98691 Unlocking the Potential for Private Sector Participation in District Heating In Partnership with ABOUT IFC IFC, a member of the World Bank Group, is the largest global development institution focused exclusively on leveraging the power of the private sector to create jobs and tackle the world’s most pressing development challenges. Working with private enterprises in more than 100 countries, IFC uses its capital, expertise, and influence to help eliminate extreme poverty and promote shared prosperity. PPIAF This report was made possible by a grant from the Public-Private Infrastructure Advisory Facility (PPIAF). PPIAF is a multi-donor trust fund that provides technical assistance to governments in developing countries to develop enabling environments and to facilitate private investment in infrastructure. Its aim is to build transformational partnerships to enable it to create a greater impact in achieving its goal. For more information, visit www.ppiaf.org. RIGHTS AND PERMISSIONS © International Finance Corporation 2014. All rights reserved. The material in this work is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. IFC does not guarantee the accuracy, reliability or completeness of the content included in this work, or for the conclusions or judgments described herein, and accepts no responsibility or liability for any omissions or errors (including, without limitation, typographical errors and technical errors) in the content whatsoever or for reliance thereon. Unlocking the Potential for Private Sector Participation in District Heating In Partnership with LIST OF ABBREVIATIONS Abstract AERS  nergy Agency of the E Republic of Serbia (Serbia) The report analyzes barriers to and opportunities for private sector AIK  gency for Investment and A participation in district heating (DH) in the Western Balkan countries of Competition (Croatia) Bosnia and Herzegovina, Croatia, Kosovo, and Serbia, as well as in Mongolia AJPP A  gency for Public-Private Partnership (Croatia) and Ukraine. CEI  enter for Monitoring C Business Activities in Specifically, the report analyzes the legal and regulatory frameworks for the Energy Sector and public-private partnerships (PPP) and for DH in each of the countries, Investments (Croatia) including an overview of the primary and secondary legislation, PPP CHP  Combined Heat and Power preparation and approval processes, institutional setup of the DH sector, DH District Heating heat tariff-setting procedures, etc. ERC Energy Regulatory Commission (Mongolia) In addition, the report describes international best practice for various ERO  nergy Regulatory Office E (Kosovo) business models for private sector participation in DH and provides ESCO  Energy Service Company country-specific recommendations to improve the attractiveness of PPP in FBiH  ederation of Bosnia and F the DH sector. Finally, the report provides an estimation of the investment Herzegovina needs in the DH sector by country and indicates selected investment HEP State-owned Energy projects, which are conservatively assessed at $1.5 billion. Company (Croatia) HERA  nergy Regulatory Agency E (Croatia) IFC International Finance Corporation Acknowledgments IPP Independent Power Production The preparation of this report was led by Alexander Sharabaroff and Luiz kWh Kilowatt hour T.A. Maurer of IFC and Carsten Glenting of COWI. MW  Megawatt (Total Capacity) MWth M  egawatt thermal (Heat The team would like to thank the national PPP agencies, ministries, Capacity) municipalities, and district heating companies met for sharing information MWh Megawatt hour and data and for providing invaluable insights into PPP and DH in their NECSRC N  ational Energy and countries. The team noted a great interest in and enthusiasm for PPP in DH Communal Services Regulatory Commission in all of the six countries. (Ukraine) O&M Operation and This report has benefited greatly from the world-class expertise, in-depth Maintenance country knowledge, and contributions from Adele Paris, Boris Nekrasov, PPP Public-Private Partnership Christine Marie Shepherd, Dzenan Malovic, Laura Vecvagare, Martin Sobek, PSP  Private Sector Participation Nebojsa Arsenijevic, Patrick Avato, Satheesh Kumar Sundararajan, Tamara RS  epublika Srpska (Bosnia R Dimitrijevic, Tuyen D. Nguyen, Vojislav Kandic, and Yana Gorbatenko of IFC; and Herzegovina) Emmanuel Py, Gailius J. Draugelis, Jari Vayrynen, Pekka Kalevi Salminen, TKE  ocal Heat Supply L Company (Ukraine) Peter Johansen, and Yadviga Semikolenova of the World Bank; and Lily Riahi of the United Nations Environment Programme. Contents UNLOCKING THE POTENTIAL FOR PRIVATE SECTOR PARTICIPATION IN DISTRICT HEATING 1 Executive Summary 2 2 Institutional and Regulatory Environment for PSP in DH 6 2.1 Legal and Institutional Framework for PPP 6 2.2 Legal and Institutional Framework for the DH Sector 14 2.3 Assessment of the Institutional and Regulatory Framework 27 2.4 Recommendations for Improving the Institutional and Regulatory Environment 27 3 Promoting and Supporting PSP in DH: International Best Practice 34 3 .1 Best-practice Regulatory Frameworks and Incentives to Promote PSP in DH 34 3.2 Best-practice Business and Financing Models to Support PSP in DH 37 3.3 Applicability of Business Models in Case Countries 52 4 Investment Opportunities in DH 54 4.1 Overview of the DH Sector 54 .2 Options for Improvement of DH Systems in the 4 Case Countries 58 4.3 Identified Investment Opportunities 60 Appendix: List of Key Legislation 62 1 1 | Executive Summary T he final consumption of energy for heating is substantial in the Western Balkan countries (Bosnia and Herzegovina, Croatia, Kosovo, and Serbia), as well as in Mongolia and Ukraine. All of these countries have district heating (DH) in their major towns; however, the majority of these DH systems are municipally owned and have limited access to adequate investment funds, modern management practices, and new technologies. All of the countries need to allocate substantial resources for renovating old DH systems over the coming decade. At the same time, many of these countries and municipalities opportunities. Furthermore, the report presents best-practice have limited public finances and fiscal room to allow for business and financing models to support PSP in DH, provides adequate investments to renovate the DH sector. In this an assessment of the readiness of the case countries for PPP context, private sector participation (PSP) in the DH sector business models, and provides recommendations on what the may bring access to private sector management practices, countries can do to attract private capital to the sector. investment funds through capital markets, and new technologies, for example in relation to energy efficiency, The results of the study were presented at the 37th Euroheat demand-side management, and renewable energy-based & Power Congress on April 27, 2015 in Tallinn, Estonia. combined heat and power (CHP) plants. Detailed country reports for each of the six countries were prepared and can be shared with potential private sector The objective of this report is to analyze barriers to and investors/operators upon request directed to IFC (subject to opportunities for private sector participation in district getting no objection from countries’ PPP agencies). heating in Bosnia and Herzegovina, Croatia, Kosovo, Mongolia, Serbia, and Ukraine. This may help identify and OVERVIEW OF THE DH SECTOR develop opportunities for private sector engagement in the District heating is the key source of domestic heating in major DH sector, which can help the transition to a more efficient towns in the Western Balkan countries, Mongolia, and Ukraine. energy system. The sector is characterized by a high degree of consolidation in most of the countries, with the two largest DH systems in This report presents an overview of the DH sector in the six Bosnia and Herzegovina accounting for 75 percent of installed case countries, the institutional and regulatory environment capacity, the four largest DH systems in Serbia accounting for public-private partnership (PPP), as well as the legal and for 60 percent of installed capacity, the state-owned HEP institutional framework for the DH sector. It provides an Toplinarstvo d.o.o. (HEP) DH system in Croatia accounting for assessment of the institutional and regulatory framework, 6 of the 10 largest DH systems and 80 percent of installed outlines recommendations for improvements, and identifies capacity, and the sector being dominated by the DH systems technical options for improvement and investment in the capital cities of Kosovo and Mongolia. 2 The fuel choice for DH reflects the local availability of is complex due to the country’s administrative structures, and fuel sources in the individual countries. Natural gas is in Mongolia the responsibility for PPP has shifted frequently predominant in Bosnia and Herzegovina, Croatia, Serbia, and in recent years, representing a risk to continuity. Ukraine, whereas Kosovo relies on heavy fuel oil (the country has no access to a gas pipeline) and Mongolia relies on coal LEGAL AND INSTITUTIONAL FRAMEWORK (mined from the large domestic reserves). FOR DH The DH utilities in Bosnia and Herzegovina, Kosovo, Serbia, Household heat tariffs vary significantly among the countries, and Ukraine are owned by the local authorities, whereas although immediate comparison is difficult because of the DH utilities in Mongolia are state-owned and Croatia different tariff structures. Figure 1 illustrates regional and has a combination of state ownership (80 percent), national differences in the tariff level, using gross revenues municipal ownership, and part-private ownership. Croatia, per DH customer as a proxy for tariff levels. Serbia and Kosovo, Mongolia, and Ukraine have formally separated Croatia have the highest revenue basis per household, the regulatory responsibilities for the DH sector from whereas Ukraine and Mongolia have the lowest. the ownership of DH utilities through the creation of an independent regulatory authority that also approves DH tariffs. In Bosnia and Herzegovina and in Serbia, there is Figure 1. Regional and National Differences no such separation, although this may change in Serbia in DH Sector Revenue Base following the recent revision of the Energy Law. Regional  and  NaJonal  Differences  in  Tariff  Levels   (DH  revenue  in  $1,000  per  household  per  year)   1.8   With regard to financial support mechanisms, all six 1.6   countries have feed-in tariffs in place for electricity produced 1.4   1.2   at CHP plants in cogeneration mode that is exported to the 1.0   grid, but none of the countries have implemented specific 0.8   feed-in tariffs for heat production from cogeneration or 0.6   renewable sources. The incentives are backed in all countries 0.4   0.2   by interconnection policies that provide CHP and renewables 0.0   with transparent and consistent interconnection procedures U  -­‐  Sumy   U  -­‐  Ternopil   U  -­‐  Poltava   B  -­‐  Prijedor   U  -­‐  Dnipropetrovsk   M  -­‐  Darkhan   U  -­‐Odessa   M  -­‐  Ulaanbaatar   U  -­‐  Lutzk   U  -­‐  Zaporizhzhia   B  -­‐  Tuzla   B  -­‐  Zenica   B  -­‐  Saravejo   K  -­‐  PrishJna   K  -­‐  Gjakova   B  -­‐  Bosanska   B  -­‐  Banja  Luka   C  -­‐  Rijeka   S  -­‐  Nis   B  -­‐  Pale     C  -­‐  Velike  Gorica   C  -­‐  Zagreb   S  -­‐  Belgrade   S  -­‐  Novi  Sad   C  -­‐Osijek   U  -­‐  Kharkiv   S  -­‐  Kragujevac   C  -­‐  Karlovac   U  -­‐  Kiev   U  -­‐  Lviv   for selling the generated electricity to the grid. Although most regulators are independent and the tariff methodologies formally allow for cost recovery, social INSTITUTIONAL AND REGULATORY concerns remain a significant determinant in the process of ENVIRONMENT FOR PPP proposing and approving DH tariffs. This is because social The legal framework in all countries is in accordance with protection programs targeted at low-income households international best practice and formally allows for private tend to be less developed, and affordability concerns are sector participation in the DH sector. However, there is still a addressed instead through low utility tariffs, which effectively lack of successful PPP projects in municipal services, which may act as blanket subsidies benefiting all connected households, create discomfort for international investors. This may reflect a irrespective of their income levels. general reluctance to adopt a more proactive approach to PPP in municipal services, including developing a pipeline of pilot Furthermore, country-specific challenges also exist. In projects, addressing the inevitable conflict between affordability Bosnia and Herzegovina, complex administrative structures concerns and financial viability, and seeking international and a high degree of decentralization have resulted in a inspiration and assistance for transaction structuring. multitude of legal acts and regulatory bodies regulating PPP Furthermore, the legal framework in Bosnia and Herzegovina transactions and in a scattered legal framework related to 3 the DH sector. In Mongolia, significant subsidies permeate BEST-PRACTICE MODELS FOR PSP IN DH the entire value chain—from primary fuel supply and CHP Private sector participation in DH may come in the form generation, to transmission and distribution to end-users— of a continuum of models that reflect the increasing which will make partial sector reforms difficult. transfer of responsibility for service provision, ranging from management contracts to lease contracts to concessions RECOMMENDATIONS ON IMPROVEMENTS to private provision (privatization of existing assets and The countries can take various actions to attract private Build-Own-Operate for new assets). It also may include capital to the DH sector. Across all six countries, PPP in models designed to address specific challenges in the DH municipal services may be promoted by developing a pipeline supply chain, such as heat entrepreneurship (mobilizing the of pilot projects for PPP in municipal services (including biomass supply chain) and energy service companies (ESCOs) DH) and seeking international assistance for transaction (addressing investment barriers at the end-user level). structuring of these projects. Similarly, all countries need to improve the commercial viability of the DH sector by The report describes these key business models for private separating tariff approval from ownership and addressing sector participation in DH used internationally and assesses the conflict between affordability and financial viability their applicability in the six case countries. The best-practice through targeted, performance-based subsidies. Further business models are drawn from experience with management to these general recommendations, the individual country agreements in Czech Republic and Sweden; leasing in recommendations presented in this report will contribute to Estonia and Lithuania; concessions in France and Lithuania; the enabling conditions for successful development of the DH privatization in the Czech Republic, Poland, and Romania; heat sector through partnership with the private sector. entrepreneurship in Finland; and an ESCO in Greece. INVESTMENT OPPORTUNITIES The study team concludes that all six case countries are Although significant investments have gone into DH ripe for management agreements in DH and that all but network improvements in all six countries over the last Mongolia (due to legal limitations) are ready for leasing decade, heat and water losses remain high, and substantial agreements in DH. With respect to concession agreements, investments are needed in this area for the coming decade. the lack of a clear strategy and sector legislation in Bosnia This investment need is conservatively assessed at $1.5 billion. and Herzegovina and the need for comprehensive subsidy In addition, substantial opportunity exists for fuel conversion reform in Mongolia makes it a longer-term option, while the to locally produced biomass in the Western Balkan countries four other countries are ready for concession agreements in and Ukraine. DH. Among the six countries, only Croatia has the necessary legislation in place to enable privatization. A review of selected DH systems has confirmed that there are substantial investment needs and opportunities in The experience with heat entrepreneurship may inspire relation to continued network improvements to reduce both the Western Balkan countries and Ukraine to consider heat and water losses (all countries), switch to cleaner fuels approaches that utilize the vast biomass potential in the region. (Ukraine and the Western Balkan countries), and shift to Meanwhile, ESCOs are a relevant option for implementing efficient CHP production (apart from Serbia and Mongolia, end-user energy efficiency measures in the Western Balkan where this is already the standard technology). There also countries and Ukraine (although Kosovo is subject to the are needs and opportunities related to waste incineration, adoption and implementation of legislative changes that are the use of geothermal sources, the use of waste heat, presently being planned to establish housing associations). extending the supply of hot tap water, and energy efficiency investments at the end-user level. Table 1 provides an overview of the DH sector in the six case countries. 