Regulatory Frameworks and Business Models for Data Centres Integrated to the Energy System: A comprehensive review of the rules and incentives affecting the provision of flexibility and waste-heat recovery by data centres in Denmark

The main objective of this report is to present the relevant regulatory framework and discuss the barriers that prevent data centres from participating as active entities in the Danish energy system. Data centres that provide flexibility to the electricity grid and feed waste heat into district heating networks offer an opportunity to support the energy transition by, among other things, enabling a higher share of non-dispatchable renewable sources through demandresponse and reducing the costs of grid reinforcement and heat generation, while decarbonising both the electricity and district heating systems. Over the past decade, data centre energy consumption has remained relatively stable despite massive increases in computing demands, largely thanks to the shift towards larger and more efficient hyperscale and cloud-based data centres. However, data-centre workloads are expected to continue growing exponentially over the next decade, even though there is still uncertainty as to whether the trend towards greater energy efficiency can continue further or it will reach its limits. Denmark has proven to be an attractive location for the development of new data-centre projects, with reliable data and power infrastructure, as well as cold environment and low-carbon electricity. As a result, Danish data centres are estimated to consume 8.8 TWh by 2030, which is approximately 28% of Denmark's final electricity consumption in 2020. It is therefore crucial that this fast-growing industry is taken into account in policy-making and energy planning to mitigate its negative impacts, but more importantly, to unlock its potential to become an active player at the interface between the electricity and district heating sectors.

The Danish Energy Agency prioritises flexibility in the future development of electricity markets. However, independent provision of flexibility is not yet allowed in Denmark’s wholesale energy markets, though new legislative proposals emphasise the importance of distinguishing between flexibility provision and electricity supply. Nevertheless, the provision of flexibility creates two main problems for the supplier of electricity to the flexible consumer: lack of balance and foregone revenues. In the first case, the supplier is brought into an unbalanced position in its portfolio, resulting in a loss or profit due to imbalances outside of its control. In the second case, this supplier misses out on sales of already procured electricity, which is then not used due to flexibility activation. The Danish regulatory authorities have not yet finalised the rules for the provision of independent flexibility. Therefore, it is unclear whether financial compensation and imbalance correction will be implemented in the Danish electricity markets. In terms of grid tariffs, the new "Tariff Model 3.0" that will come into force in 2023 will favour a more flexible electricity grid. This model will implement time-differentiated tariffs as a standard, as well as a power-based capacity payment, on the premise that the maximum consumption of high-voltage consumers substantially dictates grid requirements, while a purely energy-based tariff does not adequately reflect the grid costs associated with supplying these large consumers. The main barriers to the deployment of flexibility provision are the dampening of price signals by the current energy-based tariffs, the complexity and entry barriers for independent participation in balancing markets, and the fact that flexibility providers and suppliers have to agree bilaterally on a compensation level, which gives the latter the power to reject independent provision of flexibility.

There are also new developments with regard to the legal framework for using waste heat in district heating systems. In January 2022, new legislation came into force setting a price ceiling for waste heat, whereby waste-heat suppliers and district heating companies are free to agree on a price for the heat, as long as the total costs incurred by the district heating company for the use of the heat remain below the price ceiling. This price ceiling should be representative of the costs that the district heating company would incur by producing heat from other renewable energy sources and is set annually by the Danish Utility
Regulator. The main barriers observed to the use of waste heat are the potentially high investment costs required for heat pumps and the expansion of the district heating network, uncertainty about the long-term economic feasibility due to market conditions and regulation, as well as the lack of incentives for data-centre developers to consider the potential of waste heat use when deciding on the location of a new project.

It is recommended that regulators prioritise providing clarity on how electricity suppliers will be financially compensated for the foregone revenues and imbalances resulting from flexibility activation. In addition, more flexibility potential can be unlocked by making balancing markets more accessible to smaller market participants, either by lowering minimum bid sizes or allowing independent aggregation in wholesale electricity markets. Although the price ceiling for waste heat helps to reduce the regulatory uncertainty, the final methodology for setting it needs to be defined in order to successfully reduce project developers' uncertainties on how stable the price ceiling will be against cost fluctuations. More importantly, support schemes for investments in heat pumps and connection to existing district heating networks could become essential for smaller and larger data centres respectively, as their costs of capital are higher than those used to set the price ceiling in the first place.