Open district heating network in Greater Stockholm Stockholm, June 2009
Foreword This report is the result of an initiative by the Stockholm Property Association (Fastighetsägarna). It has been produced on behalf of a joint venture involving the Stockholm Property Association, E.ON Värme Sverige AB, and Vattenfall AB Heat Nordic. The parties' common desire is for this work to contribute to improved competition on the district heating market in the Stockholm area. This report is an attempt to describe how such improved competition conditions could be realised. At present, over 90 per cent of Stockholm's apartment buildings are heated by district heating. District heating offers significant advantages, as it has a record of good environmental performance and excellent availability. District heating is an effective and convenient form of heating in urban areas. District heating as a market is currently characterised by local monopolies, with biased pricing and very limited scope for negotiations between customer and supplier, which has resulted in falling confidence in the district heating industry. From the customer's perspective, the good technical and environmental benefits offered by district heating contrast sharply with its current shortcomings from a market perspective. By developing market functions and retaining the good technical properties of district heating, conditions are created for a long-term sustainable form of heating, with bolstered confidence among customers and suppliers. With a view to developing district heating and rebuilding customer confidence, E.ON Värme Sverige AB, Vattenfall AB Heat Nordic and the Stockholm Property Association believe that district heating customers should eventually be given the opportunity to choose their own supplier. Method This report has largely been produced by an external consultant, supported by an active working group whose members include representatives of the aforementioned parties. It is important to point out that participating district heating companies have not in any way discussed mutual price-fixing, each company's market strategies, or similar issues in connection with the implementation of this venture. This report has been written by consultant Björn Dahlroth. Björn has unrivalled knowledge of district heating in the Stockholm area from his previous employment. His knowledge and commitment have proven invaluable during this project. The report itself should be regarded as a consulting assignment where the consultant is responsible for the factual content, assessments, and any statement of principles. Stockholm, June 2009 Christer Jansson, CEO, Stockholm Property Association Kurosh Beradari, Head of Business Development, Vattenfall AB Heat Nordic Peter Engström, Head of Business Development, E.ON Värme Sverige AB Per Forsling, Energy Specialist, Stockholm Property Association Stig Andersson, Senior Business Developer, Vattenfall AB Heat Nordic Maria Lindroth, Head of Strategy, E.ON Värme Sverige AB
OPEN DISTRICT HEATING NETWORK IN GREATER STOCKHOLM Björn Dahlroth, April 2009 Summary The Greater Stockholm area is the area in Sweden with some of the best possible conditions for opening up district heating systems and creating competition between players. There are already five major district heating producers Fortum 1, E.on 2, Norrenergi, Söderenergi and Vattenfall 3. Söderenergi supplies district heating to two distributors, Tälje Nät and Södertörns Fjärrvärme AB. The district heating company Sollentuna Energi is quite a large distributor with little own production, so it purchases the majority of its district heating energy from Fortum. The district heating systems in Greater Stockholm are already partially interconnected. These interconnections were originally established to encourage joint ventures with the aim of reducing production costs. However, lower production costs are no longer a guarantee of long-term reduced selling prices for district heating. District heating has encountered some competition within this field from other forms of heating for which there are new areas and new customers for connection. Once connected, however, a customer is often essentially locked in with their chosen supplier because of the high costs sometimes associated with switching to another form of heating. Opening up district heating distribution systems to competition could potentially lead to the limitation of price trends and bring about greater variation in properties and agreement structures for district heating as a product. The report discusses the issue of natural monopolies and the peculiar properties of district heating, which account for the differences between a district heating market and those for electricity and natural gas, for example. There are also descriptions of the production structure in Greater Stockholm and the scope for regional transmission between different district heating areas. Simple illustrative calculations have been included which show that there are quite major differences in marginal variable production costs (NB not prices) for heat energy between different areas, even if we assume that costs for raw materials for production, fuel and electricity, are similar. These calculations are based on current district heating systems, but assume that Söderenergi's, Fortum's and Vattenfall's biomass power and heating projects have been completed. Taking into account the assumed fuel and electricity costs it appears that the differences between the simultaneous highest and lowest variable marginal cost among producers varies throughout the year, and that the range of variation is as much as 20 to 40 öre/kwh, excluding VAT. It is not always the same company that is highest or lowest. If you look at a complete heating season and factor in the variable production cost for the marginal customer, the difference between the highest and lowest company is in the region of 30 öre/kwh. These differences are explained by existing disparities in production, which in turn can be explained by producers' facilities having been built while different energy policies were in effect. The difference in variable costs is also reflected in district heating prices, but not to the same extent. 1 Actually AB Fortum Värme co-owned with City of Stockholm. Referred to in this document as "Fortum". 2 Actually E.ON Värme Sverige AB. Referred to in this document as "E.on". 3 Actually Vattenfall AB Heat Nordic. Referred to in this document as "Vattenfall".
