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Planning Smarter Cities: Developing District Energy

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"District Energy" is a term widely known in the energy field, but seldom enters the conversation of city planning. District energy has been popularized by EcoDistricts, an organization that embodies a paradigm shift in urban planning which includes utility services as a component of community development. District energy is not a new concept; there are hundreds of legacy systems the U.S and thousands worldwide. As district energy is reimagined in the city planning process, new models of development, governance, and financing are being considered for these systems.

Thomas Puttman, founder of Puttman Infrastructure, develops district energy systems that provide steam, cooling, and electric to a group of buildings based on local energy production. These systems can serve from as few as two or three buildings who as many as 1,800- as with Consolidated Edison's Steam System in Manhattan. Larger utilities such as Veolia typically acquire and maintain legacy district energy systems in downtowns. Puttman is working with cities like Seattle, San Francisco, and Portland to explore opportunities for new district energy that can help cities meet their climate mitigation goals.

Emerging Trends in Developing District Energy

Electricity and water utilities have consistent development models. Utilities recoup costs based on the rates charged to their end users, such as the cost of electricity ($/kWh) or water ($/gallon). Utilities also bear the large, upfront cost of building infrastructure. District systems traditionally have end users like universities or medical facilities who can sign up to purchase reliable power through a contract called a Power Purchase Agreement (PPA). The PPA ensures a stable and predictable future cash flow which is a key component in project financing.

Without the buy-in from end users, developers cannot deliver the PPA necessary for project financing. It is easier to secure buy-in from a university campus than a group of downtown building owners because universities have single land owners. It has thus been more difficult to secure financing for new district energy systems in downtowns.

Seeding DE in New Development: Some district energy systems are being seeded in new development, like Related Companies' new heating and cooling systems in Hudson Yards which will serve upwards of fourteen million square feet of mixed-use space. This is a special case where many of the barriers to district energy were absent: there was a single developer for the property and they would not have infringed on existing utility franchises.

Each building in Hudson Yards 'plugs into' the district system, eliminating the need for in-building boilers and chillers. Existing buildings would have to undergo modifications to join a district system, thus making new district systems in existing downtowns a difficult sell.

DE in Existing Downtowns: To support dialogue around a district energy concept, an Energy Improvement District (EID) was authorized by 2007 legislation in Connecticut and created by the City of Stamford by municipal ordinance.[1] The EID is established as part of a Power Purchase Agreement when a group of property owners form a board, agreeing to buy power from the new system. A private initiative under the public rubric, the EID allows private property owners to provide thermal and electric energy for one or more buildings. The Stamford project was thwarted in part because of the property owners' discomfort with long-term power purchase agreements and modifying their existing buildings to link into the district system.[2]

Living City Blocks, a Denver based non-profit, presented at last year's EcoDistrict Conference about their district energy pilot in New York City's Gowanus Canal district. Their work in New York and Denver has proposed new financing models for groups of building owners to take collective action. LCB envisions a financing tool similar to PACE that helps fund shared rooftop solar panels.

Ownership and Governance Models: Downtown district energy projects may require a Special Purpose Vehicle (SPV) to raise the funds from public sources and secure buy-in from prospective end users. SPV's also coordinate and execute a project that could include multiple projects and project owners. SPV's can be community development corporations, municipal or cooperatively owned utilities, or non-profit groups.

Special purpose vehicles like the Hudson Yards Development Corporation (HYDC) have successfully piloted the use of city government-backed bonds for infrastructure financing. HYDC has financed over $3 Billion in new infrastructure via this route. Similar bonds can be issued for district energy systems as well to help private developers finance the significant upfront capital costs of such systems.

Often, district systems require a public private partnership to make district energy financing feasible. District Energy success stories include systems that are cooperatively owned, joint ventures between cities and developers, and unregulated private utilities. Each success story has a unique regulatory environment, pricing strategy, and financing model. See the diagram below for a reference of ownership and operating models provided by the EcoDistricts group in a 2011 report.

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Figure: District Energy Ownership and Operating Models[3]

Governments can also consider the Landlord Model where the public sector funds and/or develops the majority of the infrastructure, especially those components requiring significant investment and regulatory approval. The private developer makes minimal capital investments and operates the system for a fixed concession period under a lease or revenue share method.

Existing Sources of Capital: Corix, a district energy utility company, is 100% backed by PE- BCIMC- a Canadian private equity fund with long term, low risk investments. They invest in infrastructure because it is long term and the PPA guarantees a steady and reliable cashflow. They find it to be a simple investment model that commands an average return on investment of 12%.

However, unless there are significant chances of expansion or escalation in revenues, the upside – the potential to gain through revenue growth or capital gains – is limited. This generally tends to make this type of investment unattractive to venture capital or private equity firms that tend to seek higher returns over shorter periods of time. Typically, private equity firms tend to target returns of at least 20% and have investment horizons of as low as five years.


Looking Ahead

There are major milestones to achieve before these models can become reality.  Reports such as NYSERDA's Microgrids in New York, and the sister report commissioned by MassCEC this year, outline the myriad barriers to developing district systems. As the regulatory issues are overcome with more pilot projects, we may see a rise in confidence for end users and the investment community.

Hurricane Sandy reminded business owners and building owners that the disturbance of critical infrastructure systems can ripple through economies and lives. Dr. Sarah Slaughter, of the Built Environment Coalition, argues that district services not only increase system reliability but also provide more opportunity for innovation, jobs, and positive environmental impact.

 

This post was co-authored by Ajay Prasad, Managing Director of  India Investments at Taurus Investment Holdings in Boston, MA.

 


[2] Sherman, Genevieve. "Sharing Local Energy Infrastructure." MIT Masters Thesis 2012.

[3] Portland Sustainability Institute. "District Energy Development Ownership and Governance Models." March 2011. Accessed 6/10/2013. http://www.portlandoregon.gov/bps/article/349828