Heat in buildings strategy: business and regulatory impact assessment

8. Costs and Benefits

This section provides a qualitative assessment of the Heat in Buildings Strategy (option 2) as compared with BAU (option 1). Given the proposed option comprises a comprehensive policy package, covering both regulatory and non-regulatory action most of which is in the early stages of development, it is not possible to provide a detailed appraisal of the costs and benefits at this stage. Each regulatory element will go through its own consultation phase, accompanied by a respective BRIA.

8.1 Qualitative Assessment

The following provides a brief qualitative assessment of the two options against relevant criteria arising from the policy objectives and outcomes presented above.

Climate Change mitigation

Option 1 (do nothing) will not achieve the levels of deployment of energy efficiency or zero emissions heat required to achieve emissions reductions for the Buildings sector and thus wider Climate Change objectives. This is due to a combination of supply and demand constraints, including a lack of public engagement, misaligned incentives, underdeveloped supply chains and skills gaps which taken together suggest the continued deployment of zero emissions heat will be limited and an ongoing reliance on fossil fuelled heating systems. Through a coordinated approach, including regulatory and non-regulatory action, Option 2 (the Heat in Buildings Strategy) provides a framework to drive the required deployment and ensure emissions targets are met, aiming to decarbonise over 1 million homes and the equivalent of 50,000 non-domestic buildings by 2030.

Fuel Poverty reduction

The Heat in Buildings Strategy recognises reaching emissions reduction and fuel poverty targets simultaneously is challenging, but we are committed to ensuring we decarbonise in a manner that does not increase the rate or depth of fuel poverty. The Strategy acknowledges that zero emissions heat can be more expensive to run than a modern efficient fossil fuel boiler. It commits to taking forward no action that could have a detrimental impact on fuel poverty rates, unless additional mitigating measures can also be put in place. To do this, the Strategy sets out a range of guiding principles, which include:

1. We are committed to ensuring that poor energy efficiency is removed as a driver of fuel poverty. As such, a fabric first approach will be central to how we decarbonise heat in buildings.

2. We recognise that heat decarbonisation is essential to address the climate emergency, and that in decarbonising our homes we must not make fuel poverty worse. We commit to delivering measures to help those in fuel poverty to manage their running costs. As such, it is essential that, whenever possible, measures that both promote decarbonisation and lower fuel costs are supported.

3. We will assess our heat in buildings capital delivery programmes for their impact on those households experiencing fuel poverty– both at installation and throughout their lifespan. This assessment should be proportionate to the expected impacts.

4. Where an intervention can lower running costs, fuel poor consumers should be targeted for support as soon as possible, including support for the up-front installation costs of these measures. Factors affecting the ability of consumers experiencing fuel poverty to take up these measures should be considered as part of this process, as should the provision of advice and support to ensure that households in fuel poverty derive the maximum benefit from new measures.

5. We will develop mitigation measures to be deployed across our capital funding programmes where there are demonstrable cost increases on those in or at risk of fuel poverty. Success of these measures should be regularly assessed and, if appropriate, these measures should be adjusted to better meet the needs of these households.

6. In cases when zero emissions heat interventions are assessed as likely to increase energy costs even after mitigation measures are put in place, government supported measures should be focused on consumers who are not at risk of fuel poverty.

7. In some cases, wider change will be needed for decarbonisation measures to become suitable for those in fuel poverty, including areas that are reserved to the UK Government. We will continue to urge the UKG to take necessary action in reserved areas and will use the research and practical experience gained through our decarbonisation schemes to support us in building appropriate evidence and pushing for systemic improvements.

8. Communications should be presented in formats accessible to a wide range of consumers, taking into account differing circumstances and accessibility needs.

