by Linda Bertelsen
Pricing Heat Sources for District Heating Networks, by John Tang Jensen

Pricing waste heat sources for District Heating networks should be based on sharing the “space available for negotiating heat price,” which is a price found between the marginal heat production price by the heat source owner and the substitution heat price, which is the price the district heating company can produce the same heat for by themselves. When heat/electricity and heat/cooling are produced in combination, the marginal heat production price can be established by agreeing on how to share costs. In a situation where many heat sources are available in a heating network system, it may be beneficial to split the pricing into a capacity payment part and a variable payment part to ensure the sources with the lowest marginal prices are dispatched first without losing capacity in the system.

By John Tang Jensen, District Heating Expert

Published in Hot Cool, edition no. 2/2024

This article aims to establish an understanding of which elements, procedures, and methodologies are needed, from identifying a potential waste heat source for district heating to negotiating and agreeing on a price model in a contract benefitting both the heat source owner and the district heating network company.

This occurs on purely commercial terms, and the idea that someone MUST take or give surplus heat is not relevant. However, it requires that it makes sense for both parties, and therefore, one must engage in a commercially based negotiation.
Establish cooperation between the heat source owner and the district heating company.

The business thinking in an industrial plant compared to in a district heating company is often very different, and the two partners need to understand the thinking on the other side of the table. This is important, as both partners need to understand the drivers for business in each company; otherwise, it is unlikely that a contract will be made and signed– similar to any other business negotiation.

The need for often short-term payback and limited investment resources in an industrial company cannot be neglected. At the same time, they must fit into the long-term thinking and constant and reliable supply required from a district heating network company.

Analysis of the heat value and its influencing factors

The value of heat primarily follows the temperature of the heat, but other factors also influence the value. Suppose delivery is unreliable or cannot be predicted well – in that case, the district heating company may need other and more expensive reserve-and-peak-load capacity and potentially also needs to establish storage capacity – all factors affecting the heat price that can be paid.

Delivery capacity in itself has value, and if the heat network can save on or avoid investments in reserve-and-peak-load equipment, this can be included in the price negotiations. Finally, flexibility has a value, which means heat price can be higher if delivery can be flexible over the day and year, e.g., in peak demand situations. The heat source owner needs to know how much waste heat the district heating network company can purchase and if there are any restrictions, for example, regarding summertime delivery.

For the district heating network company, knowing something about the production pattern in the industrial plant can be beneficial because the heat delivery will follow production patterns, e.g., if there are seasonal stops and weekly fluctuations. The DH company also needs to evaluate the risk of the heat owner stopping if, for example, the product produced is at the end-of-life cycle or can be expected to be replaced by other products or if the plant simply moves the production to other places.

Waste heat should always be extracted from the most efficient production lines to avoid decreasing heat delivery if the production line is renewed. The present energy input to an industrial plant can be a good starting point for initial discussions. When understanding energy input, the two partners get an idea about potential delivery. Experiences made by other similar industries can often help in understating temperature and the amount of waste heat available.

Regarding possible heat delivery compared to heat demand and capacity need, the heat source and demand often do not fit perfectly. The heat network then often needs to be enlarged before delivery can be feasible, and delivery may be postponed until the heat network size fits, or the contract has to take this into account, making it even more complex.

After the initial collection of information, both partners need to evaluate the risks before it is decided to carry on. If risks and investments are high for one partner, they must be addressed in the following negotiations.

Heat source price investigation

A heat source investigation can be complex, and often, it can be a good idea for the heat network company and heat source owner, in cooperation, to find a specialist with knowledge about the industrial processes and district heating systems to investigate on behalf of both partners. Industrial plants do not want to spend much on investigations as it is not their primary business.

Often, the district heating company or government can finance the investigations through subsidies. Some of the first investigation steps, though, can be done before a specialist is hired, as it is pretty easy to determine the grade of the heat source and to understand the expected lifetime of the industrial plant or the production line from which the waste heat can be utilised.

Besides temperature and possibly delivery profile, the investigation needs to explore investments, operating costs, maintenance costs, and, in some cases, losses and savings on both sides. For a power plant, changing to CHP will decrease electricity production, and income will be lost. Savings can, for example, be investments in new and existing equipment and costs for cooling heat away in power plants (cooling towers), data centres, wastewater treatment plants, supermarkets, industrial plants, etc.

For some categories of industries, like food factories, the input energy is used for both cooling and heat production. By reusing the heat energy from cooling production, these types of factories can often reduce both the energy demand and, thereby, the available waste heat. The investigation must first focus on using the waste heat for internal purposes.

The heat source investigation should result in a calculated average waste heat production cost, including cost and saving on investments, O&M, other losses, and savings, but before a profit, calculated for the number of years selected for the first contract period and taking into account the risks regarding delivery. This price is often called the “marginal delivery price” or “cost-based price”.

The heat source investigation and average waste heat production cost should be based on the possible heat temperature without including energy-using equipment to increase heat temperature. How to increase temperature, if necessary, should be a part of negotiations.

Heat network price investigations

Like the investigation done by the heat source, the district heating network company should also make a price investigation. The heat network price investigation should include all operation and maintenance costs (O&M costs) for the existing heat source(s) that the new heat source heat will replace calculated for the agreed contract period. Heat consumers would otherwise pay investment costs twice for heat capacity if the district heating company already has sufficient heat production capacity.

This is why investment costs are not included in the heat network price investigation. Suppose the heat network company does not yet have sufficient heat source capacity. In that case, the price investigation should include investment costs for the capacity not yet established—both in connection to the heat source and other investments.

