared. The question of what to do with energy assets once the development is complete and the developer wants to move on is a complex one. The risk to a developer is that they are left with a contingent liability in the form of the performance of the energy centre. Traditionally developers build out schemes and link in to existing utility infrastructure in the form of grid supplied gas and electricity. Although this may have its own complications and timing issues, it does offer a degree of certainty in terms of cost and security of supply. Standard conditions of connection are available with contractual frameworks well established and risk allocation known and understood (see Figure 4). During construction, the developer arranges with a utility for installation and connection of the necessary infrastructure. Once the properties are completed and sold, the contractual relationships for ongoing service provision are no longer between the utility and the developer but instead are directly between the utility and the resident/ occupier. There is no residual involvement of the developer, no issue over ownership, maintenance or performance of generation or distribution assets, and hence the developer can walk away without any potential liabilities or obligations outstanding. Even if the developer retains the ownership of the property for investment purposes, and hence retains a contractual relationship with the utility for supply of services to tenants, this will be in standard form and any obligations are wrapped up within the normal terms of the lease. Moving from this to a situation in which the developer is asked either to build its own energy centre or to contract with a sometimes unknown third party in a relatively unregulated environment significantly increases the levels of risk with which the developer has to contend. As shown in Figure 5, there are now potentially ongoing relationships between the developer and the ESCO for provision of utility services. If the development model is to sell, what assurances does the developer have over ongoing provision of services? Should it retain some ownership of the energy assets? Should it retain step in rights in the event of default of the ESCO? What would be the impact of such a default on the brand of the developer? Can this be quantified or compensated for? These issues are all complex and, although they may not be insurmountable, require considerably more time and transaction cost - to resolve. This issue of ownership and cost / risk sharing is also relevant to scheme expansion. One of the aims at design stage of many decentralised energy schemes is to link to neighbouring developments or existing stock where possible. This can improve the balance of heat loads and hence improve viability. However, it raises issues for the developer on whose land the energy centre is located. Would the energy centre need to be enlarged and if so at whose cost? Would the expansion lead to a loss of amenity to the development in which it is situated and hence a potential reduction in property value? If so, how is the developer compensated for this? If there are benefits accruing to the scheme due to expansion, should these be shared and if so how? Again, these issues are not impossible to resolve but the time, cost and effort required to do so are significant. And for a new development, this window of opportunity is small. Some local / district wide involvement by the public sector combined with a more standardised legal framework would greatly support delivery. 57

58 Conclusion Property developers are actively engaged in finding solutions to delivering decentralised energy. There are a number of issues that need to be resolved in terms of risk transfer and mitigation and in terms of legal solutions to protect all parties. Models for ESCO / developer contracts are emerging as more experience is gained. An improved business case for decentralised energy would ensure ESCOs can make the necessary investment and carry more of the risk. Involvement of the public sector at a strategic level particularly with respect to scheme expansion outside a particular development would help. Public sector: local boroughs A number of the issues specific to property developers in their role as procuring agent have been raised. The other key player in the delivery of decentralised energy schemes is the public sector in the form of local boroughs. This is illustrated by a number of the case studies in the UK which involve serving existing buildings and where the local authority acts as the procuring authority. Public sector involvement in energy delivery is generally in the form of a public private partnership (PPP). The structure itself can vary considerably in formality and balance between the public and private sector as outlined in Figure 6. Figure 6- Public sector role in decentralised energy projects PPPs enable public and private sectors to make their own contributions to the effective delivery of decentralised energy projects. In general the public sector retains responsibility and democratic accountability, ensuring delivery whilst safeguarding wider public interests, with the private sector bringing investment and expertise. Traditionally in the UK PPPs, supported by central government finance through the Private Finance Initiative (PFI), have been established to deliver core assets where construction, finance and operation risks are transferred out of the public sector to enable it to concentrate on service provision. Over 600 contracts have been let since the late 1990s leading to the construction of a range of assets such as schools, hospitals and leisure centres. The process has matured over that time with there now being a significant level of expertise and standardisation in place. This model has relevance for decentralised energy projects where a) there is an asset to be constructed in the form of an energy sector and / or a district heating network; b) the public sector needs a service low carbon heat and electricity supply over the long term; and c) the private sector has the capital and expertise.

59 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 The model has been used in a large scheme in London, namely Barkantine. The PFI was used to finance the scheme through a special purpose vehicle (SPV), wholly owned by the parent utility. The local authority let a 25 year concession to the SPV for a Design, Build, Finance and Operate contract to provide heat to its residents using CHP (see Appendix D: Case Studies). Advantages of adopting a PPP approach include: The long term commitment of boroughs and their climate change duties adds covenant to individual projects Involvement of the public sector in the feasibility stage for example in heat planning helps to de-risk the scheme so as to better attract private sector involvement The public sector could help with cross boundary issues and linking neighbouring schemes and particularly in bringing in existing stock Public participation in specific decentralised energy projects may enable particular barriers to be overcome. For example, they are often able to work closely with colleagues in planning and waste sectors of public authorities The public sector can act as supplier of last resort and hence provide comfort to consumers Disadvantages of adopting a PPP approach include: It could protract the procurement process It is potentially subject to political change In some cases, public sector may require more capability support Danger of asymmetric contracting as the energy companies would have more expertise in the field. The public / private relationship requires considerable work in the operational phase to ensure it continues to work effectively and deliver the services required. Conclusion PPP offers the best opportunity for developing larger district energy systems and linking in existing stock. The public sector provides covenant to a scheme and can help to reduce certain risks that will make a project more attractive to private sector investment. Community energy projects can be developed based on the ESCO model and can deliver a number of benefits beyond the environmental ones. These additional benefits can offset the lower financial returns associated with small scale schemes. The benefits may include: Affordable warmth savings from bulk fuel purchasing and high efficiency plant such as CHP can be passed on through lower charges. Low cost electricity community heating provided from CHP can enable the electricity generated to be sold directly to residents at cheaper rates. A community energy cooperative can service as a mechanism to aggregate the buying power of the members and potentially exert pressure on the energy market to grow in ways that are responsive to community needs. One developer has taken the approach of setting up a Community ESCO in response to the poor profitability of decentralised energy schemes. They have therefore set up a separate company which owns and manages the equipment on site, deals with all billing and metering etc. In exchange the ESCO will have an exclusive contract to sell heat to the occupants which allows it to recoup its investment over years. It is possible that the ownership of a not for profit ESCO could change, for example, residents could buy shares enabling them to take a stake in their energy system and could potentially be a common interest that could benefit the community. Conclusion Community ESCos are suitable for small scale schemes with marginal economics where other investment is not forthcoming. Community involvement : Small scale A third player in the ownership and delivery of decentralised energy projects, particularly on a small scale, is the community they serve. 59

60 1.3 Funding Finding funding for a project depends to a large degree on the quality of the project, primarily its economics and risk profile. Theoretically, once these are in place and understood, finance should become available. This section examines these issues in more detail by looking at the current market appetite for investment in decentralised energy projects, barriers to investment and investment options which may overcome these barriers Market appetite Much investment in energy projects is still directed towards conventional energy technologies thus alternative energy projects have to compete with conventional energy ones for funding. While the market is improving, alternative energy technologies, including renewables, account for only a modest proportion of the world s commercial energy demand. Market and investment conditions vary according to technology (size, capacity, energy resources, etc.) and region. Recent improvement in technologies has resulted in lower set up and operational costs for alternative energy sources which enables market growth. However private funders often have short investment horizons and prefer gas and other conventional energy options with lower capital costs. The wind sector now attracts investment on a considerable scale due to the high returns linked to the Renewables Obligation. Perceived risk A second major barrier to investment in decentralised energy is the perceived risks associated with the technologies, even where they may in fact be cost competitive. Decentralised energy, particularly combined with renewable technologies, is relatively new to finance markets. A lack of historical data together with a dynamic technological and structural offering often prevents a clear view of a project s viability. This in turn can lead to overrated project risk and increased transaction and finance costs. The information that does exist is often outdated or on an incorrect basis for the investment decision. This is compounded by the limited track records of decentralised energy project developers which results in them being perceived as high risk by financiers making them reluctant to provide non-recourse project finance. Fuel supply is always a concern for financiers. Where bio energy is used, this position is exacerbated and a guaranteed fuel supply is required for non-recourse financing. For district heating an additional concern is the ability to contract the heat supply where no long term assurance can be provided that the heat will be taken. Decentralised energy projects are also sensitive to a number of additional risks such as change in law, tariffing, network costs, carbon intensity and heat regulation which are different to those encountered in conventional energy projects. These are often difficult to quantify and there is no established risk allocation in the market at present Barriers to investment in decentralised energy projects There are a number of barriers that exist to investment in decentralised energy projects. This section considers some of these barriers, particularly the difference between decentralised and conventional energy projects and the impact this has on the financing available. Economic incentive The economics of a decentralised energy scheme are currently marginal at best. This is probably the main barrier to investment without a clear business case, funds, particularly from conventional sources, will be slow in coming forward. In practice, the research conducted for this study suggested that few ESCOs have managed to obtain significant debt finance to date. Most rely on the balance sheet of a parent (eg. a utility led ESCO). Some ESCOs have attracted venture capital funding but not for specific capital investment.

