DISTRICT HEATING DEVELOPMENT – through fair conditions for the consumers

Heat demand densities and consumer connection rates determine DH systems’ economic viability and sustainability. Hence, encouraging heat consumers to connect —and remain connected— to the local DH system is essential for DH implementation and continuation. However, discussions and the ensuing confusion on the most suitable institutional conditions for encouraging consumers to adopt DH are still ongoing in several EU countries. The study we present here intends to contribute to the ongoing policy discussions.

It’s (almost) all about consumer connection rates.

District heating can provide environmental and economic advantages in targeted areas compared with other low-carbon heating solutions such as individual heat pumps. Therefore, together with energy efficiency measures, DH systems could play an essential role in decarbonizing the heating sector and the whole energy system in the EU. Yet, the potential for DH deployment is largely untapped in many EU countries, such as Germany, Poland, and Spain, for example.

Residential heat from a consumer’s perspective

Empirical examples from various European countries (including Denmark, Germany, Romania, Sweden, the UK) show that DH companies can misuse their monopoly position and the consumer lock-in effect. Misuse can lead to disproportionate heat prices, price discrimination to attract new customers, complex bills, and tariff structures that discourage DH demand reductions. It can also result in a lack of security of supply, few hours of availability, lack of flexibility at a household level resulting in too low/high indoor temperatures, poor customer service, etc. Such malpractices may put residential DH consumers vulnerable and hinder DH adoption.

DH systems are natural monopolies of local nature, and thus, the control over the decision-making of district heating may be in the hands of just a few people. Furthermore, unlike in electricity and gas systems, there is little space for competition between producers and retailers. Therefore, DH production, distribution, and retail are often integrated under the same company. This structure has several implications, including that dissatisfied DH consumers cannot choose another DH supplier, with their only option being to invest in another heat supply system. Therefore, the consumer lock-in effect is more robust with DH than with other heat supply technologies. Individual heat pumps or natural gas boilers depend on natural monopolies but (have been regulated to) offer consumers the possibility of changing their retailer. The particularities of DH demand the institutional conditions that safeguard consumers’ interests and rights for the DH systems to be trustworthy.

Protecting consumers to promote DH

DH companies’ malpractices (see box 1) may counteract DH’s comfort and economic advantages to consumers. It may distrust DH systems and encourage consumers to adopt alternative heating solutions. Thus, the design and implementation of fair institutional conditions, based on an appropriate balance between consumer power mechanisms (see box 2), could be essential for DH deployment and continuation in EU countries. We understand that conditions for consumers are fair when DH companies comply with their duty of heat supply and customer relations at satisfactory quality levels while charging a reasonable heat price.

We investigated why the different institutional frameworks managed or failed to promote fair conditions for DH consumers in the context of Denmark and Sweden. Below we present the primary outcomes and lessons from our study on the topic. 

Understanding consumer power on the monopolistic DH companies

The analytical framework for ‘consumer power in natural monopolies’ distinguishes four dimensions of consumer power (or categories of institutional conditions) concerning natural monopolies: ‘state regulative power,’ ‘ownership power,’ ‘buying power,’ and ‘communicative power.’ The combination may result in various configurations and levels of consumer power.

The hypothesis (supported by this study’s results) is that there are links between the configurations and levels of consumer power and DH companies’ behavior regarding respecting consumers’ interests.

Why compare Denmark and Sweden?

Denmark and Sweden have succeeded in reaching and maintaining high shares of residential buildings supplied by DH: Denmark (64 %) (19) and Sweden (51 %). Despite similarities, the countries have implemented somewhat different regulations and governance models regarding DH systems’ price and quality control during the last few decades. When comparing DH in Nordic countries, Sweden has the largest share of commercial ownership and the softest public regulation for DH, with no price regulation and a free consumers’ choice of heat supply technology. In contrast, Denmark has the largest share of consumer ownership and the strictest public regulation for DH, with a non-profit (or cost-based) price regulation and, until recently, the possibility to oblige consumers to connect and remain connected to the local DH system. Furthermore, some examples of DH companies misusing their monopoly position have been seen in Denmark and Sweden. 

Lessons from Denmark and Sweden

Below, we outline our study’s insights; in box 3, we introduce policy recommendations.

1. Free choice of heat supply technology alone does not put sufficient pressure on DH companies to set reasonable DH prices. It must be supplemented with regulation, high transparency, communicative power, and possibly high or very high ownership power (e.g., as in local consumer cooperatives or local municipal companies).

   1.1. To ensure a free choice of heat supply technology, individual heating solutions must be available at a competitive price with DH. However, DH can be cheaper than individual heating from a socio-economic perspective, especially in areas densely populated or with excess heat. Therefore, creating effective market competition can result in additional costs for society due to the economic incentives that would be necessary and the reduction in the connected heat demand density.

• Strong price regulation (such as the cost-based regulation in Denmark) does not ensure reasonable heat prices unless high or very high ownership power is in place (e.g., through local consumer cooperatives or local municipal companies). It should also be coupled with high levels of transparency and communicative ability. Additionally, it could also be essential to address information asymmetry, agency problems, and lack of expertise.

• Ownership of DH companies influences DH prices and transparency. Under the same regulation, consumer cooperatives and municipal companies result in lower DH prices and higher transparency than commercial or state-owned companies. In Sweden, companies with cost-based pricing are more open about their costs than those with market-based pricing.

• With the right combination of policies and regulations, local consumer cooperatives and municipal companies can develop and run DH systems and contribute significantly to DH implementation. In Denmark, 94% of the DH demand is supplied by local consumer cooperatives and municipal companies; in Sweden, about 63% is provided through local municipal companies. Cultural aspects may influence the choice of ownership.

• Regulatory Authorities might not identify all law infringements or questionable practices by the DH companies. Transparency, access to information, and media coverage are essential to monitor and control DH companies. However, for this to work, Regulatory Authorities and policymakers must address the issues, protecting consumers’ interests and rights.

• Management of DH companies requires knowledge and expertise to avoid poor managerial decisions. Standard guidelines on investment decision-making, merging small companies, and customized expert support could support good management in DH companies.

• Short-term cost reduction approaches may lead to, e.g., poor system maintenance and higher future costs.

Policy insights to support DH systems development

– DH regulation is necessary to protect residential DH consumers, whereas opting for less or more strict regulation may depend on national or regional preferences.

– It is crucial that DH regulation promotes high levels of transparency regarding DH decision-making through regular publication of DH prices by the regulatory authorities, access to financial and technical reports, etc.

– Promoting local and inclusive ownership models (such as local consumer cooperatives or local municipal companies) could be of utmost importance to guarantee that residential DH consumers’ rights and interests are safeguarded.

This article is based on the research outcomes presented in the scientific paper ‘Getting fair institutional conditions for district heating consumers: Insights from Denmark and Sweden’,  published under the Creative Commons Attribution 4.0 International License (CC BY 4.0). The above article contains some extracts (sometimes with minor modifications) from the original scientific article.