Financial Modelling

This article describes how the CHDU project financially models centralised district heat networks including capital costs, operating expenses, revenue from heat sales and electricity generation, financing mechanisms, subsidies, and more. The model covers most of the lifecycle of the network from development and construction, operation and maintenance, and equipment replacement costs over a 50 year assumed project lifetime.

The goal of the financial modelling is to assess whether heat networks at specific sites are financially viable and compare the financial performance of networks at different locations across the UK as part of a nationwide site search.

The following are all considered part of capital expenditure. Please see our separate Network CAPEX article for values of the CAPEX costs included in the CHDU’s financial model.

Network infrastructure CAPEX costs include the costs of the pipework and trenches, the construction of the energy centre, and connections to the buildings including the installation of heat interface units (HIUs) and metering systems.

Heat generation equipment includes the commercial scale centralised air source heat pumps and thermal storage.

A significant amount of energy is needed to run a heat network, from the heat generation equipment to the pumps used to move the heat around the system. Analysis of both existing heat networks and feasibility studies indicated that heat networks which used heat pumps to supply most of the heat demand were most viable when the bulk of their electrical demand was supplied by on-site renewable generation such as wind or solar. The capital costs associated with installing onshore wind turbines and ground mounted solar are discussed in the Network CAPEX article and included in the financial model.

A factor of 10% is applied to the network infrastructure and heat generation equipment CAPEX costs to account for uncertainty in these cost estimates.

The CHDU financial model assumes that design and planning costs are 15% of the network CAPEX costs. This 15% is applied to the network infrastructure and heat generation equipment costs. This is based on the findings of Ramboll’s 2024 cost analysis study of heat networks for Scottish Enterprise. It is not clear if this over-estimates design and planning costs for the scale of the heat networks being considered by the CHDU.

The CHDU financial model assumes that commissioning costs are 10% of the network CAPEX costs. This 10% is applied to the network infrastructure and heat generation equipment costs. This is based on the findings of Ramboll’s 2024 cost analysis study of heat networks for Scottish Enterprise.

The CHDU heat network financial model uses wind and solar generation profiles to estimate how much electricity can be used directly in the network heat pumps or exported. On-site renewable generation is prioritised to be used in the heat pumps with any excess exported into the grid. The electrical demand of the heat network which is not met by on-site renewable generation is purchased from the grid at a rate of 26p/kWh.

The air source heat pumps connected to the heat network are sized to provide 90% of the total annual heat demand of the network customers. The remaining 10% of the heat demand is provided by back-up oil boilers which top up the network during periods of peak demand. This configuration means that the peak power output of the heat pumps can be reduced by approximately 50% compared to sizing them to provide 100% of the heat demand. The financial model assumes an oil price of 8.1p/kWh which is based on a price of 84p/l, which is perhaps onerous compared to recent trends in heating oil prices but is intended to account for oil price increases in the future.

Regular maintenance of the heat network is essential since customers are relying on it to supply their heat and may require specialised subcontractors due to the technical complexity of the heat network. The CHDU heat network financial model includes the costs associated with operating and maintaining network plant equipment, the pipework and the renewable generating assets.

For the heat network infrastructure we have used the benchmark average price per MWh for non-bulk schemes from DECC’s 2015 study into the costs of UK heat networks (where non-bulk schemes are defined as distribution of sales and heat to individual customers) as below:

Heat Network Component Requiring Maintenance	£/MWh of Generated Heat
Heat network pipework and connections	£0.60
Heat Interface Units	£9.00
Heat Meters	£3.40

The CHDU heat network financial model assumes that the annual O&M costs of the Energy Centre are 1% of its CAPEX, as suggested by the DECC report on cost characteristics of UK heat networks.

Annual wind turbine O&M costs are assumed to be £63,460 per 1MW of peak generation, averaged from Renewables First data. Annual land rent costs are assumed to be ~£11,000 per 1MW of generation, based on Sharenergy’s experience.

Annual ground mounted solar O&M costs are assumed to be £11,250 per 1MW of peak generation and annual land rent costs are assumed to be ~£11,250 per hectare. Both values are based on Sharenergy’s experience.

Administration includes the costs of billing and metering, customer service and management overheads. As with maintenance and repairs, DECC’s 2015 benchmark average for non-bulk schemes of £16.9/MWh of generated heat has been used to estimate the cost of administration.

It is assumed that a Community Benefit Society (CBS) will be formed to own and manage all or a portion of the heat network and associated energy generation. The annual cost of operating the CBS is estimated to be £10,000 plus an additional £2,500 per 1MW of peak electricity generation for business rates, based on Sharenergy experience.

The expected lifetime of the network pipework is assumed to equal or exceed the project lifetime of 50 years, however other elements of the network would be expected to need replacing prior to this. The CHDU financial model includes replacement costs for the following components:

• Heat pumps
• Network pumps
• Thermal storage
• Backup boilers (oil)
• Heat interface units and heat meters
• Wind turbine(s) and ground mounted solar installations (excluding grid connection)

It is assumed that these heat network components will be replaced after 25 years of operation however, in practice, these heat network components may be replaced every 20-30 years. Replacement costs are calculated by inflating the relevant initial CAPEX costs using CPIH over 25 years.

The heat network configuration modelled in the CHDU financial model has two income streams:

1. Sales of heat to customers connected to the network.
2. Sales of electricity generated by on-site wind and/or solar sold via the national electricity grid.

