District coolers can learn from power sector

27 September 2010

A change in business model could see the district cooling sector reaping financial rewards

All is not well in the region’s district cooling sector. And it is time that the sector’s stakeholders get together to rethink their industry. The problem is not with the concept of district cooling. As a way of delivering air conditioning, it is greener and more efficient than the traditional method of using split units.

Neither is the problem with the technology. Or the service. District cooling provides reliable, safe and effective services.

The problem lies with the business model. Or at least the model that has been pursued by district cooling companies such as Tabreed, Palm Utilities and Dalkia throughout the GCC’s 2003-2008 real estate boom.

In conjunction with the real estate developers, these companies grossly over-estimated the sustainability of demand in the future and, as a result of the downturn, now find themselves with cash flow problems on some schemes as they seek to repay their capital borrowings in a world of sharply reduced demand. In short, the money they are receiving today is insufficient to cover their outgoings.

The real problems lie ahead.

The huge capital expenditure required to deliver district cooling requires debt finance. And the region’s banks do not want exposure to speculative real estate developments where there are always going to be long-term questions about the reliability of cash flow.

As a result, project developers and advisers are drawing inspiration from structures used for independent water and power projects (IWPPs). Crucially, power and water projects in the region have offtake agreements in place, usually with a state utility or government agency. They are also well-regulated, whereas district cooling providers aren’t. And the projects themselves are subject to much more stringent design and construction codes.

The financial structuring of IWPPs in the region can provide a helpful guideline for district cooling projects. According to Richard Parris, partner at US law firm Clifford Chance, who advised on the region’s first project financed district cooling project, “we looked at IWPPs in the region to create a bespoke model to finance the district cooling project.” It brought about, “an evaluation of risk that enabled banks to get comfortable with the project risk.”

Also, certain adjustments need to be made to a power project structure for it to be suitable for application in district cooling projects. At the Middle East District Cooling 2010 event in Abu Dhabi, HSBC director of infrastructure Michael Cooper pointed out that power while power is a uniform product is used in the same way, district cooling is used in different ways and is sourced from different sized plants. Therefore, putting in place a pricing tariff, as would be the case for a power project, “is not reflecting the reality of commercial uses.”

But there are still important lessons to be learnt from the independent power sector for the district cooling industry. If district coolers want to raise commercial debt for their plants and pipeline networks, they need to set themselves up in the same way as the region’s IWPP and IPP projects, with guaranteed offtake agreements in place.

For speculative private-sector real estate developments however, this is not an option. And the solution lies in a more measured approach to installing new capacity - lots of smaller plants rather than one big one - and end-user tariffs for air conditioning agreed in advance.  

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