An unprecedented combination of factors are converging to make gas-fired Combined Heat and Power (CHP) more attractive, and arguably more beneficial than ever before in Ontario. Yet the pace of new development is expected to be relatively modest. “There is a lot of unrealized potential,” says Richard Laszlo, Director of Research & Education for Quality Urban Energy Systems of Tomorrow (QUEST) a non-profit advancing smart energy communities in Canada. Noting that “the benefits are greater than most people realize – and growing,” he says, “this means that, when projects do get built, the cost-benefit comparisons are likely to look very positive.”
Although the prospects for growth of CHP capacity are strong, it is not likely to experience sudden expansion like that seen by renewables in recent years. This is primarily because CHP facilities can only be built after long-term arrangements have been established with viable heat users. For example, in Ontario, this feature of CHP limits expected growth to a few hundred megawatts over the next decade. Nonetheless, the strengthening value proposition is likely to attract interest from more potential customers and lead to new types of deployments, many as part of smart grid and micro-grid systems. “Recent changes in economic conditions and policy priorities have created the prospect of adding significant amounts of relatively low-cost clean power with numerous desirable characteristics for customers and for the environment,” Laszlo says. Yet most CHP projects are held up or not advancing at all because of administrative barriers and unresolved policy questions.
Peter Ronson of Markham District Energy, which operates one of the leading examples of CHP in Ontario, explains that, “It’s still tough to finance a CHP investment without an OPA contract or other LDC incentive, even though the fundamentals would suggest that more projects should be proceeding.”
Considerable benefits
The benefits of CHP are significant, but they can be complicated and difficult to explain. Proponents frequently point to a long list of advantages for customers, for the power system and for the environment, a list that has grown significantly with the general recognition that communities need to adapt and rebuild significant parts of their infrastructure to deal with increasing incidence of super-storms and extreme weather.
The benefits of CHP are enjoyed in many cases well beyond the boundaries of the customers who pay for the installations. Ironically it is the very fact that CHP bestows many of its benefits freely on non-paying customers that makes it more challenging to finance. The list of oft-cited benefits includes the following:
• Reduced costs of fuel required by the CHP host, for heating and power generation, often leading to increased business competitiveness and job creation for the heat user
• Reduced environmental emissions
• Stabilizing the costs of energy services for directly connected customers and for other customers in the area
• Improved ability to compensate for the variability of renewable generation and volatile customer demand
• Assisting nearby customers and communities meet their resiliency targets related to dealing with climate change and extreme weather
• Overcoming many of the siting difficulties and controversies associated with the extension or upgrading of transmission and/or generation facilities in congested urban areas, many of which are needed simply for reliability
• Its natural linkage with community energy planning processes and the frequently perceived interest in developing local generation, as well as anchoring district energy systems
• Contributing to the viability of localized micro-grid systems
• More efficient use of existing grid capacity by virtue of producing power close to load
• Well designed CHP can reduce the cost of, or defer the need for, expensive new distribution and/or transmission equipment.
Anticipation of an upsurge in CHP deployment has been building steadily for several years amongst observers of the power industry. This is because the costs for CHP, both capital and operating, have been holding steady and even declining in some areas, while the value of the services provided by CHP have been climbing. The key economic ratio in this business is something called the “spark spread” – or the difference between what a kilowatt-hour is worth as unburned natural gas, compared to what it is worth when the same amount of gas is used to generate power and heat through CHP. The spark spread has been growing in most parts of the world for five years or more, leading to additional deployment of CHP and other forms of gas-fired power generation.
At a higher level, the difference between long term expected electricity prices and long term gas prices has improved in recent years, which allows for investors to focus their attention on what will produce the most efficient forms of capital investment. The fact that many customers and energy agencies are expected to develop and implement programs to improve their resiliency to extreme weather and their environmental performance, together with the increasingly attractive economics, are creating a positive base on which to build CHP. At the same time, with a majority government and a long term energy plan in place in Ontario, there is a relatively stable policy environment in the province that may lead to even more positive conditions for CHP for private investors. Although financial results are usually considered proprietary information, there is little doubt that the internal economics have become more attractive and the key concern of developers is how to manage other types of risk.