Economy

Analysis suggests the heat transition, through investment in the deployment of energy efficiency and zero emissions heat, could significantly benefit the Scottish economy through employment opportunities. In particular, research suggests the additional jobs supported in 2030 will exceed those displaced by an estimated 16,400 as a result of investment in zero emissions heat. Under Option 1, without further action investment and deployment will remain marginal and the extent of the economic benefits outlined will not be realised. In contrast, Option 2, through coordinated regulation and non-regulatory support schemes, will provide certainty to the market and drive deployment, securing and maximising economic opportunities. By promoting innovation and skills development, not only will the Heat in Buildings Strategy provide high quality jobs, it may also position Scotland to take advantage of export opportunities. It is important to note, however, the potential for displacement such that the level of positive net impact on jobs may be more limited, and that while certain sectors are likely to benefit from the transition (energy efficiency, and low and zero emission fuels and technologies), others may see a reduction in their market (high carbon fuels and technologies). However, existing firms may be able to switch from supply associated with fossil fuel to zero emissions, and policy development will seek to ensure barriers to entry are minimised. We are committed to building local supply chains, maximising local job creation, and ensuring a just transition. We will work with Scottish businesses so that they can play a significant part in the transformation of Scotland's homes and buildings, and work with industry bodies to enable existing gas and oil boiler installers to offer expert knowledge on alternative systems.

Deliverability and quality

Without additional direct government intervention and the certainty and clarity provided by proposed regulation, it is unlikely that the zero emissions heat sector will have sufficient incentives to invest in developing supply chains and upskilling their workforce to match the deployment levels required to meet emissions reduction objectives, which are far higher than current rates. This could lead to lower standards, with poor performance resulting from misspecification, particularly in the case of heritage or other hard-to-treat buildings where a specialised skillset may be required. Therefore, Option 1 poses risks in terms of deliverability and quality, which are addressed specifically under Option 2, in the Heat in Buildings Strategy, which sets out how we will engage with the UK Government, skills delivery partners and the supply chain to ensure the necessary skills, quality assurance, accreditation and standards are in place to support deployment and drive high standards.

Affordability and Value for Money

The upfront costs of installing a zero emissions heating system is often significantly higher than replacing incumbent fossil fuel boilers, and as noted above, may lead to increased fuel bills. Therefore, there are affordability concerns associated with the mass deployment of zero emissions heating systems. However, steps can be taken to ensure affordability and value for money. As the zero emissions heat market is relatively immature, there may be opportunities for economies of scale as demand increases and businesses can increase the efficiency of their production processes, leading to lower costs for consumers. Under Option 1, without kick-starting deployment at scale, it is unlikely that these efficiencies will be realised. There may also be increased running costs associated with misspecification where skills and standards are not in place, or where energy efficiency and zero emissions heat are not considered in tandem, potentially leading to suboptimal outcomes. Option 2, by taking a holistic view to energy efficiency and zero emissions heat, whilst targeting skills and embedding standards, is more likely to lead to cost-effective outcomes for households and businesses. Furthermore, the Strategy commits to establishing a Green Heat Finance Taskforce to explore potential new and value for money innovative financing mechanisms for both at-scale and individual level investment. Our holistic approach to heat in buildings reflects our broader commitment to taking a whole system view, and will support identification of least cost options and coordination efficiencies.

The heat transition will necessarily require significant investment, and by putting in place both regulatory and non-regulatory support, there is increased likelihood of attracting private sector investment, while putting in place mechanisms to support those less able to pay. Taking a holistic and strategic approach allows an accurate assessment of how costs will be recovered to ensure these, alongside benefits, are distributed fairly.

Population and Human Health

Option 1 will not deliver significant changes to health outcomes. Option 2, through the deployment of energy efficiency, may provide health benefits through improvements to thermal comfort and in particular prevent fuel poverty worsening. Furthermore, switching away from fossil fuel heating systems may have additional benefits in terms of reducing pollution and improving air quality.

8.2 Quantitative Assessment

This section provides estimated costs and benefits of the transition to zero emissions heating as set out in the Heat in Buildings Strategy. As the specific policies outlined in the Strategy are still in the early stages of development, this is necessarily a preliminary assessment. All figures should be treated as indicative and viewed in the light of current uncertainties around key aspects of the transition.

