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Conclusions and Recommendations District heating and cooling is a well-advanced technology in the United States, although its growth has been strongly sectoral and largely influenced by the presence or absence of regulation and taxation and the character of financing and decision-making processes. DISTRICT HEATING AND COOLING SYSTEMS In general, three types of district heating and cooling systems have emerged in the United States: investor-owned urban systems, municipal or not-for-profit urban systems, and institutional systems. Institutional systems have increased in number considerably since 1950. More than 3,000 institutional systems are estimated to exist in the United States today. These systems are generally not regulated by state public utility commissions and are not subject to federal, state, or local taxes (except where they are business entities). They secure their financing by legislative appropriations, bonds, or conventional bank and other commercial loans, have a well-circumscribed decision-making process, and serve a single user or sector. Urban district heating and cooling systems numbered more than 250 in 1951 (Figure 2-1~. By 1980, their number had fallen to 59. During the last five years, the investor-owned utilities in Chicago, Baltimore, Pittsburgh, and Rochester have closed their district heating operations or are in the process of being replaced by not-for-profit entities. Such investor-owned utility systems are economically regulated by public service commissions in 35 states, are taxed by federal, state, and local governments, secure their financing through bonds, have cumbersome decision-making processes with many adversarial participants, and serve many users and sectors. Since the systems are investor owned, return on investment plays a significant role in the decision process. Municipally owned or not-for-profit urban systems are growing slowly. Recently, their growth has been stimulated by the district 85

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86 heating and cooling assessment program run jointly by the U.S. Departments of Housing and Urban Development (HUD) and Energy (DOE), as well as the HUD urban development action grant program. These systems share many growth conditions with the institutional systems, except that for municipally owned systems financing through revenue or general obligation bonds is subject to great internal competition and indebtedness limitations. The decision-making process is very complex, with many vested interests and participants, which increases financial risk. These systems serve many users and sectors. To a great extent, economic regulation and taxes influence the differential growth rates of the three types of systems. Except for direct financial incentives, the greatest degree of market penetration would be brought about by regulatory reform, particularly by state public utility commissions, together with tax treatment equivalent to that of competing energy sources. o HUD should extend the district heating and cooling assessment program to include studies of the feasibility of expanding institutional systems to create new or expand existing urban systems. Where feasible, such expansions should be tested in site applications. o HUD should use the district heating and cooling systems serving public and subsidized housing units as a base to help create new or expand existing urban systems. o HUD should develop better liaison between its housing and community development offices to improve its management of community energy programs. ~ REGULATION The economic regulation of electric utilities, which follows from the concept of a publicly granted and regulated monopoly, is inappropriately applied to district heating and cooling systems. Urban systems require large initial investments, particularly during a project's early stages, when revenues are small or lacking. Where economic regulation by state utility commissions limits the return on investment and controls the ability to roll investment costs into rates, the incentive to urban systems is removed for the private sector. Currently, most successful systems in the United States are operating without these regulations or taxation because they are tax-exempt, not-for-profit, municipal, or institutional installations. Likewise, costly and lengthy regulation and permit procedures are disincentives to entrepreneural systems because they increase the uncertainty, cost, and complexity of development. Real or perceived regulatory risks unfavorably affect cost and financing. 0 Economic regulation of district heating and cooling systems by state or local authorities should be eliminated. District heating and

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87 cooling systems should be allowed to operate in the same open mar ket that now exists for competing fuels and energy systems. Fuel flexibility represents district heating and cooling's major advantage over competing energy sources. The ability to use a variety of solid fuels, such as coal and municipal solid waste, allows district heating and cooling systems to offer lower prices. District heating and cooling's primary competition is oil and gas burned in onsite boilers. If district heating and cooling systems can burn cheaper fuels, distinct economic advantages can be realized. Regulations on air quality, facility siting, and zoning are often inappropriate when applied to district heating and cooling. They can reduce or preclude the combination of fuel flexibility and technical advantages that make district heating and cooling systems economically viable. In addition, environmental regulations usually fail to consider adequately that district heating and cooling systems replace many, untreated, individual sources of air pollution with a single, treated source. o Regulation of energy systems should be modified to take into account district heating and cooling's need for fuel flexibility. o HUD and DOE should jointly convene a meeting of representatives from state and local public service commissions to develop a model regulatory approach for district heating and cooling systems. O DOE should disseminate the results of its research on the effects of siting, air-quality, and fuel regulations on cogeneration and district heating and cooling systems to state public utility commissions and local regulatory authorities. o Working with DOE, the U.S. Environmental Protection Agency should review its "bubble policy" to allow the substitution of one treated source of pollution for many, individual, untreated sources. If necessary, the Clean Air Act should be amended to allow such trade-offs. TAXES Taxes significantly affect the ability of investor-owned utilities or other for-profit corporations to build and operate urban district heating and cooling systems. Tax disincentives can ultimately affect the ability to finance the system. At the state and local levels, gross receipts, fuel taxes, franchise taxes, and special utility taxes in combination can be excessive. In the worst case known to the committee, they added 20 percent to the cost of thermal energy. At the federal level, the mismatch between tax and energy policy continues to discourage potential investors. Two years after authorizing the use of industrial revenue bonds for district heating and cooling, Congress again limited their application by placing a per