Heat sales is the core income of a heat network and is based on tariff rates and heat demand profiles. The objective of the CHDU project is to estimate the feasibility of centralised heat networks without increasing the cost of heat for consumers. The heat tariff and standing charge used in the financial model is based on the current costs of operating a fossil fuel heating system.

The standing charge for connected properties is modelled as £300/year. This is based on an annual service charge of £100/year and a 10 year boiler replacement cost of £2750, reduced by a nominal 20% to account for boilers not actually being serviced every year.

The heat sales usage tariff for on-gas grid properties is 7.4p/kWh, which assumes a boiler efficiency of 84% and a unit price of 6.24p/kWh, the Ofgem price cap value from October 2024. For properties off the gas grid a usage tariff of 8.1p/kWh could be used which targets the oil price.

Electricity generated by on-site wind turbines and/or ground mounted solar installations is prioritised for use in the heat network heat pumps. Excess electricity is modelled as exported into the grid assuming a unit export price of 10p/kWh.

A higher export price would be achievable if there was a large local electricity user who could connect to the turbine via direct wire. This configuration has not been included in the financial model since this is very location dependent.

Category	Name	Tariff
Heat	Customer Unit Sales (on mains gas)	7.4 p/kWh
Heat	Customer Unit Sales (off mains gas)	8.1 p/kWh
Heat	Customer Standing Charge	£300 /year
Electricity	PPA Unit Sales	10.0 p/kWh
Oil	Purchase for Back-up Boilers	8.1 p/kWh

Capital grant support from the Green Heat Network Fund (GHNF) is available for the development of new low and zero-carbon heat networks. The core metrics used by the GHNF to determine the total award value of the grant are:

• Up to 4.5p per kWh of heat delivered over the first 15 years of operation of the heat network.
• Up to 50% of the total construction CAPEX costs.
• Up to £1m of which can be used towards commercialisation costs.

In practice, the total grant amount available to a project is limited by the amount of heat delivered over the first 15 years of operation. Feedback from GHNF applications suggest that the competitive nature of the award means that applicants need to be aiming for 2.5p/kWh – 3.5p/kWh to be awarded funding. As such, the CHDU financial model calculates the grant award assuming 3.5p/kWh of heat delivered over the first 15 years of operation. This typically means that around 30-40% of the CAPEX and development costs are modelled as grant funded.

The CAPEX and development costs which are not covered by the GHNF grant are assumed to come from loans.

Development costs, beyond the initial £1million of GHNF grant, are assumed to be borrowed at a rate of 8% over a term of two years. CAPEX costs in excess of the remaining GHNF grant are financed at a rate of 6%, with the pipework being financed over a term of 50 years, and the remaining heat network equipment and renewable electricity generators financed over a term of 25 years. Since the heat network income is minimal during the initial two years of development, the interest on the loan is bundled up into the long term loans. All loans are modelled as annuities.

The different loan terms reflect the different lifetimes of the pipework and equipment. Financing the pipework over a longer term helps reduce the value of each annual loan repayment which is beneficial for heat networks where margins are tight, despite the loan costing more over the project lifetime when compared to shorter term loans.

If the project balance is less than the REPEX value when the equipment is due to be replaced (25 years), additional funds are provided via an additional loan.

Each 100-200 building heat network project is expected to require investment within the region of £10 million. While we anticipate that part of the funding will be achieved through community share offers, it is anticipated that these would only be able to raise 5%-10% of the total amount and hence have not been explicitly modelled in the CHDU financial model.

All costs are inflated by a CPIH value of 2.8%, which is an average of the last 10 years.

Net Present Value (NPV) and the Internal Rate of Return (IRR) are calculated as part of the financial modelling. The IRR is calculated at 25 years (before the renewable generation and heat network equipment is replaced) and at 50 years (the term of the pipework loan).

The following key success metrics were used in the site searching process:

1. Affordability of loan repayments – a potential heat network site was only considered viable if the annual income received from the sales of heat and electricity was greater than the annual operating costs and loan repayments. 
2. Payback period – sites were only considered viable if the initial payback period was less than 25 years: the term of the loan for the heat network equipment and renewable generation. The payback period is calculated as the year when the project balance becomes positive (loan value + cashflow).

Buro Happold (2016), Connecting Existing Buildings to District Heating Networks, https://www.usdn.org/uploads/cms/documents/161214_-_connecting_existing_buildings_to_dhns_-_technical_report_00.pdf

Ramboll (January 2024), Cost Analysis of a Typical 4th and 5th Generation Heat Network, Scottish Enterprise, https://www.scottish-enterprise.com/media/cgshv05h/cost-analysis-of-a-typical-4th-and-5th-generation-heat-network.pdf

Department of Energy and Climate Change (2015), Assessments of the Costs, Performance and Characteristics of UK Heat Networks, https://assets.publishing.service.gov.uk/media/5a802b44e5274a2e8ab4e95d/heat_networks.pdf

Wind Measurement International website, http://www.windmeasurementinternational.com/wind-turbines/om-turbines.php

Green Heat Network Fund, Guidance for Applications (Version 9.0), https://assets.publishing.service.gov.uk/media/6798e14afe1eabe7d7a22d76/ghnf-guidance.pdf 

Renewables First, https://renewablesfirst.co.uk/renewable-energy-technologies/windpower/windpower-learning-centre/wind-turbine-performance-finances/ 

ONS, RPI, Average Price for Heating Oil, https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/kj5u/mm23

ONS, CPIH Rate, https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/l55o/mm23