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The finance angle

Jaap Kalkman, the Head of Asset-Based Investments for the MENASA region at Arcapita, made a presentation, titled ‘Exploring financial viability of district cooling projects. Excerpts…

| | Dec 15, 2010 | 2:41 pm
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Jaap Kalkman, the Head of Asset-Based Investments for the MENASA region at Arcapita, made a presentation, titled ‘Exploring financial viability of district cooling projects. Excerpts…

Financing for district cooling is a theme for a conference in itself. The challenges for providing finance for district cooling are many. If you look at project finance, if you look at standalone projects, these are small in profile. When there is a $20-billion nuclear plant, few people are interested in a $50-million project. So you have to look at local banks, which have to understand that project finance is different from other finance.

Every bank understands project finance, but they need to understand district cooling, which is not complicated. The district cooling community has to crack the financing nut. Saudi Tabreed got finance on the Saudi Aramco project, but again, it is not a typical district cooling project – you have 100% off-take from Saudi Aramco.

It is unlikely governments are going to finance a district cooling programme. District cooling saves electricity and water and offers other benefits. So how do you get it going? A lot of district cooling companies have learnt lessons from the crisis on how to structure district cooling projects. So this presentation is on how to do that…

Most advanced developers are sympathetic to these new structures.

Arcapita is a private equity company. It is a GCC-based investment firm, which has handled 75 deals worth $28 billion.

Now the question is, why should the private sector be interested in district cooling? And are the risks manageable? The answer is ‘yes’. Construction risk is manageable through good governance and operational risk through good governance. As for collection risk, there is the option to bill buildings and not individual companies or families. In dubai, a district cooling company ran into trouble by going to individuals, because there was variance in behaviour. As for revenue-cost mismatch, the solution is to structure tariff properly. And as for demand risk, the way out is to ensure that buildings are coming up before construction starts.

Now, let us look at the ideal tariff structure for district cooling services. I would recommend a three-part tariff to mitigate revenue-cost mismatch:

  • One-time connection fee that covers ETS investment at the customer location
  • Monthly consumption fee
  • Monthly capacity fee

At this juncture, let us look at how to mitigate demand risk. It is possible to achieve this by letting the project developer/sponsor build the network. I am talking of an upfront investment, up to 30% of the total cost. The developer should put the pipes underground, because he believes in his project, correct? Also, you can’t put pipes in a modular fashion – it does not work right.

Secondly, sign or partner with a reputable sponsor or sub developer (rather than an SPVs) and agree to be paid even if the customer is late. Thirdly, insist on upfront payments from customers, upon signing of the customer agreement. Ask for at least the one-time connection fee and, ideally, also the one year of capacity fee. Fourthly, start and put customers on temporary cooling and, then, once demand increases, bring permanent structures online. And fifthly, agree to automatic concession extension, in the event of delay.

Okay, are the returns attractive? Compared to power project returns, and US Treasury returns, with district cooling, we find 12-15% returns, so this is attractive. (I must add that without a reputable operator, like Dalkia, we might not have been able to command such returns.) Maybe there is a higher risk than a power project, where you have government off take, but still district cooling is attractive.

And are there enough opportunities? Roughly half of the projects are continuing, though at a slower pace. At a very high level, there is absolutely high demand for such projects in Saudi Arabia. And Kuwait is starting with district cooling, so yes, there are opportunities.

However, we must remember that the era of “please build first, the customers will come” is over. A more sophisticated, “just in time” project structuring is required

With this new more careful project structure, it is feasible to proceed on district cooling.


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