61 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Project scale The scale of decentralised energies is a step change when compared with existing energy supply options. As such they require new thinking in terms of risk management and forms of capital. Transaction costs of smaller projects can be disproportionately high compared with conventional projects as these are often inelastic with respect to project size. Any investment requires initial feasibility work and these costs do not vary significantly with the project size. The often small scale of decentralised energy projects means that the gross returns are often low, even while the rate of return may be within market standards. Small scale decentralised energy projects are often considered to be poor value and ESCOs look for projects of a reasonable scale in which to invest. The structure of teams within lending banks is generally split between an infrastructure team that will deal with these larger scale projects and a small projects / business lending team. There is scope to improve communication and expertise between these teams within financial institutions to aid delivery of finance to decentralised energy projects. Regulation and planning policy Planning policy and regulations rather than commercial benefits are currently viewed as the main drivers for investment in decentralised energy projects. Whilst these ensure that there is a minimum level of investment in decentralised energy in new developments, this is a limited market. Little is being done to address existing stock. Complex and changing regulations further hamper investment Options for investment in decentralised energy projects This section considers the investment options for decentralised energy projects and the sources of capital needed to take a project or enterprise forward in light of the barriers identified. Gaps in the financing options are identified and where possible interventions suggested. Large scale projects with significant investment Experience within the investment community of large scale decentralised energy projects involving district heating networks (ie. other than for industrial use) is limited. A lender will specifically focus on the ability of the borrower (or, in the case of project finance, the project) to make loan repayments. An equity investor, who shares in the upside of the project, will base the decision on an estimation of the risk-adjusted return of the project. As discussed above, for decentralised energy projects risks are often difficult to assess or manage and in some circumstances a financier may have difficulty understanding both the risks and returns. One of the areas specific to district heating is the pipework. This part of the infrastructure represents a particular barrier to investment due to its high capital cost and low returns. If wrapped up in a relatively small and dense scheme it can be covered by the project, but where networks are required to be expanded out from existing heat sources be they existing CHP plants or electricity generators that need to be converted to also deliver heat, they are particularly difficult to fund. The following sections provide a high level overview of options for raising finance for decentralised energy projects together with a discussion of the ability of these options to overcome the barriers outlined. 61

62 Corporate finance A large energy company may choose to use corporate financing to fund the project. Corporate financing requires a decision by the corporate sponsor to accept the risk and potential reward of a project in its entirety and can only be used by sponsors with a significant base of assets, debt capacity and internal cash flow. In order to secure loans, the developers and sponsors would generally need to provide between 25% and 50% of the capital required in the form of shareholder equity. As the risk (real or perceived) associated with a project increases lenders will require that equity play a larger role in the financing structure. This results in a strain on a developer s capital resources and can result in an increased cost of the entire project since equity is more expensive than debt. Often the challenges of creating a successful decentralised energy project is to progress beyond the development stage. The option of using contingent development grants to facilitate the development phase can be advantageous as the project developer is then in a better position to attract external financing firstly from equity sponsors and then from banks. This enables the companies to earn a reasonable rate of return and incentivises investment. Other interventions that may help fill the gap between equity and debt available to a project could include public participation in private equity funds and tax incentives for third party investors. Typically, a utility led ESCO will be funded in this way as the balance sheet of the parent is able to support the risks involved in a project which will be relatively small in comparison to the rest of its business. It is unlikely that the decision of the parent to invest in such activities is based purely on the financial returns of the project given that these are currently fairly marginal. It is likely that other factors will come into play such as a strategic interest in a new activity, access to new customers etc. Corporate finance will not be available to small start up ESCOs. These will require equity finance, examples of sources cited by respondents included venture capital firms and house builders. Project finance Project finance is generally provided to a ring-fenced project with only limited recourse to the investors if the project under-performs or fails. Lenders rely on the future cash flows generated by the project for debt service. Their main security is the project company s contracts without which the physical assets will have significantly less value (see Figure 3). A developer is likely to be able to use project finance if the capital cost of the project is at least 5-10 million. However, firm contracts must be available for all major project participants including the fuel supplier, equipment supplier, construction contractor, project operator and power purchaser. Reasons for choosing project finance include the desire to reduce the risk to the sponsor, increase the level of debt funding or where there are multiple sponsors involved in the project. Debt is usually observed to be a major cost component in this case. In a limited recourse project financing, the lenders rely on the project to generate a stable and predictable stream of cash flow to ensure repayment of their loads. To assure that they have project cash dedicated to repay their loans, the lenders will take security which gives the lenders the ability to control the project cash as well as step in rights. While lenders will take security of the project assets, cash flow is the primary source of repayment of project debt. Commercial contracts form the basis of the security for the project cash flow.

63 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Little project finance appears to have been employed on CHP/district heating schemes to date, certainly not in the development phase. This is primarily a consequence of the difficulty of securing cash flows and uncertainty over build out rates/phasing. As a project develops and risks and revenues are better understood, it is likely that schemes could be refinanced at lower cost. Carbon bonds The issuing of Carbon Bonds could potentially be used to jump start the investment in and construction of decentralised energy projects, therefore enable projects to progress beyond the development stage. The use of bonds may be particularly relevant in establishing a number of demonstration projects for decentralised energy and thus stimulating the market. Stipulations can be attached to the bond to ensure that the bond is invested in specifics areas. Bonds can be issued by a range of issuers, indeed almost any organisation could issue bonds but the regulatory requirements are very strict resulting in prohibitive underwriting and legal costs. The entities that could potentially issue carbon bonds include: UK Governments bonds, also known as Gilts these are issued with a variety of conditions attached; Local authorities bonds are referred to as Yearlings and normally have a life of 1-2 years. Often they are issued to finance a particular project which the authority wants to undertake. Yields tend to be higher than for central government bonds, because the risk is considered greater; Companies issue corporate bonds; and Special purpose vehicles are companies set up for the sole purpose of containing assets against which bonds are issued, often called asset-backed securities. Public sector participation in financing decentralised energy projects The participation of the public sector in a project may also facilitate funding of projects that otherwise would not be possible. In terms of transaction costs, particularly for project finance but for any debt financing, the extra costs associated with satisfying the higher burden of proof that a banks loan committee would normally apply to the first few investments for a decentralised energy project fall on the project developer. Public facilities that share the costs of the investment decision-making and the transaction process can help bring a bankable project through to financial closure. This has the added advantage of building awareness and capacity within financial institutions. Public sector bodies also have a roll to play in participation in mezzanine funds. Mezzanine finance, which constitutes a number of structures in the financing package somewhere between equity and debt can help fill the equity /debt gap. If structured appropriately this can help mitigate the risks for commercial investors. It may be possible to develop a mezzanine fund to target decentralised energy markets. Public sector involvement in schemes may also enable access to sources of funding that may not be available to a commercial developer. Some of these funding sources may enable projects to progress beyond development stage, thus providing a degree of comfort to banks and financiers in terms of risk and return and securing project financing. PFI credits - Private Finance Initiative (PFI) credits can be used by both central and local government. In the case of projects procured by local authorities, the capital element of the funding enabling the local authority to pay the private sector for these projects, is given by central government in the form of PFI Credits. Large PFI projects are funded through the sale of corporate bonds issued by the company running the PFI, the rating of which affects the cost of borrowing and therefore the viability of the deal. Smaller PFI projects, the area where decentralised energy are likely to fall, are funded directly by banks in the form of senior debt. Refinancing of PFI deals is also common; once construction is complete, the risk profile of a project is much lower, so cheaper debt can be obtained. The refinancing of PFI deals may be particularly attractive for decentralised energy projects due to the perceived high risk. In the majority of PFI contracts the benefits must be shared with the procuring authority. Tranching of projects may also present a viable option particularly where decentralised energy is part of a large regeneration project as this provides an opportunity to gear up projects as the market develops and demand increases. The Barkantine scheme in London was financed with PFI credits however this experience is not common. HM Treasury issued a report in March 2008, Infrastructure Procurement: delivering long term value, in which it recognises the need to address climate change through new electricity generation including low carbon forms of generation and other investment promoting sustainability. The government is investigating how to build on the achievements of PFI to date in addressing the country s infrastructure needs and it is possible that PFI could have a larger role to play in supporting decentralised energy delivery in future. 63

