Energy Efficient Scotland: consultation on further development of the programme

Part 5 – Heat Networks

Competition and Markets Authority (CMA) Heat Networks Market Study and Consumer Protection

On 7 December 2017, shortly after the publication of our second consultation on the regulation of district and communal heating, the CMA launched a Market Study to determine whether domestic consumers were well-served by heat networks.

The Authority published its Final Report on 23 July 2018^[14] and concluded that, while most users of heat networks received similar prices and service compared to gas and electricity customers, statutory regulation of the sector is now required to ensure consumer protection is in place ahead of the expected growth in district and communal heating schemes.

The Scottish Government has taken leading steps in the UK in this area and we accept and support the CMA's findings and we will work to incorporate these within our regulatory framework.

Our own work, together with that of the Competition and Markets Authority and the Association for Decentralised Energy (ADE) provides clear evidence that regulation of the sector is now required.

The Scottish Government notes that the UK Government is now working to develop proposals for a regulatory framework for heat networks in England and Wales.

The Scottish Government is working constructively with the UK Government to harmonise standards where there is value in doing so, but will continue to develop our own Bill and regulatory framework to suit the needs of Scottish communities - such as those in our islands and remote areas.

The Scottish Government continues to call for the devolution of consumer protection in relation to heat networks in order to allow these needs to be prioritised within our proposed licensing system.

Incentives for Market Growth

Appropriately sited, low carbon heat networks are one of the 'low regrets' heat decarbonisation solutions that can support Scotland to meet our ambitious carbon reduction targets.

In line with independent advice from the Committee on Climate Change, the Scottish Government is currently focussing on encouraging the deployment of 'low regrets' solutions ahead of decisions on the decarbonisation of the gas grid.

The 2015 National Comprehensive Assessment of District Heating and Cooling estimated that 6.7% of Scotland's heat demand could be met by heat networks in 2025^[15]. We believe that heat networks can play an even greater role in the future years, beyond 2025.

In light of this, the Scottish Government has set out its ambitions for a growth in heat networks^[16] and at March 2018, there were over 800 district and communal heating networks in Scotland, supplying over 25,000 final customers^[17].

Alongside our partners, we have done a significant amount to support heat network schemes in Scotland. For instance, we have:

• Established the District Heating Loan Fund, offering low rate, unsecured capital loans to overcome a range of technical and financial barriers. Since 2011, we have offered over £15 million to 50 different projects across Scotland, providing affordable warmth to householders, creating local employment, reducing costs for businesses and cutting emissions;
• Launched the Low Carbon Infrastructure Transition Programme (LCITP) to support the acceleration of low carbon infrastructure projects across the public, private and community sectors. LCITP can support the development of investment grade business cases to help projects secure public and private capital finance and can provide financial support for capital;
• Formed the Heat Network Partnership to coordinate support identifying and developing district heating projects and a strategic approach by local authorities, to build capacity, and to share best practice;
• Created Scotland's Heat Map, with versions available to the public and to local authorities and other key public sector partners; and
• Introduced a 50% reduction in Non-domestic Rates for district heating schemes in April 2017.

In spite of this, the upfront cost of constructing district and communal heating networks often remains higher than other energy distribution networks.

Projects therefore require sufficient users over a long term to strike a balance by recouping costs while keeping bills affordable.

The Scottish Government understands that reducing this 'demand risk' can reduce the cost of capital and support the deployment of more heat networks and we have considered how this may be done throughout the development of our proposals.

For instance, we have proposed that within areas identified as Heat Network Zones, there will be particular consideration of public sector buildings as the 'anchor load' for networks and future expansion, within the confines of public procurement regulations.

In addition, we are considering requirements for the public sector to assess potential connection to heat networks during the preparation of LHEES and the encouragement of connection or the supply of surplus heat.

As part of our January 2017 scoping consultation, we sought views on a regulatory scenario in which homes and businesses may be compelled to connect to a heat network under development and / or one in which heat networks would be granted exclusive rights.

Views were mixed on the proposed power to compel existing buildings to connect to heat networks. Even among those who broadly supported the proposed power, several respondents qualified their answer and noted specific issues that would have to be considered. Views were also mixed on the effectiveness of exclusive concessions^[18].

Following the consideration of Scottish Government's powers we note that:

• Compulsory connection – for either homes or businesses – would require strong consumer protections to balance the associated risk.
• Granting of exclusive rights to develop and / or operate a new heat network within an identified District Heating Zone could exclude other forms of heat supply in the area at an early stage in the transition to low carbon heat.
• We also foresee that the such measures are likely to give rise to a range of legal issues in connection with compliance with the European Convention on Human Rights, their relationship to reserved matters in respect of consumer protection and including competition law competence of the Scottish Parliament and State Aid regulations.

The Scottish Government acknowledges that similar measures have been implemented successfully in Denmark and in some other European countries.

However, we note that such regimes emerged to ensure security of supply or have had strong steps to mitigate the risks, such as the regulation of prices and other consumer protections.

We want to see the growth of heat networks in Scotland continue and accelerate, and recognise that there may be further ways that the Scottish Government can assist with this.

The introduction of a regulatory framework and licensing system will provide certainty to the sector and investors. This can reduce the risk premium on the cost of capital faced by projects by setting clear standards and providing the kind of rights that other utility companies receive, as well as raising consumer acceptance and awareness.

As such, we are seeking evidence from the sector on whether further incentives or on-the-ground assistance could be made available to support the deployment of heat networks – or whether there are specific mitigations to the risks outlined above that may be considered. This is to ensure that the strategic opportunities identified as part of LHEES are converted into projects that are delivered on the ground.

Consultation Question

13. Taking the above into account, what further incentives coulddrive further heat demand onto networks?

14. Taking the above into account, what further assistance could support the growth of appropriately-sited, low carbon heat networks?

Respondents may wish to consider:

• How any incentivising measures can build on the LHEES and District Heating Zoning processes or through the licensing system outlined in Part 1;
• Whether the risks of the incentivising measures considered in earlier consultations can be mitigated, within current legal competence;
• Whether there are any business models which can come forward that will support a reduction in the cost of capital for heat networks, and what role could the Scottish Government have in this;
• The specific barriers to the delivery of commissioned projects on the ground and whether there are opportunities or powers within the Scottish Government's devolved competence to reduce or remove these.

We encourage respondents to provide an estimate of the impact any incentivising measures suggested may have in supporting the deployment of heat networks in Scotland.