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District energy system transactions: the opportunities and risk

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Tom Bucher | Director, Power Advisory, Houston | 16 February 2021

The value of buying and selling district energy systems is being realized in more ways than one. Here’s how to ensure your transactions run as smoothly as possible.

They’re big. They’re valuable. And there are approximately 2,500 in the USA alone. District energy systems are crucial to running our cities, universities, hospitals and businesses. Hidden under streets and sidewalks, they supply heating, cooling and/or electricity to a group of buildings from a central plant. But they often need specialized skills and attention to keep them running. That’s why many city councils and institutions are starting to realize the benefits of selling their district energy system to experts who can run these assets for them.

Selling a district energy system can provide an infusion of cash for a city or institution, while reducing the risk of system outages. For example, in 2019, Veolia, a global leader in resource management, sold its United States district heating and cooling systems for US$1.25 billion. And, with the right strategies to overcome technical obstacles and mitigate contract risks, buyers can land on a financially attractive investment.

Existing district energy systems are decades old

Some district energy systems are over 50 years old. The age alone is not concerning because they’re designed to operate for decades. But a district energy system is made up of many parts, replaced bit by bit over the system’s life. The variety of assets, combinations of original equipment manufacturers (OEMs), and their different ages make it difficult to ensure that they are optimal as a unit. Add in deferred maintenance and the result is a system with good bones that need replacements, retrofits and recommissioning to achieve its peak performance.

By conducting a thorough inspection of the district energy system, and identifying which components are in good condition, a buyer can create an ongoing maintenance and replacement plan to extend the asset life. With older equipment, significant energy savings, and therefore operating cost savings, can be gained by recommissioning or replacing part or all of a system.

But there are contracting aspects that need to be considered as part of the transaction, too. 

Ensuring reliable energy services

The commercial terms and clauses in the contract between the seller and the buyer are designed to ensure that the city or institution continue to receive reliable energy within the capabilities of the district energy system. The key performance indicators listed by the city or institution must be realistically matched to the capabilities, redundancy requirements and operations and maintenance procedures set by the buyer for the district energy system.

The buyer may also have preferred operations and maintenance contractor(s) or an engineering, procurement and construction (EPC) firm for retrofits and new assets. In these cases, the contract terms between the buyer and its vendors needs to be negotiated at the same time and closely match to the contract terms between the buyer and the city or institution. This is to ensure that if the vendors don’t perform, any financial penalties or risk will be passed through to them and not land on the buyer. 

Recognizing risk, optimizing opportunities

It’s vital that the buyers understand the risks associated with financial capital and operational estimates. Know the condition and system replacement or optimization needs, costs, and timing. Set key performance indicators and contractual obligations, environmental indemnity clauses, actions or inactions that create an event of default. And identify the different parties’ ability to terminate contracts. That’s just to name a few. A thorough review and technical analysis of the assets, and tailoring the buy or sell packages accordingly, can help buyers minimize these risks.

What’s more, by purchasing district energy systems from sellers with high-quality credit, buyers can unlock value from their credit rating by including ongoing payments for energy and services in the contract terms and use the deal structure to minimize equity investment.

It’s a win-win

Both buyers and sellers can benefit when it comes to district energy system transactions. Sellers can monetize a non-core asset and reinvest the money back into their business, while ensuring ongoing reliable utility services. And buyers can take advantage of favorable lending environments and increase equity returns by identifying opportunities to make the system more efficient.

Buying and selling district energy systems, from development to financial close, needs engineering, transactional, and consulting expertise.