New Build Heat Standard 2024: business and regulatory impact assessment

6. Costs and Benefits

78. The approach taken in estimating the direct costs and benefits of Option 2 (NBHS), including assumptions, is laid out in Section 19.3. The assessment of costs and benefits operates at the level of a social appraisal, where the appraisal is based on guidance laid out as part of HM Treasury's Green Book.^[83] Social value includes all significant costs and benefits that affect the welfare and wellbeing of the population, not just market effects.

79. In Section 17, we present the Net Present Social Value (NPSV), a summary measure of whether or not the Standard has a net beneficial impact. The NPSV is the present value of benefits minus the present value of costs, so can be viewed as a summary measure of the overall impact of the policy on social welfare. If it is positive, then this implies the policy has a net beneficial impact (the benefits outweigh the costs); if it is negative, then this implies the policy has a net negative impact (the costs outweigh the benefits).

80. Where non-monetised costs or benefits are significant, the NPSV alone will not capture the full impact of the policy. Similarly, the NPSV may fail to adequately reflect the full range of potential costs and benefits to society if there are significant risks attached to the policy that have proved challenging to quantify. It may be unrealistic to produce a single numerical NPSV that adequately captures the full impact of the policy.

81. Furthermore, a cost-benefit approach to appraisal is limited in its assessment of non-marginal change. Given this, non-monetised costs and benefits of the policy are discussed in a qualitative manner below, and as such the quantitative estimates of costs and benefits should not be viewed in isolation from these wider impacts and strategic considerations. For the numerical NPSV, a sensitivity analysis is also included in Section 19.4.

82. In line with Green Book guidance on the appraisal of buildings and infrastructure, the timeframe for the assessment spans 2024 to 2083 (60 years). The framing of the assessment assumes that, in the absence of the NBHS not being adopted, some^[84] of the new-builds constructed between 2024 and 2045 would need to be retrofitted with ZDEH technologies in 2045 to coincide with Scotland's net zero ambitions and the Heat in Buildings Strategy's position on an all-tenure zero emissions heat standard backstop.^[85] This all-tenure zero emissions heat standard backstop would also effectively act as the NBHS being adopted in 2045 in the counterfactual (i.e. no new-builds would be allowed to install DEH technologies following 2045).

83. It is important to note that the counterfactual (Do Nothing) scenario also assumes the stock of new-builds constructed between 2024 and 2045 are not affected by any technology retrofit programmes or regulations that are introduced after the intended start date of 1 April 2024 for the NBHS but before the all-tenure zero emissions heat standard backstop in 2045. BEIS guidance as part of the Green Book^[86] stipulates that an impact assessment should consider overlaps with other policies, wherein all policies to which the government is committed and which have funding are absorbed into the counterfactual Do Nothing scenario. At the time of writing, the NBHS is planned to be one of first major regulations as part of the Scottish Government's Heat in Buildings Strategy. As such, the framing of the assessment ignores the impact of future Heat in Buildings regulations, the form of which are yet to be confirmed.

6.1 Monetised Costs and Benefits

84. Additional capital costs (inc. premature scrappage). The appraisal of the policy draws upon capital cost estimates informed by research conducted for BEIS, ^{[87], [88]} the Department of Energy and Climate Change,^[89] and the CCC.^{[90], [91]} The capital costs differ depending on whether the heating system is a virgin install in a new building, whether it is a retrofit, or whether it is replaced like-for-like.^[92] Avoided gas connection costs under the Standard are accounted for using standard connection charges published by SGN.^[93] As explained above in paragraph 82, the counterfactual (Do Nothing) scenario against which costs and benefits of the NBHS are compared sees an all-tenure zero emissions heat standard being adopted in 2045. The costs of premature scrapping of DEH technologies in this year is therefore accounted for under the counterfactual. It should be noted that the cost of DEH technologies (in real 2021 prices) is assumed to be static over the time horizon of the appraisal, with the 2045 backstop assumed not to affect the capital cost of a heating unit.

85. Net energy savings. As per BEIS guidance as part of the Green Book,^[94] changes in fuel consumption are monetised using Long-Run Variable Costs (LRVCs) of energy. These have recently been revised by BEIS in light of energy market volatility observed since late 2021, and guidance recommends that central appraisal estimates use the "B" and "C" scenarios for the LRVC of gas. As such, this leads to us producing two central NPSVs. Further LRVC scenarios for gas and electricity are explored further as part of the sensitivity analysis (Section 19.4). Scenarios A to C's long-run trend for gas is based upon supply curve assumptions described in the Fossil Fuel Price Assumptions report produced by BEIS.^[95] This is the best long-run information we have for appraisal purposes, with BEIS currently working to update them for future updates.