64 It is likely that some form of PFI credit or low cost borrowing (see under Prudential borrowing below) will be needed to grow heat networks which in themselves provide very low return. Prudential borrowing - The prudential borrowing system was introduced as part of the Local Government Act It works within a framework where the authority must maintain a balanced budget, the impact of capital investment decisions must be reflected in the revenue budget over time and a set of prudential indicators will be used to provide measurement in managing and controlling the impact of capital investment decisions. Prudential borrowing has been used to support regeneration and infrastructure projects in the past and the major advantage is an attractively low borrowing rate administered through the Public Works Loan Board (PWLB). While there are benefits of a public finance route the local authority would need to consider a range of risks associated with prudential borrowing, particularly the requirement for annual interest repayments and risk allocation and contract arrangements. However the prudential borrowing route may provide an opportunity for local authorities to undertake PPPs in the absence of PFI credits. Salix finance - Public sector organisations also have access to Salix Finance which was established by the Carbon Trust. It provides funding for low carbon capital projects in the public sector and currently has funds of 20 million to accelerate its work. A grant is available for successful organisation and this is supplemented by the partner organisation to create a ring fenced fund, which is then used to implement energy saving projects through internal loans from the fund. The project loan is repaid at a minimum of 75% of annual energy savings and once it is repaid the organisation continues to benefit from ongoing energy savings. As repayments are recycled back into the fund they are available for reinvestment, so create a self-sustaining pot for further projects. The funds are managed entirely by each partner organisation with support from Salix. Green fund - A report for the London Energy Partnership Investing in London s Low Carbon Future, November 2006 outlines the potential of establishing a Green Fund to invest in medium to large scale carbon reduction projects in London. Funding sources cited include the European Investment Bank and other soft funding such as UK and EU grants with further capital being raised by way of Alternative Investment Market (AIM) floatation. The viability of a Green Fund for decentralised energy projects will require further analysis into the likely investment opportunities and returns that could be expected to be generated. The report also indicated the potential reliance on carbon credits for the fund to be successful and therefore a PPP may be required to utilise the fund effectively. Depending on the fuel source used in the decentralised energy project there may also be an opportunity to leverage Renewable Energy Certificates (ROCs) in a similar manner. Public sector organisations and private businesses may also be attracted to invest in the Green Fund as CHP may enable them to quality for Climate Change Levy Exemption Certificates or reduce the impact of the Climate Change Levy through reductions in energy consumption. Supplementary Business Rates (SBR) -The Government issued a White Paper in October 2007 outlining their proposal to introduce a power for local authorities and the GLA to raise and retain local supplements on the national business rate. Revenues will be locally raised and retained with local decision making on the duration of any supplement and the specific project on which it should be spent. The Government requires that the supplements are used for clearly specified economic development purposes, set out upfront and subject to statutory condition. The definition of economic development currently used is extremely narrow, and the white paper has indicated that this may need to be redefined to cover a broader definition. Local Authorities will also have the ability to use revenues from business rate supplements in order to support borrowing to finance capital investment. Local Authorities will be required to consult extensively with businesses on the use of business supplements. Given that a supplement would be restricted to the project specified in the consultation a supplement would cease once any debt had been fully repaid. In this way there is potential for the SBR to be used to fund the capital element of a decentralised project under the assumption that the project will be self sustaining with suitable level of returns once the initial investment period is passed. Further consultation with business would be required to determining the appetite for use of SBR in this manner. JESSICA this stands for the Joint European Support for Sustainable Investment in City Areas. It is an initiative being developed by the European Commission and the European Investment Bank (EIB), in collaboration with the Council of Europe Development Bank (CEB). Under new procedures, Member States are being given the option of using some of their EU grant funding, their so-called Structural Funds, to make repayable investments in projects forming part of an integrated plan for sustainable

65 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 urban development. These investments, which may take the form of equity, loans and/or guarantees, are delivered to projects via Urban Development Funds and, if required, Holding Funds. A review is currently underway as to how this instrument can be used in London. In particular the LDA are investigating how it might be employed to support heat network infrastructure in the capital. Small scale projects with reduced investment Small scale decentralised energy projects are likely to have different drivers and objectives when compared to medium and large scale projects and therefore the options for funding such schemes will differ. This section outlines potential funding options at this scale. Biomass Accelerator Fund This fund ( 5 million) is available to assist the commercial deployment of small-scale biomass in the UK. It hopes to achieve this by reducing costs, supply chain risks and raising awareness. The Carbon Trust will partner both new and existing biomass sites and their supply chains to develop case studies looking at how best to deploy biomass technology in the most economical and effective way. The European Commission also intends to present a Communication on financing low carbon technologies at the end of The communication will address resource need and sources examine all potential avenues to leverage private sector investment including private equity, and venture capital, enhance coordination between funding sources and raise additional funds. In particular it will examine opportunities for creating a new European mechanism for industrial scale demonstration and it will consider cost and benefits for tax incentive for innovation. Conclusion There are a wide range of different financing structures and mechanisms available to decentralised energy projects which vary according to scale. In some cases it may also be necessary to finance different parts of a scheme differently, in particular the heat networks for a scheme looking to expand. For these, some form of low cost finance is likely to be required. Essentially even in the current climate it is thought that there are funds available for green / low carbon technology. The key to unlocking this investment is improving the economic case for decentralised energy. The application of such funds has limited scope in the context of London s decentralised energy aims, however small scale funding of this type may be of benefit in smaller developments. EU options - Intelligent Energy Europe (IEE) is a means of converting EU policy for smart energy use and more renewables into action on the ground, addressing today s energy challenges and promoting business opportunities and new technologies. IEE supports European projects, one-off events and the setting up of local/regional energy agencies with a total budget of 250 million, covering up to 50% of the costs. The programme currently supports more than 200 international projects, over 30 local/regional energy management agencies, and just under 30 European events for the promotion of: new and renewable energy sources (ALTENER) energy efficiency, notably in buildings and industry (SAVE) energy aspects of transport (STEER) co-operation with developing countries (COOPENER) 1 The discussion centres on the concept of an Energy Services Company or ESCO. This is a broad term which in the context of this study is used to refer to an entity set up specifically as a joint venture, a subsidiary or a stand-alone company to provide technical and financial solutions to the project developer or sponsor. See the London Energy Partnership paper on ESCOs, bibliography reference

