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The Perfect Storm: How to approach new build developments

Switch2 Energy, Shoosmiths and HermeticaBlack came together to discuss procurement and delivery of new, low cost, low carbon heat networks.

Ian Allan, head of market strategy at Switch2 Energy, discussed:

  • How new buildings move away from risk prone design and build and adoption model
  • How early engagement of heat network operators can bring down CAPEX and operating costs
  • Integrated local energy systems and their stacking benefits

Switch2 is the largest operator of residential HNs in UK with 150 employees, 80,000 properties, 500 heat networks and over 40 years of experience.

Heat networks are a key part of delivering on climate change obligations as they provide a clean and flexible solutions, can use different low carbon energy sources and they can be cheaper than individual heat pumps (in anything but small developments).

The Government’s ambition is to increase heat networks from 2% to 20% of heat delivery by 2050. New regulations are on the way, with a second reading of the Energy Bill in the House of Lords expected soon. Two key parts surrounding this will be zoning and the regulation of customer protection and technical standards.

Ian emphasised a need to look at paradigm shift, what with the new pricing of energy, plants and equipment being more expensive, supply chain issues and general rising costs. This means there is a new focus on doing things ‘lean and mean’.

The CIBSE Code of Practice CP1 was launched in 2015 (updated in 2020) to:

  • Fix broken supply chains
  • Address poor outcomes for residents of heat network buildings
  • Set up technical standards

Whole supply chains need to be considered.

In the current regime, the adoption model is common – in which Switch2 is asked to take over management, operation and maintenance, and/or metering and billing of existing heat network. This generally leads to a lot of problems being discovered.

Switch2 is often asked to comment at design and build stage which can still be problematic, as it is still too late to-reopen design to make corrections.

Switch2 know how systems operate and have collected data across 500 schemes – developing an understanding of what demand is and when it happens, and how to size heat networks properly. Designers often work from standard sets of reference data, which can be out of date – as such not reflecting the real world.

Architects must understand heat networks going into buildings, specifically that:

  • Short terminal runs from riser needed for optimal performance to reduce distribution losses (rather than one riser with long terminal runs)
  • They need to be looked at early in procurement process.

An effective solution can be to use telemetry to inform maintenance operations and optimisation of heat networks – for example Formula 1 teams look at telemetry outputs from cars to see understand errors and what improvements may need to be made. Switch2 can identify problems before they cause outages – though highlight a crucial need to start early in planning stage to deliver on ambitions.

There are a number of stacking benefits for developers which use onsite generation, including:

  • They can deliver at cheaper price with central plant rooms, central battery storage with heat pumps delivering to individual houses instead of generation at an individual house
  • It is better to use what is on site optimally than to export energy to grid. Moving from monolithic grid to islands of local optimisation

Switch2 is currently working with developers around this concept.

Chris Holmes, managing director at HermeticaBlack, was next up to speak.

HermeticaBlack (HB) are development managers and asset managers for energy projects, working end to end but also at various stages of the energy process.

They focus on:

  • Adding value
  • Understanding technical, commercial and contractual aspects
  • Retention of value through delivery process
  • A commitment to asking right questions at right time

HB work with:

Real estate developers on:

  • Communal heat networks
  • How to procure and deliver onsite generation
  • Moving into smarter grids which deliver smarter energy on the whole
  • Infrastructure funders on:
  • Investing solely in energy products,
  • Understanding needs of how energy asset is operated
  • How transfer of risk moves across contracts
  • Local Authorities and Government on:
  • 4th and 5th generation smarts grids
  • Taking heating from waste heat and transferring to commercial end users

HB cover:

  • Entire lifecycle of projects
  • What makes an energy project and helps deliver good asset from a new build perspective
  • Monitoring installation is key, linking design, operation, build and maintenance
  • The only viable person to take risk is developer, as other parties don’t so there is a big risk gap

HB are managers, not operators, and work with Switch2 on various contracts and risk profiles, ensuring assets work as they should, and there is viable mechanism to ensure strategy is maintained. They also work with Shoosmiths on contractual structures, and the pass down of risk.

