How can current pressures to make moves towards low-carbon energy supplies be used to deliver the increased uptake of distributed technologies, such as CHP and district heating systems? John Piggott contrasts the approaches taken historically in the UK and Denmark, and takes a look at policies needed to value heat as well as power.

As policy initiatives for carbon abatement filter their way down from governments to industry, their interaction and complexity throws up many dilemmas for politicians and practitioners alike. What can be seen at national and indeed global level as a common-sense objective – to save carbon and money by collocating energy supply with demand – can be difficult to translate into clear incentives for those whose participation is required to bring any changes about.

Energy infrastructure is capital intensive and, in most developed countries, highly centralized. In the UK in particular, that means that the power and heat generating mix is locked into long-term investment cycles so that changing to a local energy model would be difficult, slow and expensive. So, in order to bring about a migration towards a local, potentially lower-carbon model, strong incentives are needed.

The UK government, like its European counterparts, is in the process of implementing new regulations requiring carbon abatement in new buildings. These regulations require a proportion of heat and power to be produced on-site, using low-carbon or renewable technologies. This has dragged many property developers into the energy services market for the first time and has caused a flurry of interest in on-site cogeneration.

This model relies on a market push, in this case a push on the property development industry, but our current economic troubles throw into sharp relief a fundamental flaw. In essence, the UK system is a land tax, diverting development profits into local, low carbon energy projects – but it is only effective if there are excess profits in the real estate development sector. With the collapse of property prices in the second half of 2008, the momentum has all but left the property market, leaving this carbon abatement intervention without any economic motive force.

However, the hiatus in the rise in land values may be seen as a short-term market correction. Land is intrinsically limited in supply, whereas demand for energy increases with economic growth, so an environmental tariff on land as a mechanism for delivering local power production may take several economic cycles to take effect.

INFRASTRUCTURE COSTS

A contrasting case often cited in the UK, is the success of Denmark in promoting distributed energy and, in particular, heat networks of a city scale. The Danish story is quite different to the UK version, because the development of the respective national energy infrastructures are controlled in a fundamentally different way.

Compared to the UK, Denmark, like most of Scandinavia, is relatively sparsely populated and rural. Until the North Sea gas and oil revolution, there was little gas infrastructure in Denmark and, when gas did become available, the Danes were careful to plan the market for it on geographical grounds.

Heat and gas network zones were kept separate and the two were not allowed to compete with each other, so as not to compromise new or existing district heating schemes. This also reduced the cost of the new gas infrastructure. Further, the tax system was used to ensure that cogeneration was the primary heat source for those networks.

In the UK, the natural gas network was progressively extended to cover the vast majority of urban and suburban areas. This now means that the cost of connecting customers to the gas network is very cheap in the UK; about five or six times cheaper than connecting to a district heating network.


District heating pipes– the cost of installation can be considerable
Click here to enlarge image

Tax incentives and long-term price security for wind energy saw that industry grow dramatically in Denmark, to the point that, at peak times, Denmark has to effectively give away its excess to other countries in order to keep its grid synchronized. This model, based on incentives that pull rather than push entrants into the energy market, has seen economic growth decoupled from energy consumption growth in Denmark. This system feeds on the economics of energy consumption itself.

RELATIVE COST OF PRODUCTION

Local energy can be more efficient than centralized energy, if supply and demand of both heat and power are well-matched in terms of timing and scale. If the relative cost of capital and fuel are favourable, then local energy can also be more economical. Even with impressive technical advances, such elegantly balanced examples are extremely rare, however, and so for a transformation of energy efficiency across a whole economy, some financial adjustment is necessary. Incentives such as guaranteed prices for electricity, tax recycling and others, work within particular markets.

For example a tariff on electricity that is used to fund renewable energy will affect buyers and sellers of electricity, but not necessarily in proportion to their influence, and it doesn’t affect major gas users at all. One of the fundamental problems with incentivizing the mass take-up of distributed energy is that, at small scale, local energy production is more expensive than its centralized counterpart (in all but those examples mentioned).

There are also interesting cultural differences between the UK and Denmark. In the UK people generally move house about every eight years, which makes homeowners reluctant to invest in things that take a long time to pay back. Also in the competitive UK energy market, the British have grown used to having the freedom to change energy suppliers.

By contrast, in Denmark, collective ownership seems to be more culturally acceptable and most district heating companies are owned by their consumers and are regulated by the state. Before the advent of cheap refrigeration, many Danes came together to build shared cold-stores, a perfect example of co-operative investment.

AFFORDABILITY

Stable energy prices depend on interchangeable energy sources; so that a range of fuels can be chosen from, according to price. Many European countries currently depend on natural gas imported from Russia for their energy. Periodic disputes between Russia and its neighbours have caused disruption to European gas supplies, with the knock-on effect that overall, energy prices are made more volatile. This in turn means that many domestic energy consumers face sudden, potentially unaffordable real price increases.

In the UK, a household that spends more than 10% of its income on energy is termed ‘fuel poor’ and addressing this is a major objective for the UK government. Renewable energy and local distributed energy both often carry a cost premium over energy from conventional, mature utility networks. This means the marginal cost of energy is higher, creating an affordability problem if those costs are passed through to the consumer.

Unless the additional capital costs of on-site, compared to central plant, can be neutralized, pushing on-site power production can make fuel poverty worse.

