With energy efficiency savings of up to 70 percent, greenhouse gas emission reductions and opportunities to monetize assets, it is little wonder that “district energy” is quickly gaining traction globally.

President Obama has mandated an additional 40 gigawatts of district energy capacity in the US by 2020, a 50 percent increase in existing capacity. In Australia, Sydney has announced plans to develop district energy (tri-generation) precincts across the city, which is part of a wider plan to reduce Sydney’s carbon footprint by 70 percent by the year 2030. In Europe, London’s Olympic Park developed a district energy system to support both the Olympics and future surrounding developments. In Asia, various governments are promoting district energy, including Singapore, Hong Kong and the People’s Republic of China. Finally, the Middle East, continuing its fast pace of real estate development, retains its mantle as the world’s fastest-growing district energy market.

What is District Energy?

“District energy” is the collective term for the centralized production and distribution of heating or cooling energy. A centralized district energy center services a large geographic area, often entire “districts” or even cities. The energy center reduces the temperature of a water supply (or increases it for heating) and then pumps the water through an underground pipe network. The looped pipe network connects to each building within the district, and chilled or heated water passes through an energy transfer station, where the water is then used to create chilled or heated air. As a result, individual buildings served by the district energy system do not require their own chillers or boilers. This provides space advantages and, even more important, energy efficiency advantages due to economies of scale.

Where the energy center is combined with a captive power plant (CHP Plant), the heat generated by the plant can be used for heating the water or for efficiencies within the plant itself, or where there is a cooling requirement, the surplus heat from the CHP Plant can be used to drive a highly efficient absorption chiller. Surplus electrical power generated by the CHP Plant can also be exported to the electricity grid to generate additional revenue and subsidize the cost of the project.

District energy schemes are increasingly combined with other low- and zero-carbon technologies (biomass, solar, waste water) to create further energy efficiencies through co-location. This was the case with the London Olympic Park, where the energy center utilized both a gas-fired combined cooling, heat and power plant and biomass-fired boilers using wood chips as a sustainable biomass fuel.

General Benefits

District energy is widely recognized as a sustainable, efficient and cost-effective solution to the provision of heating, cooling and power. Its enhanced efficiency means fewer damaging greenhouse gas emissions, thereby supporting the global push for a cleaner and healthier environment. District energy has the added benefit of reducing dependence on the electricity grid and the inherent vulnerability to grid disruptions, thereby enhancing reliability of energy supply.

Project Delivery Models for District Energy Projects

Traditionally, building owners have met their cooling or heating needs by contracting with a builder to build the district energy plant and pipe networks and then contracting with a separate utility company to operate and maintain the entire district energy system.

Another model that has become common in the Middle East market over the past decade involves a customer contracting with a utility company to deliver a turnkey solution, whereby the utility company builds, operates and maintains the district energy plant and the pipe networks, with the building owner making both the initial capital investment and paying the operating expenses for the district energy system, including an agreed return on investment for the utility company.

A new model introduced to the district energy industry involves private finance under a build, operate and transfer (BOT) concession model. BOT concessions differ from more traditional models in that the private-sector partner (which may be a consortium comprising a utility company and an infrastructure fund) undertakes to finance the district energy system (through both debt and equity) in return for the right to exclusively provide cooling services over an agreed geographic district. The key distinction compared to the traditional models is the money flow – the building owner no longer paying the up-front costs. This has been an increasingly attractive model to customers in the current economic climate.

With its proven track record, the BOT concession model lends itself particularly well to utility infrastructure projects such as district energy schemes. GCC nations are no strangers to BOT concessions. Indeed, most independent power projects (IPPs), independent water and power projects (IWPPs) and wastewater treatment plants (WWTPs) in the MENA region adopt a BOT/BOO concession model.

King & Spalding has helped develop a BOT concession model for clients on several recent Middle East district energy deals. This model differs from IPPs/IWPPs/WWTPs, where a government grantor purchases the complete power or water offtake, provided the facility is made “available.”

Under the district energy BOT concession models known as an “end user” model, the private-sector party is granted a concession to exclusively provide cooling services to end users in the district. The private-sector party collects revenues directly from end users instead of receiving a service payment from the concession grantor. In return for the concession, the concession grantor receives a royalty payment from the private-sector partner. If the district energy system is project-financed, then for “bankability” reasons the lenders may require guarantees or other forms of credit enhancement.

Key Considerations for Applying the BOT Concession Model to District Energy Projects

In the context of district energy, deals will require careful due diligence on end users’ demands for energy to ensure that plants are not overdesigned. More due diligence is required at the planning stage, because historically many projects have been overdesigned, leading to inefficiencies and overcapitalization. Another consideration is inherent in the captive nature of district energy schemes. These differ from IPPs, where if there is excess capacity not used, then that capacity can be sold to the grid. Because district energy schemes normally service a “captive” set of end users, excess cooling capacity cannot be readily diverted (e.g., to new end users) because there is no “grid” for cooling.

Conclusion

District energy schemes are taking off in the Middle East and increasingly gaining traction globally. Groups such as the International District Energy Association are increasing in size and prominence. Utility companies with expertise in power and water projects are now turning their attention to the cooling and heating market. Infrastructure funds and strategic investors are eyeing opportunities for healthy returns, particularly in unregulated markets. And governments are encouraging the industry’s growth with policies supporting the very benefits that district energy provides. Watch this space, because district energy is clearly on the rise.