COMPENSATION TO NATURAL GAS COMPANIES WHEN THEIR HEAT MARKETS CONVERT TO DISTRICT HEATING

In many places, lower consumer prices could be obtained by replacing natural gas with district heating. But such conversions are often countered by a remaining debt at the natural gas companies. This article suggests a solution based on several years of experience in Denmark, which applies to other countries.

By Ole Odgaard, Former Senior Policy Advisor on district heating at the Danish Energy Agency

Denmark supports a heat conversion from natural gas to district heating, which brings about lower consumer prices and lower CO2 emissions.

However, a key issue is that the natural gas companies may still have debt from the natural gas network’s establishment. This debt must necessarily be settled by the remaining natural gas customers. When a significant conversion from natural gas to district heating is made, the remaining gas consumers will be charged with even greater repayments on the debt. In short, there are fewer to pay. Therefore, a fair compensation scheme could be considered for larger heat markets or heat zones.

As many cities in other countries face the same challenge, this article will highlight the Danish solution, which could serve as inspiration for a similar solution adapted to the specific conditions elsewhere.

Main principles for a compensation scheme

A compensation scheme was decided in 2012. It was based on three main principles:

Firstly, the compensation scheme secures lower heat prices for the new district heating consumers. A standardized feasibility study based on the levelized cost of energy must document that the new district heating supply will result in lower consumer prices and better socio-economic costs.

Secondly, the compensation model secures repayment of debt in all natural gas distribution companies, whether they have a relatively high debt or a low debt. Thus, the size of the compensation can vary from one area to the next, according to the economy of the gas distribution company.

Thirdly, the compensation scheme must be as simple as possible. It was pointed out by all key stakeholders during the preparatory process that unclear rules and interpretation options could delay the conversion significantly. The reason is that one part could bring the case to a complaint body or court, which could result in higher costs and delayed investments.

Thus, a fair and simple compensation scheme was deliberately asked for by all stakeholders. Relatively high indebted natural gas companies were secured, and the new district heating customers would only be asked to convert if their district heating bill was lower than the previous heating bill with natural gas, incl. compensation.

Compensation = a part of the natural gas distribution company’s remaining debt

The compensation scheme compensates the natural gas companies as follows: the district heating company compensates for the leaving natural gas customers’ share of the outstanding debt.

If a district heating customer exits the district heating supply, the customer must repay his or her share of the remaining debt before the exit is approved. Thus, it is only fair that the same principle applies if a group of natural gas customers converts to district heating.

By adopting this principle, the natural gas companies will be able to receive compensation, which they would otherwise not receive, when customers on an individual basis exit from the natural gas supply. Thus, the natural gas companies benefit from the compensation scheme, as they get compensation due to an amendment in the natural gas zone affecting many customers.

As the district heating companies received full compensation and the natural gas companies received no compensation from individual heat conversions, the following compromise was made: 50 % of the remaining debt is compensation to the natural gas companies to be paid by the district heating companies.

Half of each natural gas customer’s residual debt is paid as a one-time compensation. The other half is paid by the remaining natural gas customers via higher tariffs.

How to calculate the compensation?

When the compensation is 50 % of each customer’s share of the remaining debt, the customer’s remaining debt is calculated as follows: If a customer contributes with, e.g., 0.02 % of the annual sales volume, the share of the remaining debt is 0.02 %.

Thus, the compensation = (Lost sale) / (Total sale) x (Remaining debt) x 0.5.

In the case listed above, the compensation would hypothetically be Compensation = 0.02 % x [million or billion Danish kroner] x 0.5. This compensation is paid as a lump sum.

The customer’s share of the total sales volume is calculated as a) the average gas consumption in the past 3 years and b) the consumer’s average price per m3 of gas in the past 3 years.

The remaining debt of each natural gas distribution company is calculated once and for all. Current changes in the debt are not taken into account.

The future lump sum to be paid in compensation can only be adjusted on an annual basis. The base year for calculation of remaining debt and thus compensation is 2012.

The compensation for the coming years is calculated as follows:

Compensation in 2013 = compensation for 2012 – 5 % + net consumer price index increase for 2012.

Compensation in 2014 = compensation for 2013 – 5 % + net consumer price index increase for 2013.

Likewise, the compensation for the coming years will continue until the end of the compensation scheme in 2020.

Thus, the compensation (lump sum) is typically lowered with about 3 % pr. year, as the inflation typically ranges around 2 %.

This is the setup for all large and medium-scale customers. The Danish experience is that these institutions and industries, etc., can pay the lump sum without any problems. The banks can receive the feasibility study’s documentation of the economically favorable conversion to district heating if the customer needs to obtain a bank loan for the lump sum payment. This is, however, quite rare, as most enterprises can pay the compensation up front.

In order to give the natural gas companies an incentive to cooperate with the district heating companies, the compensation scheme has a deadline. By 2020, no compensation is given. Thus, if the natural gas companies do not support the economically sound conversion projects before 2020, they will not be compensated.

Special arrangements for small-scale customers

A simpler compensation scheme is adopted for small-scale customers that consume less than 6,000 m3 of natural gas per year. They will pay a fixed lump sum regardless of their actual natural gas consumption. The reason is that the size of the compensation does not justify an individual calculation and business transaction for each household. The transaction costs are simply too high, as some households can be expected to open up a relatively long and time-consuming dialogue with the gas company on minor details.

Instead, the district heating company will quality assure the calculation for all the small-scale customers. The district heating company will also facilitate a smooth transition by paying the lump sum for all the small-scale customers. The compensation will be repaid via a slightly higher heating bill each month for maybe 1-5 years, depending on the actual size of the compensation. Experience shows that this setup works well, and no complaints have yet occurred.

Size of compensation in Denmark’s three natural gas distribution areas

The compensations in Denmark’s three regional natural gas distribution areas are shown in the table below:

Compensation to Denmark’s three natural gas distribution companies in 2012.

The annual adjustment of the lump sum towards 2020 is exemplified below for individually owned houses and other small-scale customers.

Annual adjustment in compensation for small-scale customers in 2013.

Thus, if it is economically sound to implement a new project or heat zone, even if the existing project etc. is relatively new or only has written off a modest part of the investment, compensation is offered. The size and the specific rules for such compensation follow a set of standardized rules.

A compensation scheme in other countries

The specific conditions must be taken into account and must be reflected in the secondary legislation.

One issue to consider is establishing a feasibility study based on quality-assured methods and calculations. This is needed to document the long-term economy and consumer prices of a new district heating supply versus a continued natural gas supply. Such a feasibility study – or a temporary, simpler method – must be developed. The Danish District Heating Assessment tool (DHAT) could serve as such a feasibility study. This Excel-based tool and manual can be downloaded free of charge from the homepage of the Danish Energy Agency: https://ens.dk/en/our-responsibilities/global-cooperation/district-heating-assessment-tool-dhat.

Another issue is access to the required data on natural gas consumption, prices, remaining debt, etc. from the (maybe private) natural gas companies must be ensured. Legal amendments may be required before the data can be accessed.

A third issue is the size of the inflation. If the net consumer price index increases by more than 5 % per year, the compensation will increase and not decrease from year to year. This may give the gas companies an incentive to slow down the compensation projects, as their compensation increases until the end of the compensation period. Alternatively, a fixed annual reduction of, e.g., 5 % or X % can be used.

Other issues of potential relevance could be considered.

For further information, please contact: Ole Odgaard at oleodg@mail.dk.