4 Table 1. The DH Sector at a Glance Bosnia and Herzegovina Croatia Kosovo Mongolia Serbia Ukraine Number of DH 22 20 3 7 58 21 (large) companies Installed 1,000 2,000 200 2,000 6,000 26,000 capacity (MWth) Gas, heavy Heavy fuel oil, Main fuel(s) fuel oil, coal, Gas Heavy fuel oil Coal Gas gas, coal biomass State, local DH utility Local Local Local Local government, State ownership government government government government partly private National Croatian Energy Energy and Energy Tariffs Local Energy Regulatory Local Communal Regulatory approved by government Regulation Commission government Services Office (ERO) Agency (HERA) (ERC) Regulatory Commission Heat tariff (for metered households in capital U.S. 4.7 2.8 5.7 0.6 7.0 2.1 cents/kWh, variable element only) Electricity feed-in tariff for 8.6 / 8.6 14.5 / 9.8 8.88 / [N/A] Negotiated 16.25 / 11.1 11.6 / [N/A] biomass / CHP (U.S. cents/kWh) Assessed investment need 220 230 40 100+ 270 600+ ($ millions) Assessed readiness of case countries for best-practice business models for PSP in DH Management Immediate Immediate Immediate Immediate Immediate Immediate agreements option option option option option option Immediate Immediate Immediate Longer-term Immediate Immediate Leasing option option option option option option Concession Longer-term Immediate Immediate Longer-term Immediate Immediate agreements option option option option option option Longer-term Immediate Longer-term Longer-term Longer-term Longer-term Privatization option option option option option option Heat Immediate Immediate Immediate Longer-term Immediate Immediate entrepreneurship option option option option option option Immediate Immediate Longer-term Longer-term Immediate Immediate ESCOs option option option option option option 5 2 | Institutional and Regulatory Environment for PSP in DH 2.1 Legal and Institutional Framework services (including DH); addressing the inevitable conflict for PPP between affordability concerns and financial viability through structured, performance-based subsidies; and REGIONAL seeking international inspiration or assistance for transaction In general, the legal framework in all countries is in structuring of the pilot projects. Furthermore, the legal accordance with international best practice and allows in framework in Bosnia and Herzegovina is complex due to principle for private sector participation in the DH sector. the country’s administrative structures, and in Mongolia the However, there is still a lack of successful PPP projects responsibility for PPP has shifted between three ministries in municipal services, which may create discomfort for over five years, presenting a risk to continuity. international investors. Table 2 provides an overview of the legal and institutional This may reflect a general reluctance to adopt a more framework for PPP in the six countries, followed by brief proactive approach to PPP in municipal services, including: comments on each country. developing a pipeline of pilot projects for PPP in municipal 6 Table 2. Overview of Legal and Institutional Framework for PPP Legal Framework Entry into Force / Responsible Country for PPP Last Revision Lead Agency Ministry Commission Concession Law Reports to Bosnia and for Concessions of Bosnia and 2002/04 the Council of Herzegovina of Bosnia and Herzegovina Ministers Herzegovina Concession Law of the Federation Commission for of Bosnia and Federation Concessions of Bosnia and Herzegovina Reports to the of Bosnia and 2002/06 the Federation Herzegovina Cabinet Herzegovina Cantonal of Bosnia and Concession Laws Herzegovina Cantonal PPP Laws Concession Law of 2002/13 Commission for Reports to Republika Srpska Concessions of National Assembly Republika Srpska Republika Srpska PPP Law of Ministry of Republika Srpska 2009/11 Ministry of Finance Finance Commission for Concessions Concession Law 2012 Ministry of Croatia Agency for PPP Law 2012/14 Finance Investment and Competition Ministry of Kosovo PPP Law 2011 PPP Department Finance Department Ministry of Mongolia Concession Law 2010/12 responsible for PPP Finance1 Ministry of Serbia PPP Law 2011 PPP Commission Finance PPP Law Ministry of 2010 Ministry of Ukraine Lease and Economy and 2010 Economy and Trade Concession Law Trade 1 The Department for Innovation and PPP under the Ministry of Economic Development is the lead agency on PPP in Mongolia. The department was formerly the PPP and Concession Department under the State Property Committee and will, under an ongoing reorganization, become part of the Ministry of Finance. 7 BOSNIA AND HERZEGOVINA sector and in power production (hydropower plants). The Due to the complex administrative structure of the country, PPP project development, procurement, and award process in separate concession laws exist at the state, federal, and Republika Srpska is illustrated in Figure 2. canton levels. Similarly, four separate concession commissions operate at the state level and in three entities (the Federation of Bosnia and Herzegovina, Republika Srpska, and District Brcko). In addition to concession laws, both Republika Srpska and District Brcko have adopted PPP laws, and the Federation of Bosnia and Herzegovina is planning to adopt one in early 2016. There is no PPP law on the national level. The result is a rather complex system of concession/PPP regulation, with Country Presentation – Bosnia and Herzegovina scattered responsibilities across a number of authorities. Chart 2: are mainly in the mineral extraction Existing concessions PPP Process in Bosnia and Herzegovina (for Concessions in Republika Srpska) Figure 2. PPP Process in Bosnia and Herzegovina (for Concessions in Republika Srpska) Responsible authority submits draft Commission PPP Feasibility public Responsible requests Study is invitation authority Government to Responsible submitted to Responsible including issues Public grant authority Concession authority evaluation Invitation and Concession to Contracting prepares PPP Commission issues request criteria and informs successful authority signs Feasibility for for draft contract Commission bidder after contract Study consideration qualifications to Concession after selection confirming and approval Commission of successful compliance (30 days) for bidder with criteria in consideration tender and approval (21 days) MAY 2015 1 PSP IN DH - FINAL REPORT 8 CROATIA Public Sector Comparator) may present a barrier for projects In Croatia, the new 2012 PPP Act is in compliance with that are the first PPP project in their sector. The parallel international best practice. A central national agency for PPP 2012 Concession Act includes less-stringent documentation (the Agency for Public-Private Partnership, AJPP), responsible and approval requirements, and the boundary between for implementing the PPP Act, has been established (it concessions and PPPs is determined on a case-by-case basis. recently merged with the Agency for Investment and Competition, AIK), and key guidance documents have been Croatia already has implemented a number of PPP projects, issued. Furthermore, an agency responsible for preparation and several additional projects are under procurement or in and procurement of central government PPP projects the pipeline. Apart from the Zagreb airport, all recent projects (CEI) has been established and may provide assistance to are in the building sector. However, AIK and CEI expect that procurement by local governments. Approval by AIK and there may be significant potential for PPP projects in the Country the of Finance-is Presentation Ministry Croatia required for all PPP projects, and, municipal sector. The PPP project development, procurement, Chart 3: although the approval procedure has been simplified, the and award process in Croatia is illustrated in Figure 3. documentation requirements (including preparation of a PPP Process in Croatia (Projects under the PPP Law) Figure 3. PPP Process in Croatia (Projects under the PPP Law) Contracting Public Authority Authority Project Short-listed Public team issues organizatio establishes Authority invitation project prepares ns are PPP Project PPP Project Project is for invited to Contract is may seek Proposal is sent to awarded team and assistance Contracting Proposal expressions submit full notifies submitted Ministry of after Authority for project including of interest tenders, AJPP (AIK) to AJPP Finance for standstill signs team from FS, PSC, (assuming from which of its (AIK) for consent period contract CEI or VfM, Risk restricted the winning intention to assessment (30 days) procedure) (10 days) engage Allocation, tender is implement consultants and Draft through selected a PPP Contract OJEU (37 (40 days) project days) MAY 2015 2 PSP IN DH - FINAL REPORT 9 KOSOVO Independent power production (IPP) is outside the PPP law The PPP framework in Kosovo is in accordance with and is overseen by the energy sector regulator. The PPP international best practice, but only limited implementation project development, procurement, and award process in experience exists today. A few successful PPPs exist in other Kosovo is illustrated in Figure 4. sectors (airport, waste collection), and some pilots are under way in transportation (public buses) and education (schools). With respect to PPP in the municipal sector, the law allows it, the regulatory structure is in place, and the government officially supports it. However, the sector is sensitive due to social concerns, and there is limited municipal capacity for managing PPPs; for DH, there are serious issues related Country Presentation - Kosovo to revenue collection and financial viability that should Chart 4: be resolved prior to private investors being brought in. PPP Process in Kosovo (for Projects under PPP Law) Figure 4. PPP Process in Kosovo (for Projects under the PPP Law) Public Contracting Authority Project Authority PPP pre- Implement identifies feasibility selects potential ation team qualified study and established PPP project draft Project operators Contracting approval by by Authority Contracting tender Authority PPP Unit and (informed issues Contracting conducts PPP-ISC Contracting individually issues Authority documents (PPP Law) Authority Request for evaluates submitted proposals Contract PPP pre- ), and PPP Award signs or issues Proposals contract feasibility to PPP Unit Unit issues and awards Governmen Request for (at least 40 Notice study and in Ministry Notice of contract t (LPFMA) Qualificatio days) prepares of Finance qualified n draft for review economic tender (at least 20 operators (10 days) days) documents (10 days) MAY 2015 3 PSP IN DH - FINAL REPORT 10 MONGOLIA location of the lead agency may have limited continuity in In Mongolia, the 2010 concession law is in accordance its work. The PPP project development, procurement, and with international best practice. Model tender documents award process in Mongolia is illustrated in Figure 5. subsequently have been published, and a list of priority PPP projects has been approved by the government. However, there is very limited implementation experience, with one road project for access to a mining area reaching financial close and one CHP project (CHP-5 in Ulaanbaatar) still under negotiation. Prior to a recent change to the Ministry of Finance, the lead agency for PPP has had limited capacity to support the development and implementation of PPP Country Presentation - Mongolia transactions, and frequent changes in the institutional Chart 5: PPP Process in Mongolia (for Projects with State Property) Figure 5. PPP Process in Mongolia (for Projects with State Property) Ministry of Economic Working Ministry of Group Working Ministry of Line Economic Group Economic Ministry Developme Governmen Ministry of nt Governmen issues t gives Economic t approves Developme invitation issues Developme proposes nt issues tender and nt project for considers right to Developme PPP to bid and sign a nt signs inclusion of Project List public makes considers PPP makes project on announcem tender tender contract contract Project List preliminary PPP ent evaluation evaluation selection Project List MAY 2015 4 PSP IN DH - FINAL REPORT 11 SERBIA In Serbia, the new 2011 PPP law is in compliance with international best practice. A PPP unit has been established in the Ministry of Finance, a practical guide and template Heads of Agreement has been published, and the PPP unit has provided positive opinion on 21 new PPP projects, including two small heating projects. However, there is a general lack of successfully implemented PPP projects to date, and three smaller-scale projects in the DH sector failed due to inadequate cost recovery, as cost-covering tariffs were not implemented and the assets were reverted to the Country Presentation municipalities. Serbia development, procurement, - project The PPP Chart 6: and award process in Serbia is illustrated in Figure 6. PPP Process in Serbia (for Projects with Concession Elements) Figure 6. PPP Process in Serbia (for Projects with Concession Elements) Private Party PPP Procedure suggests Commissio Standstill developme State body for granting n provides Private period / nt of PPP and expert State body concessions bodies bid Concession Public Opinion, is initiated is awarded possible project to team delivers Request for Agreement prepare and (within at State body, Concession (Public Call (within 60 protection on Concession Relevant Act least 60 Concession or Authority in the days) days) of rights Proposal Official State body provides (15 days) Approval Gazette) initiates process MAY 2015 5 PSP IN DH - FINAL REPORT 12 UKRAINE in Ukraine, but a number of PPP-type projects have been In Ukraine, the existing PPP Law (under revision) has a implemented under the less-restrictive concession law. The number of challenges when compared to international best PPP project development, procurement, and award process practice, as it introduces an additional layer of regulation in Ukraine is illustrated in Figure 7. by referring to other laws for rules and regulations, rather than asserting the prevailing force of its own provisions. This complication challenges potential investors to refer to legislative acts, which are contradictive in specific cases. Moreover, several different bodies are involved in the preparation and implementation of PPPs, as the PPP Law requests various decisions and approvals of responsible Country Presentation - Ukraine authorities at the local or state level. This complexity is Chart 7: an obstacle for the smooth implementation of PPPs. No PPP Process in Ukraine (for Projects under PPP Framework Law) PPP projects have been implemented under the PPP Law Figure 7. PPP Process in Ukraine (for Projects under PPP Framework Law) CMU  or  local   self-­‐governing   CMU  or  local   MOEDT   self-­‐governing   City  council  (if   approves  draK   authority   state-­‐owned)   Approved   authority   Publica?on  of   tender  protocol   PPP  agreement   or  municipal   tender  no?ce   Tender   decides  to   commiDee   Subsequent   launch  a  PPP   establishes  a   is  sent  to   (within  30   body  adopts   and   registra?ons   tender  and   assesses  bids,   MOEDT  and   days),  and   project   decision  to   subsequent   (for  hea?ng   sends  it  to   selects  winner,   informa?on  is   public  partner   (MRDCHUS   launch  PPP   submission  of   infrastructure   MRDCHUS  for   and  prepares   posted  on   signs  PPP   approves   project  and   applica?ons  by   at  MRDCHUS) approval  (if  in   tender  protocol website  of   agreement   tender  if  PPP  is   forms  a  tender   bidders the  area  of   public  partner with  private   in  the  area  of   commiDee hea?ng  supply) partner hea?ng  supply) MAY 2015 6 PSP IN DH - FINAL REPORT 13 2.2 Legal and Institutional Framework The Law on Energy in Republika Srpska does not explicitly for the DH Sector include heat energy, and a separate Law on Heat Energy is in the preparation stage in the Federation of Bosnia and Table 3 provides an overview of the legal and institutional Herzegovina. No DH sector strategy exists on any level. framework for the DH sector in the six countries. Ownership of the DH companies rests with the cantons and BOSNIA AND HERZEGOVINA municipalities. The tariff methodology is established at the In general, the state level in Bosnia and Herzegovina has canton and municipal levels, and tariffs are calculated and very limited competences in the energy sector, resulting approved by cantons and municipalities. Subsidies to DH in a scattered regulatory framework for the DH sector, companies and direct household subsidies also are allocated specific to each subnational entity. The most commonly at the canton and municipal levels. The heating sector in used laws for regulation of DH companies are the Law on Bosnia and Herzegovina is illustrated in Figure 8 (for Zenica Communal Activities and the Law on Local Self-Governance. DH in the Federation of Bosnia and Herzegovina). Zenica  District  Hea-ng  Company:  Example  of  Hea-ng   Sector  in  Federa-on  of  Bosnia  and  Herzegovina   Figure 8. The Heating Sector in Bosnia and Herzegovina Zenica District Heating Company Example of Heating Sector in FBiH Government  of  FiBH     Municipali-es  and  cantons   (legal  basis)   (ownership,  tariff  methodology,  tariff  approval)   Coal  mines  (85%)   (owned  by  JP   Elektroprivreda   BiH  d.d.  