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67 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Appendix D: Case Studies The following section summarises the case study evidence presented in this Appendix. In particular evidence if presented for the recommendations based on case study evidence. Key Success Factors UK Case Studies Key success factor Evidence Recommendation Local authority develop and procure scheme Local authority/public sector provide anchor heat loads from the outset Local authority involved in the ongoing governance structure of the organisation to provide protection for social tenants Provision of lease for energy centre site by the procuring authority at low/zero cost Some grant funding for initial stages of the project, including feasibility studies Reported in all UK case studies with the exception of Nottingham Reported in all UK case studies with the exception of Nottingham Reported in Southampton and Barkantine Reported in Southampton and Barkantine Reported in Southampton and Citigen London boroughs empowered and supported to develop and procure schemes. Technical expertise made available Heat mapping of all public sector property within London boroughs Industry to develop Code of Practice for easily referenced standards for minimum levels of consumer protection model Standard Service Level Agreements Involvement of boroughs can provide covenant to guarantee long term operation of heat supply Identify public sector land suitable for situating energy centres, make available at low cost for decentralised energy schemes. Include this land use in Local Development Frameworks Grant support for initial development costs and as a contribution to capital cost help remove barriers by: Reducing risk at development phase Increasing rate of return to sufficient level to allow private sector to invest Raising finance for decentralised energy can be difficult Awareness raising is required with lenders. Refinancing may be an option provided sufficient working capital (equity/parent company loan) exists to fund development and build of new projects Heat is offered at a lower tariff than gas equivalent. Connection costs are set below the cost of providing boiler plant on-site Defends against monopoly abuse of market power Risk allocation and profit sharing arrangement, requiring investment in developing the specific project and co-operation from both public and private sector partners Each partner is incentivised to ensure the success of the scheme Low cost borrowing by local authority to fund a scheme Transparency in developing project capital and operating costs Reported in all UK case studies Reported in all UK case studies Reported at Barkantine Reported at Barkantine Incentives to connect are required for connection of new and existing development Decentralised energy schemes should offer connection on an avoided cost basis Lower or equivalent energy costs should be offered, index linked with fuel prices, to manage the fuel price risk Clear and well understood risk allocation within the contract is required An incentive for the public sector in the form of financial as well as policy/environmental benefits can encourage co-operation and mutually beneficial outcomes. The public sector is key to unlocking much of the risk around developing decentralised energy projects Due to high capital costs and long term nature of return on investment some form of public sector, project specific, borrowing may be required to finance construction of heat networks. Capital costs could be recovered once the system is operating by revenue charges or sale of the asset Projects developed on an open book principle to ensure transparency and build trust between energy companies and public/ private sector partners Finance for project raised from parent company either on balance sheet or via parent company loan The fledgling wind industry experienced problems with raising project finance which are now routinely overcome as lenders understand project risks Reported in Southampton, Citigen and Barkantine 67

68 Key Constraints UK Case Studies Constraints Evidence Mitigation measure A number of schemes report that target profits are not achieved Reported in several case studies Key issues are: Low prices paid for electricity exports; Contracts have onerous conditions; Technical/design issues causing poor system performance Low value for electricity exports Lack of suitable commercial customer for power No incentive for providing low carbon heat other than Levy Exemption Certificates which are very low value The use of renewable fuel is difficult in urban locations without heat networks Most apparent at one scheme for spill electricity, however a general concern for all schemes A barrier for all schemes with the exception of Nottingham which has a private electricity network All schemes would benefit from this measure This is a key factor to determine economic feasibility of decentralised energy schemes. Being able to sell at retail rates, or otherwise capture more revenue, is key to compete with large scale non-chp generators Possible changes to regulation of electricity sales for smaller suppliers and generators ( virtual private wire ) could change this Simplified arrangements and reduced distribution charges for smaller decentralised suppliers Economic incentive for CHP carbon reductions An anchor tenant for electricity sales would enable retail rates to be achieved for electricity sales: Direct connection via private wire could be used, subject to legal challenge and proposed regulatory changes (not suitable for larger schemes) This aspect must be addressed at project feasibility and planning stage Private enterprise requires a profitable investment to be available. Incentives would improve financial viability and encourage investment and competition CHP is a relatively low cost carbon reduction measure A carbon price through the EU Emissions Trading scheme may provide an incentive but only for larger schemes

69 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Technical problems with the scheme, leading to CHP downtime and hence reduced revenue Lack of suitable and willing commercial customers to enable scheme expansion (at the time of project development) Onerous contract conditions, leading to reduced profitability Reported in one case study, but since been rectified Reported in Southampton and Citigen In one case this was related to long term agreements over heat and electricity price indexation. In a separate case this was related to very high levels of service delivery, including rapid reaction times to faults and maintenance responsibilities for individual heating systems Best practice guidelines produced to ensure that heat loads can be accurately predicted. This required investment in post-occupancy evaluation of buildings to determine hourly loads for different building types Increased experience in decentralised energy system design will minimise this problem. Opportunity to import expertise from countries with extensive heat networks The public sector can clearly be of assistance through the provision of anchor tenants against which project finance can be raised. Private sector customers may choose to join following the successful and reliable operation of the plant for a period of time. Means to incentivise or mandate the connection of existing development could be critical as this would provide a revenue stream from the project outset Easily referenced contract conditions and price indices to be determined. For example see [Action Energy, 2004, GPG 377, Guidance on procuring energy services to deliver community heat and power schemes] Contract checklist for decentralised energy schemes Expert advice for public sector when undertaking procurement of decentralised energy systems Key Success Factors Overseas Projects; Key success factor Evidence Recommendation Long-term, government led plan to achieve large- scale heat transmission and distribution networks, financing and funding obtained through the public sector Existing UK utility networks were developed in this way. Much of the current electricity system was built by the state and is now operated on a marginal cost basis as the assets have been depreciated Copenhagen and Stockholm Cross party support obtained for meeting decentralised energy objectives. An immediate realisation that the targets will not be met through new build development, and a long term strategic commitment to developing the infrastructure (as is made for transport project i.e. cross-rail) by attracting private sector investment Incentive to connect to heat network required (e.g. reduced costs) but an incentive needed for this. Alternatively mandating connection would be required Lack of cost-effective alternatives to heat networks, such as natural gas (as in the UK) Design of a market for heat, split into generation, transmission and distributionsupply. This enables elements of competition and regulation of the industry This is a long term approach requiring significant intervention by government In Copenhagen and Stockholm alternatives are solid fuel and therefore more costly than heat. In New York the steam network was developed prior to gas and is currently costcompetetive Copenhagen and Stockholm Difficult to remedy with the UK access to cheap gas Incentive to recognise low carbon heat production Long-term vision to require power stations to supply waste heat to a heat network Design of a market structure and incentives to ensure low costs for consumers Construction of new power stations within 10km of urban centres 69

70 Location: Start Date: 1988 Operated by: Capacity: Annual CO2 savings: Customer type: Electricity arrangement: Capital cost Carbon reduction capital cost index No. of customers Southampton City Centre Utilicom ~7MWe, ~25MWth 11,000 t CO 2 /annum Includes civic buildings, a hotel, a swimming pool, a supermarket and a hospital Currently sold wholesale. Exploring options for selling electricity privately Private ~ 8 million Public ~ Heat station land, 600k grant ~ 818 capital cost / tonne annual CO2 reduction 40 major customers, various other smaller or residential customers 1 Known as the Official Journal of the European Coal and Steel Community at the time 2 CEP, A funding programme instigated by DEFRA giving capital grants for public sector community heating projects. The programme closed in March Not provided, as commercially sensitive CASE STUDY 1: Southampton Community Energy Scheme Origins of the Project The project started when the Department of Energy were carrying out research into the viability of geothermal heating. In the early 1980s, the Department of Energy (now the Department for Business, Enterprise and Regulatory Reform ( BERR )) commissioned the drilling of a geothermal test well, to explore the potential of geothermal heating in the UK. A test well was drilled in Southampton and, despite a lower than expected yield the council were keen to exploit the energy. Southampton City Council ( SCC ) then conducted an extensive search for a private sector specialist in geothermal aquifers to become their partner in a decentralised energy scheme. There were limited companies with this experience and SCC found only one company that was capable and willing to work in close cooperation with SCC, being Utilicom Ltd ( Utilicom ). Due to the fact that there was only one interested party SCC were not required to publicly tender the contract in the Official Journal of the European Union. No legal or regulatory barriers to procurement were identified. Utilicom came on board and agreed to operate as an Energy Services Company (ESCo). Shortly afterwards additional customers were found, such as a new ASDA store, and this led to the need for additional sources of heat, such as CHP. Through a concerted effort, and support from local government, the scheme has grown, and now has over 40 major customers in the city centre with a view to future expansion, connection to an existing residential community heating scheme and a planned new energy centre serving over 4000 dwellings and 2 hospitals. Engineering Approach The city centre scheme consists of the following installed plant: 5.7MWe Wartsila CHP 2 x 400kWe Wartsila CHP 2MW geothermal heat pump 1.1MW Biomass Boiler Peak load gas boilers Absorption Chiller Peak load vapour compression chillers The CHP plant operates on the base-load and hot water is generated at 80 C supply, and returned at 50 C. Simon Woodward, chief executive, believes that the low supply temperature and large differential between supply and return is key to the economics of the project: The low temperature means lower heat losses and a longer life of the pipe distribution. The high differential allows smaller pipe diameter and increases the effectiveness of the CHP. The distribution pipework is pre-insulated, and space heating is supplied directly to most buildings to avoid the pressure drop associated with a heat exchanger. Electricity supplied from the CHP is transformed from 11kV to 33kV and distributed to the local substation via a G59 connection. Utilicom bore the initial costs of the transformer, cabling to the substation and additional switches at the substation. Economic Issues The electricity is sold wholesale to E-ON, however it is clear that the viability of the scheme can be greatly improved if a retail customer can be found for a long term power purchase agreement, or a private wire network used. Either option would potentially capture more of the retail value of electricity sales. So far a search for such a customer has not been successful. The scope for selling to residential customers is reduced, due to the license exempt limit of 1000 homes, and due to a perception that the electricity will be expensive. Selling over the distribution network has been considered, however the costs of participating in the electricity market are viewed as high. A reduced Distribution Use of System (DUoS) charge for customers within close proximity, and a simplified electricity market would be welcomed. Role of the Public Sector The City Council initiated the project, via the geothermal scheme and have been supportive since the outset. They have a strategic partnership with Utilicom and have a profit share.

