The amount of money people must pay up-front to connect to district heating (DH) matters. It affects the number of people who will sign-up, and it impacts the economy and risks of a DH project. In this article, we share insights from Denmark and offer advice on making a DH project more robust.
By Hanne Kortegaard Støchkel, researcher and project development manager, DBDH and Daniel Møller Sneum, Postdoctoral Researcher, DTU – Technical University of Denmark
One of the major uncertainties when developing DH in an area is whether people and companies want to connect. The economy of a DH project benefits significantly if more people connect and if they join early on. Before the energy crisis, Danish DH companies struggled to get potential customers to abandon their natural gas boilers and connect to DH instead. There was moderate interest, and it was sometimes difficult to get enough people interested simultaneously to reach a high enough connection rate for the projects to fly.
Changing the up-front payment has an effect.
Several measures were developed to fix this problem, and one of the solutions was to offer a discount on the up-front payment. Instead of paying up-front, the investments would be paid over many years as part of the heating bill. It would mean that a smaller portion of the investments would be covered for the DH company at the start of the project, but if more people connected, the overall economy of the project would improve.
The experience among Danish DH companies is that changing the up-front payment has an effect, and more people will sign-up. It was mainly a psychological effect but likely also a matter of liquidity for the individual households. Not everyone can raise money for a significant up-front investment. Both DH offers would be equally good for the customer if you look at the overall economic value seen over many years. Still, people are more likely to connect if the up-front payment is lower.
Making an offer that benefits the business case
Two essential parameters in a DH business case are the connection rate and connecting customers in one go to keep costs low. Making use of the psychological effects helps to achieve both. Typically, the process will run like this:
- A time-limited offer: “Connect now and get a large discount on your connection fee.” If enough people sign-up for the project to be economically viable, DH will be developed in the area.
- When the dates for digging are set, a new offer is made: “We come to your area to dig during this period. If you sign up before we start digging, you can still connect with a (smaller) discount”.
The second offer also has a sizable effect; the extra customers connecting adds little additional costs and much value. This will boost both the economy and the robustness of the DH projects.
Same tool – different use
During the energy crisis, the focus in the DH companies shifted. People were now eager to join, but the concern is whether their interest to connect is robust or a short-term effect that evaporates when energy prices stabilize. This has brought about a change in the use of discounts on the up-front payment. It is rare to see up-front payments that would secure the entire investment in Denmark, but discounts are smaller, and some projects have increased the up-front payment.
Before the energy crisis, discounted up-front payments were typically between 0 and 3000 Euros. Now, a broader spectrum is seen depending on the situation. Some DH companies have the philosophy that everyone should be able to have a green heat transition and that connection fees should not stand in the way if the business case is robust. Others have started increasing up-front payments as a tool to reduce financial risks and make sure that people are earnest about connecting. Also, the limit for what people consider a bargain has shifted upwards – allowing the DH companies to secure more funding up-front without significantly affecting the number of customers connecting.
How big is the effect?
Danish DH experts are not in doubt – the effect of discounts is real – but giving a formula is not so easy. It is affected by energy policy, current events such as the energy crisis, and local parameters for the area. What is considered a large amount depends on your income, the value of the building, and the size of your current heating bill. When asked how significant the effect is, the answers from Danish DH experts come from a gut feeling based on knowing their area and listening to the potential customers.
To illustrate the impact and importance of having a realistic understanding of this, figure 1 shows two different situations. The red line represents a situation where the up-front payment is a significant barrier to potential customers, and only 50% would connect if the connection fee is 3.400 €. The dotted line represents an area where the up-front payment is less of a barrier. Perhaps because it is a wealthier area or their current heat supply is more expensive. The figure also illustrates just how valuable it is to put some effort into connecting more customers.
