District cooling system as a utility infrastructure business – Contractual obligations of the district cooling operator

Introduction

The district cooling system, according to IDEA’s  “District Cooling Best Practice Guide”, is a long-term utility service business. By their very nature, district cooling systems are often structured as utility infrastructure. In this article, we shall explore the key characteristics of district cooling that distinguish it as a utility infrastructure business, as well as the contractual obligations of the district cooling system operator or owner.

Definition of a utility infrastructure business

A utility infrastructure business invests in physical infrastructure assets that provide utility services to consumers. The infrastructure usually consists of generation assets (such as power plants, which generate electricity) and transmission assets (such as power transmission lines, which transmit and distribute power to the consumers). The utility company commits to heavy upfront investment in these physical infrastructure assets in return for long-term supply contracts with the consumers. Examples of businesses in the infrastructure sector range from water, gas, and electricity to transportation and even heating and cooling energy. Due to the extended life span of the infrastructure, there are significant recurring costs for the repair and maintenance of these assets.

Key features of long-term utility infrastructure businesses include:

• High barriers to entry: The requirement for a significant initial capital investment serves as a potent barrier to entry for new competitors. Established utility companies usually enjoy a significant first-mover advantage over newer players seeking to enter the business.
• Monopolistic or oligopolistic market structure: Many long-term utility infrastructure businesses operate in markets that are monopolistic or oligopolistic in nature, meaning that there are only a few dominant players in the market.
• Long-term contracts: Utility companies enter into long-term contracts, usually lasting decades, with their consumers. The long time horizon provides a stable stream of cash flow, allowing the servicing of debt payments and the distribution of profits to shareholders, representing a return on their investment and the return of investors’ capital.
• Regulatory oversight: Utility infrastructures often provide essential services to the community and have significant impacts on the local economy. For these reasons, many utility infrastructure companies are subject to regulatory oversight.

Examples of industries that are long-term infrastructure businesses include:

• Electric utilities
• Gas utilities
• Water utilities
• Transportation infrastructure
• Telecommunications infrastructure

Definition of a district cooling system

District cooling plants are centralized cooling systems that supply chilled water to a district or community of buildings for air conditioning. This system is often more energy-efficient and cost-effective than individual air conditioning systems for each building in the district. A district cooling plant typically consists of a central chiller plant, a network of underground pipes to transport the chilled water, and a system of heat exchangers in each building to transfer the cooling energy to the air conditioning system.

How does the district cooling system fit the definition of a long-term utility business?

The district cooling industry is considered a long-term utility infrastructure business because it generates and supplies cooling energy, an essential ingredient for comfort cooling, to consumers, often for the long term.

The district cooling company invests in central chiller plants that generate cooling energy in the form of chilled water and in piping networks that distribute the chilled water to the energy transfer stations at each consumer building within a locality. The business model requires a significant capital investment in infrastructure.

In the typical district cooling project, the master developer grants the concession rights to the district cooling company for a specific period of time, usually 20 to 25 years, to supply chilled water to the designated service area. The concession rights or agreement protect the district cooling company from new entrants. It also effectively creates a monopoly for chilled water services within the designated service area by granting the district cooling company the exclusive right to finance, construct and operate the district cooling plant and network for the duration of the concession period. The master developer who grants the concession rights will also ensure that any successor developer or body corporate will take over the rights and obligations under the concession agreement. In other words, no other district cooling provider can enter the market and compete with the existing district cooling provider within the same service area. And in many jurisdictions with a successful track record of district cooling projects, there are legal and regulatory frameworks that govern the industry to protect the rights of various stakeholders. Consider Singapore, Abu Dhabi and Dubai as examples.

Consequently, the district cooling industry shares key characteristics of the long-term utility business, such as:

• High barriers to entry
• Monopolistic market structure
• Long-term contracts.
• Regulatory oversight.

In summary, the key characteristics of the district cooling business as described above correspond well to the definition of a long-term utility infrastructure business.

As a utility infrastructure business, what are the contractual obligations of the district cooling operator?

The district cooling operator has a number of contractual obligations to meet and comply with as a long-term utility infrastructure business. These obligations usually pertain to the availability, reliability, and quality of the chilled water supply to the consumer, and the terms and conditions are usually spelled out in the chilled water supply agreement.

The chilled water supply agreement is a contract between the district cooling operator and the customer that sets out the terms and conditions for the supply of chilled water.

Below are some of the key performance metrics to be found in the chilled water supply agreement:

• Chilled water tariffs
• Tariff adjustment formula
• Payment terms
• Quantity of cooling energy
• Quality of chilled water
  • Chilled water supply temperature
  • Water quality
• Plant efficiency guarantees
• Plant availability guarantees
• Customer service response time
• Liquidated damages and penalties

A breach of contract by the district cooling operator can result in significant legal and financial repercussions. This may result in the payment of liquidated damages or monetary compensation to the consumer.

Summary and Conclusion

In summary, the district cooling system has many key features that qualify it as a long-term utility infrastructure business, and the district cooling owner shoulders heavy responsibilities and has many contractual obligations to be met. Should the district cooling system fail to meet the key performance metrics and guarantees as stipulated in the concession agreement, then there shall be legal and financial consequences, often in the form of liquidated damages and penalties.

In order to avoid a breach of contract, the district cooling system must be ready to supply chilled water to consumers in a reliable, secure, efficient, and safe manner. Hence, the design, development, and operation of the district cooling system must adopt a long-term utility infrastructure business approach to ensure high availability and reliability, optimize life cycle costs, and ensure a return on investment and return of capital to the investors.