Energy Act 2023 – is this the silver bullet for the expansion of heat networks in the UK?
Why do we need heat networks?
In our previous article, we looked at the issue of decarbonisation of heat in the UK and the UK government’s strategy for tackling this issue. (Click here to read that article.)
A key element of the government’s strategy1 for heat and buildings in the UK is the expansion of heat networks.
About 2% of heat in the UK is currently delivered via heat networks. The Climate Change Committee estimates that around 18% of UK heat could come from heat networks by 2050.2 If this is to be achieved, then a huge amount needs to be done to scale up the expansion of heat networks.
The Energy Act 2023, which received Royal Assent on 26 October 2023, sets out ambitious plans to deliver a cleaner, more affordable, and more secure energy system.
The Energy Act sets out plans for the regulation of heat networks which, if implemented, will radically transform the way that heat networks are deployed to commercial premises, public buildings and homes across the UK.
“If the UK is to meet its 2050 net zero target, decarbonising the way we heat our homes, businesses and public buildings is one of the biggest challenges ahead.”
What are the challenges for expansion of heat networks?
When it comes to expansion of heat networks in the UK, there are several hurdles to overcome:
- Attracting offtakers – to make heating schemes economically viable and reduce reliance on government grants, schemes need to be able to attract sufficient offtakers. Incentivising businesses and consumers to make the switch will require harnessing the confidence that, in giving up their trusty gas boiler, they will still have a reliable and cost-effective means of heating their homes and businesses.
- Protecting Users – the Competition and Markets Authority (CMA) carried out a market study into the sector in 2018 which found that although on average heat networks deliver a comparable service to individual heating systems, there was a sufficient minority of users who received significantly worse outcomes, such as high prices and frequent outages. Regulation is therefore needed to better protect users.
- Supply Chain – a great deal of investment will be needed to upskill the supply chain in this sector; from manufacturers, installers, operation and maintenance contractors, through to investors and professional advisers. Investors and supply chain members need certainty regarding the upcoming project pipeline to justify investing resources in developing skills and expertise in relation to heat networks.
- Construction industry challenges – the wider construction industry continues to face huge challenges, including labour and materials shortages and inflationary pressures.
- Route to procurement – public procurement regulations mean projects can take a long time to come to market. Consideration needs to be given as to how procurement routes can be expedited, for example through utilising existing frameworks.
- Encouraging private financing - the UK government acknowledges that scaling up heat networks requires potential investment of GBP60 billion to GBP80 billion by 2050.3 (Many of those in the industry view this as a conservative estimate and in reality tens of billions more may be needed.) If we want to see private investment in heat networks, projects will need to be “bankable” and funders and investors comfortable with the risk profile. Consideration should be given to the risk appetite of funders at the very early stages of project development when structuring projects and contractual arrangements.
- Future proofing the source of heat generation – many heat networks utilise natural gas as a source of heat generation. If we are to phase out the use of natural gas and transition towards greener technologies, we need to ensure heat networks are “future-proofed” to allow for an interface with alternative sources of heat generation such as hydrogen, heat pumps, surplus heat from data centres and geothermal plants.
- Energy efficiency of buildings – to maximise carbon reduction, heat network schemes need to be combined with energy efficiency measures; such as insulation, heating controls and heat distribution systems, to prevent heat loss and reduce demand.
The Energy Act 2023
The framework legislation established by the Energy Act 2023 is driven at protecting the interests of consumers, with objectives including reliability of supply, reduction of greenhouse gas emissions, pricing protection and transparency of information. Regulations will also seek to promote effective competition between those engaged in commercial activities associated with heat networks.
Heat network operators and suppliers would need to apply for a heat network authorisation from Ofgem (the heat networks regulator appointed under the Energy Act) to operate in the market.
This is intended to address criticisms of early heat networks, some of which have been inefficient, built to poor standards, lose a lot of heat and suffer from unplanned interruptions.
This is a policy intended to help expand heat networks by identifying potential areas which would be suited to heat networks due to factors such as building density and availability of central heat sources. The heat network zoning system would then require certain buildings in the area to connect, thus expanding the heat network – see further below.
As heat networks typically purchase energy through commercial contracts, they are not covered by the existing Default Tariff Price Cap (ie cap on heating costs to users). Ofgem will have powers to investigate and intervene where prices appear to be disproportionate when compared with heat networks with similar characteristics, or if prices are significantly higher than those users would expect to pay if they were served by an alternative and comparable heating system. The Energy Act also provides the Secretary of State with powers to introduce various forms of price regulation, including a price cap, should it be necessary to protect users whilst growing and decarbonising the market.
