Overview of CHP Payment Mechanism for LESCs
1. Introduction
This document provides a brief introduction to the proposed CHP payment mechanism for SEAI’s template Local
Energy Supply Contract. In addition to providing an overview, it discusses how it will be incorporated in the contract
and the tender evaluation criteria. It has been prepared as part of the LESC consultation process, and so it poses a
number of questions which SEAI would like to solicit the reader’s views on.
2. Objectives
SEAI is anxious to adopt a payment mechanism that achieves a number of objectives, including:
 Encourages the use of CHP thermal output – achieved by the customer only paying for thermal energy
consumed and by putting a value on heat (discussed further below).
 Doesn’t commit the customer to buying a minimum quantity of energy, whilst avoiding exposing the ESCO to
capital and financing costs with no guaranteed revenue – achieved by the customer paying a monthly Fixed
Payment, which is similar to a standing charge.
 Encourages ESCO to strive for high grade CHP
 Doesn’t expose the ESCO to fuel price variations/risk – achieved by the proposed indexation method
 Encourages bidders to optimise the CHP size to the facility electrical and thermal load profile, use a CHP with
high electrical efficiency and to invest in thermal storage and/or part load capability – achieved by the
procurement process adopting the Net Present Value for price evaluation of tenders.
3. Payment Mechanism
Monthly Payment = Electricity Payment + Heat Payment + Fixed Payment
Where: Fixed Payment = cost of capital investment and associated financing.
Where: Heat Payment = Heat Price x Quantity of Useful Heat1
Where: Heat Price = Cost of Boiler Gas Fuel, e.g. if gas is 4 c/kWh, Heat Price is 4 c/kWh
Logic: This approach means that the unit price of useful heat supplied by the CHP equals the marginal unit price of gas
fuel to the customer. It means that heat is never free (“free” heat results in it being wasted or intentionally dumped),
but that CHP heat is always cheaper to the customer than the alternative heat source (how much cheaper depends on
the seasonal efficiency of the boiler2). It also means CHP heat sold (but not dumped heat) has a value to the ESCO,
motivating the ESCO to supply as much heat as can be usefully consumed, and encouraging the ESCO to invest in
thermal storage to address supply-demand imbalances, and also encouraging the ESCO and client to work together to
find uses for the heat and ensure return water temperatures are kept low enough for the CHP to be able to impart
useful heat. From a tendering standpoint, all bidders will be using the same heat price, and so will compete based on
electricity price and fixed payment, thereby reducing tender complexity and improving transparency.
Where: Electricity Payment = Electricity Price x Quantity of Electricity Consumed 3
Where: Electricity Price = price bid by ESCO to cover all non-capital related costs less any costs covered by the Heat
Price, including fuel and other consumables, operation, maintenance (including major and minor overhauls),
and profit.
Logic: As useful heat has been assigned a value, and capital costs are dealt with by the Fixed Payment, it is expected
that the price per unit of electricity from the CHP will generally (but not always) be lower than the cost of electricity
from the grid. If it is not, there is no case for a CHP and the customer will not buy CHP electricity.
For definition of “Useful Heat” refer to CER12125 “Certification Process for High Efficiency CHP”.
If the customer has a high existing boiler seasonal efficiency, then the saving from using CHP heat will be low. E.g.
if the customer has heating system that is 85% efficient, the CHP heat saving is 15%; but if the customer heating
system is 70% efficient, the CHP heat saving 30%.
3
Electricity consumed by customer, i.e. net of any parasitic loads associated with the CHP installation.