Let us assume for now that we continue to encourage on-site power production by making it a requirement for new buildings. This will presumably increase the cost of new buildings or the cost of energy, or both. Since the price of a building is largely a function of other buildings, any tariff that raises the price of a new building, whilst leaving the price of existing buildings unchanged, will reduce demand for new buildings. Hence a tariff placed on new build could easily be self-defeating, since it will reduce the demand for and migration towards newer, more energy-efficient buildings that incorporate some of their own energy supplies.

Such a dilemma could be overcome, if the additional costs of producing the new building and its energy equipment are taken care of. This would then allow new development to compete for demand without an onerous cost premium on the buildings or their energy, whilst delivering carbon abatement through on-site energy production. Of course, more expensive new buildings might encourage the market to refurbish existing buildings. It is very difficult to regulate refurbishment though, so that is unlikely to deliver significant carbon abatement.

HEAT AND POWER REGULATION

In the UK, like many developed countries, the supply of electricity is highly regulated when compared to heat, which has little or no associated regulation other than indirectly for gas supplies. The cost of acquiring and retaining an electricity license in the UK is prohibitive at the small scale generally associated with local energy. The simple reason for this regulatory asymmetry is that heat distribution is limited in scale, being expensive and hard work, so the more active markets, which require regulation are the ‘primary energy’ ones for fuel and power.

However, since heat networks are often publicly sponsored monopolies, a major part of the cost of setting up a new district heating scheme goes into creating a suitable regulatory ‘microclimate’ in which it can live. Unlike the Danish system, in the UK contractual arrangements stating who is responsible for what, how much users should pay and what happens when things go wrong, are far from standard from project to project – and anything but transparent.

At present, UK government subsidies aimed at renewable energy are channelled into electricity. There is no mechanism for heat. This can make electricity from renewable sources disproportionately valuable compared to heat, and lead to perverse incentives such as heat dumping from CHP projects. Even with the increases in gas prices, the retail value of heat is low in comparison to the investment required to build a heat network. All of which adds up to a pretty daunting set of challenges to the establishment of the new heat networks that are necessary for reducing the marginal cost of cogeneration.

The most serious problem for district heating in the UK is the cost of connecting customers. Compare district heating with the gas network: the major part of the UK gas infrastructure was funded through the public utility system before privatization and is now a mature network. The marginal cost of connection to the existing gas system is about £500 per dwelling. The cost of the first connections to a new heat network will be much higher – £1000 to £3000 in urban areas.

The recent ‘Citiworks’ case in the European Court of Justice, has brought the issue of electricity supply licensing into renewed focus and has potentially major implications for distributed energy. A company called FLH, which is the incumbent energy services provider at Leipzig Airport, was challenged for preventing competitors from supplying electricity to its customers. It had been operating a licence-exempt ‘site network’, sometimes referred to as a ‘private wire’ system, in which it owned the electrical distribution system leading up to its clients’ electricity meters. It refused to carry electricity to those customers from other suppliers, including Citiworks, which a licensed network is not allowed to do.

The European Court of Justice upheld the Citiworks claim that, licensed or not, FLH was obliged to allow third-party access. Since the main reason for private wire networks is to create mini-monopolies for retail sale of electricity, this ruling undermines the rationale of investing in a private wire network in order to retain customers.

In the UK, if a distributed energy company sells the electricity it generates to the wholesale market, rather than retail, either because it cannot afford a licence to sell electricity retail or because a licensed supplier has ‘poached’ its customers so that it can only sell wholesale, it stands to lose about 50% of its potential income from power generation. Although the Citiworks ruling comes as no surprise, it may help to frame the context in which the UK government can create new incentives for distributed energy.

SOCIAL LIMITS

Like many countries, in the UK the uptake of a particular fuel or energy source has largely been left to the market. The economic cost of finding, processing, converting, distributing and retailing energy, has driven the market share that each competing energy source enjoys. Oil progressively replaced coal which in turn was replaced by natural gas, the cost of energy has now been reduced, making it more affordable. This to some extent has discouraged efficiency. The cost of being efficient through the use of technical solutions has reduced, so the market delivers a level of efficiency that could be considered to be economically ‘optimized.’

However, this is only true when it is seen from the perspective of the individual, who is seeking to optimize his/her position. The individual might well have a preference for wider use of renewable energy, with the environmental benefits. The individual cannot achieve this on his/her own, and it could be argued that they are wasting their money if no one else bothers.

Whereas social trends might encourage altruistic example setting by those that can afford to, it is questionable whether such behaviour can have any long-term effect in a market. Markets, efficient though they are at fulfilling individual needs, are not effective mechanisms for delivering social benefits as long as individuals feel that they cannot change the market. It is argued here that the environmental and energy security benefits that stem from the increased uptake of on-site low carbon power generation are benefits for society as a whole and that they are best addressed collectively.

It can be seen that, by directing national spending and limiting the development of the energy market, Denmark socialized the cost difference between central and local energy sources. For those of us who live in countries that allowed the energy market to develop without those restraints, the cost of migrating from a centralized to a partly decentralized model is far higher than if we had planned it that way. The dilemma that we face is that, in order to migrate to local, affordable low-carbon energy, we have to have social action, yet seem to be constrained to work through market mechanisms.

My counterparts in Denmark tell me that they are envious of our scope for market choice in the UK. The fact remains that if we are to deliver on our carbon abatement promises without either passing on the cost to consumers without a choice, or exacerbating the destructive cycles in the property industry, there seems to be no choice but to take the decision out of the market, by socializing the additional costs.

John Piggott is with Arup, London, UK.
e-mail: john.piggott@arup.com