These differences indicate that freer trade could have an equalising effect on costs and possibly also, in some way, on heating prices. Greater consideration of operating in line with variable costs in a fully interconnected system could significantly reduce the mentioned range of variation. Increased trade in heat energy between producers leads to a levelling out of the variable costs and, probably also, to some levelling out of district heating prices, but if competition for customers develops at the same time, this is likely to lead to stronger price equalisation. In order to be able to guarantee in the long term that competition will have an impact on prices, it is necessary for the buyer to have considerable freedom of choice when it comes to choosing and signing agreements with the various producers or sellers on the district heating market. Freedom of choice for buyers, particularly where this is an end user, also provides scope for a certain amount of diversification in district heating as a product. The opportunity to diversify can bring about other important values for freedom of choice and competition, but what these could be is for the future and customers to decide. However, the report mentions confidence, payment terms, service, and environmental aspects. Deciding not to choose something can be just as important. The report looks at four different methods of organising heat energy trading - market models A, B, C and D. One buyer Multiple buyers Block trade A D System optimisation B C Combined offers. Optimisation by suppliers Two of these models are "multiple producers/one buyer" and two are "multiple producers/multiple buyers". The last of these, D, involves a heat exchange market on which players can deal in heat energy. It should be possible to open up the market gradually, switching to the preferred model for one customer category after the other in turn and at an acceptable pace for the technical and administrative changes that will be necessary. Once one model is in use, it should be possible, using a similar method, to switch to another one gradually. The models are related to one another to a certain degree but in different ways. If, for example, D were to be regarded as the ultimate and most desirable model, you could achieve this starting out from either A or C. The models with "one buyer" are price focused, while the other two are intended to afford some product differentiation as an element of competition. All these models include a proposal that the right of disposition over the natural monopoly, i.e. the transmission and distribution systems, be transferred to a single common systems operator for the entire region. Ownership of the systems operator is an essential issue, as is the need for transparency in its activities. One possibility is making it a legal entity where the current network owners become part-owners, contributing their networks in payment. Other part-owners might, for example, be municipalities and customer organisations. Instead of contributing networks in payment, right of disposition could be ensured by assigning networks to individual network companies and by means of long-term rental agreements between these and the systems operator. The systems operator must be run as a profitable operation in order to ensure a return on major investments in conduits and pumping stations, and to enable continued
expansion of district heating. Relatively low risk within the operation should provide a reasonable required return. However, there are other heating options, particularly in urban areas where heating is sparse, so there is a slightly greater risk than is the case for electricity network operations, for instance. The four models have different advantages and disadvantages as mentioned in the report, but no overall preference is expressed for one or the other of them. Should the networks be opened up with the aim of creating scope for competition and equalising production costs, system integration should be increased with two brand new regional interconnections. If not immediately, then certainly within a few years. Traffic through any bottlenecks can be arranged by commercial means. The methods for this can be the same as those discussed and used for the electricity market, but the report also briefly describes another method which involves auctioning off utilisation of capacity in bottlenecks. If in the longer term there is a desire to maintain trade that can run virtually unhindered by a lack of capacity in bottlenecks, the transmission systems must be strengthened. Two new regional interconnections, plus increased capacity in the existing regional transmission network, is estimated to cost between SEK 2 and 3 billion. The cost is comparable with those for construction of additional new biofuel-fired electricity and heating plants, which, suitably located, could reduce the pressure on heat transmission through bottlenecks. SEK 2.5 billion spent on the entire district heating load over 25 years, with a return in proportion to the low commercial risk for pipe systems, which will always be a natural monopoly, is less than 2 öre/kwh for distributed district heating. This cost is insignificant compared with the reduction in the range of variation in variable costs that could be achieved, and hopefully less than the lowering or dampening effect on prices which increased competition might lead to. It can also be supposed to be moderate in relation to other less-calculable benefits which could be achieved in the future thanks to increased integration and trade. Examples of such benefits might be a possible network for future waste heat from energy combines and a positive effect on possible sites for new installations. Greater Stockholm is a region with a growing population. The limit for growth cannot be predicted only studied based on suppositions. What we do know for certain is that new production facilities for district heating will be required, and that we will have to deal with much greater quantities of greenhouse gas-neutral fuels for district heating production. Ports and railways are needed for fuel logistics, power lines for electricity production. Energy plants, other developments, and conservation concerns are competing for land in those areas of the region where the population is increasing and new developments are being planned. If increased system integration is able to address these problems in some way, this would be a significant step towards the improved supply of district heating in the Greater Stockholm area. At present, it is not only the district heating network that can be described as a natural monopoly. The benefits of being able to utilise sites with good logistics for the ever increasing volume of fuels required and with good potential connections to the district heating system and to power lines are also characteristic of a natural monopoly. Without exception, a good site is essential for the competitiveness of future new facilities. An open district heating market therefore places greater demands on the overall approach taken by the municipalities involved when applying their planning monopoly, so that competition conditions are not distorted.