Improving district heating (DH) is one of the main focus areas of the U.S. Agency for International Development’s Energy Security Project (USAID ESP), alongside the electricity and gas sectors. However, as the number of households receiving DH has almost halved since independence, is it really necessary to develop this system when there are ample opportunities for individual or autonomous heating? What are the benefits of DH? Diana Korsakaite, USAID ESP District Heating Sector Lead, answers these and other questions in our interview.
Let me start by saying that at ESP, we work to transform DH because we are sure that this infrastructure offers significant advantages to the country.
Indeed, in 30 years of independence, many households in Ukraine (sometimes entire cities) have stopped using DH because of consumers’ views on poor service quality, high tariffs, and the availability of other comparable options.
The main reason for the crisis is that for decades, the state has not recognized the strategic opportunities that available DH infrastructure brings. DH has been regarded as a burden, as a stepchild. As a result, not enough attention has been paid to reforming and modernizing the sector.
But in some ways, Ukraine is ahead of the curve: European countries are now planning to build DH systems with extensive urban coverage, which Ukraine has had in place for decades. Now it is time to transform these systems technically and pursue regulatory reform.
Experiences from Western and Northern Europe show the competitiveness and advantages of DH. First of all, it is more economical – in apartment buildings, energy costs are lower for DH than for individual heating systems (IHS). It’s important to bear in mind that electric heating in Ukraine is only less costly because of artificially low electricity tariffs for household consumers. As soon as the state lifts the caps on electricity prices, electricity will become the most expensive way to heat houses and water. On top of that, a mass shift to electric heating is far from realistic for technical reasons: the current electricity system is not designed for electric heating at a mass scale. Similarly, though for different reasons, individual gas heating solutions are only cheaper when technical safety requirements are disregarded (and residents’ life is put at risk).
DH is also more environmentally friendly. There are environmental regulations and technical solutions for DH entities, but they are not equally strict for individual solutions. Some countries have even created restrictive regulations – if you want to install individual heating when a centralized system is available, you have to prove that your solution has higher energy efficiency and environmental sustainability parameters than DH.
In Europe, it is widely recognized that DH systems are the most straightforward way to decarbonize heating and reduce energy waste. That is why Ukraine’s DH system must be preserved and developed, making the most of its benefits.
What are the key problems of the DH sector in Ukraine? Which steps should be prioritized in DH transformation?
Deconstructing the complex challenges of Ukrainian DH reveals several types of problems.
Technical problems: The technical efficiency of supply, transport, and generation must increase. The mass installation of standardized IHSs on district-basis and subsequent transformation of the DH network may be the first significant kick-off for essential technical reform. IHSs under an independent scheme of connection and switch to quantity regulation, lower temperature regimes, fewer technical losses, and less electricity consumption, to mention just a few outcomes for the DH system. Widespread IHS installation may also result in heat savings for consumers. Replacing worn-out heating pipes with pre-insulated pipes will avoid emergencies and reduce heat losses to the physical minimum. Increasing generation efficiency and switching to environmentally sustainable types of fuels, including waste fuels such as industrial waste heat, municipal waste heat will keep heating costs relatively stable and independent from international fossil fuel market trends, thereby making the service much more affordable to local consumers.
Financial issues: The tariff setting system needs to allow DH companies to recover reasonable costs, including fuel costs and the investment costs of transforming and developing the system. Of course, these companies are not purely commercial entrepreneurs – they also perform an important social function. However, it shall be ceased the practice of DH companies being not paid until much later, and the payments would not even fully cover their fuel, operating and capital costs.
Moreover, customers often do not pay their bills. As a result, consumers owe DH companies millions of hryvnia for heat and DH companies in turn owe millions to Naftogaz for the gas they buy. Consumer payment discipline must be strengthened. All this makes it harder for companies to invest in the technical transformation Ukraine needs.
Competition considerations: Ukraine has had consumer housing and utility subsidies in place for several years, which is a major achievement. However, indirect (or “hidden”) subsidies are still deeply embedded in the system. Hidden subsidies (which are simply market distortions) are expensive for the Ukrainian economy and prevent energy entities and consumers from making investment decisions based on real economic costs. For example, low electricity prices make electricity look like a cheap way to heat Ukrainian houses, creating an incentive for consumers to switch from DH to electric heating. However, this is only true until the government decides to lift the tariff caps. Similarly, individual gas heating only seems to be cheaper as long as the government keeps gas prices low and mandated bodies overlook technical safety. Instead, we believe that direct subsidies for vulnerable consumers should be expanded so as to get rid of indirect subsidies entirely with time.