Analyses like this can help DH companies decide on the criteria for going ahead with a project and to better understand the consequences of some of the risks involved. For their company and this project, is it better to ask for 1.700 € in connection fee and aim for a 70% connection rate, or to ask for 10.100 € and aim for a 50% connection rate if they are satisfied with a calculated break-even after 20 years? Or if increasing cost levels are a concern, perhaps they recalculate to better understand the consequences of that risk and decide to play it more safely.
Figure 1: An example of a DH company’s net present value (NPV) for different combinations of connection rate and size of up-front payment. The analysis shows the results for all combinations of connection rate and fee; both two parameters are correlated. The two lines illustrate two situations where the connection rate depends differently on the connection fee (up-front payment).
Source: The report that this article is based on.
A discount alone is not enough.
A good DH project must be attractive to the customers and a robust investment for the DH company. In any given situation, the DH company has a range of parameters that can be adjusted to create the most suitable solution. The size of the up-front payment is one parameter, and others are related to financing, depreciation, tariff structure, and assessment period. Figure 2 illustrates simplified advice on when to focus on the up-front payment.
Figure 2: Changing the up-front payment has an impact and can be a valuable tool, but the correct use depends on the circumstances—an illustration based on experience and analyses.
When trust and interest are moderate or high, there is room to adjust the up-front payment and balance it against needs such as the ability to secure cheap financing, agility to make the most of strategic opportunities, risk mitigation, and compliance with a regulation. Investigating the ability and willingness to make up-front payments and using sensitivity analyses to understand the risks can help DH companies decide which offer to make to potential customers in a new DH area.
If the trust and general interest in joining DH is low, the up-front payment would still have an effect, but it would not address the principal risks of the project. In this case, the DH company should consider that a discount alone might not be enough and use other tools to improve trust and interest. In the case of low trust, a high up-front payment might even reinforce the distrust if people feel the DH company is trying to transfer all the risk to them.
How to get a higher connection rate
The up-front payment plays a role, but the most important tool is effective communication. Keeping people informed, being transparent, building trust, and sharing information about the benefits of having DH. Here are some examples of how Danish DH companies have worked to increase the connection rate:
- Contact large potential customers directly. They are essential for the connection rate and the system’s long-term efficiency. Set the scene for a long-term collaboration and scout for potential suppliers of surplus heat.
- Arrange information meetings at the local school, sports arena, assembly hall, or anywhere with enough room. Make an offer and a process that is attractive and easy to understand for potential customers. Address all concerns and bring a DH unit so people can see what it looks like and how little space it takes up in a home.
- Collaborate with the municipality. The municipality can assist with the process, is used to stakeholder involvement, and share a common goal, as establishing more sustainable DH will help the municipality reach its climate goals.
- Find the right level for the connection fee. Low enough not to be a barrier to the connection rate and high enough not to jeopardize company liquidity or the ability to invest in other projects.
- Give customers a choice between owning the unit or having a service agreement with the DH company. The new service agreement option has become very popular in Denmark, with about 90% of new customers choosing this option and existing customers asking for the chance to join as well.
- A guarantee that the DH company will fix your heating if your current system breaks down while you wait for DH to be installed. This prevents people from being forced to reinvest in a new gas boiler or invest in another alternative, such as a small heat pump. This is a way to keep customers unconcerned and committed to DH while waiting to be connected. Once connected, people very rarely want to leave DH, but the waiting period is a risk to handle.
- Meet end-users where they are online with competent communication: Use Facebook (or other social media). As each project covers a small geographical area, it is not expensive to target exactly the potential customers in that area. With remarkable success, some DH companies have hired a company with knowledge of DH and communication to handle their Facebook communication during the expansion period.
- Local ambassadors can be excellent and trustworthy advocates for DH development. These can be locals with an interest in getting DH themselves. Find them and work with them!
A political tool to ensure a high connection rate is to make it mandatory to connect to DH, but even so, these ideas could be used to increase customer satisfaction and move attention to the benefits of DH.
The up-front payment is a parameter that affects both the connection rate and the economy of a DH project. It can strengthen DH development if used wisely, especially if supported by other efforts to increase the connection rate.