Sarajevo  )   >  95%  CHP  and   heat-­‐only  boilers   Natural  gas  (15%)   located  at  Arcelor   (supplied  by   MiSal  Co.  -­‐  Zenica   J.P.  “Grijanje“  DH   End  users   J.P.  “Grijanje“  DH   (households,  public   company  owned   company  (owned   company   ins-tu-ons,   by  government  of   by  municipality)   FBiH)   business  premises)   <  5%  biomass   Na-onal  forests   heat-­‐only  boiler   (managed  by     units  owned  by   public  company   J.P.  “Grijanje“  DH   owned  by  ZE-­‐DO   company   Canton)   Heat   Heat   Heat   Heat   Fuel  supply   genera-on   transmission   distribu-on   consump-on   14 Table 3. Overview of Legal and Institutional Framework for the DH Sector Responsible Energy Sector Country Key Legal Basis for DH Ministry Regulator State Electricity Bosnia and Regulatory Herzegovina Commission1 Federation Federation Law on Use of Renewable Energy Sources Ministry of Energy, Electricity of Bosnia and and Efficient Cogeneration, Federation of Mining, and Industry Regulatory Herzegovina Bosnia and Herzegovina (2013/14) Commission2 Bosnia and Energy Strategy of Republika Srpska up to Herzegovina 2030 Ministry of Administration and Law on Energy of Republika Srpska (2009) Republika Self-Governance Republika Law on Energy Efficiency of Republika Srpska Energy Srpska Ministry for Spatial Regulatory Srpska (2013) Planning, Civil Commission3 Law on Renewable Energy Sources and Engineering, and Efficient Cogeneration, Republika Srpska Ecology (2013) Energy Development Strategy for Croatia (2009)4 HERA (Croatian Energy Act (2012/14) Energy Croatia Ministry of Economy Regulation Act on Heat Energy Market (2013/14) Agency) Act on Regulation of Energy Activities (2012) Law on Energy (2010) Energy Ministry of Economic Kosovo Law on Energy Regulator (2010) Regulatory Office Development (ERO) Law on Central Heating (under revision) Energy Law (2001) Energy Energy Sector Development Strategy (2002) Regulatory Mongolia Ministry of Energy5 Renewable Energy Law (2007) Commission (ERC) State Policy on Fuel and Energy (2008) Energy Law (2011/13/14) Energy Agency of Ministry of Energy Serbia the Republic of Law on the Efficient Use of Energy (2013) and Mining6 Serbia (AERS)7 Ministry of Regional National Energy Law on Heat Supply (2005) Development, and Communal Ukraine Law on Housing and Communal Services Construction, Services (2004) and Housing and Regulatory Communal Services Commission 1 Jurisdiction is limited to international energy trade and transmission and transmission system operation, including regulation of transmission tariffs. 2 No regulatory oversight of DH sector 3 No regulatory oversight of DH sector 4 In connection with its EU accession on July 1, 2013, Croatia has transposed the EU regulations into its national legislature. This concerns in particular the implementation of the so-called Third Energy Package whose objectives include stronger market competition and liquidity, improvement of network infrastructure operation, security of supply, customers’ active role and protection, as well as promotion of renewable energy sources. 5 Presently being merged with the Ministry of Mining 6 After the transfer of responsibility for the DH sector from the Ministry of Public Administration and Local Self-Government 7 The DH sector is a municipal responsibility, but the role of the regulator has increased with the new energy law at the end of 2014. 15 CROATIA network, usually own the DH companies (apart from HEP), In Croatia, the accession to the European Union as of July and plan and approve DH network development. 1, 2013 has been instrumental in a comprehensive revision of energy sector legislation in recent years, including HERA was established in 2004 as an independent regulator harmonization of legislation with the Third Energy Package. with a broad mandate that includes designing heat tariff The Third Energy Package’s objectives include stronger methodologies and approving heat tariffs proposed by market competition, and it foresees an unbundling of the the DH companies. New tariff methodologies have been heat sector, which, in principle, would enable third-party implemented recently, and the first tariff decisions have access. Only HEP and Energo Rijeka own and operate CHP been made for a number of smaller DH systems. This led to plants, but most DH companies own local/isolated boilers tariff increases, which improved the financial viability of DH that provide heating for nearby buildings. The DH distribution utilities, taking an important step toward realistic cost- companies own the network. Substations and pump stations reflective heat energy tariffs. HEP DH, which accounts for are owned either by the DH distribution companies or by the 80 percent of the sector, had not yet applied a new tariff end-buyers of heating energy. The building owners oversee methodology at the time of preparation of this report. The hot tap water installations and internal building installations. heating sector in Croatia is illustrated in Figure 9 (with The municipalities issue concessions for the DH distribution potential third-party access illustrated in dotted lines). Figure 9. The Heating Sector in Croatia 16 KOSOVO owned Termokos DH in Pristina, which buys heat from the The Law on Energy established ERO as an independent state-owned Kosovo A&B and possibly from a future Kosovo regulator responsible for defining the electricity and heat C, for which an IPP agreement is under negotiation. tariff methodology, approving electricity and heat tariffs, and awarding licenses for independent power production. Municipal ownership of the DH companies and political concerns about affordability, however, seem to prevent tariffs from reaching cost-recovery levels. The sector is burdened by the high costs of imported fuel. In spite of subsidies, the companies frequently lack funding for fuel and run at low operational levels, with many off days during the heating season, which results in low credibility and low revenue collection. A new 2014 law enabling the blocking of bank accounts in case of non-payment and improved court processes is apparently helping significantly. The heating sector in Kosovo is illustrated in Figure 10 for the municipally Hea-ng  Sector  in  Kosovo   Figure 10. The Heating Sector in Kosovo Parliament   Ministry  of  Economic  Development   Energy  Regulatory  Office   Municipali-es   (sector  strategy)   (tariff  methodology  and  approval)   (ownership  and  investments)   Kosovo     A  &  B   (state-­‐ Imported   heavy  fuel  oil   owned)   Termokos  DH  Company   End   (possibly  local   (municipally  owned)   users   lignite  In   Kosovo  C   Building   future)   (IPP  under   admini-­‐ nego-a-on)   strators   Heat   Heat   Heat   Heat   Fuel  supply   genera-on   transmission   distribu-on   consump-on   17 MONGOLIA as well as between commercial and household heat In Mongolia, the 2001 Energy Law introduced ambitious customers). The incentive for switching users to metered unbundling of the electricity and heat sector, but state billing (and thereby the promotion of end-user energy ownership is retained for heat generation, transmission, and efficiency) is currently limited. The heating sector in Mongolia distribution from the substation to end-users (outside new is illustrated in Figure 11 for the state-owned Ulaanbaatar development areas). DH is the preferred form of heating in DH company, which buys heat from the state-owned CHP Mongolia, with DH networks covering most major urban 2, 3, and 4 plants and possibly from a new CHP 5 plant to be centers. The sector is characterized by significant fuel implemented as a PPP project. subsidies (domestic coal is provided at production cost) and cross-subsidization (between electricity and heat generation Figure 11. The Heating Sector in Mongolia Hea-ng  Sector  in  Mongolia   State  Great  Hural  (Parliament)   Fair  Compe--on   Customers  Rights   for  Customers     Protec-on     State  Agency   State  Agency   (tariff  review)   (tariff  review)   Energy  Regulatory   State  Property   Ministry  of  Energy   Ministry  of  Finance   Commission   Municipality  of   CommiSee   (ownership  and   (ownership)   (tariff  methodology   Ulaanbataar   (ownership)   investment)   and  approval)   Housing  and   CHP  2,  3,  4     Public  U-lity   (state-­‐owned)   Authority  of   Ulaanbataar   Ulaanbataar   Coal  mines   District  Hea-ng   End  users   (state-­‐owned)   Company   Private  city   CHP  5   (state-­‐owned)   housing   (PPP)   companies   Heat   Heat   Heat   Heat   Fuel  supply   genera-on   transmission   distribu-on   consump-on   18 SERBIA In Serbia, the Ministry of Energy and Mining has taken over responsibility for the DH sector, which is now covered in the Energy Strategy. The regulator will define a common methodology for tariffs, but municipalities still approve heat tariffs. The Law on Energy includes feed-in tariffs for electricity produced by CHP, renewable energy sources, and waste incineration; renewable-based heat-only generation is not covered under the Law. The heating sector in Serbia is illustrated in Figure 12 for the municipally owned Belgrade DK company, which encompass both heat generation and distribution. Belgrade  District  Hea-ng  Company:   Figure 12. Belgrade District Heating Company Example  of  Hea-ng  Sector  in  Serbia   Example of The Heating Sector in Serbia Parliament   Ministry  of  Energy  and  Mining   Energy  Agency   Municipali-es   (sector  strategy  and  minimum   (regula-on  of  electricity  and  gas     (ownership,  investments,  and  tariff   prices)   but  not  DH)   approval)   Gas  and   JKP  Beogradske  Elektrane   End   heavy  fuel  oil   (municipally  owned)   users   (mazut)   Building   associa-on   Heat   Heat   Heat   Heat   Fuel  supply   genera-on   transmission   distribu-on   consump-on   19 UKRAINE Local heat supply companies (TKEs), usually owned and In Ukraine, the Law on Heat Supply establishes legal, managed by local governments and municipalities, operate economic, and organizational grounds in the sphere of the DH plants and distribution networks. TKEs buy gas, coal, heat supply. It regulates relations concerning production, and heavy fuel oil to produce heat at their own plants, or they transportation, supply, and management of thermal energy, may purchase heat from CHP plants belonging to others, with a view toward improving the energy security of which they supply to final consumers. The heating sector in Ukraine, increasing the energy efficiency of thermal energy Ukraine is illustrated in Figure 13 (with heat purchase from an supply systems, and protecting consumer rights related to external CHP shown in the dotted line). thermal energy supply. In addition, the Law on Housing and Communal Services regulates the terms and conditions of housing and utility service agreements, the fundamentals of tariff regulation, and a few types of classification of housing and communal services. Figure 13. The Heating Sector in Ukraine 20 ROLE OF REGULATOR Table 4 provides an overview of the role of the sector regulator in the six countries. Table 4. The Role of the Regulator Country Role of Sector Regulator Regulation of electricity generation, distribution, and supply is implemented by separate entities; however, Bosnia and none of these entities have regulatory oversight of the DH sector. The regulation of DH is in practice Herzegovina exercised through municipal/canton ownership in accordance with the responsibilities allocated to them by laws on local self-governance. The regulator establishes heat tariff methodologies (without setting the specific tariff levels) and approves the tariffs proposed by the DH companies. The regulator issues licenses for carrying out energy activities and rulings on granting the status of eligible producers. Note that heat and electricity generation are Croatia commercial activities rather than public services, in contrast to where a concession is given. Independent heat and/or power production would require an authorization from the Ministry of Economy as well as a production license from the regulator. The regulator grants licenses, establishes heat tariff methodologies, and approves tariffs for regulated energy services. The regulator also grants permits for the construction and operation of new generation capacity. The regulator prescribes the general conditions for energy supply and the standards of service to be met by the licensees, and resolves disputes among customers and energy enterprises, system operators, Kosovo and energy enterprises, as well as between generators. Furthermore, the regulator issues general acts, individual acts, and secondary legislation in accordance with the Law on Energy Regulation; revises, approves, and controls compliance with all codes (including the grid and distribution code) as well as all technical rules; enforces the provision of the Law on Energy Regulation; and imposes fines for violations. The regulator sets the terms and conditions to obtain a license, issues licences, establishes the Mongolia methodology to determine heat tariffs, defines the structure of tariffs, and reviews, approves, and publishes tariffs of licensees. The regulator approves prices for electricity and gas and is responsible for the grid code. The DH sector is a municipal responsibility, but in general the role of the regulator is expected to increase with the opening Serbia of the natural gas market and increased focus on renewable energy. The local assembly will, however, still have the final approval responsibility for tariffs, and municipalities will retain operational responsibility for the DH sector. In August 2014, a National Energy and Communal Services Regulatory Commission (NECSRC) was established as an independent regulator for the larger DH utilities, and it presently regulates the 227 largest DH utilities. NECSRC’s main responsibilities include issuing licenses and regulating tariffs for generation, transmission, and supply of heating and hot water supply services. In addition, the regulator is responsible for approving the investment programs of utilities, monitoring them through review of their annual and quarterly reports, and controlling compliance with the license conditions. NECSRC’s current work program Ukraine includes increasing all of the mentioned tariffs to a full cost-recovery level and eliminating cross subsidies among the public, budget organizations, and other customers. However, NECSRC is in a challenging position because of the significant increase in natural gas prices, the non-cost-recovery tariffs of DH utilities for the public, and the reduced affordability for end-users due to the current political situation in Ukraine. One of NECSRC’s current priorities is to stimulate utilities to switch to alternative fuels and reduce gas dependence. 