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88 state limit of $150 per capita on the use of industrial development bonds . Municipalities are deterred f rom building new systems because the Internal Revenue Service does not allow investment tax credits to be used by a tax-exempt organization or government for district heating and cooling equipment. District heating and cooling is subject to higher financial risk assessments in part because it is not clear whether the distribution pipes qualify for the accelerated capital recovery provisions of the Economic Recovery Tax Act of 1981. The difference between a 5- and 15-year depreciation schedule significantly affects the system's viability and the customer's costs. O State and local taxes should treat district heating and cooling equally with its competitors. Fuel and franchise taxes are particularly discr iminatory. These taxes should be changed to recognize the energy efficiency and conservation attributes of district heating and cooling. Federal tax policy currently provides credits for those who install solar energy systems, windmills, home insulation, and other energy- conserving measures. These tax credits are scheduled to expire at the end of 1985 unless Congress renews them. District heating and cooling systems can compete with other energy systems if all are treated equally by the tax laws. o Federal tax policy should be modified to place district heating and cooling systems and equipment on a par with other energy systems. If Congress renews the tax incentives for other energy systems and equipment, the incentives should be applied to district heating and cooling too. If so, particular attention should be given to the following: - Providing investment tax credits for district heating and cooling property. - Allowing residential energy credits for district heating and cooling expenditures. - Transferring district heating and cooling property to a municipal government or tax-exempt organization without recapture of depreciation or investment tax credit by the former owner. - Applying accelerated capital cost recovery schedules to district heating and cooling property and retrofitted equipment. - Arranging tax-exempt financing through exclusion of district heating and cooling systems from the $150 per capita state limit and the project size restr lotions recently placed on the use of industrial development bonds. - Arranging an additional 20-percent investment tax credit for district heating and cooling property through December 31, 1990.

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89 DATA AND INFORMATION Municipal and not-for-profit urban systems have been hindered by the lack of public awareness of district heating and cooling and its attributes. Where the technology is known, it is often referred to by a name other than district heating and cooling. Until recently, the district heating and cooling industry's outreach and education efforts have been inadequate to the task. Too much activity has been directed toward lobbying and too little toward developing the potential market. More recently, the joint efforts of the district heating and cooling industry and the U.S. Conference of Mayors have substantially increased awareness and understanding of the technology and its attributes among senior municipal officials. Unfortunately, only limited efforts have been made to encourage such knowledge in the financial community. The high financial risk assessments for urban systems can be reduced only by disseminating more information about them. o The district heating and cooling industry should undertake a series of regional seminars in cities where urban systems are operating. These seminars should focus on the role of district heating and cooling in promoting energy efficiency and the redevelopment of central c ities . They should include federal, state, and local officials, design professionals, bankers, building owners and managers, business representatives, and community leaders. o HUD, DOE, and relevant professional associations should support and participate in these seminars. Few data are available on the extent and condition of district heating and cooling in the United States. Despite all the studies funded by industry and government, the data are still fragmented, incomplete, and often biased. In part, this reflects the fragmentation of the industry itself. In part, it reflects the view promoted by the European experience that district heating and cooling is limited to those systems that sell thermal energy or cogenerate. This limited international definition of district heating and cooling does not reflect the U.S. situation. The technology is found extensively in institutional settings where the sale of thermal energy is not a condition of use. There are an estimated 1,000 cities in the world with some form of urban district heating and cooling. In comparison, there are an estimated 3,000 U.S. institutional systems. The latter is probably a conservative figure. The extent, locations, and scope of institutional district heating and cooling systems suggest that they may offer a greater potential for developing urban systems than utilities. The opportunities for joint ventures between institutional systems and municipalities are many and unexplored. The Danish experience of creating an urban system by combining many small systems may have applications in the

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90 U.S. market. Without data about these systems, an opportunity may be lost. o DOE should maintain a data base on district heating and cooling as a part of its continuing energy information activities. The data should be consistent, verifiable, and analyzed periodically. The data base should encompass the institutional applications as well as urban ones. The information should be readily available to the general public. o DOE should fund studies to determine the extent of district heating and cooling, particularly institutional systems, in the United States. o Concerned professional societies, trade associations, and major public interest groups should actively assist DOE in disseminating information on district heating and cooling. The focus should be on encouraging technology transfer, especially for district cooling, to Europe and elsewhere. DOE has played a limited role in the International Energy Agency (IEA), particularly in its district heating committee. This has hindered the transfer of technology and the development of the consistent data base discussed above. IEA activities are funded by either direct or in-kind contributions by the member nations. o To accelerate the international exchange of data, information, and experience pertaining to district heating and cooling, DOE should actively participate as a full partner in IEA district heating activities. THE FEDERAL ROLE While district heating and cooling is widely used by institutions, it is not often used for urban development by munic ipal officials, urban planners, and architects. Federally assisted urban renewal efforts in the 1950s and 1960s may have been a major contributor to the decline of investor-owned urban systems. The removal of industrial and commercial customers from central business districts eliminated many former and potential customers. The trend was exacerbated by the lengthy rebuilding process and the tendency to equip new buildings with individual heating systems. Because of its responsibilities for community development and because of budgetary realities, HUD has had the lead program responsibility for community energy projects, including district heating and cooling. DOE supports HUD programs by sponsoring demonstration projects. The HUD and DOE demonstration programs have had a significant effect on the recent revival of urban district heating and cooling systems. Federal energy policy has consistently emphasized increased