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A typical profile for such a payment mechanism is illustrated below:
ESCO Revenue
(= Customer Payments)
€30,000
€25,000
€20,000
€15,000
€10,000
€5,000
€Jan
Feb
Mar
Apr
Fixed payment
May
Jun
Heat payment
Jul
Aug
Sep
Oct
Nov
Dec
Electricity payment
It is likely that at different times, depending on gas prices, electricity prices and the CHP characteristics, the following
situations will arise:
 The ESCO will follow the heat load of the facility, selling all electricity and heat
 The ESCO will follow the electrical load of the facility, dumping any surplus heat
 The ESCO will shut down because it is not economical to operate at low heat loads, e.g. during mild weather
 The client will not buy electricity because grid electricity is cheaper, e.g. at night.
 The client will want the ESCO to follow the electrical load, due to high utility electricity prices, but the ESCO
(who has bid a fixed electricity price) will want to follow the heat load, e.g. during winter peak demand. This is
discussed below.
4. Payment for Peak Electricity Tariff Operation
Ordinarily it is not expected to be cost-effective for the ESCO to operate the CHP at full electrical output and dump
unused heat. However, there will be times, traditionally between 5pm and 7pm on Monday-Friday from November to
February, the client will want the ESCO to follow the electrical load, due to high utility electricity prices, but the ESCO
(who has bid a fixed electricity price) may want to follow the heat load.
In such circumstances it is envisaged that the customer and the ESCO would negotiate to achieve a balanced solution.
5. Important points
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The customer is not required to buy any energy, but is normally required to pay the fixed monthly payment
even if the customer chooses not to buy any energy.
The ESCO is not required to operate the CHP in times when the thermal load is below the rated thermal
output of the CHP, but the ESCO may choose to do so where this is in its financial interest.
The customer only pays for useful heat except where the customer instructs the ESCO to operate at full
output regardless of the thermal load; in which case the customer compensates the ESCO by paying the
ESCO for the full thermal output of the CHP even if some of that heat is dumped. This is proposed such that
both ESC and client are motivated to maximise heat output.
If the customer pays the initial capital cost, the Fixed Payment = 0.
Ownership is likely to transfer from the ESCO to the client at some point. Whether or not this occurs at the
beginning or end of the contract, and at what price, will depend on accounting rules, balance sheet
considerations (i.e. the potential for off balance sheet treatment of the debt) and possible loan covenants.
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6. High Efficiency CHP4
In order to motivate the ESCO to maximise the efficiency of the CHP, but without requiring the ESCO to do so, it is
proposed that the benefits of any carbon tax rebate associated with high efficiency operation will be shared equally.
The ESCO will be responsible for putting in place the systems, certification process and all other administration. On
receipt of the rebate from the Revenue Commissioners, the client will issue a payment to the ESCO.
7. Alternative Payment Mechanism: free heat
The payment mechanism outlined in Section 3 is proposed. However, SEAI are also seeking views on a more traditional
approach, outlined below:
Monthly Payment = Electricity Payment + Fixed Payment
Where: Fixed Payment = cost of capital investment and associated financing.
Where: Electricity Payment = Electricity Price x Quantity of Electricity Consumed 5
Where: Electricity Price = price bid by ESCO to cover all non-capital related cost, i.e. fuel, operation, maintenance,
etc.
In this case, the heat is effectively “free”. In order to minimise the quantity of heat dumped, the ESCO will be required
to ensure the unit qualifies as High Efficiency CHP or incur a penalty. The size of the penalty is to be established, but it
is envisaged that it would be sufficient to discourage non-HE operation.
8. Indexation
In order to avoid exposing the ESCO unduly to fuel price variations/risk, whilst keeping the CHP contract relevant to
variations in energy prices (including possible month-month changes in gas price), it is proposed that:
 The CHP heat price will be 100% index linked to the customer gas prices at the time of gas purchase or other
fuel as appropriate. .
 The CHP electricity price will be 80% index linked to the customer gas prices at the time of gas purchase and
20% to Consumer Price Index (to allow for that portion of operating and maintenance costs that are not
driven by fuel prices).
 The Fixed Payment will not be index linked, as capital cost will be known at time of tender and interest rate
on the loan will be fixed.