71 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 SCC s contribution to the partnership included the land for the development which was not valued at the time the partnership was created, the geothermal well together with an EU support grant which it had secured of approximately 600,000, and the agreement to be the first customer of the Company. Utilicom contributed the remaining capital, (approximately 8 million to date), skills and experience; and bore all of the project risks as discussed in the section on risk below. SCC were well placed to assist with other issues, such as granting wayleaves and licensing Utilicom as a statutory undertaker. They were also well placed to assist in the planning process and now have an unofficial role as scheme promoter, raising awareness amongst potential developers. The partnership also helps to empower the private company and provide covenant for customers. Commercial Issues As an incentive to switch to Combined Heat and Power ( CHP ), SCC and Utilicom s latter customers were entitled to preferential rates. Connection charges are set at 75% of the avoided costs of providing conventional plant. Whilst project finance was achieved for one of the CHP engines (circa 3 million), this was an involved process. Utilicom now obtain all finance via their parent company, IDEX. The main issue with obtaining project finance is that the scheme had few secure customer contracts at the outset, and is therefore viewed as a risk by the lenders. Decentralised energy is regarded as a small and complex investment for banks to consider. Utilicom see this ability to obtain financing through their parent company as a key advantage for ESCOs. At the outset of the Southampton project (in the late 80s) the country was in recession, and little development was being undertaken, therefore limiting the rapid growth of the project, and enlarging the perceived risk. The project was able to obtain European funds for investment in the innovative aspects of the scheme (such as the geothermal system). At present the schemes operators see the closure of the Community Energy Programme as an additional barrier to new schemes. Risk All risks associated with the project were borne by Utilicom including financial, technical, design, construction and operational. SCC was unwilling to bear these risks given that novel nature of CHP public-private partnerships and therefore perceived to be relatively high risk at the time. The success of this scheme is largely attributed to the collaborative and close working relationship between SCC and Utilicom. This agreement has since been emulated by other Local Authorities, such as Birmingham City Council, in their decentralised energy schemes. Contractual and Legal Issues SCC and Utilicom formed the Southampton Geothermal Heating Company ( the Company ), a wholly owned subsidiary of Utilicom, in The two parties were bound by a Cooperation Agreement for 20 years, upon signing. The Cooperation Agreement expired in 2006 and was renewed for a further 25 years. The contract terms were fine-tuned, but the essence of the contract remained the same. The entire scheme is owned and operated by Utilicom. The contract required any profit earned by the Company above Utilicom s required rate of return to be split 50:50 between SCC and Utilicom. Consumers were not obliged to connect to the community heating scheme, and the business case offered by Utilicom had to be attractive enough to overcome issues of risk. The heat costs are index linked to offer a reduction compared to conventional heat supply (i.e. linked to gas price index, with assumptions about boiler efficiency). Utilicom are statutory undertakers within the SCC area and are therefore able to ensure service delivery by maintaining the pipe network. In reality very little maintenance has been required over the first 20 years of the project s life. The key issues raised by Utilicom were the current rules associated with using the distribution network, the prices paid for top-up electricity and the lack of any incentive to provide low carbon heat (i.e. low carbon heat obligation). Supply Chain All maintenance is carried out in-house, whilst installation is performed by local contractors. No issues with the UK supply chain for decentralised energy have been experienced. Summary It is clear that this project is highly successful and has steadily grown over 20 years. However, it started by chance, with strong public support, and the backing of a large parent organisation with a proven track record in utilities and energy services. They have struggled to unlock the value of the electricity, and the rules around the license exemption, and distribution network charges are seen as barriers. They suggest a reduced charge for using the network if the customer base is within a short distance of generation. Financing at commercial project finance (nonrecourse finance) rates of interest appears to be considered a key barrier for smaller entrants to the market place, suggesting that larger companies are likely to dominate the market place. Limited project financing was utilised. Utilicom raised finance on its own balance sheet and via its parent company. The support by SCC in providing land, an anchor heat load and the same rights as other utility providers was vital, however the main success factor appears to have been the SCC s willingness to champion the scheme. The council have made strides in reducing CO2 emissions and providing low cost energy to clients, as well as securing a modest income, suggesting that the benefits work both ways. 71

72 Location: Start Date: Early 1990 s Operated by: Capacity: Annual CO2 savings: Customer type: Electricity arrangement: Capital cost Carbon reduction capital cost index No. of customers London Port Authority Building, Central London Citigen (London) Ltd 31 MWe, 25 MWth Not calculated. (Carbon is valued as waste heat ) Numerous city of London buildings including the Guildhall, Barbican arts centre, Guildhall School of Music & Drama, Museum of London and many other commercial customers Traded by the parent company, E.on 55M estimated Not known 14 medium to large customers CASE STUDY 2: Citigen Community Energy Scheme Origins of the Project The City of London Corporation were keen to replace old plant with a community heating and cooling scheme for their buildings, reducing their carbon impact, and issued a specification for supply of a CHP scheme. The package included: Two derelict buildings owned by the council (provided at a commercial lease rate); A customer base of City of London buildings, requiring heat and coolth; A cooperation agreement to enable use of City subways and car parks, and to promote the use of DE in other buildings in the City Initially a joint bid by Utilicom and British Gas was successful. The scheme has passed ownership several times since, before being taken on by Citigen (owned by E.on), over 5 years ago. Engineering Approach The city centre scheme consists of the following installed plant: 2 Wartsila diesel 15.8 MWe CHP engines (converted to high pressure gas); 2 x 5.5 MW single effect absorption chillers; 3 x 1.1 MW electric chillers 3 x 3 MW dual fired boilers; The heat is distributed at 105 C and a number of on- and off-site boilers provide back-up generation. The plant is designed with a selective catalytic reduction system for nitrous oxides removal. Prior to engineering work and investment by E.on, the scheme had suffered for many years from a number of technical issues, including: Low efficiency from absorption chillers due to a low differential between flow and return and a low contracted supply temperature; Reliability issues with the engines and gas compressors following conversion to high pressure gas CHP; The reliability and efficiency issues have largely been overcome during E.on s ownership, improving financial viability; These issues did not undermine reliability of heat and coolth supplies to customers, which have been maintained at over 99% by use of backup plant. The switch to gas was mainly related to the need to minimise the environmental impact from running on heavy fuel oil, as the originally installed desulphurisation plant was difficult to operate. The current environmental permit limits operation on gas-oil to a maximum of 500 hours per year. The Electricity is generated at 11 kv and fed into the EDF Energy network via a connection at Beech Street sufficient to deliver the full export capacity.