21 Table 5. Ownership and Tariff Approval Tariff Methodology Country Ownership of DH Utilities Established by Tariffs Approved by Bosnia and Municipalities/cantons Municipalities/cantons Municipalities/cantons Herzegovina State (HEP), municipalities, and Croatian Energy Regulation Croatian Energy Regulation Croatia partly private (Rijeka) Agency (HERA) Agency (HERA) Kosovo Municipalities Energy Regulatory Office (ERO) Energy Regulatory Office (ERO) Jointly by State Property Energy Regulatory Commission Energy Regulatory Commission Mongolia Committee, Ministry of Finance, (ERC) (ERC) and Ministry of Energy Municipalities, but a common Serbia Municipalities tariff methodology will be part of Municipalities the new Energy Law National Energy and Communal Municipalities (some under National Energy and Communal Ukraine Services Regulatory Commission private lease-type contracts) Services Regulatory Commission or local self-governments OWNERSHIP AND TARIFF APPROVAL uses the gross revenues per DH customer as a proxy for the Table 5 provides an overview of the ownership of DH utilities tariff levels to illustrate regional and national differences in and the responsibilities for establishing tariff methodologies the tariff level. and approving tariffs in the DH sector. Note that Serbia and Croatia have the highest revenue In Bosnia and Herzegovina and in Serbia, regulatory basis per household, whereas Ukraine and Mongolia have responsibility for the DH sector is not separated from the lowest. the ownership of DH utilities, whereas in the other three countries there is greater separation. In Serbia, this will change following the recent revision of the Energy Law. HEAT TARIFFS Table 6 provides an overview of the present heat tariffs for unmetered and metered, household and commercial customers in the six countries (standardized to U.S. dollars for comparison). Because the tariffs vary from city to city in most countries, the table shows representative large cities for comparison. With the different tariff structures across the six countries, immediate comparison may be difficult. Figure 14 therefore 22 Table 6. Overview of Heat Tariffs Bosnia and Serbia Kosovo Croatia Herzegovina Mongolia Ukraine Heat Tariff (Belgrade) (Pristina) (Zagreb) (Sarajevo) (Ulaanbaatar) (Kharkiv) Tariffs are the $0.30/m²/ $1.18/m²/ same as for month Unmetered $0.84/m²/ $0.80/m²/ $0.21/m²/ month + $32.3/ metered but (subsequently household tariff month month month kW/year measured at increased on the substation April 1 2015) and divided Unmetered $1.25/m²/ $0.20/m2/ N/A proportionally $2.7/m²/month N/A commercial tariff month month to m². $27.7/MWh (consumption) $70.7/MWh $56.9/MWh + $11.20/kW/ $47.0/MWh Metered + $0.42/m²/ + $0.83/kW/ year (capacity) + $0.32/m²/ $6.1/MWh $17.0/MWh household tariff month month + $13.70/year + month $0.98/m²/year (fixed element) $62.7/MWh + $56.9/MWh + $50.0/MWh Metered $23.5/kW/year $86.5/MWh $0.83/kW per + $0.63/m²/ $13.0/MWh $53.0/MWh commercial tariff + $13.7/year + month month $0.98/m²/year Note: Incl. 10% VAT Excl. 16% VAT Excl. 25% VAT Excl. 17% VAT Excl. 10% VAT Excl. 20% VAT Figure 14. Regional and National Differences in Tariff Levels Regional  and  Na3onal  Differences  in  Tariff  Levels   (DH  revenue  in  $1,000  per  household  per  year)   1.8   1.6   1.4   1.2   1.0   0.8   0.6   0.4   0.2   0.0   23 Table 7. Overview of Support Mechanisms Financial and Fiscal Country Support Mechanisms Regulatory Mechanisms Interconnection Policies Feed-in tariffs for electricity from Priority access and dispatching renewables and cogeneration Bosnia and incentive foreseen (Federation (Federation of Bosnia and None Herzegovina of Bosnia and Herzegovina and Herzegovina and Republika Republika Srpska) Srpska) Requirement for all new thermal electricity generation above 20 MW to allow for recovery of heat by means of a high-efficiency cogeneration unit to be sited Feed-in tariffs for electricity from Croatia where waste heat can be used Equal access to all generators renewables and cogeneration (Article 10 of Energy Efficiency Directive). Guarantee of origin for electricity. Preferred energy generator status (access to feed- in tariffs). Feed-in tariffs for electricity from Connection, purchasing, and renewables and cogeneration. Certificate of Origin for electricity Kosovo dispatching priority for renewable Law foresees similar incentives for from renewables and CHP and CHP electricity and heat heat production. Feed-in tariffs for electricity from Preferential access for electricity Mongolia None renewables from renewables. Privileged electricity producers Feed-in tariffs for electricity from (access to feed-in tariffs and not renewables and cogeneration. The paying balancing service). The Privileged producers have Serbia new energy law foresees similar new energy law foresees similar preferential access incentives for heat production incentives for heat (Articles 57–58 (Article 62). and 365–366). Feed-in tariffs for electricity from Ukraine None Equal access to all generators renewables and cogeneration SUPPORT MECHANISMS FOR DH/CHP Table 7 provides an overview of the support mechanisms. With regard to financial support mechanisms, all six countries have feed-in tariffs for the CHP electricity that is exported to FEED-IN TARIFFS FOR RENEWABLE ENERGY the grid, but none of the countries have implemented specific Table 8 provides an overview of the feed-in tariffs for feed-in tariffs for heat production from cogeneration or renewable energy. renewable sources. The incentives are backed in all countries by interconnection policies that provide CHP and renewables with transparent and consistent interconnection procedures for selling the generated electricity to the grid. Some countries also have market-based mechanisms (such as a requirement for new capacity to be CHP, status of privileged producer, and Certificates of Origin ). 24 Table 8. Overview of Feed-in Tariffs for Renewable Energy Feed-in tariffs (U.S. cents/ Bosnia and kWh) Serbia Kosovo Herzegovina Croatia Mongolia Ukraine 5.6–13.5 (RS) CHP (coal) 10.1 N/A 8.6 Negotiated N/A 9.8 (FBiH) 5.6–13.5 (RS) CHP (gas) 11.1 N/A 8.6 N/A N/A 9.8 (FBiH) 14.5–15.5 (RS) Biomass 16.3–20.7 8.9 14.5–20.0 (FBiH) 8.6–21.2 Negotiated 13.2 Geothermal 8.7–12.1 N/A N/A 19.6 Negotiated N/A 8.0–9.9 (RS) Hydro 9.3–15.5 7.9 8.6–17.4 4.5–6.0 8.2 7.9–18.5 (FBiH) 13.0–20.0 (RS) Solar PV 20.3–25.8 NA 25.0–31.0 15.0–18.0 45.3–49.4 9.4–23.7 (FBiH) 10.6 (RS) Wind 11.5 10.6 8.6 8.0–9.5 8.9–12.0 9.4–23.7 (FBiH) Waste 10.7 N/A N/A 8.6–21.8 N/A N/A Duration of feed-in tariffs 12 10 12 14 10 5 (years) Note: RS = Republika Srpska; FBiH = Federation of Bosnia and Herzegovina 25 Table 9. Assessment of the Institutional and Regulatory Framework Bosnia and International Best Practice Serbia Kosovo Croatia Herzegovina Mongolia Ukraine Regulators should be independent from ownership Partly Yes Yes Partly Yes Yes and management Regulatory and tariff approval process should be transparent Partly Yes Yes Partly Partly Partly and documented The approved tariffs should allow investors to cover full Partly Partly Partly Partly Partly Partly costs Regulation should provide incentives for efficiency Partly Partly Yes Partly Partly Partly improvements Policy instruments are used to support the use of DH/CHP (financial and fiscal support Yes Yes Yes Yes Partly Yes mechanisms, market-based mechanisms, interconnection policies) Social protection of DH customers against price Partly Partly Partly Partly Partly Partly increases should explicitly target low-income households Investment decisions consider the interests of consumers (by Yes Yes Yes Partly Yes Partly promoting low-cost, reliable heat supply) Legislative framework allows for private sector participation Yes Yes Yes Yes Yes Yes in the DH sector 26 2.3 Assessment of the Institutional and 2.4 Recommendations for Improving Regulatory Framework the Institutional and Regulatory Environment Table 9 compares the institutional and regulatory framework in the six countries to international best practice on The assessment of the institutional and regulatory facilitating private sector investment in CHP/DH (see Section framework above highlighted key challenges in the 3 for further discussion). framework conditions for PSP in DH, including challenges related to the conflicting goals of financial viability of the DH Note that the key issues across all six countries concern sector and affordable heating for households, and to a lack of implementation rather than inadequate regulations: successfully implemented PPPs in the municipal sector. ▶▶ Although most regulators are independent and The key recommendations for all countries to improve the tariff methodologies allow for cost recovery, financial viability of the DH sector are: social concerns remain a significant determinant in proposing and approving DH tariffs. This is because ▶▶ Tariff methodology determination and approval of social protection programs targeted at low-income tariffs should be separated from ownership (ideally households tend to be less developed, and affordability with an independent national regulator); concerns are addressed instead through low utility ▶▶ Affordability concerns should, in the longer term, be tariffs, which effectively act as blanket subsidies that handled through targeted subsidies to the poorest, benefit all connected households. rather than through generally low tariffs; and ▶▶ The legislative framework in all six countries allows for ▶▶ In the transition phase, performance-based subsidies private sector participation in the DH sector, but there for utilities may be a solution. is still a lack of successful PPP projects, which may create discomfort for international investors. Furthermore, the key recommendations for all six countries to enable testing of PSP in the DH sector are: Furthermore, country-specific issues exist: ▶▶ Developing a pipeline of pilot projects for PPP in ▶▶ In Bosnia and Herzegovina, complex administrative municipal services (including DH); structures have resulted in a multitude of legal acts ▶▶ Seeking international inspiration or assistance for and regulatory bodies regulating PPP transactions transaction structuring of the pilot projects; and as well as in a scattered legal framework related ▶▶ Addressing the inevitable conflict between to the DH sector. Due to significant government affordability concerns and financial viability upfront, decentralization, PPP and DH decision making is locally through structured, performance-based subsidies. driven and differs substantially depending on the locality. Table 10 (next page) provides country-specific ▶▶ In Mongolia, significant subsidies that permeate the recommendations on improvements in the institutional and entire value chain—from primary fuel supply and CHP regulatory framework in the six countries to facilitate private generation, to transmission and distribution to the sector investment in the CHP/DH sector. end-users—make partial sector reforms difficult. 27 Table 10. Country-Specific Recommendations Country Key Recommendations Due to complex administrative structures and a high degree of decentralization, a multitude of legal acts regulates PPP transactions. PPP models are split into different sets of acts and are regulated by different regulatory authorities. The legal space regulating PPPs needs internal harmonization, with key principles consolidated within a single document at the national and entity (Federation of Bosnia and Herzegovina and Republika Srpska) levels. The country should set clear and uniform PPP policy with regard to all PPP models and provide clear division of competences between PPP and other country legal acts (for example, Public Procurement Law). Establishing a single regulatory body in each entity for concessions and other forms of PPP is also recommended. The legal framework related to the DH sector is incomplete. The country lacks an Energy Strategy, a District Heating Sector Strategy, and a national legal document regulating key principles of the DH sector. A Law on Thermal Energy is in preparation in the Federation of Bosnia and Herzegovina; however, a more coherent framework regulating DH sector operation in both entities and at the Bosnia and Herzegovina national level needs to be established. In selected utilities, tariffs do not cover the costs of operation and investments, although the methodology formally allows inclusion of all costs. Concerns about affordability and social burden are frequently given as the reason for not adjusting tariffs to the proper level. There is a need for legal and regulatory enforcement of the tariff-setting and approval process. One option could be to establish a single regulator in each entity or ideally a national regulator. The methodology of tariff calculation also needs revision to take into account the need for substantial investment in DH infrastructure, and corresponding adjustments in the tariff-setting methodology. Various social assistance plans exist, but they are not uniformly applied. In some administrative units, funds are paid directly to customers, whereas in others they are allocated to the monthly invoice or to companies. Both entities need to revise their existing household social assistance plans to allow low-income families to receive direct targeted household subsidies. The program should be imposed uniformly across all municipalities and cantons. 28 Country Key Recommendations Croatia has had some PPP experience, and several projects are under procurement or in the pipeline. Apart from the Zagreb airport, all recent projects are in the building sector. However, AIK (previously AJPP) and CEI expect that there may be significant potential for PPP projects in the municipal sector. It is recommended that AIK identify selected pilot projects in municipal sectors where a potential for PPP exists (for example, waste management, street lighting, and possibly DH) and that CEI provide project development assistance for the pilot projects to demonstrate the viability of PPP projects in municipal sectors and facilitate development of sector-specific tender and contract templates. Approval from AIK and the Ministry of Finance is required for all PPP projects, and although the approval procedure has been simplified, the documentation requirements may present a barrier for projects that are the first PPP project in their sector. The parallel 2012 Concession Act includes less-stringent documentation and approval requirements, and the boundary between concessions and PPPs is determined on a case-by-case basis . The risk of strategic representation of PPP-type concessions as not being of a PPP type Croatia in the context of the legislation (for example, to avoid the requirement for establishing a Public Sector Comparator) should be recognized. For smaller PPP-type concessions at the municipal level, it may be beneficial to relax upfront documentation requirements for first-of-a-kind projects or to provide central government funding for selected pilot projects to enable the development of templates. New tariff methodologies recently have been implemented, and the first tariff decisions have been made for a number of smaller DH systems. This led to tariff increases, which improved the financial viability of DH utilities, taking an important step toward cost-reflective heat energy tariffs. The key test will be the ability of the state-owned HEP DH (accounting for 6 of the 10 largest DH systems and 80 percent of installed capacity) to propose and receive approval for rational heat energy tariffs. It is likely that social concerns will continue to be a factor in heat energy tariff determination, and there is a risk that such concerns may prevent the timely adaptation of cost-reflective tariffs that are fully compliant with the regulatory framework. It therefore is encouraged that strategies for targeted subsidies that benefit mainly the poorest households be considered and implemented. 29 Table 10. Country-Specific Recommendations, continued Country Key Recommendations PPP in the municipal sector is allowed by law. The regulatory structure is in place, and the government officially supports it. However, the sector is sensitive due to social concerns, and there is limited municipal capacity for managing PPPs; for DH in particular, there are significant issues related to revenue collection and financial viability that should be addressed prior to private investors being brought in. If the government of Kosovo would like to test PPP in the municipal sector, and in particular in DH, it should consider identifying selected pilot projects; balancing the concerns about affordability of DH services and financial viability through structured, performance-based subsidies from local governments to DH utilities; and seeking international assistance for transaction structuring of the pilot projects. Currently, affordability concerns are being addressed through blanket subsidies that benefit all connected households. Strategies for targeted subsidies that benefit mainly the poorest households should be considered. At the end-user level, an inadequate framework for organizing multi-apartment Kosovo buildings may limit energy efficiency initiatives, as no entity is responsible for common building installations. New legislation is under preparation at the time of this writing that may promote the establishment of Housing Administrations that would take over heat metering and system maintenance at the substation level. Based on metered consumption of heat, the DH company would prepare invoices (bills) for each substation, which are sent to the Housing Administration (as a result, the DH company would receive payment from the Housing Administration). Meanwhile, the Housing Administration would prepare separate invoices for consumers—individual apartment owners— based on the heated area (or according to calculations by means of heat allocators), plus typically an extra charge for the housing service. Considering the technical design of DH secondary systems in multi-apartment buildings, and the importance of safe and secure operation for reliable heat supply, the Administrator could engage a third party for operation, maintenance, and repair of the substation. The third party could be a district heating utility under a special service contract or any other specialized private company. 