9. Tendering
The public sector will be required to issue a Request for Tender. The proposed approach to tendering below would
apply to all organisations bound by public procurement rules; some private sector organisations may choose to adopt a
similar approach.
Information Provided in RFT
The request for tender will include client typical electricity and heat loads profile for information and evaluation model,
gas fuel price for tender evaluation, evaluation criteria and method, test discount rate.
Information Requested in Tender
The Tenderer will be required to provide at least the following information:
 CHP rated electrical and thermal outputs
 Cost and intervals of CHP major and minor overhauls
 Electricity price and fixed payment
Tender Evaluation
It is envisaged there will be a technical evaluation, perhaps accounting for 10-30% of the marks, and a price evalution,
perhaps accounting for 70-90% of the marks.
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For definition of High Efficiency CHP, refer to CER12125 “Certification Process for High Efficiency CHP”.
Electricity consumed by customer, i.e. net of any parasitic loads associated with the CHP installation.
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Technical evaluation - will take account of size, electrical and thermal efficiency of proposed CHP, the inclusion of
thermal storage, potential for part load operation, inclusion of a heat dump radiator. It will ask the bidders to describe
how they propose to deal with high return water temperatures at lower heat loads. Consideration will be given to the
quality and reliability of equipment specified. It is likely that all units will be required to be capable of operating at part
load (i.e. modulating to follow the heat or electrical load).
Price evaluation based on NPV - To encourage optimum sizing, efficiency and equipment selection that will facilitate
part load operation and heat dump when it is economic to do so, tenders will be compared based on which delivers the
highest Net Present Value over the expected life of the equipment for the given energy load profiles.
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The reason for using the life of the equipment as the period for the assessment (as opposed to contract term)
is this approach allows the benefits of capital investments in features that will improve operational savings
(such as thermal storage or recovery of low grade heat from the intercooler) to be assessed over a longer
period of time, thereby affording them full value in the comparison.
The NPV method assesses the financial return in euro over the life of the project. Because it delivers a result in
euro terms the proposal with the highest euro amount will win. Doing an Internal Rate of Return (IRR) analysis
could result in undersized CHPs winning because they have a higher rate of return due to higher utilisation.
10.
Questions for Consultation
1.
Is the payment mechanism described in Section 3 clear?
2.
Is the rationale for using the payment mechanism described in Section 3 clear? Please identify any ambiguities.
3.
Do you think the payment mechanism described in Section 3 will achieve its desired objectives?
4.
Do you think the payment mechanism will work in practice? Please identify any reservations you may have.
5.
Do you think the payment mechanism will create price distortions that will result in customer and ESCO being at
odds? If so, please elaborate.
6.
What are your views on generally only charging for useful heat energy?
7.
Do you think the ESCO will be motivated to install a heat dump radiator based on the payment mechanism?
8.
What are your views on the proposal to negotiate for operation during the peak electricity tariff?
9.
What are your views on the proposed sharing of any carbon tax rebate associated with high efficiency CHP? Will
this motivate high efficiency CHP?
10. What are your views on the alternative payment mechanism (Free Heat) outlined in Section 7? Would this be
more/less desirable than that described in Section 3 and why?
11. What are your views on the proposed approach to indexation of electricity prices, heat prices and fixed payment?
Do you think the split for electricity indexation, which is 80% gas price and 20% CPI, is reasonable?
12. What are your views on the proposed use of NPV over the equipment life for evaluation of tendered prices?
13. Are bidders likely to incorporate features that might result in a higher capital cost, but lower operating cost or
additional energy sales, such as thermal store, or unit designed to follow heat load? Why?
14. Do you think extended warranty or equipment insurance should be included?
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15. Under the proposed approach, will the ESCO suffer unduly it client return water temperatures are high? If so, can
you propose an alternative approach to deal with this?
16. Do you foresee potential for ESCOs to game the tendering system to gain unfair advantage?
17. Please add any other observations
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