73 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Citigen are constrained in their expansion to a certain extent by the spatial limitations of their site, but have sufficient space available to increase their heat and chill output, combined with extension of the network for increase resilience and routes to new customers. The pipework is between 350mm and 80mm diameter, and Citigen mainly use routes through subways, underground car parks and basements. This has been a big advantage due to avoiding trenching in public highways and ease of access for maintenance. Economic Issues The scheme sells electricity through E.on, the parent company. They tend to operate the plant during office hours as these cover the main demand periods, and maximise revenue. Outside of these hours they use conventional gas boilers and the electric chillers recently installed to meet demand. The scheme has heat rejection capacity for periods when it is economically viable to generate excess power during times of low thermal demand (e.g. during a Triad period where payments are available for generating during periods of peak demand). Citigen are considering refurbishment and expansion of the scheme, with the costs competing with other E.on projects based on a range of investment criteria. Customers are enticed by the low carbon source of supply, simplicity and space saving, and by the support that connection to a DE scheme provides on planning consent. They treat connection charges on a case by case basis depending on customer requirements; sometimes by an up-front contribution, sometimes by factoring into the tariff rates for heat and chill. Role of the Public Sector The public sector client (City of London Corporation) developed the project and managed the procurement. Key inputs were: Providing a building as an energy centre; Provided a base load through their existing buildings; Granted licenses and wayleaves where required; The City of London supports the scheme and often will direct development in the area to connect to the scheme through their planning department. They have conditioned some development to connect in the past (Barts Hospital). The City of London also work with Citigen to identify strategic developments in the area which may help the expansion of the scheme. Citigen feel that further roles could be found for the public sector; The introduction of NETA/BETTA has had a greater effect on smaller generators, such as CHP schemes, resulting in reduced electricity prices for inflexible plants with thermal customers. The new OFGEM proposals are welcomed but there should also be better recognition of the low carbon value of the heat supplied; Strategic planning and heat mapping within the planning system would identify strategic developments for network infrastructure and enable locations for low-carbon heat sources; Commercial Issues As the scheme was operating when Citigen took it on, some of the commercial issues in development are unknown. The scheme was taken on when E.on took over TXU Europe. As Citigen are owned by E.on, they can use their in-house traders for fuel and power, and can rely on the technical expertise of their organisation for metering and billing. It is clear that the investment required for this scheme must be compared to other investments in E.on s portfolio in the UK and elsewhere. Risks All commercial risks associated with the project are borne by Citigen. Input (fuel, labour, parts) and output (heat, coolth, electricity) prices are determined by the market with no support mechanism in place from the City of London. Contractual and Legal Issues At present a flexible approach is taken to the contracts with customers. For example the unit price of heat/coolth can also include an allowance for costs incurred in connection. Some customers have back-up heating plant, and therefore may have an interruptible supply contract. Contracts also specify the supply and return temperatures for the heating/cooling networks. The ESCO see their core duty as ensuring that their customer base is supplied with the required heat and coolth. Supply Chain Few issues were noted regarding the supply chain. Summary The scheme was procured by a public sector client, who supplied the premises and an initial customer base; Commercial clients are now contracted to the scheme, however there is always a risk that these buildings will be redeveloped and terminate the contract; The scheme has suffered from technical problems related to the load characteristics and conversion of engines from diesel to natural gas, these issues have been rectified by Citigen without any interruption to customer supplies. 73

74 Location: Tower Hamlets, London Start Date: October 2000 Operated by: Capacity: Annual CO 2 savings: Customer type: Electricity arrangement: Capital cost Carbon reduction capital cost index No. of customers EDF Energy 1.35 MWe 1,700 tco 2 /annum Domestic, leisure centre, community centre, school Power purchase with EDF Energy. Supply to retail customers with discounted rates via EDF Energy licence, over licensed network 6million (PFI Credit) 3,500 / tco 2 /annum 600 domestic, 4 non-domestic Figure 1: Flow of energy and revenue in the Barkantine scheme CASE STUDY 3: Barkantine Community Energy Scheme Origins of the Project In the late 1990s the heating system in the Barkantine estate (a mixture of high and low rise dwellings built in the 1950s and 1960s) needed to be replaced. In high rise blocks (60% of customers), Tower Hamlets removed the existing warm air system and installed risers for a wetsystem, initially heated by gas boilers. Tower Hamlets decided to go to tender for a 25 year concession for a Design, Build, Finance and Operate (DBFO) contract to provide heat to residents through a CHP. The project was financed through PFI credits. After extended discussions with EDF Energy, a 25-year concession agreement was signed for EDF Energy to connect these tower blocks to the new CHP district heating scheme. A Special Purpose Vehicle (SPV) was set-up, Barkantine Heat and Power Company (BHPC), who are a wholly owned subsidiary of EDF Energy. Several low rise blocks were also connected (40% of customers) and their individual boilers were replaced with a heat interface unit to enable them to receive heat from the district heating system. Other community buildings were connected at the same time (school, leisure centre, sheltered housing scheme and Barkantine Hall). The drivers for CHP and heat networks on this scheme were broadly about fuel poverty and environmental benefits. A key issue was to ensure that the residents were willing to be served, and act as the anchor heat load ; a number of community meetings took place to explain the scheme. All residents were connected to the schemes and are now billed via a pre-payment system for their heat. The land for the energy centre was provided by refurbishing a derelict electricity sub-station on the site. This was provided as part of the initial contract. Engineering Approach The city centre scheme consists of the following installed plant: 1.4MWe, 1.65MWth CHP; 4 x 1.4MWth gas backup boilers; m thermal store; The scheme also offers the residents a preferential electricity rate through EDF Energy, however electricity generated by the scheme is sold through a power-purchase agreement. BHPC are required to maintain all heating systems within the Barkantine estate (including the plant, heat distribution, dwelling heat exchangers, heat meters and dwelling heating system) and up to the heat meter for other customers. This is subcontracted to a dedicated maintenance company. They report that the heat distribution network has been relatively trouble free and have had some minor maintenance issues with the CHP prime mover. Most of their maintenance effort is in responding to issues within the dwellings, either the domestic hot water installation or the heating system. Economic Issues Customers are given index linked prices for heat, guaranteeing that they are lower than market rates. The Tower Hamlets residents are charged through a pre-payment meter. BHPC will operate the scheme for 25 years. The borough are entitled to a share of profits in excess of an agreed level. Residents connected to the heat network are offered a discounted electricity tariff if they choose to receive their electricity from BHPC. The electricity is supplied through EDF Energy s supply licence, however BHPC collect the revenue through their pre-payment system, passing it on to EDF Energy. Electricity generated through the CHP is sold wholesale through a power purchase agreement. BHPC also receive a (TRIAD) payment if they are running their plant at peak periods. The scheme was procured through 6m in PFI credits under the pathfinder scheme from the Department of Food and Rural Affairs (DEFRA), which was instrumental in allowing Tower Hamlets to have the necessary financial capital to award the DBFO concession. Tower Hamlets pay BHPC monthly to cover the initial expenditure (two thirds of payments) and pay a variable rate linked to operations and

75 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 maintenance of the scheme. The payment is linked to penalties related to delivered heat and the time it takes them to respond to faults. BHPC are looking for opportunities to expand the scheme, and have plans to connect several private developments in the future. Role of the Public Sector The borough prepared the ground for the scheme by: Packaging the tender; Providing a dedicated client contact to work through contractual matters; Providing the land; Providing anchor customers for heat; Taking a long-term interest in the scheme; The borough s continuing role is as follows: Two members are on the board of BHPC; Take part in commercial meetings with BHPC on the day-to-day commercial matters; Take part in operational meetings to discuss technical matters; Ensure that a BHPC member attends the tenant liaison meetings; The borough estimate that they spent 1 ½ person year on setting up the scheme. This involved preparing the tender, evaluating the tender, negotiating the contract and setting up a governance model. BHPC allow the borough to see their accounts, which enables clarity for future negotiations. Commercial Issues To enter into a Design, Build, Finance & Operate contract, the local authority was required to obtain PFI credits, amounting to 6million, from DEFRA. BHPC obtained finance through their parent company, EDF Energy. They recover their capital investment through: 1 Monthly repayments (through the PFI capital element); 2 Sale of heat to customers; 3 The power purchase agreement; The private sector can also rely on a long-term public sector partner, this helps with expansion to future private sector clients and ensuring that risks associated with non-payment are reduced through consultation with residents and the governance structure. This is also obviously mitigated through pre-payment meters, however there are a very small minority of non-payments. The ultimate risk in recovering the energy payments lies with BHPC. BHPC report that they are not achieving the level of profit assumed in the original financial model. This is because heat demand is lower than expected, therefore limiting the hours run of the CHP and the eventual revenue generated through electricity sales. Originally Tower Hamlets had supplied historical energy data for the flats. The heat demands have reduced, partly due to façade improvements, reducing the heating loads. Individual metering and billing has also reduced demand. Risks In this scenario all risks are transferred to the private sector, with risk mitigation on the public sector side through investing in the tender and contract. The risks to the private sector are reduced by ensuring that land costs are minimised and anchor tenants with favourable heating demands (residential and leisure) are provided for the contract length. Contractual and Legal Issues To ensure an adequate service is delivered, BHPC must perform to specified performance level, such as response times to heating malfunctions, if BHPC don t rectify the problem within the time limit they must pay a financial penalty, usually in the form of a reduction through their bills. The clauses are stringent, requiring a 3 hour response time. As the maintenance also includes the tenant heating system, this can be relatively costly for the ESCo. In the second phase of the project, a number of dwellings are low-rise, meaning more costs associated with pipework. Additionally some of the residents are private leaseholders. This caused complications as through the contract BHPC own the heating system for the contract length. This means that leaseholders may not be able to make alterations to their systems. This has cause some frustration, however where possible BHPC tries to accommodate changes. The 25 year concession agreement has a clause which states that the scheme should have at least two years of plant life left to ensure that Tower Hamlets can plan for plant replacement/ refurbishment. Supply Chain Setting up the contract was the main supply chain issue as few similar contracts had been let by the public sector at the time. Summary The project was tendered by the public sector, providing land and anchor customers; The PFI credits ensured that fixed costs were available to BHPC, ensuring secure revenue in the long term; Stringent requirements are placed upon BHPC in terms of maintenance reaction times and the need to maintain the heating systems within the flats; Consultation was required with the residents to obtain their buy-in to the CHP scheme; Despite offering discounted electricity prices to residents, few actually decided to change supplier; 75

