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THE LOWER THE IRR - THE MORE DH It is as simple as that…. The lower expectations to the IRR, the more or larger DH projects a company can invest in, within their economic framework. The picture below illustrates this fact. People familiar to the east of Scotland will recognise the map of Dundee. The examples given are not in any way based on the actual situation in Dundee – any city map could have been used. Dundee has merely been used, as discussion with knowledgeable people from Dundee created the initial idea for this article some years back. The drawing illustrates that a DH system in a city (at least in the beginning) consists of several individual projects – the blue line areas. For each of them the IRR can be calculated ranging from very high to very low. At the same time, an IRR calculation has been made to establish how large a DH system the city could create within the IRR threshold at 4% - the red line.
Picture 2. An example of projects that can be developed with high IRR expectation (14% or more). More may be developed but would then rely on subsidies or grants from e.g. the local authority. The large low carbon heat sources to the left will not be included in the project and thereby lost.
A municipal led DH company with a 4% threshold will over many years develop DH throughout the entire area - see picture 3. Of course, starting with the most economic viable projects and then working their way through the different expansions and new projects. Please note that a municipal led company planning to build out into the entire area will consider building a project with a very low IRR in order to improve the economy of the entire system. In this example, it could be creating the 3% project (to the right in the picture) with the main purpose to gain access to low-cost surplus heat (as illustrated with the small black production site) and connecting several individual projects to that heat source through the project with only 1% IRR. Other factors than strictly economical could similarly influence the order of which projects are rolled out. For example, areas with severe fuel poverty, areas in need of renovation and other local and political reasons may lead to decision makers prioritising specific projects before projects with a higher IRR – again illustrated as the 1% area.
Picture 1. A simplified example of several projects which are to be developed over time with different levels of calculated IRR. For simplicity, only a limited number of projects have been illustrated. The remaining parts of the city will also have DH in the future. These areas would have an even smaller IRR and would therefore be the last to be developed If a project can only muster up 10% IRR, a commercial company would not accept it unless support is given that would bring the calculated IRR up to their threshold. A municipal DH company, with a threshold of 4% IRR, would see this as a very relevant and investable project and would go ahead immediately. In the case of a strictly commercial ESCO approach, only three projects would be built in this city, see figure 2 – the ones with an IRR of 14% or above. A few more could be added if the local authority or another benefactor would support the developments with subsidies or cash allowances. Sooner or later, the ongoing support from any benefactor will run out and then no more projects will be developed. The complexity of having up to three individual and competing companies operating in the same area and the effects on possibilities for expansions and alterations to the systems is not discussed here.
Picture 3. Development of projects based on a council approach - on the way to rolling out DH in the whole city. In this picture the expansion of projects has been included. IRR has been assumed constant due to access to the large low carbon heat source, lower cost as the DH company has been established, experience has been gained etc.
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