A licensing regime which will grant Ofgem with the authority to issue licenses that give heat network developers similar rights and powers to those of other statutory undertakers, such as gas and electricity providers. This would include powers to install equipment in roadways, undertake street works and certain land rights. The intention is that this will enable heat networks to be built out more quickly and cost effectively.
Heat network “zoning”
The Energy Act will enforce heat network “zoning”. This will empower local authorities to act as “zone coordinators” to identify and designate areas best suited for heat networks. The benefit of empowering decision making at a local level is that local authorities are thought to be best placed to understand the current and future demand or the local area, grid capacity and constraints, alongside the needs of other future development projects. Zone coordinators will have an exclusive right to design, construct and operate a district heat network within a zone.
Once a zone has been designated, it will be mandatory for certain types of building to connect within a prescribed timeframe. Buildings which will be required to connect are:
- new buildings;
- large public sector buildings;
- large non-domestic buildings; and
- domestic buildings which are already communally heated.
“Large” has been provisionally defined as all buildings with an annual heat demand of 100MWh or more (although the government is open to consultation and review on this point).
Domestic buildings within the zone which do not have communal heating systems installed would not be required to connect, but may have the option to do so.
The requirement for mandatory connections is one of the most radical and potentially politically controversial aspects of the Energy Act. If central and local governments are to get local stakeholder to invest in heat network projects, users will need confidence that by connecting to a heat network, they will be supplied with both a reliable and affordable source of heating. The other provisions of the Energy Act in relation to mandatory minimum technical standards, fair and transparent pricing and, enforcement powers of Ofgem will be key in ensuring such confidence.
The Heat Network Zoning Pilot Programme (HNZPP) is currently being conducted in 28 English cities and towns of varying sizes to test a methodology for identifying heat network zones. The pilot programme is intended to develop, test, and refine the government’s approach to developing heat network zones.
Heat network zoning is intended to help drive demand and removes barriers of uncertainty around the ability to attract offtakers. By providing certainty as to the number of buildings that will connect, this should help provide project sponsors and investors with greater assurance as to the deliverability and economic viability of heat network projects.
Conclusion – is the Energy Act enough?
The UK government boldly claims that the Energy Act will have the effect of “kickstarting the development of heat networks” and that heat network zoning “will overcome barriers to deployment”.
The Energy Act certainly includes many welcome changes. Zoning should help create certainty of demand, improving investor confidence and the economic viability of heat networks. Giving heat network developers the same powers as statutory undertakers should improve the speed and efficiency at which projects can be constructed. The appointment of Ofgem as a regulator will give customers similar protections as they currently have for gas and electricity supply, thus improving user confidence. Meanwhile, mandatory technical standards should improve reliability and efficiency.
That being said, we still have a long way to go, and huge amounts investment is required to scale up heat networks.
The government has pledged to invest GBP338 million by 2025 into a Heat Network Transformation Programme to scale up low-carbon heat network deployment. This appears to be a drop in the ocean when taking into account the likely tens of billions of pounds in investment needed to ramp up the development of heat networks on a mass scale.
If we are to rapidly accelerate the development of heat networks, private funding and investment will be essential. If the risk profile of heat network projects is to be “bankable”, consideration should be given to the risk appetite of funders at the very early stages of project development when structuring projects and contractual arrangements. Investors will also need confidence that projects will deliver an attractive IRR. Certainty of revenue stream will be essential to raising debt to fund capital investment to design and build heat networks. The proposed zoning measures (in particular mandatory connections) should provide investors with some confidence regarding the revenue stream from projects, but consideration will need to be given as to credit risk of offtakers paying their energy bills. Projects which have public sector offtakers or large commercial outfits as “anchor” offtakers may therefore prove attractive to investors.
Heat networks have huge potential to create thousands of skilled jobs, provide economic stimulus to local communities, and support the government’s “levelling up” agenda.
At DLA Piper, we are proud of being at the forefront of this new market and have been working with clients over the last decade to deliver decentralised energy networks and energy efficiency projects, helping to reduce energy bills and carbon emissions. We are excited about the prospect of new projects and innovative technologies coming to the market, and the opportunity to work with clients to create sustainable, affordable and secure energy systems of the future.
1HM Government, Heat and Buildings Strategy October 2021
2GOV.UK, Energy Security Bill factsheet: Heat networks regulation and zoning (updated 20 March 2023)
3GOV.UK, Energy Security Bill factsheet: Heat networks regulation and zoning (updated 20 March 2023)
