Heat — a new regulated utility

Introduction

There are over 14,000 heat networks in the UK that supply 480,000 customers with heating and hot water. The Climate Change Committee forecasts that this must increase to 4.3 million customers by 2050 (or 18% of UK heat) if we are to achieve net zero cost-effectively. Despite the critical importance of district heat networks, the market is largely unregulated. This is now set to change.

Back in February 2020, we reported on the publication of the Government’s consultation document “Heat Networks: Building a Market Framework” which set out its preferred approach for regulating the supply of Heat in the UK. The Government has now responded to the consultation confirming its proposals for the future regulation of the heat market. While it has not committed to specific timings, the Government is committed to legislating for the required regulation “within this Parliament” and will do so “at the earliest opportunity”

Impact

The introduction of regulation will be a step-change for the industry and will have a significant impact on all stakeholders within the market, including suppliers, operators, project developers, local authorities, asset owners and customers. This includes:

• existing suppliers/operators — will need to review their existing contractual arrangements to ensure they are compliant with the new regulation and to identify where they are not. They may be required to amend their pricing or incur capital costs as a result of the regulation which may have a significant impact on underlying financial models. Change of law provisions will need to be reviewed carefully
• new district heating projects — developers/operators/suppliers of new projects should have regard of the proposed regulation and should review their draft agreements to future proof them as far as possible. For example, building in the protections set out below to minimise any impact and including the flexibility to make changes if this needed as a result of the future regulation
• customers — there is no firm date for when regulation will come into effect and so there will be little impact for customers connected to heat networks until then. Once the relevant legislation is implemented, customers can look forward to enhanced rights of protection and redress. It should be noted that the majority of customers already receive high levels of service and contractual protection.

Whatever your role in the market, our expert low carbon heating lawyers can help you to prepare for the upcoming changes.

Proposals

So how will the heat market be regulated?

1. The regulator

As expected, Ofgem has been chosen to be the regulator for heat. It will have equivalent powers of enforcement as for the gas and electricity markets, including the power to set rules, monitor compliance, levy financial penalties, issue customer redress orders and revoke licences.

The energy ombudsman will take on the role of the independent ombudsman for heat network consumers and will provide redress for any domestic or micro-business consumers with complaints. Citizens Advice will be appointed as the consumer advocacy body for heat networks in England and Wales.

2. Scope of regulation

The regulatory framework will operate under a general authorisation model (similar to financial services) which will apply to heat network operators and suppliers. BEIS is giving further thought to whether regulation should also extend to asset owners where they are not the operator or supplier - e.g., as may be the case under many existing concession arrangements.

The costs of regulation will be recovered from all electricity, gas and heat consumers to avoid heat customers paying a disproportionately high amount. BEIS estimates this will add £1.40 per year to a typical heat bill and £0.10 per year to gas and electricity bills.

All domestic customers and micro businesses will be protected by regulation, with no de-minimis thresholds regarding the size of the relevant heat network they are connected to. BEIS is considering whether larger commercial customers should also benefit from regulatory protection.

3. Pricing

As expected, BEIS does not intend to introduce price caps or direct profit regulation given the nascent state of the market. However, it will provide for Ofgem to have powers to mandate and enforce price transparency, to introduce rules on cost allocation and fair pricing and the ability to set price comparison and benchmarking methodologies.

Should Ofgem enforce these new powers then it would represent a significant shift from current practice where all of these matters are governed by negotiated (or not) contractual provisions. This would require all suppliers and operators to review their existing agreements to ensure their pricing mechanics are compliant and to amend them if they are not. This may have significant implications for their underlying financial models and business cases.

4. Consumer Protection and Quality Standards

Transparency will be a key focus and consumers will be required to be provided with a minimum level of information and guidance on heat networks at the pre-contract stage of any property transactions. They must also be provided with a minimum level of accessible information during their occupation of the relevant property. This is an important consideration for landlords and property developers who will need to ensure these processes are incorporated into its sales and lettings functions.

BEIS will also introduce minimum standards of service which must be delivered by regulated entities. These will be outcome-based to ensure that the regulatory burden and cost impact of such standards is not disproportionately high for smaller schemes.

5. Step-in Arrangements

To maintain continuity of heat supplies, BEIS intends to implement step-in arrangements to guard against serious supply failures or the insolvency of operators/suppliers. A “supplier of last resort” mechanism is likely to be a feature of the authorisation scheme, although BEIS acknowledges that more than one approach may be required given the diversity of ownership and contractual structures in the market. Many existing projects include some form of step-in arrangements if there is a failure

6. Technical Standards

There will be technical standards that will apply to all future schemes. These will be based on standards that already exist, particularly the ADE-CIBSE Code of Practice (CP1). Technical standards will also be applied to existing networks. However, it is not clear how this will be implemented. This could have a significant implication for existing operators/asset owners if the new regulation requires them to bring their schemes up to a standard beyond what they are contractually required to do.

7. Rights and Powers

The authorisation scheme will introduce a system to allow authorised entities to apply for a licence to become a statutory undertaker, like gas and electricity companies. This will allow them to take advantage of a broader range of powers to facilitate the delivery of low carbon heating projects including access rights, permitted development rights and street works permits.

Next Steps

While the timings and precise content of the proposed regulation is not yet certain, our team of expert lawyers can help you to begin to prepare now. Please contact us to find out more.