The Perfect Storm: Impending regulation and the energy crisis

Switch2 Energy, Shoosmiths and BEIS came together to provide an update on how regulation, rising energy prices and decarbonisation targets are impacting heat network operators and customers.

This first webinar looks at the background to heat networks, an update on policy and impending regulation.

The next webinars will cover:

• Webinar2: What to do with existing buildings? 
• The focus will be looking at historic existing heat networks, which are older, less efficient and often non-compliant, and what needs to be done here. It will look into problems and solutions to help them operate more efficiently, including:
  • How to fix problems
  • Funding
  • Meeting carbon targets
  • Protecting residents
• Webinar 3: How to approach new build developments.
• The focus will be looking at new heat networks, looking at the ambition of low cost, reliable and low carbon heat networks and whether this is realistic. It will cover:
  • Design and build
  • ESCo
  • New technology
  • Managing costs

Key points from the first webinar

Background of heat networks in the UK

• Switch2 is the largest heat networks operator in the UK with 80,000 properties in UK, providing a full service offering
• Heat networks are linked to cleaning up heat which started in move away from coal back in the 1950s/ Clean Air Act in response to pollution and the Great Smog of London. Focus from then for new builds on heat networks, initially with coal and then to gas. In the same way heat networks will be developed for cleaner energy sources such as heat pumps
• UK lags behind other European countries but 2004 renaissance helped with The London Plan which meant 20% of energy (up from 2%) needed to be from renewables so new builds were developed with central heat networks 
• Lots of issues with this initially such as the lack of a supply chain, designs, and the necessary skills, which were addressed with: 
  • Heat Trust being developed in 2014 
  • Minimum standards and best practice with CIBSE CP1 in 2015, which particularly aimed to fix broken supply chain 
  • CMA Market Study in 2017 to investigate the issues which recommended regulation of the industry
  • BEIS HN Market Framework in 2020
• All aimed to help with the UK Net Zero Carbon ambitions for 2050

Gas price increase by five-fold is a significant factor which presents issues:

• Commercial contracts, which are not protected by the energy price cap for residences
• Procurement of gas
• Lack of access to government support, especially for private wire connections

As well as opportunities:

• Paybacks on improvement work are very attractive 
• Operations and maintenance

Regulation

• Why the government is interested: 
  • Key to helping achieve climate change targets
  • Can connect heat networks to wide variety of low carbon heat sources
  • Adaptable – e.g. could include hydrogen, which is still being considered by government
  • Can enable lower costs for consumers via economies of scale
  • Big investment opportunity - £60-80bn needed by 2050
  • Committed to heat network zoning
  • Increase skills and capacity in UK supply chain

Future government policy

• Main area is Heat Network zoning and committed to this for 2025
• This will mean a standardised national methodology to identify zones 
• Local government will have the power to designate these zones and buildings will be required to connect – breaking the issue in the market that is stopping them from developing in scale. 
• The Heat Network Zoning Pilot Programme (HNZPP) is being conducted in 28 cities and towns to test methodology
• In addition, Heat Networks Policy team is introducing Ofgem as new statutory regulator which will help with transparency as well as minimum service and technical standards and making development easier with improved statutory and step-in powers 
• Key standards must be met for consumers across GB on pricing, transparency on contracts and info provided, and quality of service standards
• Minimum technical standards for new and existing heat networks

Energy price rises

• £15bn package of support for consumers including:
  • £1.5bn Household Support Fund – a discretionary fund for Local Authorities to help the most vulnerable
  • Energy bill grant to vast majority of consumers
  • Grant for those on universal credit, tax credits, pension credits
  • Additional help for pensioners and those on disability benefit
  • Council tax rebate
  • Extending Warm Homes Discount
• Companies can help hold down costs by:
  • Shopping around for better deals on energy provision
  • Looking at VAT and climate change levy exemptions
  • Improving system, ensuring efficiency of system
• What government doing for heat networks specifically
  • Business Rates exemption brought forward a year
  • Unlocking the best purchasing deals working with trade associations and energy purchasing companies
  • Guidance on current support/ steps to take issue in March
  • Working with DLUHC to see if arrangements can be changed to allow longer-term purchasing
  • Guidance on efficiency improvements in the summer
  • Engagement with the sector to understand impacts on company finances (considered key prior to next winter)

Outsourcing of design and build and operation of heat networks

Rationale for outsourcing the construction and/or operation of heat networks:

• Decentralised energy – need experience/ expertise to deliver safe, reliable service
• Ability to handle increasing regulation
• Opportunity for the developers to transfer responsibility and risk to party better placed to manage risk
• Contractual structures include:
  • Design and Build (for new heat networks only)
    • fixed price turnkey solutions based on standard form (e.g. JCT) with limited negotiation
  • Concession agreement
    • for long term operation and maintenance of new build or existing networks as this covers everything that will be required (metering, billing etc) and is risk transfer from the asset owner to the heat network operator
  • Supply agreement
    • direct between the service provider and resident/ occupiers which is usually standard T&Cs of service provider
• Concession agreement – key issues
  • Service quality assurance
  • Regulations compliance (particularly as more regs introduced over time)
  • Debt management and risk
  • Unoccupied units (potentially grace period for new builds)
  • Handover and Handback
  • Management and sufficiency of sinking fund
  • Defects in energy system
  • Change in Law risk – risk with net zero and decarbonisation targets

Questions

1. What process can existing buildings follow to review funding and have access to expertise so they can have advise on upgrading their heating systems to efficient systems such as heat networks? I find there is a huge lack of information and guidance at a local level especially for small businesses.

• Forthcoming legislation will provide technical standards 
• There is a Heat Network Efficiency Scheme which is available and a plan to scale this up with capital available for system improvements
• Government is publishing guidance this summer around cost-effective improvements
• If heat network already exists, then look at the partners and maintenance team and how they can help. It is worth talking to specialists in heat network industry.

2. How does a heat network get upgraded to a low carbon network?

• An upgrade should take a cautious and measured approach as it has a big impact on the residents – don’t need to do quickly but have a plan for this as technology is continually changing
• Make the best of what you have and see how you can transition in the future – this is part of the operations and maintenance obligation for Switch2 with their clients
• As heat pumps become cheaper and more widely available, low carbon heat networks will also become more widely available
• There is funding available, which was outlined earlier in the webinar and can be found in this note
• If you are already in a long-term contractual arrangement then look at what exists already in the contract as change in law provisions. These are intentionally generally worded to keep the commercial arrangements and a bit ‘woolly’ but will depend on the changes and who is best placed to deliver

3. The government’s imminent response to the Heat Zoning consultation includes obligations on building within zones to connect to the district heat network. Who will bear the costs of connection?

• They will focus on larger, non-domestic buildings first and act as anchor offtakers, making it easier and more affordable for smaller/ domestic consumers to connect
• Details of who will bear costs to be covered by future consultations and legislation
• Direct cost to connection is being looked into and trying not to pass to consumers
• Need try to ensure balance across regions with investment not simply flowing to familiar investment areas.

4. What are the government’s thoughts in relation to how Ofgem might ‘step in’ to a failing district heat network operator?

• The step-in is intended and likely to apply to operators of large district heat networks rather than smaller communal heating networks
• This still requires further consideration and consultation by government
• During the pandemic, there was already a considerable amount of co-operation between operators with supply chain and servicing support provided by operators to others in distress.