Green Heat Finance Taskforce: report part 1 - November 2023

10. Annex 4 - Rationale for government involvement and summary of Existing Scottish Government Initiatives

10.1 Rationale for government intervention

A starting point for considering the case for government intervention in the heat (or any other) market, is to ask whether market failures exist. That is, are there specific issues that prevent private finance providers and potential customers getting together at scale to grow a market? If so, there is a sound case for government involvement.

Within heat in buildings, it can be argued that a range of market failures exist, including around split incentives (an illustration of the principal-agent problem), externalities and information asymmetries^[52]. The split incentive problem - which is discussed in greater detail in section 4.2.4 - basically arises as landlord and tenant interests do not align in a way that supports installation of ZDEH solutions and/or energy efficiency measures, as landlords would typically incur the costs, while tenants experience the benefits.

Externalities arise when a cost or benefit is experienced which is not directly captured within a price mechanism. Externalities exist within heat in buildings, as society and the environment in general would benefit if heat was generated by non-fossil fuel means, although the costs that individual consumers incur do not fully reflect this benefit, therefore weaking the incentive for any individual to install and use ZDEH solutions.

Information asymmetries are another important market failure that exists in various forms within heat in buildings. From a consumer perspective, individuals understand gas boilers and heating systems using fossil fuels, although most people lack confidence with ZDEH systems because they do not know what solutions will work best for them, the potential lifetime benefits of new systems compared to gas boilers, or the energy efficiency requirements to ensure technologies like heat pumps work optimally. From a finance providers perspective, there are information asymmetries around the level of demand and nature of risks associated with lending for products which are not widely used in the UK. This combines to constrain consumer demand for ZDEH and provider supply of financial products to help fund installations.

Flowing from this, there is a strong case for government intervention, not only to resolve market failures, but also to spur innovation and lead by example, particularly in the short term, to support market creation and maturation.

10.2 Existing Support

The Scottish Government currently provides free and impartial advice, support and in some cases finance, through Home Energy Scotland (HES), Local Energy Scotland (LES), the Green Public Sector Estate Decarbonisation and Business Energy Scotland (BES).

• The HES advice service provides in-depth advice to householders and landlords on low and zero emissions heating technologies, other domestic renewables, and more complex energy efficiency improvements. It acts as a referral scheme for the Scottish Government funded financial support schemes. These include our Area-Based Schemes (ABS) and its flagship fuel poverty scheme, Warmer Homes Scotland, which provides installation of grant funded heating and energy efficiency measures. It is also a gateway to domestic grants and loans programmes for heat and energy efficiency improvements, including the PRS Landlord Loan scheme and HES Grant and Loan Scheme.
  • The new HES grant provides funding for heat pumps up to £7,500 and for energy efficiency improvements - up to 75% of the combined cost of the improvements and up to the maximum grant amount of £7,500. A rural uplift of £1,500 applies to both the heat pump and energy efficiency grants. This uplift increases the heat pump grant flat rate and the maximum limit of the energy efficiency grant to £9,000. An additional £7,500 of funding is available as an optional interest free loan for both heat pumps and energy efficiency measures.
• LES manages the Community and Renewable Energy Scheme (CARES), which helps communities to engage with and benefit from the energy transition to Net Zero emissions. It provides advice and support - including funding - to communities across Scotland, looking to develop renewable energy, heat decarbonisation and energy efficiency projects. This includes -
  • The Community Buildings Fund, which supports community organisations to decarbonise their buildings. This support takes a whole building retrofit approach, covering zero emissions heat installations, energy efficiency measures, and additional small-scale generation where there is a clear benefit to the community organisation in terms of energy bill reduction;
  • The Off Electricity Grid Communities Fund, which provides a package of support to some of Scotland’s more remote and rural off-grid communities to help them upgrade their energy systems and decarbonise their energy supplies, with the aim of making them more resilient and sustainable; and
  • The Community Heat Development Programme, which helps eligible community organisations and groups of householders to develop their ideas for locally-generated, low and zero carbon heat project ideas.
• BES provides advice to SMEs implementing energy efficiency and heat decarbonisation measures, with the aim of reducing carbon emissions, cutting running costs for organisations, and increasing economic competitiveness. It is responsible for signposting businesses to the SME Loan and Cashback Scheme and for producing the bespoke assessment reports that are a prerequisite for application.

The Scottish Government currently provides strategic and grant support to develop large scale decarbonisation projects through the Green Public Sector Estate Decarbonisation Scheme (GPSEDS), the Social Housing Net Zero Heat Fund (SHNZF), Scotland’s Heat Network Support Unit (HNSU), and Scotland’s Heat Network Fund (HNF) -

• GPSEDS will invest a minimum of £200 million in this parliament in the public sector to develop and deliver a comprehensive offer of support for public bodies across Scotland. GPSEDS consist of three components including, the Scottish Public Sector Energy Efficiency Loan Scheme, the Scottish Central Government Energy Efficiency Grant Fund, and the Scottish Public Sector Non-Domestic Energy Efficiency Frameworks (NDEEF) and Project Support Unit (PSU);
• HNSU will support the growth of heat networks by addressing key challenges in the pre-capital stages of heat network development and building capacity across the public sector to deliver successful projects;
• HNF has made available £300 million to support the development and rollout of zero emission heat networks across Scotland. This fund aims to stimulate commercial interest, private investment and maximise Scotland’s vast potential in the low carbon sector, whilst contributing to the positive progress on reducing Scotland’s greenhouse gas emissions; and
• SHNZF provides grant funding to support social housing landlords across Scotland to install zero emissions heating systems and energy efficiency measures across their existing housing stock. We have made £200 million available.

Many households already choose to use private financing to pay for their heating systems, with options and products offering zero or low interest finance often offered by installers to help create a smooth customer journey. These offerings and products will continue to evolve over the coming years, and will be influenced by the regulations that the Scottish Government is proposing to introduce.

Overview of building composition - while there can be overlap between the categories on which we have focused in this report, we have, nevertheless, tended to concentrate on issues impacting buildings with the following ownership structures

• Owner-occupier - accounting for almost 1.5 million properties, these are homes where the occupier also owns the property, either outright or through a mortgage. The Scottish Government proposes to introduce regulations from 2025 onwards, requiring owner-occupier buildings to meet a level equivalent to EPC C, where it is technically feasible and cost-effective to do so, by 2033, bringing forward the previously proposed backstop from 2040.
• Private Rented Sector (PRS) - accounting for around 312,000 properties, these are homes which are privately owned and rented out. Almost 75% of private landlords only have one property, 24% just 2 properties, and only 1% have three or more properties. To help to make the heating bills of those living in those homes more affordable, the Scottish Government has committed to the introduction of Regulations to ensure private rented properties reach a minimum standard equivalent to EPC C, where technically feasible and cost-effective to do so, on change of tenancy, by 2028.
• Multiple Occupancy Multiple Use (MoMU) - flats, which account for around 900,000 properties, are often found in MoMU buildings, where residents include owner occupiers, private and social renters, with commercial premises sometimes occupying the ground floor. Currently 61% of dwellings in MoMU buildings are rated EPC C or better, with 36% rated EPC D or E and 4% rated EPC F or G.
• Non-domestic - accounting for around 200,000 properties with estimated costs to transition to Net Zero heating totalling around £6 billion. Only 15% of non-domestic buildings have an equivalent EPC rating of C or better with almost 75% rated EPC E or worse and an average EPC equivalent rating of G. The target levels of energy efficiency / decarbonisation of emissions have yet to be proposed.