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Increasing the commercial viability of district heating systems

By Markus Bencsits

District heating (DH) and district heating systems (DHSs) are widely considered as an effective way to reduce the carbon footprint of heating (Di Lucia & Ericsson, 2014). However, the high capital costs and long pay-back periods associated with DH often constitute a barrier to DH deployment (Bürger et al., 2019, pp. 885–886). The public sector as a “patient investor” has therefore often been involved in DH projects (IFC, 2014, p. 37). This paper looks at two approaches to increasing the commercial viability of DH. More profitable DHSs are expected to attract investors more easily and to be deployed also in areas where public sector support is not available. Below, the advantages of each approach and its state of implementation in EU countries will be outlined. Barriers to each approach and how they can be overcome by new business models will be discussed. 

A first avenue to increase the commercial viability of DH is the integration of heat pumps (HPs) in DHSs. In essence, HPs use electricity to convert low-temperature heat from the environment into high-temperature heat (Barnes & Bhagavathy, 2020, p. 3). HPs deliver a thermal output several times greater than the required electrical input and are therefore a highly efficient technology (Thomaßen et al., 2021, p. 1)

The combination of HPs and DH comes with a number of benefits, many of which increase the profitability of the overall heating system. First, the integration of HPs increases the fuel flexibility in heat supply (Averfalk et al., 2017, p. 1276). Alternative energy sources that can be tapped with HPs include sewage water, industrial waste heat, geothermal heat, and flue gas (Terreros et al., 2020, p. 2). In particular, HPs allow for a greater share of cheap renewable energy to be used for heating purposes (Lund et al., 2014, p. 6). This last point is particularly important, since renewable energy sources are variable and intermittent. With heat pumps, renewable energy can be stored as heat, which can be used at times when there is a shortage of renewable electricity (Bloess et al., 2018, p. 1622). Greater fuel flexibility, in turn, reduces the dependence on fluctuating electricity and fuel prices (Kontu et al., 2019, p. 867): The end user can switch heat sources depending on the marginal cost of electricity prices and DH generation (Lygnerud et al., 2021, p. 2). Some studies also show that introducing large-scale HPs in DHSs decreases the total fuel consumption for heat generation, which in itself reduces operating costs (Helin et al., 2018, p. 463). Yet another factor which increases the profitability of combined DH and HPs systems is that HPs facilitate the co-production of heating and cooling (Kontu et al., 2019, p. 867). Quantitative evidence is provided by Lygnerud et al., who find that through the integration of HPs in DHSs, annual heating costs can be reduced by up to 33% (2021, p. 6). In Denmark, heat pumps are projected to enable savings of 10% of system costs in 2030 (Hedegaard & Münster, 2013, p. 681).

The integration of HPs in DHSs is particularly advanced in Northern European countries, where DH itself is a very established form of heating (Åberg et al., 2016, pp. 222–223). In some countries, like Sweden, a structural electricity surplus provided an incentive early on to use HPs as a way to absorb excess electricity domestically (Averfalk et al., 2017, p. 1277). Countries particularly affected by the oil crisis in the 1970s also had a stronger tendency to introduce HPs in DHSs, to reduce the use of fossil fuels for heating purposes (ibid.). In countries with a low electricity tax or otherwise low electricity prices, HPs as part of DHSs are usually more viable and therefore also more common (ibid., p. 1281). 

Despite these advantages, several barriers exist to the development of combined DH/HP systems. In some countries, heat pumps have traditionally been considered as competitors to DHSs (Lygnerud et al., 2021, p. 9). Especially in rural areas, HPs still lack awareness compared to other technologies (Werner, 2017, p. 425). Service provision is often underdeveloped and co-creation of value for both customers and network operators is difficult to establish (Lygnerud et al., 2021, p. 9). Another challenge is that heat pumps come with high upfront capital and installation costs, especially when compared to gas boilers (Barnes & Bhagavathy, 2020, p. 6). Other competing technologies, like biomass boilers, benefit from higher subsidies (Terreros et al., 2020, p. 12).