30 Country Key Recommendations The policy framework for PPP is in accordance with international best practice, but only one PPP project had reached financial close at the time of this writing. The lead agency role for PPP has moved several times in recent years, reducing continuity. The lead agency also has limited capacity to support the development and implementation of PPP transactions, and some ongoing transactions are implemented with limited transaction advisory. It is recommended that the government of Mongolia consider attracting financial resources and management expertise for utility services such as DH through a long-term contractual PPP. This could be promoted through establishment of a pipeline of selected PPP pilot/demonstration projects and attraction of international support for transaction structuring and implementation to increase the chance of success. In spite of significant fuel subsidies (domestic coal provided at production cost) and cross subsidization (between electricity and heat generation as well as between commercial and household heat customers), the end-user heat tariffs do not cover system operation and maintenance costs and are not adjusted to changes in cost basis. Therefore, the DH companies rely on subsidies from their owners, and their ability to undertake necessary system renovations and expansions is limited. The government of Mongolia should address the issue Mongolia of cost recovery in the DH sector. Without a clear and trustworthy model for cost recovery and servicing of loans / payback of investments, it will be difficult to attract private investment in the DH sector unless a sovereign guarantee is provided. Currently, affordability concerns are addressed through blanket subsidies that benefit all connected households. Comprehensive tariff reform should be considered to ensure cost-reflective heat tariffs and targeted subsidies that benefit the poorest households. In the context of tariff reform, the relation between the heat consumption- based tariffs (presently applied at the substation level) and heated area-based tariffs (presently applied at the end-user level) should be analyzed, as it appears to limit the incentive for switching users to metered billing and thereby the promotion of end-user energy efficiency. The present tariff approval process limits the ability of the regulator (ERC) to approve tariffs that ensure that revenues of licensees are sufficient to support their financial viability. It is recommended that ERC consider engaging in a dialogue with the country’s Fair Competition for Customers Agency and the Customers Rights Protection Agency on approaches to tariff adjustment that balance affordability and financial sustainability concerns. 31 Table 10. Country-Specific Recommendations, continued Country Key Recommendations The 2011 PPP law is in compliance with international best practice. A PPP unit has been established in the Ministry of Finance, and a practical guide and Heads of Agreement template have been published. However, there is a general lack of successfully implemented PPP projects in municipal services to date. The government of Serbia should consider: developing a pipeline of pilot/demonstration projects for PPP in municipal services (including DH); addressing the inevitable conflict between affordability concerns and financial viability upfront through structured, performance-based subsidies from local governments to DH utilities; and seeking international assistance for transaction structuring of the pilot projects. The independent regulator AERS will define a common methodology for tariffs, Serbia but municipalities still have to approve tariffs. Social concerns are likely to continue to be a significant determinant in municipal approval of tariffs. An independent approval procedure (for example, by the regulator) would be likely to provide a better framework for ensuring the financial viability that is necessary for development of the sector. The Ministry of Energy and Mining has taken over responsibility for the DH sector, and the DH sector will now be a part of the Energy Strategy. The implementation program to be prepared after the adoption of the new Energy Strategy for Serbia should explicitly consider private sector participation in the continuous modernization and extension of existing DH systems, as well as in relation to fuel switching (increasing the use of biomass, municipal waste, CHP) and end-user energy efficiency. 32 Country Key Recommendations The risk of strategic representation of projects as concessions rather than as PPPs in order to avoid the formal requirement under the PPP Law should be recognized. For smaller PPP-type concessions at the municipal level, it may be beneficial to relax upfront documentation requirements for first-of-a-kind projects or to provide central government funding for selected pilot projects to enable the development of templates. The PPP law could be strengthened in several areas to improve its role in regulation of PPP-type projects and to reduce ambiguity. In the context of the PPP Law, it should be considered to distinguish real PPP projects from other projects; eliminate inconsistencies between the PPP Law and other laws; improve regulation of relationships resulting from land allocation for PPP purposes; expand application of competition procedures for selection of private partners; introduce effective mechanisms and forms of state support for a PPP project; clearly define competencies of national and local authorities regarding Ukraine their roles in PPPs and in the analysis of the effectiveness of a PPP arrangement; and introduce additional guarantees for a private investor. Renewable energy sources and CHP could provide important contributions to increased energy supply security for Ukraine. It is recommended that support be provided for development of the biomass / solid waste supply chain and market to facilitate a switch from dependence on imported gas to alternative domestic fuels. High-efficiency cogeneration should continue to be promoted in the interest of efficient use of the fuel sources. Hence, the government of Ukraine should ensure that CHP is an integral part of the renewable energy action plan. End-user energy efficiency can be promoted through ESCOs, but, according to the Energy Efficiency Agency of Ukraine, the current subsidy policy targets end-users and may limit the opportunities for ESCOs. It is recommended that legal and incentive barriers to the use of ESCOs in Ukraine are assessed further to enable the testing of ESCOs as a means of implementing end-user energy efficiency investments. 33 3 | Promoting and Supporting PSP in DH: International Best Practice 3.1 Best-practice Regulatory they do not pay their heat bills. This, however, requires the Frameworks and Incentives to Promote introduction of heat consumption-based meters, which PSP in DH improve access to information for consumers and suppliers about heat consumption and losses. Only when they are FRAMEWORK CONDITIONS aware of actual consumption levels rather than estimates International experience shows that governments can based on norms will consumers and heat suppliers have facilitate private sector investment in CHP/DH by creating incentives to take action to reduce their losses and costs. policies that attract private players to CHP/DH facilities: TARIFF-SETTING METHODOLOGIES ▶▶ Tariffs should allow investors to cover full costs; Another important aspect of incentivizing efficiency is the ▶▶ Regulation should provide incentives for efficiency tariff structure. improvements; ▶▶ The regulatory process should be transparent and Key tariff-setting methodologies are: predictable; ▶▶ Regulators should be independent from ownership 1. Cost-plus, where the operator is compensated for and management; the cost of operating the DH system with a fixed ▶▶ Social protection programs should target low-income percentage of profit built in, which the operator must households; use to pay for upgrades. ▶▶ Investment decisions should consider the interests of 2. Return on investment, where the operator is consumers (least-cost and supply security); and compensated for operating expenses, depreciation ▶▶ The legislative framework and subsequent regulations on longer-term investments, as well as a return on have to allow for private sector participation in the invested capital to be included in the base for tariff sector. determination. 3. Tariff indexation or price cap, where prices are set to Furthermore, well-designed policies can incentivize heat cover the costs of the preceding year multiplied by suppliers, network operators, and end-users to save costs an index that reflects a change in specific conditions and energy. (such as rising fuel costs) as well as an expected annual efficiency gain. One aspect is the existence of a contractual relationship 4. Benchmarking, which allows prices to be established between heat suppliers and consumers that clearly defines based on a review of a group of peer heat suppliers and that heat-generating enterprises are responsible for providing thus incentivizes the more-efficient (and penalizes the heat of sufficient quality and for contracting network less-efficient) heat suppliers in the group. operators (in cases where the DH sources are not part of the company or the waste heat is procured from third parties) Table 11 compares the advantages and disadvantages of each to distribute the heat. The contract also should specify that tariff type. heat suppliers have the right to disconnect customers if 34 Table 11. Comparison of Tariff-Setting Methodologies Examples of Methodology Pluses Minuses Application in DH Does not promote efficiency due to Clear and logical calculation method; push-through of costs onto consumers Scandinavia, Cost-plus lower costs of tariff administration (for example, fuel costs); asymmetry in Romania availability of cost data to regulators Does not have particularly strong incentives to improve efficiency or Encourages investment and private lower cost (although it could explicitly sector involvement by guaranteeing a include the efficiency incentive, as with Return on Estonia, Lithuania, rate of return on investment; an energy Regulatory Asset Base regulation in the investment United Kingdom efficiency incentive may be included United Kingdom); poses a risk for the explicitly (U.K. experience) Averch-Johnson effect (overinvestment in capital assets to increase regulatory asset base) For systems that have seen significant Provides incentive for efficiency and Tariff underinvestment, price caps may cost savings if utility is allowed to retain indexation / not allow enough tariff funding Hungary energy saving; public advantage of a Price cap for modernization and unexpected tariff that is more or less capped equipment failures Provides strong incentive for efficiency Requires significant data on comparable improvements and cost savings through district heating systems and careful Used primarily in Benchmarking market comparison; can help address thought to adjust for differences in electricity markets asymmetry in cost data between district conditions heating company and regulator The countries presently rely mainly on cost-plus methods POLICIES USED TO PROMOTE DH/CHP for heat tariff setting, giving the DH companies limited DH systems and CHP often require higher upfront incentives to reduce costs and deterring investments in investments than conventional alternatives. This can deter energy efficiency, because any potential savings would be operators from investing in DH and CHP, even though curtailed in the following year’s tariff. In parallel, the tariff operating costs may be lower and socioeconomic benefits structures also affect end-users’ motivation to save, as (for example, when internalizing externalities such as consumers will be more motivated if their bills are based on greenhouse-gas emissions) may be significant. In such their actual consumption, rather than on estimates, fixed situations, several policy measures may be used to help fees, or norms of consumption. trigger DH and CHP. The key policies used internationally to promote DH and CHP are: To encourage cost efficiency and energy efficiency, regulators could provide incentives for DH companies to 1. Feed-in tariffs, which provide direct operational move away from cost-plus tariffs in favor of benchmarking, support for CHP and renewable energy generation. A return on investment, or a form of price-capping, and in feed-in tariff usually takes the form of a bonus added parallel encourage a move from norm-based tariffs toward to the market electricity price paid to generation plant consumption-based tariffs at the household level. operators for each kilowatt hour (kWh) of electricity supplied to the public network, but it also can be fixed 35 Table 12. Overview of Support Mechanisms for DH/CHP Support Mechanism Policy Goal Success Factors Examples of Application Provide greater certainty for Czech Republic, The level and duration of the feed- investors in CHP and incentivize Denmark, Germany, Feed-in tariffs in tariff should allow a sufficient organizations to operate efficient Hungary, Netherlands, return to attract investments CHP plants Portugal, Spain Should target developers that lack financing Address the issue that DH and Requires careful analysis of the CHP often require higher upfront Belgium, Italy, Capacity grants market investments than conventional Netherlands, Spain alternatives Level should be reviewed on a regular basis to reflect changes in technologies and market conditions Allow CHP/DH developers Provide greater certainty accelerated depreciation on Belgium, Italy, Germany, for investors in DH/CHP and Fiscal support investments and/or exemption Netherlands, Sweden, incentivize organizations to invest from fuel taxes without inducing United Kingdom in efficient DH/CHP too-high administrative burdens Make CHP plants competitive in the Obligation share should be high electricity market and guarantee a enough to create scarcity and Most EU countries (for market for CHP electricity. sustain demand but also reflect a Utility supply renewable energy); realistic potential for developing obligations Create a demand for CHP electricity Belgium, Poland (for CHP. Can be supported by a through a purchase obligation on CHP) ceiling (buy-out price) and a floor electricity suppliers (guaranteed minimum price) Requires knowledge of heat demands and available sources Establish efficient low-emission Heat planning/ as well as coordination at Denmark, Germany, energy systems in urban areas, zoning the municipal level among Sweden including DH infrastructure policymakers, energy suppliers, and customers to establish clear goals Streamline interconnection procedures, enable grid access for Close monitoring of all stakeholders Interconnection CHP (through net metering, priority by regulators; development of Most EU countries, and grid access dispatch, and licensing exemption standards that address all elements United States measures to improve commercial conditions), of the interconnection process and ensure fair treatment of CHP independently of the electricity price, and it may be of tax relief that allows accelerated depreciation combined with an obligation on the network operator of CHP/DH investments for tax purposes or that to buy CHP or renewable energy-based electricity. provides exemption from fuel or carbon taxes. 2. Capacity grants, or upfront one-off subsidies 4. Utility supply obligations, which use the trading of provided to facilitate installation of CHP/DH systems certificates to guarantee a market for CHP electricity by when upfront costs present a barrier to investment. placing an obligation on electricity suppliers to source 3. Fiscal support or incentives, for example in the form a certain percentage of their electricity from CHP. 36 5. Heat planning or “zoning,” coordinated municipal 3.2 Best-practice Business and Financing processes to establish efficient, low-emission energy Models to Support PSP in DH systems in urban areas, including DH infrastructure and generation based on CHP and renewable energy sources. 