I would also like to take this opportunity to draw your attention to another problem: DH companies will not be able to fully and timely finance system transformation and modernization under current model of economic regulation. Necessary financial capacity may come from third parties – private or institutional investors if the regulatory system ensures transparency, a fair return on investment, stability and predictability of regulation, and an acceptable level of political risk.
One last priority area is that Ukraine has real potential for synergy effects. For example, DH capacities can participate in the ancillary services market and provide system services, which supports system flexibility and allows the integration of more renewable energy like wind and solar power. This means the benefits of DH will be shared beyond the sector, including for national electricity decarbonization and energy sector decarbonization in general.
Which model of tariff setting should Ukraine use for the DH sector?
Several European countries have well-functioning DH regulatory models, and these models differ in how to incentivize DH entity behavior and guide heating systems to evolve toward national objectives. However, there is one principle embedded in each best practice case: reasonable costs for development are covered by tariffs and financial sources are available.
Personally, I think that tariff setting based on the regulatory asset base, allowing for a reasonable rate of return, extra incentives for environmentally sustainable investments, and dynamic reflection of pass-through fuel costs would be a game-changer. ESP is working to embed this type of regulatory model into the Ukrainian framework.
What do you think about the fact that local governments (OMS) have started setting tariffs for DH and hot water?
Let’s first recognize the regulatory actors in the field – OMSs (tariff setting), Oblast administrations (licensing), Ministry of Communities and Territories Development (drafting tariff methodology), Cabinet of Ministers (COM) (adopting tariff methodology), and the National Energy and Utilities Regulatory Commission (NEURC) (support). This division of responsibilities only came about recently.
I think NEURC’s decision to pass the licensing and tariff setting functions to local governments includes several points of interest for the current Ukrainian framework. First, the very fact that the regulator can swap licensees back and forth raises considerations about whether the regulator itself shall define and flexibly change the regulatory subjects or it should be set in advance by law. To ensure transparency, predictability, and lawfulness, the limits of regulatory powers should come from the legislative body after a thorough public discussion with stakeholders.
Another issue is that for multiple years, there have been two parallel methodologies for setting tariffs: one by COM and another by NEURC. The frameworks are not identical, and the COM framework is currently applied to licensees of local administrations. At the same time, NEURC still has a legal obligation to develop and adopt methodological regulations. At some point, this duality needs to end and the regulatory framework must be unified.
For local administrations to be successful in tariff setting (and by successful, I mean setting tariffs that enable financial sustainability for DH companies to operate and develop/transform DH systems), several key elements must be in place: a clear and high-quality regulatory unified methodology that allows for cost recovery and transformative investment; local know-how to apply the methodology; central body’s power to intervene in case of undue delays or incorrect methodology application; and a robust regulatory reporting and public accountability system.
What effects will the new ESP-supported heat supply schemes have for its ten partner municipalities?
ESP is helping develop new heat supply schemes for ten pilot Ukrainian municipalities that have maintained DH systems. These new schemes will reduce energy intensity and use renewable energy sources, making local heating systems more environmentally friendly.
We work closely with the Ministry of Communities and Territories Development, the Parliamentary Committee on Energy and Utilities, NEURC, local governments, and service providers – we provide advice, conduct trainings for specialists, and prepare information and analytical materials. For instance, ESP has helped create a manual on developing heat supply schemes for residential settlements and conducted a series of workshops on this topic. We also provide technical assistance to the partner cities to implement reforms aimed at optimizing and developing DH infrastructure. In the capital, we promote modernization at Communal Utility Kyivteploenergo.
Municipal assistance is based on two founding principles. First, municipalities should approach their heating infrastructure from the standpoint of long-term planning, which incorporates heat consumption development perspectives. Infrastructure planning should be backed with investment programming and financing sources for the duration of the plan to make it viable and beneficial for consumers and implementable for heat providers. The second principle is that municipal heating infrastructure development should contribute to decarbonization. Long-term planning provides opportunities to embed technical and organizational solutions to decarbonize heating in the near future. ESP’s standard package for municipal partners covers heat supply scheme development and the necessary accompanying support (e.g., development of strategies and 10 year investment programs) to make it easier to implement the schemes at both the municipal level and the DH company level.
Ultimately, ESP’s support is about improving heating systems’ energy efficiency, quality, reliability, and environmental sustainability. We aim to create an optimal combination of district, autonomous, and individual heat supply for municipalities and to eliminate mixed heat supply (district and individual) in multi-apartment buildings. This will contribute to the technological, environmental, and financial transformation of DH systems in partner cities.