Overall, there is still a lack of innovative business models for combined HP/DH systems that may help overcome these barriers (Terreros et al., 2020, p. 12). Two of these barriers, the  cooperation between network operators and customers as well as high upfront capital costs, will be addressed in greater detail below. Lygnerud et al. (2021, p. 8) suggest two alternative business models: The connected product model and the performance contract model. In the first model, the DH company provides the customer with a control interface that is connected to the customer’s HP and DH substation. The DH company then signals the customer when they should switch from one heating source to the other. In this way, customers can optimize the combined use of DH and HPs and recoup their investments more easily. In turn, the customer can be charged an installation fee and monthly subscription fees for the optimization service. In the performance contract model, the DH company guarantees a certain indoor temperature and owns the HP. The DH company thereby has an incentive to optimize the operation of the two heat sources so as to minimize the heating costs and to recoup the investment as quickly as possible. In this model, the customer is charged a fixed fee for the maintenance of the desired indoor temperature. 

A second approach to increasing the commercial viability of DHSs is to increase customer engagement in DH networks.

Increased customer engagement is essential in order to improve the fault detection rate in DHSs (Månsson et al., 2019, pp. 164–165). By detecting faults in DHSs more effectively, the return temperature in DHSs can be decreased (Gadd & Werner, 2014, p. 60). The return temperature is the temperature of the water that flows from the final customers back into the DHS. Lower return temperatures reduce the overall temperature of the DHS, which in turn yields a number of key benefits. A low-temperature DHS is more efficient from a technological viewpoint (Lygnerud, 2019, p. 2). It can more easily supply low-energy buildings, which do not need high water temperatures for heating, thereby increasing the potential customer base of DHSs (ibid.). Lower distribution temperatures also facilitate the integration of cheap renewable and excess heat supply sources (Rämä & Mohammadi, 2017, pp. 655–656), reducing the operating costs of DHSs.

Customer engagement is particularly advanced in Northern European countries with a long tradition of DHSs (Månsson et al., 2019). However, the 5th and latest generation of DH requires temperature reductions which necessitate a new approach to customer engagement even in these countries (Gadd & Werner, 2014, pp. 59–60; Pakere et al., 2023, p. 1).

However, one key barrier to the realization of these benefits is that high return temperatures do not affect customers’ indoor temperatures and remain largely unnoticed (Månsson et al., 2019, p. 164). In traditional DHSs, customers have thus little incentive to make the investments needed to lower return temperatures (Leoni et al., 2020, p. 3)

Lygnerud notes that while this barrier would require the traditional DH business model to change, this often does not happen in practice (2019, p. 12). Traditionally, investments in DH system upgrades have been borne by the DH network operator. However, the scale at which technology upgrades will be necessary poses significant investment risks for DH operators and    challenges their liquidity reserves (Müller et al., 2021, p. 162). An alternative business model that  allows for more customer engagement is referred to as “motivation tariff” (Lund et al., 2022; Müller et al., 2021, pp. 162–163): The final customers make the necessary investments in low-temperature technologies and are rewarded through a bonus-malus system. The latter can take on different forms. In the Austrian village of Flachau, there is in fact no malus and the bonus is paid out in the form of a coupon (Leoni et al., 2020, p. 4). If there is a malus, extensive information campaigns are crucial as to increase its acceptability among customers (Diget, 2019). It can also be helpful to invest the “malus-payments” in optimization measures that benefit all customers (Abildgaard, 2017)

While motivation tariffs can be scaled easily, they are often not very effective in rented apartments, where tenants do not have the long-term perspective required to make the necessary investments. Conversely, since heating costs are usually borne by the tenants, building owners cannot benefit from the “bonus” and therefore do not have much incentive to invest, either. (Leoni et al., 2020, pp. 3–4) In another business model referred to as “contracting,” an external company implements the low-heat technologies for the customer and the resulting savings are shared between the customer and the external contractor. If contractors operate on a national or European level, they can realize economies of scale which enable them to lower the costs per installation. (Müller et al., 2021, p. 166)

But even without changing their business models, DH operators can already substantially increase customer engagement by building strong customer relationships. For instance, on-site visits and free of charge surveys of customer installations help to facilitate fault detection. They also help to communicate the importance of low return temperatures to customers. (Månsson et al., 2019, p. 170)

To conclude, both the integration of HPs in existing DHSs and more customer engagement can drive down the costs of DHSs. To implement these measures, changes in the business models currently employed by DH operators as well as more generally a greater customer focus will be crucial. 

List of abbreviations

DH: district heating

DHS(s): district heating system(s)

HP(s): heat pump(s)


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