April 8, 2020

Will Regulation of Heat Networks help achieve the Government’s net-zero target?

Government Consultation

On 6 February of this year the Department of Business, Energy and Industrial Strategy (BEIS) released a Consultation on heat networks.  This Consultation is open until 1st May 2020, and seeks responses from market participants on the proposed regulatory framework for heat networks. 

The Consultation has come in a pivotal year for the UK Government.  In November, Glasgow will be hosting COP 26, which is regarded by many as being our last chance to keep temperature rises below 2 degrees by 2050.  Heating represents a third of greenhouse gas emissions in the UK and so heat networks are crucial to decarbonising heat.  The Committee on Climate Change estimated that heat networks will have to provide 18% of heat by 2050 to reach the Government's 'net zero' target by 2050 - currently, heat networks provide just 2% of heat in the UK.  Although we are a long way behind our European neighbours in terms of market share we are overtaking them on technology.  There are two things holding the heat network market in the UK back: low investor confidence, and inadequate consumer protection.

The Consultation aims to address these two issues by bringing in a regulatory framework for heat networks in the hope that this will unlock the $16 billion worth of capital investment required for heat networks to deliver their full contribution towards net zero.

Consumer protection

There are currently no sector specific consumer protection provisions for customers on heat networks apart from a single piece of UK legislation (the Heat Networks (Metering and Billing) Regulations 2014) that implements part of the EU's Energy Efficiency Directive  and only applies to the metering and billing of heat networks' customers.  The sector, therefore,  largely relies on the good faith of the 2,300 suppliers in the UK, and the voluntary Heat Trust Scheme Rules.  This is concerning as heat networks essentially operate as monopolies.  Customers are unable to compare the prices they pay with prices on other networks, and unable to seek redress if they are treated unfairly.  As the sector grows, and indeed in order for it grow, a more robust consumer protection scheme is needed to enhance consumer confidence and protect the reputation of heat networks. 

The Consultation aims to place customers of heat networks on the same footing as customers of regulated utilities like gas and electricity.  In practice, this means proposals for:

  • quality of service standards;
  • fair and transparent pricing;
  • provision of information; and
  • a system for complaints and redress.

Appointing a regulator

Although the Heat Trust Scheme , an independent consumer protection scheme designed to protect heat network customers,  exists,  its Rules are voluntary and the sanctions that can be imposed are limited. 

The Consultation suggests that a regulator should be appointed just as Ofgem is regulator for regulated utilities, with statutory powers to set and enforce regulatory requirements for heat networks. However, the Consultation diverges from the approach taken with other utilities, recognising that heat suppliers are likely to require a more flexible framework than that imposed on regulated utilities.  This has led BEIS to suggest an outcome-based rather than a prescriptive approach, with firms being judged on their ability to deliver the outcomes set by the regulator.  BEIS hopes this will encourage firms to develop innovative services and business propositions. 

BEIS suggests that Ofgem's powers should be extended to cover heat networks to harness its significant experience in developing and enforcing consumer protection measures, and believes that having a single energy regulator would benefit heat network customers.

The Consultation proposes that individual consumer complaints about a heat network should be addressed to the Energy Ombudsman which provides an independent ombudsman service. The regulator's powers would be reserved for more systemic problems.

The Consultation recognises that consumers can be left stranded without a heat supply where a network operator fails to perform.  In order to mitigate against this risk the Consultation has suggested a range of options which would require all authorised companies to have a contingency plan to avoid loss of heat and hold reserve funds to cover financial difficulties. These would be backed by the right of the regulator to appoint another company to take over the supply and ultimately by the right to appoint an administrator.

Pricing

One of the key powers the regulator will have is the authority to require suppliers to publically disclose their fixed charges, tariffs and unit rates and provide clear explanations for how prices are set for consumers. The regulator will be required to work with industry to design a system for reporting, monitoring and benchmarking prices with regulations to set upfront pricing requirements such as cost allocation rules on what can be recovered from fixed and variable charges. This should in turn enable effective cost comparison between schemes. While the Consultation recognises the importance of developers taking into account the whole life costs of a network , it avoids imposing price regulation for the time being although it reserves the Secretary of State's power to introduce a price cap if he considers that necessary.

Provision of price information is part of a wider information requirement to provide the minimum range of information a consumer will need to understand its future ongoing heating costs which should also cover the terms of service and age and type of heat network system.

Investor Confidence

Although appointing an experienced regulator with significant statutory powers will go some way to improving investor confidence, a clear regulatory framework is also needed to reassure investors and provide certainty. The Consultation addresses this.

Who will be regulated and how?