3.2.1 TRADITIONAL PUBLIC PROVISION 6. Interconnection and grid access, comprehensive OF DH VS. PPP policies to streamline interconnection procedures, Traditional public provision of DH is when the service is enabling grid access for CHP and incentives for provided by a government or municipal department or by a network operators to ensure fair treatment of CHP. public authority or a publicly owned company. Table 12 provides an overview of the policy goals, success Figure 15 provides an illustration of the DH value chain, factors, and examples of countries where these support from fuel supply, heat generation, and transmission, to the mechanisms are applied. distribution of the heat to end-users. Under the traditional model, the government (national or municipal) owns the CHP plant or conventional (heat-only) Figure 15. Traditional Public Provision of DH 37 boiler used for generation and also owns the DH network, management contracts and lease contracts to concessions regulates the sector, provides investment support, and and private provision (privatization of existing assets and determines tariffs. Build-Own-Operate for new assets), as well as models designed to address specific challenges in the DH supply The traditional model has, in most economies in transition, chain, such as heat entrepreneurship (mobilizing the biomass been characterized by challenges related to inadequate supply chain) and ESCOs (addressing investment barriers at maintenance, insufficient funds for infrastructure the end-user level). development, poor planning and project selection, as well as inefficient or ineffective delivery. These challenges are a key The key business models for private sector participation in DH reason for considering alternative delivery models involving used internationally and described in further detail below are: the private sector through public-private partnership (PPP) or private sector participation (PSP). ▶▶ Management agreements, where a company takes on the responsibility for managing the DH system and A PPP is a long-term contractual agreement on private conducting sales, as well as minor upgrades. provision of services that traditionally have been provided ▶▶ Leasing, where a private party (lessee) takes on the by the public sector. As discussed in this chapter, it includes operation, management, and implementation of a continuum of models that reflect the increasing transfer facility upgrades under a contract with the public party of risk and responsibility from the public sector to private (lessor). operators. A key premise is, however, that the political ▶▶ Concession agreements, where the concessionaire responsibility for the provision remains with the public takes on the responsibility for investment in system authorities. PSP in DH is used to describe situations when the upgrades under a long-term concession agreement. provision of DH services involves a PPP. ▶▶ Privatization, where a private investor brings financing for DH and seeks recovery through heat sales, with the PSP may contribute to solving the challenges of the traditional government providing framework conditions through model by providing long-term investment perspective, tariff regulation, energy planning, standards, and norms. enabling access to additional sources of funding, and providing ▶▶ Heat entrepreneurship, a model developed in Finland private sector experience, innovation, and incentives. since the early 1990s that facilitates the development of biomass-based heat generation and distribution The involvement of the private sector through a PPP may through a partnership-based approach involving the create value for the public authority that holds political wood fuel supply chain. responsibility for the provision. This value is created ▶▶ Energy service companies (ESCOs), which address through output-based contracting (compared to input- investment barriers at the end-user level through based contracts when procuring deliverables under provision of energy services to final energy users, the traditional model), optimized risk allocation (which including the supply and installation of energy- transfers project risks to the party most able to manage efficient equipment and/or the refurbishment of them), optimization over the project lifecycle (through the buildings; they can arrange financing for the operation, integration of responsibility for design, construction, and with their remuneration being tied directly to the operation), improved incentives for quality service provision energy savings achieved. supported by performance-based payments (depending on quality of service delivered), as well as access to additional Table 13 illustrates key differences in the allocation of risk and financing sources. responsibility of these models. PPPs are a variety of models that reflect the increasing The sections below discuss the international best-practice transfer of responsibility for service provision, ranging from business models introduced above. 38 Table 13. PSP Models Operation and Payment for Investment Ownership Management Services Management Private Public Public Public agreements Leasing Private Private Public Public Concession agreements Private Private Private Public Privatization Private Private Private Private Heat entrepreneurship Private Public/Private Public/Private Public/Private ESCOs Private Private Private Public/Private Note: Public may be by local or national government 39 3.2.2 MANAGEMENT AGREEMENT collection risk in terms of performance standards, but it is A management agreement involves the outsourcing of public unlikely to collect bills on its own behalf. service management, while the ownership and investment decisions are retained in the public sector. Management agreements may include obligations on the private operator to operate and maintain the assets, and Management agreements generally are short term (two they may include the cost of routine replacement of small, to five years) and usually do not involve any transfer of low-value components of equipment. employees to the operator. The benefits that can be realized from a management The private operator is usually paid a fixed fee to cover its agreement compared to the traditional model include staff and expenses, as well as a performance-based fee addressing issues of poor management in an existing public linked to the quality of the service provision, with liquidated company and enabling a separation of the operation and damages for failure to achieve performance parameters. regulation of district heating. The operator under a management agreement is required However, it should be noted that management agreements to collect bills on behalf of the utility and may accept some have only limited potential for improvements in efficiency Figure 16. Management Agreement Model for Provision of DH 40 Box 1. Management Agreement for the Kolpino The Kolpino Combined-Cycle Gas Turbine power CHP Plant in St. Petersburg, Russia plant is situated in St. Petersburg’s rapidly growing northwest industrial district. The plant had previously selected GE’s advanced gas turbine technology and Management agreements cover a range of different Siemens’ steam turbines as the basis for its power plant models, from operation and maintenance (O&M) upgrade. support services where the private partner provides local support to the client’s staff as well as performance In 2011, the private partner Fortum signed a long- monitoring of the plant; to O&M management term service agreement with GSR that included where the private partner takes responsibility for the optimization of the service and spare parts strategy, operations management (including key managers) but streamlining of the O&M organization, and the the power plant owner provides the staff of the plant; provision of IT systems, including an Integrated to full-scope O&M where the private partner takes Management System and a Customer Management full responsibility for the operation and maintenance System. of the client’s power plant, including the planning The realized benefits for the client included access of operation, performing daily operations, plant to the private partner’s long-term international maintenance, material and resource management, and experience in operating and maintaining gas turbine- continual improvement. operated power plants; restructuring of the O&M The management agreement entered by Fortum for organization with clearer responsibilities, higher the Kolpino CHP Plant in St. Petersburg, Russia, is an efficiency, and significant head-count reduction; the example of O&M support services where the private introduction of Western European O&M business partner participated in the client’s energy upgrade processes integrated with organizational and Power IT and efficiency project. The management agreement systems; the transfer of know-how and training, and is entered with GSR Energy, a major supplier of access to the private partner’s expert service network heat energy to residents in the Kolpino district of St. and remote support. Petersburg that is partly funded by Macquarie Russia The original agreement covered 2011–2014, and the and CIS Infrastructure Fund (in which IFC is one of the partners met in April 2015 to discuss future cooperation investors). based on the successfully achieved results. and performance, and they typically do not bring in large- Management agreements in DH are, for example, used in the scale financing. Czech Republic, Russia, and Sweden. Box 1 provides a case example of a management agreement. Figure 16 provides an illustration of a management agreement for provision of DH. In the example shown, the management agreement covers both generation as well as transmission and distribution, which is assumed to be combined in one public service company; however, the management agreement could equally well be for a more limited part of the value chain if generation and transmission/ distribution are separated in several public entities. 41 3.2.3 LEASE AGREEMENT affermage fee. The lessee recovers the lease costs via the A lease agreement involves a private party (lessee) operation, and the revenue collection risk is passed to the taking on the operation and management, as well as the lessee. Therefore, the lessee requires assurances as to the implementation of facility upgrades, under a contract with tariff levels and increases over the term of the lease, as well the public party (lessor). The lessor receives rent payments as a compensation/review mechanism if tariff levels do not from the lessee that are reinvested into facility upgrades, meet projections. which the lessee is contracted to implement. The cost of maintenance and some replacement is passed Lease agreements generally are medium-length (8 to 15 to the lessee, and the lessee assumes some degree of asset years) and involve employees being seconded or transferred risk in terms of the performance of the assets. Furthermore, to the operator. the lessee may be put in charge of overseeing the capital investment program/ specific capital works. The lease fee is either fixed or, in case of an “affermage” 1, the employer receives net receipts from customers less an The lessee will maintain an asset register and operation 1  In the case of an affermage, the operator retains the operator fee out of the and maintenance manuals/records, etc., and the contract tariff receipts and pays an additional surcharge (charged to customers) to the typically will include minimum maintenance or replacement awarding authority to go toward investments that the awarding authority makes or has made in the infrastructure. Figure 17. Lease Agreement Model for Provision of DH 42 Box 2. Lease Agreement for the Vilnius DH The benefits for the city have included activation of the System in Lithuania DH market, increased operational efficiency, access to financial resources, accelerated investments in system renovation, and improved asset management. In Lithuania, around one-fifth of the municipalities Furthermore, the private sector helps the city to have entrusted the management of their DH assets to achieve other goals such as pollution reduction and private operators under long-term lease agreements, fuel switching. where operation and management, revenue collection and investment are privately managed but ownership The State Commission for Energy Control and Prices remains public. The employees are transferred to the defines the methodology for price calculation, lease company, and, after contract expiration, they are including an acceptable level of cost recovery with transferred back to the municipal DH company. a regulated profit that provides incentives to invest in DH system renovation, as a return on investment In Vilnius, the lessee is JSC Vilniausenergija (a can be recovered by private and municipal-owned subsidiary of Veolia) under a 15-year lease contract. DH enterprises. The DH company calculates the The level of investments and its schedule is defined in price according to Commission methodology and the lease contract and includes reconstruction of the presents it for approval by the municipality board, heat network, elimination of group heat substations, but the Commission has a right to approve the price reconstruction of boiler houses, and innovative unilaterally if justified prices are not approved by solutions with regard to a remote data collection and the municipal board. The state government applies monitoring system. Furthermore, the DH company a reduced VAT (9 percent instead of 21 percent) for has established a €5.8 million Energy Efficiency Fund, heat prices for all residential consumers, and low- which financed 75 percent of the individual heat income consumers are protected through a national metering costs of more than 10,000 households in compensation mechanism. Vilnius. provisions toward the end of contract to ensure that the Figure 17 provides an illustration of a lease agreement for facilities are handed back to the lessor in an operational state. provision of DH. Again, the example shown covers both generation as well as transmission and distribution, but the In addition to the benefits realized under a management lease agreement could equally well be for a more limited part agreement, a lease agreement provides stronger incentives of the value chain. for operational efficiency and improved asset management. Lease agreements in DH are, for example, used in Estonia But a lease agreement also limits the authority’s right to and Lithuania. Box 2 provides a case example of a lease intervene and involves a risk of degraded asset quality agreement in Lithuania. at hand-back if not adequately regulated in the lease agreement. Furthermore, lease agreements typically do not mobilize additional capital. 43 3.2.4 CONCESSION AGREEMENT The concessionaire usually assumes risk of demand for use Under a concession agreement, the public authority grants a of the asset, as well as risks of design, finance, construction, private party (concessionaire) the right to renovate, finance, and operation. The public authority, however, may share the and operate an existing infrastructure asset, or (in the case demand risk by agreeing to a minimum level of usage. of a Build-Own-Operate-Transfer) to design, build, finance, and operate a new infrastructure asset. The assets are owned User charges may either be prescribed in the contract or set by the public sector, but concession agreements usually by the concessionaire under supervision of a sector regulator. are long-term in nature (typically 25–30 years) to enable the concessionaire to recover investments, after which The benefits of concession agreements include the benefits responsibility for the operation reverts to the public authority. of management agreements and lease agreements; in addition to this, a concession agreement provides stronger The concessionaire recoups its investment, operating, incentives for operational efficiency and for optimizing financing costs, and profit by selling its services directly to lifecycle costs—and, importantly, well-structured concession the end-user of the services. The concessionaire usually pays agreements may mobilize additional financial resources. a concession fee to the awarding authority. Figure 18. Concession Agreement Model for Provision of DH 44 Box 3. Concession Agreement for DH in This district heating project will allow new customers Paris, France to switch to a more environmentally friendly heating source and will facilitate the future development of renewable heating boilers by CPCU. The network is to The Paris DH system is operated by the Paris Urban be built along the T3 tramway line under construction Heating Company (CPCU) under a concession, in Paris. District heating was not available previously in originally obtained in 1927. The system has 4,000 this area (customers were using other forms of heating MWth of heat generation capacity, a 450-kilometer such as individual electric heating) and will result in network, and 460,000 customers (one-third of Paris), a significant reduction of carbon dioxide emissions and it is more than 50 percent based on renewable compared to heating from conventional sources. energy sources (primarily geothermal and biomass More generally, it will encourage future investments resources). CPCU is owned two-thirds by GDF Suez in renewable heating boilers to be connected to this and one-third by the city of Paris. As remuneration for network and will lead to the closing of a conventional the concession, CPCU pays 1.85 percent of the annual boiler using fossil fuel in this area. Thanks to this and turnover to the city of Paris. other projects under way, by 2020 nearly 20 percent The government of France recently provided a €26 of the energy used in the heating of Paris would come million direct grant to CPCU for the construction of from renewable sources (biomass, biogas, geothermal), a district heating transmission pipeline and related as opposed to none at the moment. local district heating networks in the northeast The project will increase the beneficiary’s sales by of Paris. The French authorities also extended the less than 5 percent and introduce a new competitor district heating concession by seven years, to 2024, to among the providers of heating in the northeast of allow the concessionaire to recoup the €170 million Paris. The French authorities have committed either network investment costs without undermining the to putting out the concession for tender in 2024 or to commercial operation of the concession contract. operating it in their own account as of 2024. However, concession agreements also require relatively Figure 18 provides an illustration of a concession agreement advanced framework conditions: the responsible authority for provision of DH. Again, the example shown covers both has to be willing to delegate operation and maintenance, generation as well as transmission and distribution, but the design, and investment decisions; the tariff determination has concession agreement could equally be for a more limited to be independent or backed by a compensation mechanism part of the value chain. for inadequate adjustments; the output-based requirements and allocation of project risks have to be defined prior to Concession agreements in DH are, for example, used in contracting; and obligations related to present workers and France and Romania (Ploiesti). Box 3 provides a case example non-commercial service have to be addressed upfront. of a concession agreement. 