76 Location: Start Date: 1953 Operated by: Capacity: Annual CO 2 savings: Customer type: Electricity arrangement: Capital cost Carbon reduction capital cost index No. of customers Nottingham City Centre EnviroEnergy Limited Approximately 14MWe and 20MWth 149,000 tco 2 /annum. Carbon factors: 136 kgco 2 /kwh for delivered heat kgco 2 /kwh for delivered electricity Domestic, civic buildings, offices, two shopping centres, leisure facilities, schools and a university Private wire arrangement is possible for customers near the heat station Not known Not known ~4,600 domestic, various large non-domestic Figure 1: A Diagram Indicating the Plant within the Waste Incineration Scheme Source CASE STUDY 4: Nottingham District Energy Scheme Origins of the Project In 1953 the Boots Drug Company built an industrial power station to serve their premises that spread across the centre of Nottingham city council. In the early 1970s Boots sold the site to Nottingham Corporation, with British Coal as the leaseholder. At this time Nottingham city council choose incineration as their preferred method of waste disposal. It selected a private company, Waste Recycling Group, to operate a new waste-to-energy incineration plant in Eastcroft, near Nottingham city. The incineration of domestic and commercial waste collected in and around Nottingham made available an abundant source of high temperature, high pressure steam suitable for generating electricity. This was piped in a 14 high-pressure main to the nearby London Road Heat Station, where turbines use the steam to generate electrical power. The waste heat from the turbines enable the system to operate as a CHP plant. Nottingham City installed a district heating scheme consisting of 16 diameter high temperature hot water main through the city centre and into the nearby residential areas of the St Ann s estate. The electricity is transmitted on a private ring main to consumers local to the heat station. In 1995, with the demise of British Coal, the scheme transferred to Nottingham City Council, and traded as EnviroEnergy (Nottingham) Limited, an ESCO owned and operated fully by the council. Nottingham City Council took the opportunity in to significantly upgrade the St Ann s Estate district heating scheme. The pipework was renewed, all substations revised, indirect heat exchanger connections were made to each property and electronic metering technology was installed so consumers could make pre-payments. Engineering Approach The Eastcroft Waste to Energy incineration plant burns 150,000 tonnes of waste each year collected from 250,000 homes & businesses. The London Road heat station scheme consists of the following installed plant: 2 of the original coal boilers were replaced by gas-fired boilers in 1997 The 3rd original boiler has been mothballed. An assessment is presently being made on the suitability of replacing it with one that uses biomass as its fuel source. 2 original turbines - 2.6MWe 3rd turbine installed in late 90s MWe Over 60 miles of underground pipework

77 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 In 2001, 177,279 MWh of heat was distributed using the extensive pipe network. Customers include over 4,600 domestic consumers, Victoria Baths, the National Ice Arena, the Broadmarsh and Victoria shopping centres, Nottingham Trent University, several civic buildings and large offices. In 2001, 61,862 MWh of electricity was generated. A private wire ring main supplies this to a collection of major consumers close to the heat station site. These customers include offices, a hotel, the National Ice Arena and the waste incineration plant. Contractual and Legal Issues A 60-year contract was put in place at the time when the waste-to-energy incineration plant was built. This contract stated that all the steam generated by the waste incineration plant would be used by the CHP scheme. This contract was taken over and recognised by Nottingham City Council in 1995 upon the demise of British Coal. This abundant availability of heat has meant the heat station has never been over stretched by the demands of its customers, therefore incentives to encourage consumers to use less thermal energy were never required. Commercial Issues Annual increases to the price set for the heat supplied to consumers is restricted to the Retail Price Index (RPI) for national inflation. Since the price for gas on the National Grid has increased substantially in recent years, the RPI restriction has brought substantial financial savings for consumers. For EnviroEnergy however, this represents a considerable lost source of income. Additionally, the rates for waste disposal have increased, which has contributed to the profits of WRG. Profits made for waste incineration are not shared with EnviroEnergy. On the other hand, rates for electricity generation have decreased. Excess electricity (spill) sold wholesale is an uneconomic option for EnviroEnergy and is avoided if possible. A consultant to EnviroEnergy noted that the system as a whole (i.e. incineration and CHP plant) is profitable. The issue is that the majority of profits are made by WRG, whilst EnviroEnergy runs at a loss and hence requires support from Nottingham City Council. The long and rigid contractual terms as well as the increases in gas prices are the primary cause of the problem. Risk All risks are borne by EnviroEnergy. They have the risk of increases in fuel (gas) prices, whilst being unable to increase charges for heat and electricity in line with the market. If the incinerator shuts down for a period (for technical reasons), the supply of steam stops. For heating this is not an issue, however EnviroEnergy are required to purchase electricity from the grid at emergency rates, which results in further losses for the company. Future Plans To enable the district CHP scheme to become a profitable operation once again, new domestic, civic and commercial customers for heat are sought both in the city centre and across the Meadows residential area to the south of the London Road heat station. A considerably influential factor in the success of this endeavour is the introduction in Nottingham of a 10% renewable energy planning obligation in the style of the Merton Rule. The carbon factors associated with the scheme bring 36% reduced emissions for the same delivered thermal energy when compared to the best gas condensing boilers, and 38% reduced emissions for the same delivered electrical energy. This should make the heating scheme the first choice for developers in future. The support of Nottingham City Council has been instrumental in the historical growth of the scheme, its present operations and the future expansion plans of EnviroEnergy. They are to presently fund a 1.5million expansion of the scheme to the Meadow s Gateway site on Queen s Road. It was stated by a consultant to EnviroEnergy that a significant barrier to CHP and energy from waste CHP in particular, is the high capital cost of associated infrastructure, such as laying the pipework underground. The consultant believes that if grants are available to subsidise the upfront capital outlay, future uptake could be significant. Summary Historical construction of heat and power station by the Boots Drug Company Construction of waste-to-energy incineration plant Involvement and financial support of Nottingham City Council Substantial heat demands of civic buildings in the city centre Expansion to nearby St Ann s residential estate and refurbishment in recent years Several substantial customers for electricity on the private ring main local to the heat station New consumers attracted by the lower cost of thermal energy than gas Electronic Metering System to ensure prompt payment by consumers City Council using Merton Rule planning for new developments 77

78 Location: Copenhagen and surrounding municipalities Start Date: 1903, but transmission networks built Operated by: Capacity: Annual CO 2 savings: VEKS, CTR ~8,500 GWh / year ~1,900 MW heat CHP or waste ~1,300 MW heat peak load ~1,400 MW electrical CTR system: estimated 1.5 million tco 2 /annum Customer type: Large numbers of residential demands but supplies 97% of buildings in Copenhagen in total Electricity arrangement: Wholesale into national pool system from large power plants Capital cost CTR transmission system only, 230 million VEKS: 2007 book value, 70 million Cost of CHP plants and distribution networks unknown Carbon reduction capital cost index Not known No. of customers CTR, 275,000 VEKS, ~150,000 CASE STUDY 5: Copenhagen Community Energy Network Origins of the Project District heating systems have been in use in Copenhagen since 1903 and developed during energy crises brought on by both World Wars. However, they were systematically expanded following the oil price shocks of the 1970s. This energy crisis forced the Danish government to devise methods to reduce their reliance on imported fossil fuels. The process of achieving high levels of penetration has taken 30 years to realise. This included the greatest possible utilisation of CHP. This was achieved through systematic heating network planning. In Denmark it is mandatory for large scale power production to put waste heat to use, and it is also mandatory for all buildings with a heat load over 250 kw to connect to a district heating network if available in your area. High fuel oil taxes also encourage connection. 97% of buildings in Copenhagen are connected to the district heating scheme. In total the district heating network supplies 50 million square meters of floor area. The heat is distributed using a transmission system which connects four CHP plants, 4 waste incinerators and around 50 peak load boiler plants. 1 According to CTR see -

