Get ready – Decarbonising heat – 2020 and beyond
We are expecting a Government paper on the range of policy options under consideration to be published early in 2020.
The future of heat regulation
On the 17 December 2018, the Government announced in its paper “Heat Networks: Ensuring Sustained Investments and Protecting Consumers” that it would implement a regulatory framework for heat networks in order to expand the market and protect customers.
This announcement followed recommendations made by the Competitions and Market Authority (“CMA”) in July 2018 that the heat market should be regulated after the conclusion of a comprehensive market study (“the Study”). The Study found that, while a significant number of customers on heat networks were receiving a good service and paying fair prices, there were a number of customers on privately operated networks that were receiving poorer deals in terms of price and service quality, compared to people that were provided with heat using gas and electricity. Without action the Study concluded that there was a risk that this problem could escalate.
We are expecting a Government paper on the range of policy options under consideration to be published early in 2020. So, ahead of its publication, what could we expect to see?
It is generally accepted that any form of regulation will incorporate a statutory regulator empowered with statutory powers. Ofgem appears most likely to carry out the role of regulator given it has many of the analogous skills and resources that would be needed to carry out the role. However, this is not confirmed and the National Infrastructure Commission (“NIC”) is recommending significant reform of energy, water and telecoms. This may have a bearing on the appointed regulator.
In terms of tariffs, given the diversity of heat networks and the fact that the sector is evolving relatively quickly, there are unlikely to be any form of price caps introduced. Instead, it is anticipated that some form of ‘principles based’ regulation of pricing will be introduced. This will include rules and guidance around fair pricing, monitoring and audits and a right for consumers to seek redress. It will also be interesting to see whether the Government looks to adopt a ‘heat as a service’ model whereby a customer pays for an outcome as opposed to fuel. This would have a significant impact on how tariffs are regulated.
This is the most important area that needs to be addressed for developers and funders of heat networks. Fundamentally, this is the risk regarding number of customers that connect into a heat network once it has been constructed which, in turn, affects the revenues that may be generated. Heat networks are capital intensive projects and there needs to be confidence in the revenue streams that they can generate if there is to be an increase in investment. This is a complicated issue and there are a number of options available. These range from placing statutory duties on local authorities to promote the development of heat networks where this is appropriate (e.g. such as the use of ‘heating hierarchies’ in London); using planning laws to create local zones that facilitate the development of heat networks (e.g. the development of Local Heat and Energy Efficiency Strategies (“LHEES”) in Scotland), creating frameworks for granting exclusive concessions to developers and operators of district heat networks and compelling certain ‘anchor load’ customers to connect to a heat network to effectively underwrite a portion of the capital cost. The details of all of these options, particularly any requirements to compel customers to connect to heat networks, remain to be resolved.
Consumer protection and supplier of last resort
A key focus for any regulation will be consumer protection. This is particularly important given that heat networks are generally not well understood by consumers - even those that are connected to one – and that they are natural monopolies. As such, the two main focus areas are likely to be (a) improving transparency; and (b) introducing mandatory performance requirements or guaranteed standards of service. In terms of transparency, this should include requirements regarding the provision of clear pre-contractual information, having plain English heat supply agreements, more frequent and simplified bills that enable customers to understand what they are paying for and transparency with regards to how they can manage their usage. Mandatory performance requirements could be introduced through some form of licensing structure and will need to strike the balance between providing adequate consumer protection and not placing a disproportionate burden on operators – particularly of very small schemes. There are a number of good performance standards in existence already which could form the basis of such performance requirements, such as those contained in the Heat Trust Scheme. However, they are not always used and are not mandatory to adopt. Finally, there is recognition that, depending on how a scheme has been structured, consumers may have very little protection in the event that their heat supplier becomes insolvent or is no longer able to perform its obligations. Accordingly, there is likely to be some form of regulatory framework to appoint a supplier of last resort to provide that final protection.
A common issue cited by the CMA as a reason for the poor quality of service that has been experienced by some customers is the conflicting interests between (a) developers, who would often be focused on installing a heat network for the lowest capital cost – particularly where they were forced to include one to comply with planning requirements; and (b) consumers, who may end up bearing the ongoing operation and maintenance costs of the network. In particular, these sorts of considerations may not have been adequately taken into account at the design phase. Some form of binding technical standards is expected that must be complied with in order to ensure quality is maintained.
Accurately predicting and managing heat demand is all about having good data. With that in mind, any regulator will be in a unique position to manage the gathering and distribution of good quality data to ensure that heat demand can be properly understood. In turn, this can help to unlock investment into heat networks as more accurate data will increase confidence within the sector. At present, there are significant challenges associated with obtaining access to such data. While by no means certain, any future regulation could try to resolve this issue.
There is no doubt that district heat networks have huge potential to de-carbonise the supply of heat in the United Kingdom, as well as being able to provide a range of other benefits to customers that are connected to them. That said, there are barriers that could prevent their wide scale deployment. Any regulation that is introduced will need to address these barriers to be effective and sufficiently bold in order to unlock the potential of this exciting market.
How can we help?
Our cross-practice national team has been working on all aspects of district heat networks for many years. We are experts in this sector and can use our experience to advise local authorities on what is market practice, ensuring they receive commercially focused, relevant advice.
In addition to this, we are also leading experts on all aspects of local government and our infrastructure and projects team has extensive experience on the delivery of complex infrastructure projects.
We are able to combine all of these strengths to provide you with comprehensive legal advice across the entire lifecycle of a district heating project, through feasibility, commercialisation and all the way through to project delivery.