The changes to our buildings and energy systems that are needed to eliminate emissions from heating comprise both capital investment and ongoing costs. Different pathways and options have different balances as to where these costs arise in the system. For example, heat pumps have a high building-level capital cost relative to other zero emissions heat systems (and incumbent fossil fuel systems), while hydrogen concentrates a higher proportion of capital costs upstream in networks and hydrogen production facilities^[21] How heat consumers are exposed to these costs, e.g. whether through bills, upfront costs, or taxes, depends on policy choices, energy market frameworks and new business models (such as heat-as-a-service). This diversity in potential outcomes further underscores the rationale for this impact assessment to take a broad qualitative approach, with quantitative assessment deferred to more specific policy development.

Our analysis indicates that to remain within the Buildings sector emissions envelopes published in the recent Climate Change Plan update, over 1 million households and the equivalent of around 50,000 non-domestic buildings will need to convert to a zero emissions heating system by 2030, with the remainder converting by 2045 at the latest. The Strategy identifies strategic technologies for the near term while acknowledging that other options may be cost effective in the longer term, and proposes to handle this uncertainty by targeting deployment of strategic technologies in low and no regrets areas.

We estimate that the total cost of converting our building stock to zero emissions by 2045 is in the region of £33 billion, with additional investment required to upgrade energy networks and ensure sufficient energy generation capacity. This is an estimate of the gross cost and does not take account of investment in fabric measures and boiler replacements in a business-as-usual scenario. For example, it would cost around £5 billion to replace existing fossil fuel heating systems in the domestic sector on a like-for-like basis. We also anticipate that, under the current market framework and electricity pricing structure, zero emissions heat could result in increased running costs for some, however this may be partly or fully offset by the higher efficiency of some zero emissions heating systems, demand reduction through improved energy efficiency and targeted support where appropriate. While cost projections are subject to considerable uncertainty, the finding that low and zero emissions heating is likely to add whole-system lifecycle costs relative to the incumbent system is robust, reflecting a wider range of estimates.^[22]

Residential Buildings: Upfront building-level costs

The Strategy identifies heat pumps and heat networks as strategic zero emissions heating technologies available in the near term, and underscores the importance of deploying them to buildings and areas that are no- or low-regrets.

Figure 7 shows average capital costs for converting a home from a fossil fuel boiler to either an air source heat pump or a heat network connection. Including fabric upgrades the average building-level cost of installing an air-source heat pump is just over £12,000, and for connection to a heat network just under £8,000. By comparison, replacing a fossil fuel boiler (and not upgrading fabric) costs in the region of £2,000 to £3,000.

Source: Element Energy (2020) "Development of trajectories for residential heat decarbonisation to inform the Sixth Carbon Budget" study for the Committee on Climate Change.^[23]

Residential Buildings: Operating costs

The impact on energy bills of converting a home from fossil fuel heating to a zero emissions system depends on property characteristics such as build form, occupancy levels, and fabric efficiency. The retail cost of energy is also an important factor. The Strategy identifies the role of environmental and social obligation costs (levies) in shaping the relative costs of different options. The development of UK Government policy in this area, along with future evolution of wholesale and other system prices, means forecasting future relative operating costs is challenging. Therefore, this section considers the impact on fuel bills of adopting strategic zero emissions heat technologies under current market conditions.

Heat pumps are a key zero emissions technology, and a very efficient way of using electricity to provide heat . Although one kWh of electricity is currently more expensive than one kWh of gas (currently by a factor of about 4-5), the higher efficiency of a heat pump means the amount of energy needed can be less than a third the amount of energy needed by a gas boiler to produce an equivalent amount of heat. This means that for some properties, heat pumps can help reduce bills where they are replacing older, more inefficient oil and gas heating systems, or where they are combined with upgrades to the efficiency of the building's fabric. Modelling undertaken using the National Household Model shows that for the vast majority of Scottish dwellings that are currently using fossil fuels and which are below the equivalent of an EPC C, modelled fuel costs can fall where a heat pump is installed along with fabric measures, supplemented in some cases by solar PV or solar thermal. Conversely, properties currently using fossil fuels that have already attained the equivalent of an EPC C may have fewer options to offset the increase in fuel costs due to change in heating system. This latter group comprises around half of homes that use gas and around 8% of homes that use oil.^[24]

