This webinar talks about the financial risks associated with district heating investments, based on Barcelona’s DistriClima experience. It also explores the difficulties of integrating these risks into conventional “return on investment” and “cash-flow” analysis due to the specific limitations of simple methods of discounting.
1. New approaches in understanding the risks in DH investments
In order to make a reasonable business plan some initial assumptions have to be considered:
- The energy consumption of the customers
- Where, and how large the connections/pumps need to be
- The relation of cost between the purchased energy heating the water (gas, electricity, waste heat)
- The final pricing
- The financial costs.
Regarding the design and construction, there should always be a backup source. Water temperatures need to taken into account, and be adaptable to future needs. The complexity of handling the piping, including the need of a contingency plan because of things found in the ground, should not be under-estimated. Finally, legislational changes – including taxation – has to be considered for the future.
2. Appraising investment in district heating networks: accounting for strategic interdependencies and risks
There are some challenges of investment appraisals of smart cities. Although all investment appraisal is difficult, appraising ‘smart cities’ investments is particularly difficult since they include interdependent portfolios of projects, rather than individual projects. Moreover, many different agents are involved which involve radically different forms of asset class (e.g., physical vs digital) as well as many sources of risk (e.g., technological, political, regulatory, demand etc.). Emphasis is typically on development and expansion; hence dynamic strategy, not one-off investment, is required.
Existing appraisal methods are based on relatively simple techniques, such as cost-benefit analysis (CBA) and the Internal Rate of Return (IRR). However, these techniques have major limitations, because they cannot consider inter-dependencies nor accommodate strategic behaviour. Instead, they assume analysts have perfect knowledge of the future and ignore the dynamic flexibility in decision making available to management, and cannot accommodate learning over time.
Recently, a new portfolio-based framework for the appraisal of smart cities investments has been developed. This new real options-based approach enables the representation of interdependencies, risks, flexibilities and strategic behaviour. The approach is more complex than the traditional ones, but is still practically applicable. As an example in the presentation, the appraisal technique has been applied to the Bunhill Heat and Power network in London.
3. Questions from the audience:
– In a country where there is a lot of scepticism towards district heating and cooling, is there a tipping point when enough early adaptors invest in it, which starts a trend – and thus easier to finance?
– The new, real options-based approach for investing appraisal is complicated. How can cities actually make use of this new tool?
– How could a detailed and clear urban planning including district heating (DH) help the decrease of risks, and thus increase acceptance for district heating?