86. Carbon savings. Likewise, changes in fuel consumption are monetised using carbon values provided by BEIS as part of Green Book guidance. Carbon values are used across government for valuing impacts on GHG emissions resulting from policy interventions. They represent a monetary value that society places on one tonne of carbon dioxide equivalent (£/tCO2e). Carbon values are used in the framework of broader cost-benefit analysis to assess whether, taking into account all relevant costs and benefits (including impacts on climate change and the environment), a particular policy may be expected to improve or reduce the overall welfare of society.^[96] Feedback from the Fraser of Allander Institute on the issues associated with using these carbon values in the Scottish context is acknowledged, but is ultimately beyond the scope of this impact assessment.^[97]

87. Air quality benefits. Changes in fuel consumption are monetised using air quality values provided by BEIS also. These are discounted by the relevant health social discount rate^[98] so as to reflect increases in willingness to pay for avoided health outcomes over time. The updated activity costs take into account an improved understanding of health impacts, based on the latest advice from UK Health Security Agency (UKHSA) and the Committee on the Medical Effects of Air Pollution (COMEAP). Fuel combustion is associated with emissions of primary particulate matter (PM) and nitrogen oxides (NOx), among other air pollutants, with these negatively impacting respiration and cardiovascular function.^[99]

88. Maintenance costs. It is assumed that all heating systems under consideration in domestic new-builds face an annual maintenance cost of £100. Therefore, relative to the Do Nothing scenario, these costs are simply netted off. For non-domestic new-builds, estimates of opex (excluding fuel costs) per kW of installed capacity for specific technologies^[100] are rolled into the capex estimates.

89. Familiarisation costs. We account for the direct costs associated with professionals familiarising themselves with the new Standard using median hourly (gross) pay from the Annual Survey of Hours and Earnings (ASHE),^[101] number of professionals working in construction industry from the Annual Population Survey (APS),^[102] and an assumption of one hour for familiarisation. Given the relative simplicity of these regulations, we believe this to be a reasonable assumption. In line with treatment of costs and benefits, familiarisation costs are deflated to 2021 prices.

90. Residual values. In line with Green Book guidance, assets' residual values at the end of the appraisal period are also included. In our case, the assets are the heating systems. Therefore, the value of heating systems that have not reached the end of their lifetimes before the end of the appraisal period is prorated by their lifetime assuming a linear amortisation. This value is then rebated in the analysis. For example, if a heating system is only 60% through its lifetime in 2083, then 40% of its upfront capital cost is rebated.

6.2 Non-monetised Costs and Benefits

91. Supply chain development. By providing certainty to industry that new-builds will require ZDEH technologies, the standard will support investment in supply chains for these systems. Were this to drive cost reductions, this could confer benefits in the future when the existing stock of buildings is retrofitted with these technologies, lowering the overall cost of the heat transition. If monetised, we would expect these impacts to make the NPSV more positive.

92. Disruption associated with the 2045 backstop. The assessment takes a simple approach to estimating the costs of retrofit under the counterfactual Do Nothing scenario, wherein the cost of retrofit is assumed to be static (fixed). In reality, were there to be a large spike in demand in response to the 2045 all-tenure zero emissions heat standard backstop without sufficient supply chain preparation and expansion for this, we may expect the cost per retrofit unit to balloon. This would be as a result of demand outstripping supply. Furthermore, this spike in demand should be considered alongside the need to retrofit the already-existing stock of buildings, of which there may be more than^[103] 2,183,000 homes^[104] and more than 94,000 non-domestic properties.^[105] Therefore, if the NBHS were not adopted, there might not only be a spike in demand for ZDEH retrofits in the run-up to 2045 driven by the stock of buildings that exist today, but also added pressure from a spike in demand for ZDEH retrofits from the stock of new-builds constructed in the future. If this disruption were monetised, we would expect the impact to make the NPSV more positive.

93. Anticipation effects. It is possible that developers may attempt to overcome the 1 April 2024 start date of the Standard by applying for building warrants prior to the Standard coming into force. This may lead to a spike in warrant applications and disruption in the warranting process. If monetised, this effect may make the NPSV less positive.

94. Innovation and general equilibrium effects. Second-order effects on the general economy may include innovation spill-overs and multipliers associated with investment in ZDEH supply chains. If monetised, we would expect these impacts to make the NPSV more positive.

95. Grid reinforcement. The cost of electricity network reinforcement and flexibility solutions are not included in the impact assessment. However, the Scottish Government recently commissioned WSP to undertake research into such costs for electricity distribution networks across Scotland operated by Scottish & Southern Electricity Networks (SSEN) and Scottish Power Energy Networks (SPEN).^[106] This report focused on the electrification of domestic heat and transport. The cost estimates presented below should be viewed bearing in mind that electrification of non-domestic heat and transport was not included within the scope of the research, and the research assesses the impact of electrification of both existing and new-build homes constructed over the time period. As such, it is not possible to attribute a cost of grid reinforcement specifically to the NBHS, nor even to electrification of heat alone.

96. Across the three net zero-aligned Distribution Future Energy Scenarios (DFES) considered in the aforementioned report, the discounted investment cost over the period 2020 to 2050 ranged from almost £1.6 bn to almost £2.5 bn, with the upper-end estimate being associated with the scenario most aligned with Scottish Government ambitions for the electrification of domestic heat and transport. This range is reduced to £1.1 bn to £1.6 bn when flexibility solutions are implemented.^[107]

97. The business-as-usual scenario^[108] in which net zero is not achieved sees discounted investment costs over the period amounting to almost £1.5 bn in the case of no flexibility solutions, and £1.0 bn in the case where flexibility solutions are implemented. The net cost, therefore, of electricity distribution network reinforcement needed to achieve the Scottish Government's ambitions for domestic heat and transport could conceivably be viewed as being in the range of £0.6 bn to £1.0 bn with and without flexibility solutions, respectively.

98. If it were possible to attribute costs of grid reinforcement specifically to the NBHS, then this would make the NPSV less positive.