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Click here for DEVN Newsletter June 2020

Editorial: Crisis, what crisis?

Four months in and we are still not clear. Even when this lockdown is lifted it is going to take some time before we can start organising events again. Meanwhile we thought we’d reboot the District Energy Vanguards Network Newsletter to stay in touch and keep you informed and entertained. If you are intrigued by the reference in the title to a supposed quote from Prime Minister Jim Callaghan then read on.

Despite the lockdown heat networks up and down the country have continued to provide homes and businesses with the heat and hot water they need. The three network companies in which I have an involvement had previously laboured over the development of business continuity plans (BCPs). Long hours were spent running up and down the accountability chains and agonising over every link to make sure it was secure. So many ‘what if’s?’ to be considered. But when the lockdown hit they all clicked neatly into place. Could it have been that the response to the crisis might have been easier if others had done the same?

Which reminds me that the BEIS consultation on the ‘Heat Networks Market Framework’ closed at the start of last month (a number of responses to which are highlighted below). This is primarily about regulation to protect consumer interests. My correspondent at Fuel Poverty Action shared their response with me (below) and it makes depressing reading. The overarching impression is of customers playing a bizarre game of snakes & ladders – with a few extra cul de sacs thrown in, in trying to secure accountability for the poor service they endure. Ofgem has been suggested as the likely regulator. If they are able to pin down responsibility and straighten out these chains of accountability then we will all be well served.

The proposals under consultation also seeks to strengthen demand certainty so as to increase confidence amongst investors. Developing heat networks has at least six classes of risk. Most of these are within the control of proposers, developers and operators and can be managed with prudence and patience. There are others that are entirely unknown and are contractually covered by ‘force majeure’ clauses that are the legal equivalent of rolling your eyes, throwing up your hands and exclaiming ‘whatever!!’. But a known risk outside the control of the project managers is demand risk. You know how much load is needed to make a project fly but you just can’t guarantee it. This is the biggest barrier for investors that causes them to shy away or add multiples of percentages to the cost of capital that eventually sinks the project under the weight of debt.

BEIS’s consultation document identifies three ways of addressing demand risk. We consider each in turn.

Demand Assurance is considered on page 21 of the consultation document and is in response to a proposal set out by the ADE in their 2018 Heat Network Taskforce Report. The basic proposition is that an ‘unspecified other’ underwrites a pipe run or spur to a potential customer until that customer connects. This was declined by Government as, firstly, they figured out that they are (and the public purse) the ‘unspecified other’ picking up the risk. And, secondly, it could encourage developers to install speculative pipes runs to prospective loads that take a very long time to materialise – or even never – whilst being paid for by the taxpayer. Although BEIS does leave to door open to underwriting projects that have a strategic importance. The other facet of the ADE offer was that if the industry was given this assurance then it would deliver customer standards. Whilst not responding directly to the sequencing of this offer the whole BEIS consultation essentially says that they will insist on having the customer standards up front.

Regulated Asset Base (RAB) [page 20] is what happens in other major regulated infrastructure sectors – water, gas and electricity. The cost of any individual project is spread or ‘socialised’ across the entire customer base. As payment by customers is guaranteed (that is they are obliged to pay by the regulator acting in their best interests) it provides a very stable and low risk revenue stream which the network operator can use to leverage in private sector investment, typically from pension funds. Key features are that the customer base is very large (i.e. all customers connected to gas, electricity or water networks) and that a large proportion of the infrastructure network has been amortised. Taken together this means that the actual charge paid by customers is relatively small.

RAB was declined by BEIS in the consultation on the grounds that the customer base for heat networks was too small and patchwork. Additionally, it would require the regulator to scrutinise the business plans and financial models of heat network operators to ensure “returns are legitimate”. This scrutiny would add to the regulatory burden and, taken together, the consequent costs falling on individual customers would be too high.

However, in discussing the features for a regulatory framework (Table 1 p28) BEIS declares that: “Requirements of the framework should, in the main, be outcome focussed rather than prescriptive.”

What is the outcome sought? I would suggest that it is reliable, affordable decarbonise heat. Heat networks are only a means to that end. As such should the Regulated Asset Base for this outcome not be extended to cover all consumers of heat no matter how that is produced? This would include all consumers currently receiving heat from gas boilers. With such a huge customer base the objections set out above would fall away. It would also provide a framework under which energy network operators and investors would be encouraged to select the technical option that will be most effective to securing the desired outcome instead of focusing on the vector for distribution.

Heat Zoning is a policy under which the characteristics of particular areas lend themselves to certain technologies which are then prioritised. A study by Element Energy for for the National Infrastructure Commission considered seven bundles of technologies that could be used to decarbonise heat. However, each was best applied in certain locations – biomass in rural areas, heat networks in heat dense urban areas or close to major sources of waste heat. The authors conclude: “it may be appropriate and beneficial for the public sector – most likely through the local authority – to develop ‘heat zoning’ policy to incentivise and/or regulate the use of different heating and other energy technologies, where market failures persist or where substantial benefits can be gained through coordinated behaviour” (p10).

Whilst BEIS acknowledges that local authorities are best placed to deliver such a policy it could find nothing to prevent local authorities from implementing them. And whilst showcasing a number of leading examples in Bristol, Leeds and Birmingham it expressed caution over mandating such a policy for fear it could overburden some local authorities. My experience is that those local authorities currently lacking the capacity to consider such a policy choose to do so precisely because it is not a mandated activity. Instead BEIS proposes to work with a number of pilot authorities to develop local heat decarbonisation plans. If HNDU are not effectively doing so already, might this be a good place to start?

The Scottish Government, on the other hand, have chosen to make it mandatory by obliging local authorities to undertake Local Heat & Energy Efficiency Strategies (LHEES) which will then be used as a basis for the identification of Heat Network Zones. Currently a Heat Networks Bill in progressing through the Scottish Parliament to provide the necessary legislative powers. This is a thorough-going piece of legislation covering the duties on local authorities in establishing heat network zones, licensing of heat network operators, permits to operate within a heat network zone and more. What is missing is an ‘obligation to connect’. This was floated in the first consultation on LHEES. It was a longstop power that would only be used when the heat network operator could prove that it was in the longterm interest of a major heat consumer to connect but they refused to do so. This disappeared from later versions. An international review of heat network market frameworks published alongside the BEIS consultation found that: “Mandatory connection is cited throughout the literature, and by stakeholders, as being crucial for creating a stable investment environment. At least in the early stages, most markets have adopted this in some form or another” (p35).

A key aim of the BEIS Heat Networks Market Framework and the Scottish Government’s LHEES approach is to increase investor confidence. But the former fights shy of mandating heat zoning whilst the latter avoids mandatory connection. If the latter is because of concerns over commercial, legal and consumer protection issues then at least the Heat Networks Bill could require a major heat consumer to provide an explanation of why they refuse to connect.

Last year the Scottish Government declared a Climate Emergency. In the present COVID crisis, all UK Governments jointly closed down society and the economy and ordered everyone to stay at home. If we cannot mandate heat zoning in England & Wales or require an explanation of the major heat user’s refusal to connect in Scotland then you have got to ask ‘are we in a climate crisis or not?’

Stay safe!!

Michael King, Editor

 

Click here for DEVN Newsletter June 2020

June 2020: Crisis, what crisis? - / Sep 2020
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