Running costs when using a heat network are more difficult to generalise, as they are dependent on the configuration of the network infrastructure (and hence capital cost that are recovered through bills) and the particular heat sources used. Heat networks are best suited to high density areas where per-connection network costs can be minimised. Larger networks are able to generally supply at lower cost, due to their lower average cost of development and operation, driven by factors such as more consistent demand, storage potential, renewable usage and available business models. Evidence collated by KPMG to inform the Heat Networks (Scotland) Bill Business and Regulatory Impact Assessment^[25] suggests that heat networks could provide bill savings, with a potential saving of around 17% or 1.29 p/kWh in 2019 under a central scenario, and potentially ranging up to 36% under a high scenario. While further work is needed to estimate the range of heat network operating costs faced by users should networks extend to lower density areas, in this BRIA we assume they will generally be lower than levelised costs of alternative zero emissions options, as this represents an efficient resource allocation.

Non-Domestic Buildings costs

Figure 8 shows the estimated levelised costs associated with zero emissions heating options for non-domestic buildings, alongside equivalent costs for gas and oil boilers. These are presented on a £ per MWh basis. This is because the size, use and energy demand of non-domestic buildings varies significantly and to a much a greater extent than residential buildings. As such, average costs are unlikely to provide an accurate representation of the cost of zero emissions heat in the non-domestic sector.

The levelised^[26] costs of an air-to-air heat pump are similar to those of gas boilers at around £40-50/MWh. They present a potential saving in comparison to oil boilers, which are around £60-70/MWh. Air-to-water heat pumps are more expensive than both gas and oil boilers, at £77/MWh for public buildings and £95/MWh for commercial buildings, reflecting the relatively high upfront capital costs of air-to-water systems. Direct electric heating is also more expensive, at around £80/MWh, reflecting high fuel costs.

Source: CCC Sixth Carbon Budget. Note: costs of capital of 3.5% assumed for public sector and 7.5% assumed for commercial

Energy infrastructure and other costs

By 2030, a much larger proportion of heat demand will be electrified compared to today, supplied through either individual heat pumps or larger scale heat pumps supplying heat networks. In the wider context of policy initiatives to decarbonise other sectors such as transport and industry, there is significant potential for increased electricity demand in the future. This could have implications for both electricity generation capacity and distribution networks. Therefore, there is likely to be costs associated with increasing capacity and reinforcing networks. Given the electricity system's role in decarbonising services other than heat, the sharing and apportionment of these additional costs to zero emissions heat is difficult to specify. Due to the significant complexity and interdependencies, a robust estimate of these costs is not available currently. However, as set out in the Strategy, research is being commissioned to explore the likely range of network investment costs and potential impacts on consumers.

In addition to electrification decarbonised gas is also likely to play a, albeit more limited, role in emissions reduction to 2030. This will involve increasing amounts of green gas (currently exclusively biomethane, but in the future also potentially hydrogen) being blended into the gas network. As committed to in the Strategy, the costs and benefits of increased hydrogen blending will be kept under review. Furthermore, subject to successful demonstration and safety case trials, parts of the gas network could be converted to 100% hydrogen and in the longer term this could play a vital role in decarbonising Scotland's building stock. This will require continued demonstration and rapid investment, in hydrogen generation, storage and the repurposing of the gas grid. The Energy Strategy refresh will provide more detail on the pathways to decarbonised gas and options for hydrogen for heat, and it is not possible to provide robust estimates of potential investment costs or the impact on consumers in the meantime. However, in all instances the evolution of energy infrastructure costs (both for electricity and gas) depends on UK Government action, as energy policy and regulation remains reserved.