Home Articles TARIFFS, ACCOUNTING, AND BUDGETING IN DISTRICT HEATING COMPANIES

TARIFFS, ACCOUNTING, AND BUDGETING IN DISTRICT HEATING COMPANIES

by Linda Bertelsen
Tariffs, accounting, and budgeting in district heating companies

District heating companies are, in many aspects, not different from other companies selling goods to consumers. There is only one product, “heat,” and the price normally is the same for all customers. The district heating companies, though, have a monopoly, and the sales for the coming budget year are predictable and follow a season with high sales in winter and low sales in summer.

By John Tang Jensen, District Heating Expert, Danish Embassy London

This article was published in Hot|Cool edition no. 1, 2024

Budgeting and accounting then should not be much different and probably easier compared to other industrial companies operating on unpredictable market conditions and market prices. There are some principles that may need to be considered when making budgets, tariffs, and accounting to ensure best practices are used and provide utilities with a stronger position in case of conflicts. The most important principle is to keep heat price development stable because heat is a large part of the consumer economy, and consumers do not like sudden price increases and prices above alternatives, which causes conflicts. This article discusses some important principles regarding tariffs, accounting, and budgeting, which can make the district heating sector and company pricing reliable and fair.

Pricing principles

To ensure reliable and fair heat prices, some principles should be followed regarding transparency, discrimination, cross-subsidizing, and investment allocation.

Transparent

Heat prices must be transparent and comprehensible for consumers, which means the payment must reflect a cost that can be found in budgets and accounting reports. If, for example, prices are based on budgets, the district heating company should publish prices for all consumer groups on the website or send them to customers by mail/letter.

Non-discriminating

Prices must be non-discriminating, which means payment for consumers having the same capacity demand and annual demand profile should be the same. If this principle is followed, it, for example, should not be possible to charge different prices between consumers depending on distances from the network (Periodic payments).

Normal heat network consumers have a heat demand profile related to outdoor temperature and the use of hot tap water because most district heating consumption is for heating buildings and hot water. It is non-discriminating if this consumer group has the same payment for the same capacity and delivery.

For consumers using the heat for different purposes having a capacity and profile not related to outdoor temperature like industry (processes), paint shops, swimming pools, churches, etc., it would be discriminating if these consumer groups are not identified separately and have own pricing according to the cross-subsidization principles.

When it comes to prices for connecting consumers, the price can be dependent on actual connecting costs, a standard connection fee, a price per meter branch pipe, or a combination of the last two (One-off payments).

Cross-subsidization

Heat prices must be cost-reflective, which is when each individual heating consumer partly pays the costs inflicted on the district heating company by the consumer’s connection to the network and presence as a consumer and partly the costs associated with heat supply.

Investment allocation

If investments are paid too fast by consumers compared to the lifetime of the equipment, early consumption can subsidize late consumption. This can also be an issue if heat network companies (for flexibility, supply of security, and price security reasons) invest in more complementary heat source capacity than necessary. Capacity that gives the choice to choose the cheapest heat sources and to store heat produced when prices are low and used when prices are high can be beneficial for heat network companies. Such capacity choices deliver low heat prices over time, but if a loan is paid too fast and depreciation is too fast compared to equipment lifetime, consumer prices momentarily can get very high. If extra heat source capacity, for example, is established for flexibility reasons, the average equipment lifetime will increase, and depreciation time should follow this.

If the equipment is not used much, though, the lifetime cannot be expected to be forever. Then, it may be suitable to set a maximum depreciation time of, for example, 30-40 years, but without any requirements on linear depreciation.

Impact on tariffs

The pricing principles mean that the tariff system must be constructed in a way that ensures the following:

  • The fixed costs of the district heating company are covered by fixed fees, and variable costs are covered by consumption-based fees.
  • The costs are covered by income from the tariff elements to which they can naturally be attributed.
  • Each individual consumer pays the share of costs required for its own heat supply so that no consumer will benefit financially at the expense of others – different consumer groups may be established if demand profiles differ.
  • A specific heat source delivery cannot be allocated to a specific consumer, except when third-party access where supply and consumption are by the same company/person and at the same time is a part of regulation.
  • Depreciations should follow the lifetime of equipment, and it should be possible to adjust the depreciation time if the equipment is changing production and lifetime. Maximum depreciation time is perhaps 30 years.

Impact on accounting

District heating network companies have a monopoly, and the government must establish a regulator function responsible for following the sector the same way as for water-, electricity- and gas companies. The regulator’s role is to monitor the sector and to report to society and the Government if the sector is using its monopoly status and power to suppress consumers by not having fair delivery and pricing systems.

Ensuring resilience and consumer protection in district heating

For district heating companies and the district heating sector, it will be resilient and reliable if all are following the same accounting principles because it then would be easier for the regulators to monitor and control companies and solve conflicts between companies and consumers. Especially when it comes to regulation of depreciation, equity capital and profit it is important that legislation and regulator on one side give space for levelling out prices from year to year. On the other side legislation and regulator should not allow unnecessarily accumulation of capital not benefitting consumers and giving profit out of line with normal standards.

Establishing a national standard accounting system

A standard accounting system on national level will give regulator the possibility to benchmark and intervene if companies for some reason do not manage to follow best practice. This require that regulator collect all annual accounts reported to a common system and will be the foundation for following the sector in general and the basis for handling complaints.

Impact on budgeting

A standard accounting system will make it easy to create a budgeting system, where costs can be allocated to Fixed fees and Consumption-based fees. Some costs should allocate direct to a certain fee and others like for example heat source costs should be possible to share between output fee and consumption-based fee, because heat source costs are not entirely Consumption-based costs and may include investments etc. Because district heating network companies have monopoly, transparency is very important, and the direct transformation from budget costs based on standard accounting systems to actual fees ensures that pricing principles are followed.

Leveraging depreciation and equity capital

It should be possible in the budget system to use the depreciating principles and equity capital systems to level out prices. If, for example, fuel or electricity prices go up, depreciation should be allowed to go down and saved capital to be used for holding prices on a lower level. Visa versa if fuel and electricity prices are falling. This is a balance, and if prices in general are going up, of course, heating prices should follow over a longer timeframe.

Optimizing heat prices through complementary technologies in heating networks

Several complementing heat sources reliable on different fuels and electricity is another and more important way of levelling out heat prices. If, for example, a heating network both has a CHP and a heat pump capacity, the CHP heating production should be preferred in time with high electricity prices and heat pumps in time with low prices.

As long as the technology producing the heat is depreciated more according to production and the technology producing less heat is depreciated less, a system with complementary technologies will level out heat prices and benefit both consumers and companies. If the accounting and budgeting systems are not able to follow the use of different complementing technologies, the pricing benefits of having more technologies may be lost in the short term, and projects may not show feasibility.

For further information please contact: jtjensen10@gmail.com

“Tariffs, accounting, and budgeting in district heating companies” was published in Hot Cool, edition no. 1/2024. You can download the article here:
Tariffs, accounting, and budgeting in District Heating Companies

Meet the author

John Tang Jensen
District Heating Expert