HB are also involved at exit on behalf of client, including how to list on London Stock Exchange as well as helping developers to sell energy centres to existing ESCO market.

Their goal is to set up projects so market can take over especially considering upcoming regulation, with need to viably be able to hand over unless developer wants to retain role in perpetuity – highlighting it is important to understand strategy at outset of projects.

Energy management’s approach typically includes:

  • What are delivery options and what needs to be understood at start
  • Commercial structures can be created in many ways
  • Needs to align with strategy approach of developers and investors, how they’ve raised money and how they are selling product (strategy must then follow this)
  • HB can do contracts from start to finish, as well as at various life cycle stages
  • Must consider at an early stage what energy management approach is
  • The risk of stranded assets from investment perspective, if not compliant with local area plan, or expectations of energy provision
  • The fact that people have options where to live – this will therefore take a nuanced approach
  • Investment cycles can span 30 years, there is a need to think about energy management approach to support through these cycles
  • The goal to predict and future proof where possible

Approaches shouldn’t be just be led by regulation and policy, they should also question what you want to do, how to support product, what you think future will look like in your asset class and how energy can best support this.

Everyone who works in property is energy supplier at some level – there is a need to question:

  • How do you design and deliver assets to support those outcomes?
  • How do you deliver costs and manage risks?
  • Which technology is best in project specific scenarios?

There must be a market able to operate the assets to give value-added energy supply at the end point.

Various types of business case required at different stages:

  • For real estate, outcomes and strategy must match outcomes and customers
  • Energy trilemma must be taken into account, align with key objectives
  • Commercial control – phasing is critical, don’t give away control too early

There are ESG: SSDR regulations coming in for funding developments and how developers raise cash. Looking at litigation and challenging people across Europe is deemed not to be achieving outcomes – impacting what businesses do on strategic level.

There is a need design assets to best market practice in order to reduce inefficiencies over a long time, if not there is the massive issue of heat loss and overheating as result.

What matters? Designing assets for operation:

  • Standardised specification and monitoring
  • Internal systems which reduce losses, improve efficiencies
  • Metering and data critical to support function and improve
  • Generation and connection with multiples sources of energy such as waste heat and excess power, storing solar in thermal

HB are still seeing direct electric coming through , poor performance and un-future proofed – which won’t be primary going forward. Electrically driven heat pumps (air, ground, water source) is where the business want to focus efforts.

There are commercial structures and funding structures, with grant funding and equity available depending on risk profile.

There are also multiple structures available, including:

  • SPV – which can retain risk and control (until worth giving profit to market)
  • Energy management, which retains complete commercial control, using specialists to provide services

In terms of delivery and monitoring , HB have process that they go through with clients:

  • What they learn in operation and KPIs ( a result of asking the right questions)
  • Have they asked contractors for right reporting and data
  • Questions and findings must flow down to contracts and operations (which can then feed into the next project)

Development must be aligned with what you’re trying to achieve, including:

  • A need for robust contracts in place with gaps in risk covered
  • Checks for what was designed is actually delivered, that don’t allow contractors to water down specifications
  • The risk of getting it wrong from cost, customer and marketing perspective is huge

HB do not take projects on without sustainability at forefront – but projects hat achieve all three parts of energy trilemma can be met if right approached at the outset of planning

James Wood Robertson, partner and head of energy and infrastructure sector at Shoosmiths, covered off the below in previous sessions:

  • The importance of design, build and operation to have people with proper expertise to deliver each aspect of project
  • Contract structure for outsourcing or subcontracting
  • Key issues in concession agreements, especially re. existing heat networks

In this session he discussed context for new heat networks, likely contractual arrangements and key issues for new heat networks

A carrot and stick approach was used years ago (typically using stick only), looking at planning requirements to connect to and the condition of land transactions that they agree to connect into primary district heat network.