According to the above, the costs for its own heat sources during the expected contract period can then be calculated as an average heat production price for heat delivered to the network. Suppose the district heating network saves or adds costs like emission trading system (ETS), taxes, or other operational costs by purchasing waste heat. In that case, these should be reflected in the heat price calculated. The calculated heat production price is often called the “substitution price” or “contrafactual price”, meaning the heat price that can be substituted by cheaper waste heat sources delivered instead.

Negotiating the heat price

To agree on a contract and establish the heat price, the heat substitution price needs to be higher than the marginal heat delivery price. If the heat is too expensive, the negotiation stops. Figure 1 shows the principles for waste heat price negotiation.

Figure 1: Principles for negotiating waste heat price.

Figure 1: Principles for negotiating waste heat price.

Sometimes, the marginal heat delivery price is high because heat delivery is limited due to low heat network demand compared to the capacity for waste heat delivery or if another cheaper heat source is blocking heat delivery, e.g., during the summer. Expanding the heat network can increase demand and decrease marginal heat delivery prices, bringing the marginal heat delivery price below the substitution price.

The difference between the heat substitution and marginal heat delivery prices is the room for negotiating the heat price. If the partners have investments on the same level, the negotiations can end so the partners share the space equally.

There are no rules about how the heating price should be negotiated and how the space for negotiating the heating price should be split – but both partners are interested in reaching an agreement. Both partners’ risks, though, need to be evaluated, and the price may be adjusted in the contract period according to risks.

If one of the partners needs to invest more than the other, it creates a higher risk for this partner. This risk can be aligned by up-front payment from the partner with a low investment to the one with a higher investment or through a large share of the “room for negotiation.” Also, the expected pay- e can influence both the timing and share of the “room for negotiation.”

Often, the waste heat source owner requires a short payback of investments, which is impossible if the common surplus is split equally. This can be solved by letting the district heating network company pay a more significant part of investments from the beginning, but if the price is split equally, the payback time may still not be satisfying.

The district heating company is often better suited for long-term investments. The solution then may be to split the price with a higher payment at the beginning of the contract period and a lower one later in the contract period.

However, this solution needs a guarantee or insurance for the district heating company because the heat delivery may dry out before the end of the contract period, and the investments may not be paid back.

If the waste heat is expected to be delivered to a heat network with more heat sources, there is a risk that some of the other heat suppliers can provide a price lower than the heat price offered. Then, the heat network can no longer purchase the volume of heat agreed upon.

This can be solved by making a “Take-or-pay” contract, which will ensure that the agreed minimum heat delivery will be purchased, as the heat network company will have to pay anyway when not enough heat is used. Another approach is to let the district heating network company pay all the waste heat suppliers’ investment costs up-front or by separating capacity payment from energy payment. The supplier’s investment risk is removed, and heat sold is simply a revenue stream.

This solution further gives flexibility and is generally better for the district heating network, which can always choose the cheapest heat source, and the risk for the heat supplier is also lower.

Contracts with CHP plants, waste-to-energy plants, and cooling.

To establish the marginal heat delivery prices in a Combined Heat and Power (CHP) plant producing both heat and power simultaneously, it is either necessary to determine the extra fuel use for producing the same amount of electricity in CHP mode compared to power alone mode (extraction mode) or agree on a fair cost-sharing (backpressure plants).

For waste incineration CHP (WtE CHP) plants, finding a marginal fuel price based on fuel consumption is impossible. This price will be negative due to a negative fuel price (the WtE plant gets paid for taking the waste). The solution is to share costs between the waste and heat side and include the income from selling electricity in the cost-sharing.

In most cases, heat from cooling processes is regarded as waste heat, and the marginal heat price can then be calculated according to the general “negotiating heat price” principles. But in some cases, cooling is established in a way that makes it possible for the cooling equipment (a heat pump) both to deliver cooling to a needed cooling temperature and heat to a needed district heating forward temperature. In this case, the combined cooling and heat process may need to share the costs.

Contracts for low-grade infrastructure and ambient heat sources.

Low-grade infrastructure heat sources from wastewater treatment plants, data centres, electric transformers, mines, subways, gas compressors, freshwater systems, etc., and some ambient sources like, for example, canals, pumping sources, and geothermal sources are all categorized by having low temperatures not possible to use directly in district heating systems.

Heat pumps are needed, and often, the best solution is for the district heating network owner to invest in and establish the heat collection and production equipment. Investments and operation costs are often high, and “room for negotiating” a price for utilising the heat source is typically non-existent. However, the heat source owner will then not be financially interested in utilisation and developing the heat source.

Sometimes, goodwill and the possibility of marketing the green solution can be of value to the heat source owner, and the DH company can support that. Anyway, the best way forward is often to offer the owner economic compensation through a (small) annual or monthly fee for using the source independent of the heat taken.

The payment can also be rent for land or the right to use the heat source. A symbolic payment per MWh may also be relevant, which can be essential for keeping the heat source owner interested in maintaining the relationship.

In conclusion, setting the price for different heat sources is very much like setting the price for any other long-term service or product a company needs. Here, the quality (temperature), cost of connecting, saving in other processes, the required investment profiles, expectation to payback time, the quantity, time of delivery, etc, are all components that need to be understood and negotiated. External factors like supporting the local community with low-cost heat or a green profile for the heat owner can also influence the negotiations.

For further information, please contact: John Tang Jensen, jtjensen10@gmail.com

Pricing heat sources for district heating networks” was published in Hot Cool, edition no. 2/2024. You can download the article here:
Pricing Heat Sources for District Heating Networks, Hot Cool article, by John Tang Jensen

meet the author

John Tang Jensen
Senior Advisor