Risks and hurdles to overcome
The business risks for developers of new CHP can be formidable and are, in fact, the primary reason for central procurement of CHP. Yet, the risks to overcome seem modest compared to the benefits, at least from a public policy perspective. They include:
• Broad economic risks such as: Will the spark spread change again in any major way?
• Political and regulatory risks such as: Will the applicable rules and regulations affecting the business conditions for CHP change significantly before the investments have time to be substantially paid off?
• Local institutional risks including whether the policies and practices of the connecting electricity distributor are amenable to the addition of CHP in the proposed location.
• Project-specific risks like where the specific combination of equipment is technically well-suited to managing the customer’s risk.
Developer experience seems to show that, even when general conditions might add up to highly positive circumstances for development of new CHP, the persistence of political and regulatory risks for owners or developers is the primary reason that long term contracts are widely considered necessary for development. Certain types of risks can be managed through appropriate engineering and contractual arrangements, but the policy risks require a different set of tools.
Ironically, the policy and administrative barriers affecting CHP could be the primary obstacle standing in the way of achieving widely-shared policy objectives like reliability and sustainability, even when the economics are attractive. First of all there is a fragmented approach to CHP from a policy and procurement perspective. Although there are two different procurement programs in place at the provincial level, the practical targets are ambiguous and neither program has been able to finalize very large amounts of capacity, despite being authorized to proceed for years. Apparently, the agencies’ mandates as to the pace of development in the near term are less than perfectly clear. In addition, there is uncertainty at a policy level as to the appropriate type of relationship to develop between the CHP owner and the local electricity distributor: Should the developer view the local distributor as a partner, facilitator or potential competitor, or some combination of all three, considering the likely involvement of utility affiliates? Although CHP can proceed under any model, investment planning is made more complicated by the need to provide for potential upset in the partnership options and competitive circumstances. Energy consultant Marion Fraser notes that, “CHP and district energy are only seen as supply options by many, but in fact they represent significant, system-wide conservation tools. Too often, government mandates and programs are narrowly targeted at either supply or conservation, and/or limited to either gas or electricity.”
In addition, many applicants struggle with complex local rate structures. Distributors in Ontario have widely varying rate approaches to CHP, some of which include almost punitive standby charges for load displacement generation. The regulatory initiative that’s intended to address these problems is showing signs of progress - but has to complete some important steps before it will be definitively resolved. There is a questionable public policy in Ontario that gives priority to connecting renewable generation over gas-fired CHP, even if the CHP might be a better use of the limited connection capacity. In addition, many of Ontario’s power distributors are simply unfamiliar with CHP and are not fully equipped to assess applications for connections or to proactively plan the best locations for CHP in their areas.
Complex policy issues
In contrast with these historic and policy-related difficulties, there is a positive force embedded in provincial energy policy: LDCs in Ontario have been mandated to install large amounts of load reduction as part of their conservation and demand management license requirements. The context for this kind of work is promising, as many distributors and customers consider such initiatives at the same time as contemplating upgrades related to accommodating smart grid technology. In addition, as mentioned earlier, as part of the same or related investment initiatives, many municipalities will likely consider CHP options as part of meeting their obligations to improve the resiliency of local infrastructure. And of course many private companies will find CHP attractive as it enhances both the reliability of their own power supplies and their ability to present themselves as sustainability-minded members of the community. With all these forces operating together, the prospects for CHP are steadily improving.
Many utilities see CHP not as a challenge but as an opportunity. Tim Short of Enbridge Gas Distribution says that “CHP is a truly excellent energy application for the gas and electric utilities to seriously collaborate when dealing with our mutual customers whilst we help them conserve energy.” Short notes that “utility collaboration is a directive of the MOE during the delivery of both the gas and electricity conservation programs.”