There is now an opportunity to:

  • Develop sustainably
  • Achieve environmental commitments
  • Boost environmental reputation
  • Create more marketable development in environmentally aware marketplace
  • Deliver energy security by disconnecting from cost of gas crisis e.g. using waste energy from plant or data centre

The opportunity to take on new heat networks operating properly risk sits with developer or operator, plans need to be outcome based and is vital to ensure the right team is around you.

From a lawyer’s perspective, it is important to question which party is best placed to manage risk? It doesn’t make sense for risk to sit with party not best placed to manage it, which can lead to costs getting carried away. Whatever structure is in place, there needs to be someone to build and install, design, operate and maintain operations.

There is an option to get fixed price turnkey projects based on standard form design, or they can be sliced up more.

Contested issues in plant installation contracts include:

  • Delay
    • What happens if there is a delay?
    • Circumstances where developer gets relief for time and cost of delay
  • Defects
    • Liability period of a few years from taking over from design and build
    • Include lots of negotiation
    • The developer can usually push a bit further and limit exceptions where operator not taking risk
  • Management and sufficiency of sinking fund
    • There is a big risk of unexpected, unplanned overhaul and replacement
    • With new heat networks, risks much smaller so should push risk onto operator – they should be comfortable sinking fund is sufficient and take responsibility

New heat networks should be future proofed, much more than existing networks. They must still cater contractually for changes in law, manage through partnership arrangement, avoiding unexpected and dispute issues.

Questions

Integrated local energy systems – are they a real opportunity and way forward? Are you seeing opportunities in general terms, and are you excited?

Chris:

  • The industry is starting to get excited, seeing more and more appetite, but aware of risks as critical parts of development are external
  • Big regulatory push away from being scared of what other parties do e.g. local plans and zoning, regulation on how heat networks managed
  • There is a skills gap in developing and managing in the long term – with the market market desperately trying to work towards this, BEIS doing great job of pushing towards this

Ian:

  • We see interest amongst boutique developers looking to develop and sell low carbon credentials of scheme
  • The UK Electricity Act licence exemptions are poorly written and unclear, especially if operating site with private wire electricity network – so it is not clear what to look out for under the Act. Around 10% of Switch2’s portfolio has electricity meters.

James:

  • To take point about exemptions, particularly if generating and distributing/supplying, there are some linked class exemptions, which can get tripped up. Therefore care and specialist advice needed.
  • Local integrated energy systems, if mixed up with EV charge points for individual units, can lead to issues around ownership and rights – are they attached to the unit or communal?
  • As with issue of getting mortgages on a buildings with solar panels 10 to 15 years ago – people will come up with solution and then get comfortable with it over time.

Ian:

  • With private wire networks, there is an advantage of disaggregating and metering separately – with smart metering in network at the moment not sufficient.

Chris:

  • Integrated energy systems don’t necessarily enable continuous operation, but first step in enabling better system.
  • How Ofgem regulates distribution market, how costs are distributed onsite, how energy system compliant with that are all complex matters– so there is a need to take advantage of future market position.

Ian:

  • We have had discussions with BEIS on exemption review – they are very supportive of these ideas – not something they are trying to regulate against, with the intention to adapt licensing exemptions.

Divisibility of energy assets – can they be separated out from the rest of the site for funding purposes?

Funds are interested in talking to developers about this, as they take financing and risk away from developers and manage on their behalf. There is an appetite but not awareness in development market that these funding solutions are available.

Chris:

  • They are valuable assets, with scale that drives value
  • However, a large real estate development doesn’t necessarily have large energy assets
  • Timing is critical - some risks hard to pass out early from development, so need to know when funding should be looked for

James:

  • This should be higher up in developers minds, as it provides an exit opportunity

Ian:

  • Some funders nervous about technical standards and operation – approaches must be consistent.

 

Disclaimer

This information is for educational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given. © Shoosmiths LLP 2022.

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