45 3.2.5 PRIVATIZATION typically is used to develop a discrete asset rather than a whole network and is generally entirely new or greenfield Privatization may involve full divestiture of an existing utility in nature. For Build-Operate-Transfer projects, the operator or private provision of new assets through Build-Operate- generally obtains its revenues through a performance-based Transfer. availability payment charged to the utility/government rather than through tariffs charged to consumers. Full divestiture of an existing utility usually will be accompanied by limitations on the private operator, which Figure 19 provides an illustration of privatization or private will be required to hold a license to provide the service, and provision of heat generation assets. The revenue basis is a such license is subject to termination. Hence, although full combination of electricity sales to the power grid (under a privatization is often considered to be a more final form of power purchase agreement) and heat sales to the public DH private sector involvement in a utility than a concession, transmission company (under a heat purchase agreement). similarities often exist. Privatization in DH has, for example, been used in the Another form of privatization is private provision of a new Czech Republic, Poland, and Romania. Box 4 provides a case asset through a Build-Operate-Transfer contract. This example of privatization in Poland. Figure 19. Privatization Model for Existing or New Heat Generation Assets 46 Box 4. Privatization of a Cogeneration Plant and The network extension also resulted in elimination of DH Network in Poznań, Poland the city’s small coal-fired facilities, which had caused considerable pollution. The Poznań DH system supplies heat to more than The contractual framework for the sale of the DH 60 percent of the inhabitants of the regional capital assets required the operator to invest in sources of Wielkopolska and up to a dozen other towns in heat production for the district network. This could the region through a 470-kilometer DH network. have been done either by building a new power The generation capacity of 1,090 MWth is mainly plant or by acquiring shares in the state-owned cogeneration and is based on 87 percent coal and 13 company supplying the network, which was slated for percent biomass. privatization. The operator chose the second option, and, in March 2004, the Polish treasury department Under the Polish privatization process in the early awarded the contract privatizing the Poznań electricity 1990s, the existing municipal DH assets were and heat generating plant to the operator. corporatized and restructured and subsequently sold to Dalkia in 2002. (In connection with the sale of Entry to an international group has enabled the DH Veolia’s majority ownership in Dalkia to Électricité de company to improve operational efficiency, carry France in July 2014, the activities in Poznań continued out investments, and develop new services. Today, as Veolia Energy Poznań.) the Poznań DH company offers energy services for buildings through which it designs, builds, and Upon privatization, the new owners upgraded and operates installations (boiler rooms, networks, central expanded the DH system, invested over €20 million, heating, and hot and cold water supply systems) on and improved the financial viability of the system. behalf of the building owners. It also offers energy The network was expanded to serve some 10,000 services for businesses, including management of additional households, representing close to 100 technical installations, advice on energy efficiency, MWth in new connections. This resulted in a 12 percent and implementation of investments related to reduction of network breakdowns between 2002 cogeneration, biomass, and heat pumps. and 2003, as well as in improved energy efficiency. 47 3.2.6 HEAT ENTREPRENEURSHIP risk; here, the involvement of the heat entrepreneur has The heat entrepreneurship model has been developed in parallels to a management contract. Alternatively, heat Finland since the early 1990s to facilitate the development of entrepreneurship may be “investment by entrepreneur,” biomass-based heating plants and DH networks through a where the entrepreneur (or a third-party investor) bears the partnership approach. A key feature is the involvement of the investment risk, and the involvement of the entrepreneur biomass/wood fuel supply chain (for example, through equity resembles a concession agreement. participation in the generation capacity) to reduce supply chain risks, as well as a carefully crafted balance of ownership Figure 20 provides an illustration of heat entrepreneurship. In and responsibilities among stakeholders. Apart from this the example, the heat entrepreneurship does not encompass involvement of the biomass/wood fuel supply chain, the heat heat transmission and distribution, but that could equally entrepreneurship model may otherwise be structured much have been the case. However, the model’s key difference like the earlier-discussed PSP models. from the other PSP models is the explicit focus on involving the biomass supply chain. Heat entrepreneurship may be “investment by customer,” where the entrepreneur oversees the practical operation and This makes the model specifically suitable for the maintenance, while the municipality bears the investment establishment and operation of new generation capacity Figure 20. Heat Entrepreneurship Model 48 Box 5. Heat Entrepreneurship in Eno, Finland than 50 cooperative members (mostly forest owners who carry out the harvesting themselves) and is partly sourced on the open markets. Heat entrepreneurship has been developed in Finland The benefits in Eno include heat being cheaper for to establish biomass-fired heating plants and district consumers compared to light fuel oil (about half price). heating networks, organize the wood fuel supply For forest owners, local farmers, and contractors, heat chains, and define ownership and responsibilities entrepreneurship provides extra income, benefits of among all stakeholders involved (sellers/buyers of the improved forest management, use of under-utilized service, subcontractors, and fuel producers). harvesting equipment, and increased employment. Heat entrepreneurs operate locally at a municipal For the municipality, heat entrepreneurship level, producing heat from local wood fuel resources. provides increased security of heat supply, savings in An example is the Eno Energy Cooperative in Eno operational and investment costs of energy production (7,000 inhabitants) located in North Karelia in eastern (when fuel oil is replaced with cheaper wood fuels), Finland. The first heat plant was invested by the increased use of local labor, and creation of new municipality, but the cooperative founded in 1999 built business opportunities, as well as environmental two more plants in 2002 and 2004 with a combined benefits. capacity of 9.5 MW. A one-hectare forest yields 250 m³ of roundwood The Eno Energy Cooperative is now the owner and (for the local sawmill/pulp mill) and 160 m³ of forest operator (largely similar to a concession) of two residues and stumps (of which one-third will be left heating centers (heating plant and distribution in the forest as fertilizer). This in turn yields 40 m³ of network) and the operator (similar to a leasing bark, sawdust, and other wood residues (from the agreement) of five heating centers. Heat from all sawmill/pulp mill) and 110 m³ of forest chips (from three plants is sold on a 15-year agreement to the forest residues and stumps). This results in 150 m³ total municipality and in parallel to private customers. Fuel of wood fuels, which can generate 170 MWh of heat wood is mainly (70 percent) supplied by the more and 85 MWh of electricity. based on biomass and for the management of the related supply chain, and the solution may be implemented independently of the ownership and management model selected for the rest of the heating system. Heat entrepreneurship, originally developed in Finland and subsequently tested in Canada and Russia, may be an interesting inspiration for mobilization of the biomass supply chain. Box 5 provides a case example of heat entrepreneurship. 49 3.2.7 ESCO In some countries, the ESCO market has been facilitated An energy services company (ESCO) provides energy services by third-party insurance of the energy savings, with such to final energy users (such as households), including the risk mitigation instruments typically being supported by supply and installation of energy-efficient equipment and/or development banks. building refurbishment. Figure 21 provides an illustration of an ESCO for end-user In a “shared savings” model, the ESCO makes investments, energy efficiency in DH. whereas in a “performance guarantee” model, the ESCO provides a savings guarantee and the host company or ESCOs in DH have been used in a number of countries, housing association makes investments. including the United States and Greece, from which the case example in Box 6 comes. The ESCO guarantees energy savings and/or provision of the same level of energy service at lower cost, and the remuneration of the ESCO is tied directly to the energy savings achieved. Therefore, the ESCO accepts some degree of risk for the achievement of improved energy efficiency. Figure 21. ESCO Model for End-user Energy Efficiency in DH 50 Box 6. ESCO1 Agreement for Serres DH in A separate private company, Techem Energy Greece Contracting Hellas EPE, acts as an ESCO that provides substations, meter reading, and billing services and engages in the collection of payments and invoices. The Thermie Serres CHP plant started operation in The consumer signs a common contract with both 2007 as the first CHP in Greece. Electricity from the WARM Serres SA and Techem Energy Contracting cogeneration is delivered directly to the national Hellas EPE for heat supply and for the supply and transmission grid, while the heat covers the needs installation of a substation. for heating and sanitary hot water for buildings in the city of Serres, in northern Greece. The gas-fired Ownership and maintenance of the substation remains CHP is backed up by gas-fired conventional (heat- with WARM Serres SA, but Techem Energy Contracting only) boilers covering peak district heating demand. Hellas EPE provides meter reading, billing, and State support to enhance the CHP project’s viability collection. Consumers are not obliged to use district was essential for project implementation and was heating, but they are charged an annual fixed fee for provided through an investment subsidy (under Greek maintenance and equipment costs, thereby providing Investment Law 3299/2004) and the state feed-in an incentive to use district heating. The main benefits tariff regime. of this setup are a high connection rate (ensuring, fast penetration of district heating in Serres), high The heat and electricity producer, Thermie Serres network efficiency, high production efficiency, and a SA, established a subsidiary, WARM Serres SA, that high collection rate due to reliable heat services and distributes the heat to consumers in Serres. About affordable prices. 800 buildings with more than 10,500 apartments have been provided with supply and installation Techem furthermore provides energy services to its of consumer substations, free of charge for the residential and commercial customers and offers to consumers to ensure a high connection rate. The result assume the full risk of energy renovations on behalf of is a highly efficient district heating system with high customers, including undertaking all works, ensuring production efficiency and high heat density along increased efficiency, guaranteeing financial soundness pipelines. and long-term stability, and ensuring agreed reductions in carbon dioxide emissions. An energy service company (ESCO) provides energy services to final 1 energy users (for example, households), including the supply and instal- lation of energy-efficient equipment and/or building refurbishment. 51 Table 14. Assessed Readiness for PSP in DH Readiness for Best-practice Bosnia and Croatia Kosovo Mongolia Serbia Ukraine Business Models for PSP in DH Herzegovina Management agreementsa I I I I I I Leasing I I I L I I Concession agreements L I I L I I Privatization L I L L L L Heat entrepreneurship I I I L I I ESCOs I I L L I I : Immediate options (requiring no or minor changes in existing framework conditions) I L: Longer-term options (requiring comprehensive implementation of the country-specific detailed recommendations on the improvements to primary and secondary legislation, institutional set-up, etc.) 3.3 Applicability of Business Models in end-user energy efficiency measures in the Western Balkan Case Countries countries and Ukraine (although Kosovo is subject to the adoption and implementation of legislative changes that are Based on the best-practice business models described in presently being planned to establish housing associations). Section 3.2 and on the identified barriers and regulatory/ institutional bottlenecks for the individual countries The countries can take various actions to attract private described in Sections 2.3 and 2.4, Table 14 provides an capital to the DH sector. Across all six countries, PPP in assessment of the immediate options (requiring no or minor municipal services may be promoted by developing a pipeline changes in existing framework conditions) and longer-term of pilot projects for PPP in municipal services (including options (requiring comprehensive implementation of the DH) and seeking international assistance for transaction country-specific detailed recommendations) for private structuring of the pilot projects. Similarly, all countries sector participation in district heating in the six countries. may improve DH sector commercial viability by separating tariff approval from ownership and addressing the conflict As noted in the table, all six countries are ripe for between affordability and financial viability through targeted, management agreements in DH, and all but Mongolia (due performance-based subsidies. Further to these general to legal limitations) are ready for leasing agreements in DH. recommendations, the individual country recommendations With respect to concession agreements, the lack of a clear presented earlier in this report will contribute to the enabling strategy and sector legislation in Bosnia and Herzegovina conditions for successful development of the DH sector and the need for comprehensive subsidy reform in Mongolia through a partnership with the private sector. makes it a longer-term option, whereas the four other countries are ready for concession agreements in DH. Among the six countries, only Croatia has the necessary legislation in place to enable privatization. The experience with heat entrepreneurship may inspire both the Western Balkan countries and Ukraine to consider approaches that utilize the vast biomass potential in the region. ESCOs are a relevant option for implementation of 52 53 4 | Investment Opportunities in DH 4.1 Overview of the DH Sector The review conducted of selected DH systems in the six countries has confirmed a substantial investment need and opportunity in the sector in relation to continued network improvements to reduce heat and water losses, switch to cleaner fuels, shift to efficient CHP production, utilize waste heat, and make energy efficiency investments at the end- user level. A conservative assessment of the immediate investment needs in the DH systems reviewed is provided in the overview Table 15 and sums to $1.5 billion. Table 15 summarizes key aspects of the DH sector in the six countries. 