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91 self-sufficiency and energy efficiency. The federal government still has a role in assisting in the accomplishment of these goals. In particular, DOE has helped develop economic models and assessment techniques that can simplify the planning for future urban systems. Similarly, HUD's urban development action grant program has provided both key funding and encouragement in developing new and revitalized urban district heating and cooling systems. The continuation of these efforts at this time is important to the growth of urban systems. o HUD should continue to have the lead program responsibility for district heating and cooling. DOE should continue to support HUD programs and should expand its research and data programs for district heating and cooling. o The HUD community development block grant program should be amended to encompass projects that enhance the ability of communities to conserve and make more efficient use of energy. District heating and cooling should be among the eligible activities specified. o DOE and HUD should prepare and disseminate broadly a concise topical review of the district heating and cooling assessment program as a follow-up to this report. The review should be written for decision makers, not technicians, and should take into account contacts, technical assistance sources, available technical assessment studies and economic models, funding sources, and legislative and regulatory initiatives. Complete case studies of cities in the assessment program should form the basis for the review. FINANCING The municipally owned and not-for-profit urban district heating and cooling systems have experienced difficulties in securing financing to construct and operate the systems during the start-up phases. High interest rates certainly add to the projects' costs, but the largest problem is the unnecessarily high risk assessments levied on these systems. The risk assessment is expressed in the form of additional guarantees or liens over and above the value of the systems themselves. Municipal participation in urban systems usually involves the issuing of either revenue or general obligation bonds. With revenue bonds, the system's revenues are used to meet the bond payments as a first right. General obligation bonds are paid from the municipality's general fund, which is based on local taxes, fees, interest on investments, and other earnings. In either case, the bonds are guaranteed by the full faith and credit of the municipality. For district heating and cooling systems, a further guarantee is required. Customers must sign 20- to 30-year "take or pay" contracts, which means they guarantee that they will remain customers of the system for the term of the financing or pay an annual penalty equal to the cost of the service if they fail to use it. Under the law, the

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92 agreements may be considered long-term liens against the users' property and may be an important factor in the future sale, alteration, or demolition of a structure. In contrast, institutional systems are financed either by revenue bonds, direct appropriations, or both, for government agencies; by self-guaranteed development bonds, for private institutions; or by direct borrowing, for commercial or industrial entities. Direct borrowing is usually the most costly in terms of interest rates. Two aspects of the institutional f inancial situation are signif icant. First, financing is relatively simple. Second, such systems are known by names other than district heating and cooling. Under other names they are considered an ordinary and common energy system used in institutional complexes and have been financed without the risk assessments applied to new urban systems. The costs of financing and fuels are not the critical issues for institutional decision makers. The lower cost of operations and maintenance, fuel flexibility, and energy efficiency are the key determinants. o The district heating and cooling industry, trade associations, DOE, and HUD should aim their information efforts especially at the financial community. The goal should be to increase this community's awareness of district heating and cooling and of the degree to which investors already support it in institutional settings. o Special seminars should be held for representatives of the national financial community. DOE and HUD should support these seminars. TECHNOLOGY AND PRODUCT DEVELOPMENT The technology for district heating and cooling is well understood. Nevertheless, there are opportunities to improve system components in ways that would reduce costs and, most importantly, give a competitive advantage to U.S. manufacturers both at home and abroad. The international market for district cooling, in particular, could do well, since virtually all the district cooling is located in the United States. The district heating and cooling industry, typical of the construction industry, is small and fragmented. It has limited capital and capacity for research and development. DOE recognizes the importance of research, especially in areas related to district heating and cooling. In general, DOE research emphasizes more cost-effective technologies that use local energy sources. The current DOE research budget concentrates on low-cost, accurate control and metering systems, combined heating and cooling systems, retrofit systems, distribution systems, and thermal production equipment. According to DOE estimates, if the capital and operating costs of district heating and cooling can be reduced by 10 to 20

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93 percent, its market potential in the United States could more than double. The market penetration model developed by the Argonne National Laboratory estimates that 2.5 quads of energy, primarily in oil and gas, could be saved over the next 20 years if the market penetration of district heating doubled (see Chapter 3~. These two estimates do not include the institutional systems that are by far the largest segment of district heating in the United States, nor do they include district cooling or noncogenerating facilities. o DOE should convene industry, academic, and user groups to aid in establishing and evaluating its research agenda for district heating and cooling. Such groups should allocate roles, responsibilities, and resources among public and private institutions. o Research should emphasize simultaneous heating and cooling technologies that will enhance the sales opportunities for U.S. manufacturers both here and abroad.

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