Neetika Sathe, Vice President of Corporate Development at PowerStream Inc., shares her enthusiasm for the integration of CHP technology with other parts of the distribution system. “The electrical distribution sector is becoming more complex as customers are looking for enhanced resiliency, sustainability and price certainty. CHP systems will be a key part of distributed generation portfolios since they have an advantage over intermittent renewables – they can be fired when needed.”
Because of its site-specific nature, the CHP development industry faces a problem that is almost unique: Supportive public policy is required to facilitate new investments, even when the underlying economics of individual projects may be positive. CHP has to overcome special challenges related to the risks of building a thermal distribution system, including change in the nature of the heat customers over the life of the investment, along with a range of policy difficulties. Policy analysts are often confounded by this complexity: Why should technology that is fundamentally economic require any assistance from policy-makers?
In order to understand why CHP requires special public policy provisions it is necessary to appreciate the administrative hurdles facing CHP developments, and the many benefits CHP provides. A significant example of this is the system for setting power prices in Ontario, under which the market price does not come close to reflecting the actual cost of power.
APPrO Executive Director Jake Brooks says, “If you want to get the most efficient and effective CHP projects, just as with other types of generation at this stage in the development of the market, you need to have a well-managed form of central procurement as part of the picture.”
The logic of a portfolio approach
Jim Baxter, Director of the Environment & Energy Division for the City of Toronto, has an apt solution for this apparent conundrum. “When dealing with CHP, there needs to be a portfolio approach,” he says. CHP is effectively a cluster of related technologies, that when configured in specific installations tend to fall into one of several distinct subcategories. Most of the subcategories require contracts like those from the OPA, although a few subcategories in specific niche areas may be able to move forward without such contracts. “Public and private agencies need to recognize that some projects will operate most effectively behind the meter without central procurement, whereas others are going to be most effective if designed and financed with the use of a power purchase agreement from a procurement agency. Both kinds of CHP will deliver benefits to customers and the system, and both need a little policy attention to ensure that minor administrative obstacles are cleared out of the way,” Laszlo says. “There is no inherent contradiction in operating a system that develops some CHP with the use of centrally procured contracts while other projects are developed primarily on the basis of internal fuel savings. The reasons for procurement by a central agency are largely to alleviate non-economic barriers – and its cost will be modest for the same reason.”
Although this problem of having two parallel procurement models primarily affects CHP at the moment, it is entirely possible that shifts in the economics of various generation options will over time make such a portfolio approach relevant and applicable in more and more areas. A range of other technologies may require similar portfolio approaches, combining central procurement with parallel systems for fostering new investments based primarily on internal revenue streams. The latter group will of course be limited to a relatively small subset of opportunities that happen to have easily-monetizable benefits. These may be highly visible projects, but they will not necessarily be the most beneficial projects overall. Laszlo notes that, “When your benefits are disseminated so widely, even the most traditional economic theory agrees that a form of market failure is likely and policy measures will be necessary to achieve the most economic results.”
Proponents note that recent advances in small scale combustion and control equipment have improved the appeal of CHP technology further: The market now offers a greater selection of pre-packaged CHP systems than ever before. This will make adoption more convenient for a wide range of customers and it also helps to keep costs under better control.
The pressure to address resiliency and improve local emission profiles, combined with improving economics, might be enough to finally push the various authorities to address the obstacles to CHP. If so, there could be a period of rapid growth and relatively clean low-cost dependable power capacity ahead.
For further information, see these articles in past issues of IPPSO FACTO:
• CESOP updated, delayed again (November 2008)
• Groups press the OPA to resolve pricing model for CHP (April 2010)
• APPrO stresses initialization rules and financial concerns in FIT program (June 2009)
• Industry groups recommend adjustments to CESOP (September 2008).