54 Table 15. Overview of the DH Sector Key DH Sector Bosnia and Aspects Herzegovina Croatia Kosovo Mongolia Serbia Ukraine 21 Number of DH 22 20 3 7 58 (largest companies systems) 21,451 MWth Installed capacity 1,000 MWth 2,000 MWth 200 MWth 2,000 MWth 6,000 MWth (heat-only boilers) Natural gas, mazut (heavy Mazut, natural Main fuel use Natural gas Mazut Coal Natural gas fuel oil), coal, gas, coal and biomass State, Ownership of DH Municipalities/ municipalities, Municipalities State Municipalities Municipalities companies cantons and partly private National Municipalities Energy and (but new Communal Tariff Energy Energy Energy Municipalities/ energy law Services methodology Regulatory Regulatory Regulatory cantons will include Regulatory established by Agency Office Commission common Commission methodology) and local self- governments National Energy and Energy Energy Energy Tariffs approved Municipalities/ Communal Regulatory Regulatory Regulatory Municipalities by cantons Services Agency Office Commission Regulatory Commission $0.028/kWh (consumption) Heat tariff level $0.047/kWh + $11.2 /kW/ $0.057/kWh + (metered $0.07/kWh + $0.021/kWh + $0.32/m²/ year (capacity) $0.83/kW per $0.0061/kWh households in $0.42/m²/mth (April 1, 2015) month + $13.7/year + month capital) $0.98/m²/year (fixed element) CHP electricity 11.6 /[N/A] feed-in tariff 8.6 / 8.6 U.S. 14.5 / 9.8 U.S. 8.88 / [N/A] Negotiated 16.25 / 11.1 U.S. U.S. cents/ (biomass- / gas- cents/kWh cents/kWh U.S. cents/kWh individually cents/kWh kWh (January fired CHP) 1, 2015) Assessed investment need 100+ 40 230 270 220 600+ ($ millions) 55 BOSNIA AND HERZEGOVINA CROATIA Centralized district heating services in Bosnia and The DH sector has a combined capacity of almost 2,000 Herzegovina exist in 22 cities and towns, with a combined MWth. It is characterized by the state-owned HEP DH capacity around 1,000 MWth. Sarajevo and Banja Luka accounting for more than 80 percent of the total sector account for 75 percent of total installed capacity: through its ownership of 6 of the 10 largest systems: ▶▶ Sarajevo (Federation of Bosnia and Herzegovina), ▶▶ Zagreb (HEP), 98,700 connections, annual sales 51,800 connections, annual sales of $31.7 million of $102 million ▶▶ Banja Luka (Republika Srpska), 21,800 connections, ▶▶ Osijek (HEP), 11,700 connections, annual sales annual sales of $16.3 million of $17 million ▶▶ Zenica (Federation of Bosnia and Herzegovina), ▶▶ Rijeka, 9,900 connections, annual sales of $7.8 million 19,800 connections, annual sales of $10.1 million ▶▶ Karlovac, 7,700 connections, annual sales ▶▶ Tuzla (Federation of Bosnia and Herzegovina), 21,300 of $7.8 million connections, annual sales of $7 million ▶▶ Velike Gorica (HEP), 5,900 connections, annual sales ▶▶ Prijedor (Republika Srpska), 3,600 connections, of $4.9 million annual sales of $3.7 million ▶▶ Slavonski Brod, 1,500 connections, annual sales ▶▶ Bosanska Gradiska (Republika Srpska), 1,950 of $3.7 million connections, annual sales of $1.4 million ▶▶ Sisak (HEP), 4,100 connections, annual sales ▶▶ Pale (Republika Srpska), 725 connections, annual sales of $3.3 million of $0.6 million ▶▶ Vukovar, 3,700 connections, annual sales of $2.3 million ▶▶ Zapresic (HEP), 2,400 connections, annual sales of $1.5 million ▶▶ Samobor (HEP), 1,400 connections, annual sales of $1.1 million KOSOVO The DH sector in Kosovo consists of three DH networks with a combined thermal capacity of around 200 MWth: ▶▶ Pristina, 12,500 connections, annual sales of $7.7 million (reflecting reduced fuel access in 2013, normally $12.9 million) ▶▶ Gjakova, 1,850 connections, annual sales of $1.2 million (reflecting reduced fuel access in 2013, normally $2.5 million) ▶▶ Mitrovica (no longer supplies residential customers) Furthermore, a recent study of the largest Kosovo towns without DH systems (Peja, Prizren, Gjilani, and Ferizaj) identifies several as viable for DH. 56 MONGOLIA UKRAINE Two cites in Mongolia, with a combined capacity of 2,000 In Ukraine, 7.5 million households (40 percent of all households) MWth, have DH systems with size, income, and investment are connected to DH systems, with the 21 largest DH systems needs that could make PPP a relevant frame for system in Ukraine having a combined capacity of 26,800 MWth. improvements and extensions: ▶▶ Kyiv, 686,589 connections, annual sales of $197 million ▶▶ Ulaanbaatar, 156,000 connections, annual sales ▶▶ Kharkiv, 484,432 connections, annual sales of $29 million of $104 million ▶▶ Darkhan, 20,000 connections, annual sales ▶▶ Zaporizhzhia, 248,155 connections, annual sales of $3 million of $35.4 million ▶▶ Odesa, 225,576 connections, annual sales A number of smaller cities (Erdenet, Khovd, Ulaangom, Choir, of $35 million and Uliastai) also have DH; however, these systems are very ▶▶ Lviv, 120,473 connections, annual sales of $22.4 million small. ▶▶ Dnipropetrovsk, 193,564 connections, annual sales of $19.1 million SERBIA ▶▶ Poltava, 89,611 connections, annual sales The DH sector in Serbia consists of 58 DH networks with a of $12.3 million combined capacity of 6,000 MWth. The four towns Belgrade, ▶▶ Lutsk, 54,302 connections, annual sales of $11.3 million Novi Sad, Nis, and Kragujevac constitute 60 percent of ▶▶ Sumy, 61,931 connections, annual sales of $9 million installed capacity: ▶▶ Ternopil, 40,184 connections, annual sales of $9 million ▶▶ Belgrade, 300,000 connections, annual sales ▶▶ Khmelnytsky, 55,097 connections, annual sales of $322 million of $8.4 million ▶▶ Novi Sad, 85,000 connections, annual sales ▶▶ Vinnytsia, 70,226 connections, annual sales of $91 million of $8.2 million ▶▶ Nis, 28,000 connections, annual sales of $23 million ▶▶ Chernihiv, 62,319 connections, annual sales ▶▶ Kragujevac, 18,000 connections, annual sales of $8.2 million of $23 million ▶▶ Rivne, 63,375 connections, annual sales of $7.9 million ▶▶ Mykolayiv, 85,768 connections, annual sales Several other DH systems have annual sales above $5 million of $6.7 million (Zrenjanin, Subotica, Pancevo, Bor, Krusevac, Sabac, Kraljevo, ▶▶ Cherkassy, 40,414 connections, annual sales Cacak, Uzice, and Jagodina). of $6.6 million ▶▶ Zhitomyr, 63,273 connections, annual sales of $6.3 million ▶▶ Chernivtsi, 39,340 connections, annual sales of $5 million ▶▶ Ivano-Frankivsk, 30,148 connections, annual sales of $3.7 million ▶▶ Kherson, 43,871 connections, annual sales of $3.6 million ▶▶ Kirovohrad, 24,325 connections, annual sales of $3.2 million 57 4.2 Options for Improvement of DH Systems in the Case Countries The following general options for future development of the DH systems in the six countries have been identified. 58 Table 16. Identified Options for Improvement of DH Systems Relevant in Development Option Background Which Countries In spite of significant investments in DH system rehabilitation over Network improvements the last decade, heat and water losses remain high in most systems, to enhance system All making improved system efficiency a priority for most DH distribution efficiency systems over the next decade. End-user energy End-user energy efficiency could be improved by retrofitting of internal All efficiency building installations. In the Western Balkan countries, there are significant opportunities Bosnia and Fuel switching for fuel conversion from mazut (heavy fuel oil) and coal to gas and/or Herzegovina, Croatia, biomass. Kosovo, Serbia, Ukraine The potential for combined production of electricity and heat is not fully utilized in the four countries, due partly to unfavorable load Bosnia and CHP production characteristics, with heat being produced only during the daytime in Herzegovina, Croatia, winter in some systems. In contrast, CHP generally is used in Serbia and Kosovo, Ukraine Mongolia. Municipal household waste is presently being landfilled, but difficulties Bosnia and in siting new facilities and the need to comply with EU landfill Waste incineration Herzegovina, Croatia, directives in the Western Balkan countries make waste incineration an Serbia, Ukraine increasingly attractive option. Bosnia and Some of the countries have geothermal resources within the reach of Geothermal energy Herzegovina, Croatia, DH networks that are not being utilized. Ukraine Bosnia and Utilization of waste heat, for example excess heat from cooling water Heat pumps Herzegovina, Croatia, or from industry. Serbia, Ukraine Some systems have no hot tap water production in the DH substations today. This is an important potential for expansion of the district Bosnia and Supplying hot tap heating to all-year operation and would create a better basis for future Herzegovina, Croatia, water production of CHP and production based on biomass fuels and/or Kosovo, Serbia waste incineration. CHP projects are planned mainly to replace power production capacity. Transmission from Heat loads will have to be estimated carefully to avoid CHP capacity Kosovo, Mongolia planned CHP plants oversizing, often seen in Eastern Europe. Households within reach of the DH network that presently have System expansion to alternative heating solutions could convert if a competitive service is Bosnia and replace other heat provided by the DH companies and if pervasive cross-subsidies are Herzegovina, Serbia sources removed. Greenfield Some countries have existing or developing urban areas that are viable establishment of new Kosovo, Mongolia for DH but where no system has been established. DH systems Interconnection of existing smaller DH systems is an option in some Interconnection of cities, which may reduce staffing costs substantially and also could Croatia existing systems reduce the need for peak- and reserve load capacity. One system visited is still an open-type system, with hot water being Conversion from open drawn directly from the system, limiting the opportunities for pH Mongolia to closed systems control of DH water. 59 4.3 Identified Investment Opportunities Table 17 gives an overview of identified projects at the utility level in the six countries and the assessed investment need in the sector. 60 Table 17. Identified Investment Opportunities in the DH Sector Assessed Investment Need Country ($ millions) Identified Projects Utilization of heat from Kakanj thermal plant, construction of transmission pipeline, rehabilitation of DH network and energy efficiency of buildings (Sarajevo) Gas-fired CHP plant to replace heat supply from metal manufacturing plant (Zenica) Rehabilitation of network and substations (Zenica) New biomass boilers (Zenica) Bosnia and 220 Reconstruction of DH network (Banja Luka) New biomass boilers (Banja Luka) Herzegovina Utilization of geothermal energy in DH (Banja Luka) Renovation and operation of DH systems (Gradiska) Biomass conversion of existing boiler stations (Gradiska) Replacement of DH network and connection of hospital (Gradiska) Biomass-fueled CHP (Gradiska) Renovation of existing DH network (Rijeka – Energo) Interconnection of selected separate small DH networks (Rijeka – Energo) Waste-to-energy CHP based on refuse-derived fuel (RDF) from Mariscina (Rijeka – Energo) Fuel switch to biomass-based CHP or conventional (heat-only) boiler plants (Karlovac - Croatia 230 Gradska Toplana) Renovation of existing DH network (Karlovac – Gradska Toplana) Fuel switch to biomass-based CHP (HEP Toplinarstvo systems outside Zagreb) Interconnection of selected separate networks (HEP Toplinarstvo systems outside Zagreb) Heat utilization from cooling water at Kosovo B power plant (Pristina) PPP for CHP based on lignite, biomass, and waste (Pristina) Kosovo 40 PPP for CHP to feed into existing DH system (Gjakova) Greenfield project for establishment of new DH system (Pejë) Rehabilitation of existing transmission network (Ulaanbaatar) System extension into uncovered peri-urban Ger areas (Ulaanbaatar) Upgrading of internal building installations to enable installation of thermostatic radiator Mongolia 100+ valves (Ulaanbaatar) Conversion of the “open”-type network to a closed-type network (Darkhan) Replacement of aging pipe network and extension of service to new urban development areas (Darkhan) Fuel switch from mazut (heavy fuel oil) to biomass (Belgrade and Nis) Heat pumps using river water (Belgrade) Serbia 270 Waste heat utilization from power plant (Belgrade) Independent power producer: CHP based on biomass (Nis) Privatization (Kragujvac, subject to prior restructuring of balance sheet) Network improvements to enhance system efficiency (all) Fuel switch from natural gas to renewables in CHP-4 (Kharkiv) Utilization of waste heat in CHP-3 (Kharkiv) Ukraine 600+ Energy efficiency (Kharkiv) Independent CHP (Lviv) Energy efficiency (Ternopil) 61 Appendix A List of Key Legislation The following table provides an overview of the key legislation governing PPP in the municipal sector in the six countries. 62 Country Key Legislation Governing PPP in the Municipal Sector Law on Concessions of Bosnia and Herzegovina (Official Gazette of Bosnia and Herzegovina, nos. 32/02, 56/04) Law on Concessions of the Federation of Bosnia and Herzegovina (Official Gazette of the Federation of Bosnia and Herzegovina, nos. 40/02, 61/06) Law on Concessions of Republika Srpska (Official Gazette of Republika Srpska, no. 59/13) Law on Concessions of Brcko District (Official Gazette of Brcko District, nos. 41/06, 19/07, 2/08) Bosnia and Herzegovina Law on Public-Private Partnership of Republika Srpska (Official Gazette of Republika Srpska, nos. 59/09, 63/11) Law on Public-Private Partnership of Brcko District (Official Gazette of Brcko District, no. 10.07) Cantonal Laws on Concessions in Cantons of the Federation of Bosnia and Herzegovina Cantonal Laws on Public-Private Partnership in Cantons of the Federation of Bosnia and Herzegovina Set of Laws on Communal Activities PPP Act (Official Gazette, 78/12, 152/14) Concessions Act (Official Gazette, 143/12) Public Procurement Act (Official Gazette, 90/11, 83/13) Croatia Regulation on Implementation of Public-Private Partnership Projects (Official Gazette, 88/12, 15/15) Ordinance on the Organization and Keeping of the Register of Public-Private Partnership Contracts (Official Gazette, 16/13) Municipal Utilities Act (Official Gazette, 36/95, 70/97, 128/99, 57/00, 129/00, 59/01, 26/03, 82/04, 178/04, 38/09, 79/09, 49/11, 84/11, 90/11, 144/12, 94/13, 153/13) Law on PPP (2011) Kosovo Law on Public Procurement (2011) Law on Energy Regulator (2010), regulates tendering of IPP State Policy on PPP (2009) Mongolia Concession Law (2010, amended 2012) PPP Act (Official Gazette of the Republic of Serbia, no. 88/11) Public Procurement Act (Official Gazette of the Republic of Serbia, no. 124/12) Public Utilities Act (Official Gazette of the Republic of Serbia, no. 88/11) Construction and Spatial Planning Act (Official Gazette of the Republic of Serbia, nos. 72/09, 81/09, 64/10, Serbia 24/11, 121/12, 42/13, 50/13) Labor Act (Official Gazette of the Republic of Serbia, nos. 24/05, 61/05, 54/09, 32/13, 75/14) Civil Servants Act (Official Gazette of the Republic of Serbia, nos. 79/05, 81/05, 83/05, 64/07, 67/07, 116/08, 104/09, 99/14) Privatization Act (83/14) Law on State-Private Partnership, the “PPP Law” (No. 2404-VI, 2010) Ukraine Law on Lease and Concession of Municipal Central Water Supply, Heat Supply and Water Discharge Facilities (2010) 63 The table below provides an overview of the key legislation governing the DH sector in the six countries. Country Key Legislation Governing the DH Sector Law on Energy of Republika Srpska (Official Gazette of Republika Srpska, no. 49/09) Law on Energy Efficiency of Republika Srpska (Official Gazette of Republika Srpska, no. 59/13) Law on Renewable Energy Sources and Efficient Cogeneration, Republika Srpska (Official Gazette of Republika Srpska, nos. 39/13, 108/13) Law on Use of Renewable Energy Sources and Efficient Cogeneration, Federation of Bosnia and Herzegovina Bosnia and (Official Gazette of the Federation of Bosnia and Herzegovina, nos. 70/13, 5/14) Herzegovina Law on Communal Activities, Republika Srpska (Official Gazette of Republika Srpska, no. 124/11) Energy Strategy of Republika Srpska up to 2030 Law on Local Self-Government (Official Gazette of Republika Srpska, nos. 101/04, 42/05, 118/05, 98/13) Law on the Principles of Local Self-Government of the Federation of Bosnia and Herzegovina (Official Gazette of the Federation of Bosnia and Herzegovina, nos. 49/06, 51/09) Energy Development Strategy for Croatia (Official Gazette, 130/09) Energy Act (Official Gazette, 120/12, 14/14) Croatia Act on Heat Energy Market (Official Gazette, 80/13, 14/14) Act on Regulation of Energy Activities (Official Gazette, 120/12) Law on Energy (2010) Law on Energy Regulator (2010) Kosovo Law on Central (District) Heating, under revision and awaiting government approval Law on Electricity Energy Law (2001) Energy Sector Development Strategy (2002) Mongolia Renewable Energy Law (2007) State Policy of Mongolia on Fuel and Energy (2008) Energy Law (Official Gazette of the Republic of Serbia, nos. 57/11, 80/11 – corrections 93/12, 124/12, and revised 29/12/2014) Law on the Efficient Use of Energy (Official Gazette of the Republic of Serbia, no. 25/13) Public Debt Law (Official Gazette of the Republic of Serbia, nos. 61/05, 107/09, 78/11) Draft Energy Sector Development Strategy of the Republic of Serbia for the period to 2025 with projections by Serbia 2030 (Ministry of Energy, June 2013) Regulation about incentives for privileged electricity producers Regulation about the method of calculation and manner of distribution of funds collected for fees for privileged electricity producers Regulation on the conditions and procedure of acquiring the status of privileged electricity producers Law on Housing and Communal Services (No. 1875-IV, June 2004) Law on Heat Supply (No. 2633-IV, June 2005) Law on State Regulation of Communal Services (No. 2479-VI, July 2010) Law on “changes to certain laws of Ukraine regarding improvement of settlements for energy carriers” (No. 1198- VII, April 2014) Ukraine Resolution of the Cabinet of Ministers on procedures to calculate tariffs for housing-and-municipal services (No. 869, June 2011) Resolution of the Cabinet of Ministers on rules for providing municipal services (No. 630, July 2005) Resolution of the Cabinet of Ministers on rules for recalculating the payments for municipal services in case of their improper quality / absence (No. 151, February 2010) 64 This publication can be downloaded at www.ifc.org/sustainabilitypublications Cross Cutting Advisory Solutions International Finance Corporation 2121 Pennsylvania Ave, NW Washington, DC 20433 inclusivebusiness@ifc.org ifc.org/inclusivebusiness July 2015