79 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 Engineering Approach 70% of annual heat demand is generated by 4 large scale CHP plants, 25-30% by waste incineration plants, and the remainder by peak load natural gas or oil boilers. Heat is transmitted from the CHP plants and other heat sources using a high temperature, high pressure transmission network. This network is operated by VEKS and CTR. Heat is then distributed by local, often municipally owned, distribution companies. Heat losses amount to approximately 12% of the total heat generated by the CHP and waste incineration plants. Economic Issues The mix of heat energy production plants means that the local district heating companies have a choice of where they buy heat from. This introduces competitive pricing and the benefit of reduced prices. The heat prices paid by consumers are based on the operating costs of the system, which are calculated each year. Generators offer their heat to a pool, with suppliers buying the heat in advance, based on the prices offered. The total investment for the systems is not known as there are multiple companies involved. Commercial Issues The transmission network system was financed largely by foreign loans, most work took place in The investment is recovered in the prices charged for heating. The entire system is operated as a not-for-profit venture. Around ninetween co-operatives own the system and the plant is operated by two main companies, VEKS and CTR, in turn owned by the co-operatives. The system is separated into three businesses, the generation, transmission and distribution/supply components. The generators bid to sell heat to the system based on demand predictions from the system operators. The transmission companies sell heat at municipality sub-stations to distributorsuppliers, who are then responsible for selling heat to individual customers. It is estimated by CTR that distributor-suppliers charge customers approximately double the wholesale cost to cover their operations. Public Sector Involvement The government and municipalities are the architects of the scheme and have executed a long-term plan to enable a market to emerge. They strictly zoned the city into area that would and would not have district heating. A number of initiatives were required to ensure the acceleration of the project, such as: Ban on electric heating in new buildings; Heat planning; Investment subsidies to utilities who rehabilitate and complete networks; Investment subsidies to consumers who install central heating and connect to district heating; Mandatory connection of buildings above 250 kw heat load. Summary Long-term government initiative to achieve large-scale district heating; Send clear signals to all involved, with heat-planning zones and a market with transparent costs; Provided incentives for those involved in generation, transmission and distribution; 79

80 Location: Stockholm Start Date: Earliest plant (Hasselby) began running in 1959 CASE STUDY 6: Stockholm District Heating System Operated by: Capacity: Annual CO2 savings: Customer type: Electricity arrangement: Capital cost Carbon reduction capital cost index No. of customers AB Fortum Värme 480 MWe, 3,400 MWth 800,000 tco 2 /annum Households, commercial, and industrial premises. Wholesale into the national power pool Unknown Unknown ~ 6,000 large customers, approximately 60% of buildings Origins of the Project Stockholm s district heating network has been in operation for approximately 40 years and is currently operated by Fortum Energy of Finland. Prior to district heating, buildings would generate heat through either wood stoves or oil burners. The district heating project was seen as a means of providing heat efficiently and avoiding air quality problems in the city. The city has seen a reduction in sulphur and NOx emissions over the last 40 years. The district heating plant is competitive with other means of heat supply, this is predominantly because there is not an extensive natural gas network. The district heating network consists of four main plants serving different geographic areas of the city. The first of the four main plants, Hasselby, began operation in 1959 and the system s capacity has gradually been expanded with the addition of new piping and plants, and now runs on biomass. Vartan, the largest plant, was gradually converted from electricity generation to also supply heat during the 1960s and 70s. A waste incinerator plant was added to the network in 1970 and since expanded.

81 Cutting the Capital s Carbon Footprint - Delivering Decentralised Energy October 2008 At the beginning of the 1980s, rising oil prices and the availability of cheap electricity led to a growth of interest in heat pumps. This lead to the building of the Ropsten District Heating Plant, the world s biggest heat pump installation, with a total capacity of 260 MW. In addition to district heating, Stockholm Energi also provides district cooling. Engineering Approach The distribution system in the City of Stockholm is geographically divided into three major networks: the Central Network, the North-Western Network, and the Southern Network. The total pipe length of the distribution system is 765 kilometres. Oil-fired plants contribute to 2,000MWth of capacity, mainly during peak load. 420MWth heat pumps are used to feed the base load along with 200MWth of biofuel-fired plants. There are also 530MWth of electrical boilers, but the use of these is dependent on the price of electricity. The only coal-fired plant has a capacity of 220MWth. Over the entire system, 35% of heat produced originates from fossil fuels (oil and coal), 24% comes from biofuels (household waste, wood chips, bio-oils, olive grains), 26% comes from waste water and sea water (the corresponding heat pumps use electricity corresponding to 13% of the used fuel). Cogeneration produces a total of 480 MWe.in electricity. Stockholm Energi s district cooling scheme utilises new and existing infrastructure to serve the centre of Stockholm. The coolth is extracted from seawater and is transported to central parts of the city in new pipes, located mainly in existing rock tunnels for district heating. Economic Issues The district heat turnover of 5,500 GWh includes sales of 250 GWh to neighbouring municipalities. This enables increased security if supply for the region as a whole and offers better diversity for the system operators, Stockholm Energi.. Currently, district heating s strongest source of competition comes from individual heat pumps and boilers run on wood pellets. In the past, individual oil or electric boilers were more common, but rising prices made these alternatives less popular. There is demand for expansion of the district heating network in Stockholm. During the past few years, new customers have been connected at a rate of GWh per annum. This is projected to continue during the years ahead, leading primarily to more efficient use of already installed capacity. Each premises is metered and billed for energy consumption, based on volume of water used and temperature difference between entry and exit. Role of the Public Sector The City of Stockholm were sole owners of the original energy supply company, therefore fiftiesera city government was able to stipulate that new buildings connect to the district heating network when it sold land to developers. This allowed the fledgling system to gain critical mass; the current system has been cost-competitive in the heating market for decades. Commercial Issues The network is owned and operated by a company jointly owned by the City of Stockholm and the Finnish energy company Fortum. Maintenance work is carried out by Fortum and their sub-contractors. Contractual and Legal Issues Stockholm Energi is the sole operator in the city, but the district heating competes with other heating alternatives. As Stockholm has no supply of natural gas, these consist of oil-fired or electric heating. Customers are charged a connection fee and required to commit to use the system over a specified time period if they want to join the district heating scheme. Contracts are negotiated on an individual basis. Summary Long-term planning from the local government; Heat market with neighbouring municipalities; No competing gas infrastructure; Expensive alternative heat sources; Providing an anchor load at the onset of the scheme; 81

82 Location: Start Date: 1881 New York District Steam CASE STUDY 7: New York District Steam System Operated by: Capacity: Annual CO 2 savings: Customer type: Electricity arrangement: Capital cost Carbon reduction capital cost index No. of customers ConEdison ~400MWe electricity ~6000MWth heat Unknown (117 lbsco 2 /Mlb Steam, typically 70% saving over oil, 60% saving over dual fuel, 5-10% saving over gas) UN, Empire Stave Building, large offices, hotels, schools, residential complexes, dry cleaners, laundrettes Sold retail through ConEdison who also supply gas and electricity throughout New York. Unknown, but recently invested $200 million in network refurbishment Unknown 1,800 steam customers Origins of the Project The project was privately financed by New York Steam and established in 1881 and has developed into one of the largest steam networks in the world. The steam system pre-dates electrical distribution within the city. The scheme started with only a few customers, quickly expanding to 40 within a year. The scheme saw rapid expansion in the 1920 s and 1930 s. ConEdison took over 75% of the steam company in 1932 and fully acquired it in To summarise the drivers were: No competing infrastructure; Avoiding the need for combustion in the city (pollution); Built in conjunction with the construction boom of the pre-depression era; Engineering Approach The steam distribution scheme includes over 105 miles of pipework with a total of 7 plants supply the steam. The scheme consists of the following installed plant: 5 Manhattan plants 1 Plant is located in Queens 1 Plant is located in Brookyln 3 of which are CHP with 4 boiler only plants The East River plant is a 360 MWe combined cycle gas turbine cogeneration plant