There are three main stages in the development of a heat network - design, build and operate. The key phase with a direct impact on consumer experience is the operation and maintenance phase, although the design and build stages are also important as operation  will be affected by how the network is designed and built.  If a network is  correctly designed and built this will optimise performance, lower the risk of network failure and so reduce outages. The Consultation has suggested a hybrid approach to regulation, imposing a general authorisation regime on the operation of all heat networks, alongside an optional licensing scheme.

General authorisation

Under a general authorisation scheme there is no requirement to obtain a specific licence upfront to operate. Instead companies are automatically authorised to operate providing they meet a set of conditions set by the regulator.  This allows regulatory requirements to be updated when necessary and reduces unnecessary administration costs as a business does not have licence application costs and amended licences do not have to be reissued each time  changes are made to the regulatory regime.  

The Consultation proposes that the regulated entity for a heat network will be the heat supplier or network operator, who must notify the regulator of the operation of each of its heat networks that provide heat to domestic consumers and / or micro-businesses.  

One of the authorisation requirements will be that the network meets technical standards which in turn ensures that the network will operate reliably and operation costs will not be excessive. The Consultation proposes a certification scheme to demonstrate compliance. In many cases the asset owner or project sponsor will have been responsible for the design and build of the heat network and will have to obtain certification that the heat network meets minimum technical standards from an approved certification scheme prior to operation. If the regulated entity is not the entity responsible for the design and build of the heat network, it will have to obtain this certificate from the asset owner or developer when it contracts to operate the heat network.

Optional licence for statutory rights and powers

Developers and operators of heat networks unlike regulated utilities supplying gas or electricity are not "statutory undertakers".  In other words they do not have statutory powers and rights to access land to install equipment or carry out street works on roadways which adversely impacts on development timetables. The Consultation proposes that a developer could voluntarily apply for a licence for statutory rights and powers.  This, unlike operation of a heat network, would be a licensed activity because the regulator would need to assess whether the licence holder had the necessary financial means to pay compensation if it used its powers incorrectly. Statutory rights and powers should enable developers to reduce their build out costs and timetable giving greater certainty that projects will finish on time and on budget. They  would also assist during operation in the event of a system failure, when a network operator could use access rights to carry out maintenance required to bring the network back online.

The holder of the licence need not be but can be the same entity as the regulated entity which operates the heat network. The licence will not be scheme specific except where easements are required to install pipework across private land and so could apply to all of the applicant's heat network developments or operations wherever located.  The licensee will need to submit a separate  application to the Secretary of State for the grant of an easement for a specific scheme as a decision to amend existing property rights will need to be taken on  a case for case basis.

How will the regulator be funded?

Expanding Ofgem's role to heat networks will inevitably result in a need for additional resources and additional management costs.  The Consultation suggests raising these funds from fees applied to regulated entities, scaled accordingly to the regulated entity's size.  The regulator will not be funded directly from penalties levied against regulated entities that fail to comply to avoid creating incentives for the regulator to be heavy handed in using its powers. 

Regulation of decarbonisation

Heat networks will be required to make information available on the network's energy performance and the low carbon heat sources they use.

The Government has a range of measures in mind to drive decarbonisation and achieve energy savings. These include changes to Building Regulations and the Future Homes Standard for new build homes to be future proofed. The latter will encourage low carbon heating sources to be used as the primary energy source in new networks connecting to new developments from 2025. The Government also intends to set a maximum carbon emission standard in the future that larger district heating networks would be required to meet.

What does this mean for your business?

The introduction of the consumer protection measures proposed  are unlikely to represent  a major shift for those firms that already comply with the Heat Trust Scheme Rules. BEIS worked closely with the Heat Trust when drafting the Consultation, and states explicitly that firms that comply with the Rules will "be better prepared for the transition to regulation".

The current proposals are likely to result in lower costs for developers given the ability to obtain a licence to exercise statutory powers which reduces the time to build out a network and removes the risk of a landowner demanding a high price in return for the right to install equipment. It should also improve investor confidence with little or no increase in reporting obligations from those contained in the Heat Network (Metering and Billing) Regulations 2014.

 The minimum technical standards will force developers and investors to think long-term, rather than focusing on ways to save costs at the design and build stage. This may make projects less profitable on what was already a very thin margin for many firms. There will also be additional administrative burdens – the heat network will need to be certified prior to its operation, and the regulated entity will need to show that the network complies with regulatory requirements.

In conclusion the Consultation shows that the Government are listening to the concerns of market players and its proposals for regulation recognise  the importance of heat networks for the UK to reach net zero by 2050.