Guidelines for Improvement of District Heating Pricing Methodology

The current pricing methodology does not encourage consumers to save energy resources, motivate producers to introduce resource-saving measures, or provide economic incentives for private sector participants to invest in municipal infrastructure projects. The absence of relations with main market elements such as demand, offer, and competition also holds back market mechanisms. The tariff setting procedure in Ukraine is based on the Laws of Ukraine on Prices and Pricing, on Natural Monopolies, on Heat Supply, and on Housing and Municipal Services. However, the procedure remains undeveloped, and district heating pricing does not provide incentives for consumers to save energy resources. The majority of consumers pay on the basis of heat consumption standards rather than for the actually consumed resource. This lack of incentives leads to a deterioration of municipal district heating systems as consumers try to disconnect from the systems and save money on payments. Consumers also cannot influence the amounts they pay on the basis of single-tier tariffs. Paying for services on the basis of a single tariff without division for conventionally constant and conventionally variable parts, consumers cannot assess how much they pay for their residential or public building to have a certain design heat load. Design loads envisaged by engineering documentation are often the result of calculations and can be higher than those needed in reality. As a result, consumers have no incentives to introduce measures to optimize such design figures, particularly in buildings constructed before 1995. Producers in Ukraine also face barriers in terms of resource-saving incentives. The pricing rules prevent producers from using funds acquired through overplanned saving of resources. Producers cannot use the funds generated by their efficiency measures to return investments or pay dividends, as they are forced to reinvest them fully into the utilities infrastructure. The tariff setting procedure also establishes that salary expenditures should be planned on the basis of the list set by the procedure and with due regard of the general, sector, and collective agreements. This restriction prevents DH companies from decreasing salary expenditures by decreasing the number of employees. The establishment of profitability standards for the full planned prime cost creates no incentives for consumers to save resources. Tariffs are set through establishment of profitability standards in relation to the full planned prime cost, and not the amount of the invested capital. Accordingly, the producer has no economic interest to reduce expenditures, as this will decrease its planned profit. Today, the planned profit, which is also defined as a percentage of the full prime cost, is the only source of investment revenues for a private investor. In such a way, a private investor loses any economic incentive to decrease expenditures and increase the sale of services, being rather interested in increasing the full prime cost of services. The legislative provision on the state support and promotion of heat supply is insufficient to encourage companies. Article 8 of the Heat Supply Law sets that if heat generation and supply companies implement energy-saving measures, they will be entitled to receive state support. However, this provision is not sufficient to encourage companies to implement energy-saving measures, as the benefits of such measures are not clearly defined. The Municipal Heating Reform Project (MHR) aims to improve district heating pricing in Ukraine. The project has identified the barriers to the development of district heating in Ukraine generated by imperfect pricing and has developed guidelines to improve district heating pricing methodology. The guidelines aim to create incentives for consumers to save energy resources, motivate producers to introduce resource-saving measures, and provide economic incentives for private sector participants to invest in municipal infrastructure projects. The project also aims to ensure interconnection and interrelation of the main market elements of heat supply to ensure its operation.