Green Heat Finance Taskforce: report - part 2

1. Executive Summary

Introduction to Taskforce

The cost of heating homes and buildings in Scotland is having a negative impact on health outcomes, life chances and a productive economy. Transforming how buildings are heated can deliver multiple social and economic benefits and ensure Scotland achieves its 2045 climate goals.

This Taskforce was established to identify innovative financing solutions to transition Scotland’s homes and buildings to clean, affordable heating systems. The need to leverage private sector finance to supplement constrained government resources, whilst minimising the financial burden on citizens grappling with cost-of-living challenges, was central to the Taskforce’s deliberations.

In considering the challenges and opportunities associated with this heat transition, it became clear that financial products alone are insufficient to achieve the step change required and that additional action is required to ensure:

• projects reach a level of maturity to attract investment and finance;
• strong business cases with demonstrable returns for models that deliver clean heat and energy efficiency are brought forward;
• coordination and delivery of "collective approaches" that facilitate the access of project developers to financial resources; and
• a clear delivery plan forms part of an integrated approach which overcomes barriers and can be scaled.

Key recommendations: the Taskforce recommends that as soon as possible, and ideally in the next six months:

1. Accelerate and coordinate the testing of a place-based demonstrator approach across Scotland:

• This innovation process and delivery plan should clearly articulate the design of a coordinated Place-Based Demonstrator Programme.
• Develop a fully operational Programme Development Unit that shall have the capability to deliver this Place-Based Programme by helping provide multi-disciplinary technical assistance and nurturing feasible funding streams for place-based projects.
• Integrate and leverage heat network and social housing projects.

2. Accelerate the development of heat networks:

• Establish a forum bringing together industry, cooperatives and the wider public sector, to address heat network policy gaps at pace.
• In collaboration across layers of government, alongside regulators and others, agree and articulate simplified heat network delivery pathways.
• Provide financial and advisory support certainty for heat networks to 2030 by committing to multi-year funding for project development and delivery.

3. Accelerate blended finance solutions utilising public and private financing for social housing retrofit:

• Set out plans for establishing a Social Housing Project Support Unit.
• Conclude and publish work with the Scottish Federation of Housing Associations (SFHA) and others, providing a robust evidence base supporting business case development for retrofitting social housing across Scotland.

4. Scottish and UK Governments to develop a ‘Clean Heat Mission’ approach starting with clear goals and a coordinated delivery plan for the clean heat transition;

• Map existing financing and governance structures at different levels of government to support project sponsors and individuals to more easily navigate the system.
• Ensure that energy and infrastructure planning takes account of waste heat, including future waste heat from data centres, hydrogen production and the opportunity for thermal storage.
• Consistently evidence and communicate the financial and non-financial benefits of retrofit, clean and affordable power and clean heat.
• Agree a Memorandum of Understanding between the Scottish and UK Governments to align strategies and solidify a partnership approach to optimising delivery of clean heat support in Scotland.

We believe that driving the decarbonisation of heat in buildings requires early, coordinated and determined effort to build the necessary momentum for change. We would therefore like to see clear and prompt action against our above recommendations, accompanied by regular updates on progress.

Why do we need to transform heating in our buildings?

Our homes and the way we heat them remains a key challenge for Scotland. Our poor housing stock and our reliance on gas is contributing to the current elevated cost of living and the number of people living in fuel poverty in Scotland^[1]. The impacts of the high cost of heating Scottish homes are profound: it affects community and individual health outcomes, educational outcomes, and wider economic productivity. It is therefore imperative to transform our buildings to create affordably warm homes and enable Scotland to become a thriving place to live and work.

This challenge, of improving the quality of homes – warmer homes at lower cost – is inextricably linked to the realisation of substantial personal as well as wider societal, economic and environmental benefits to Scotland. It follows, then, that any delays in making the necessary improvements to Scotland’s buildings, and the way in which they are heated, will continue to impact negatively on peoples’ lives, as well as failing to maximise the economic opportunities presented by the clean energy transition. Improving our homes is truly a generational challenge that will impact almost all people in Scotland while also delivering wide individual and societal benefits.

Our starting point to address the challenge:

As an expert group we have come at this work from lots of different positions. Our main starting points for addressing these challenges were:

a) Need for private finance: this generational change cannot be achieved with public funds alone. This means we must create the conditions to attract private finance, recognising this will require a financial return on investment whilst protecting just transition outcomes for the people of Scotland. Change on this scale will require alignment of many factors, including the expansion of existing and new financing mechanisms and the development of new structures focused on financing building retrofit. Public and private sources of financing will both be necessary and will need to be coordinated in such a way that they do not crowd each other out or limit choice for individual property owners.

b) Lack of projects at scale: we see no major issue with the supply of private finance per se, although private lenders will require a reliable return on any investment. The challenge is that there are a lack of scaled projects for investment to flow. More needs to be done to build a pipeline of investible projects that enable a just transition to clean heating.

c) Attractiveness of investment for individual householders means that collective solutions need to be explored that can share the costs of larger schemes that should explicitly aim to bring the costs down over time. The cost of repaying borrowing to deliver clean heat can exceed the energy cost savings created, particularly if the payback period is longer than home tenure or ownership. Furthermore, much of the current private finance offer for retrofit is typically closer to consumer than mortgage finance rates. Because paying for a clean heat transition individually further exacerbates cost of living pressures, this reinforces a lack of consumer demand for clean heat, as we highlighted in our Part 1 report.

d) UK energy market design: a key regulatory barrier to delivering clean heat cost effectively has been the UK’s electricity market design (pricing electricity at the cost of the last megawatt hour [MWh] needed to balance the system – which in recent years is gas). This issue is outside the scope of this report and needs to be addressed at UK level alongside other features of electricity market design that are necessary to scale-up clean heat and retrofit activity.

e) Heating is generally more expensive in Scotland than elsewhere in the UK for several reasons: colder northern temperatures, poor building performance as measured by energy efficiency (noting that social housing performs much better than average), a notable proportion of off-gas grid homes, and persistently high energy prices – driven by UK market design and the cost of gas relative to electricity.

f) Recent high and volatile cost of gas in turn is set by international markets and is prone to volatility due to international events, for example in recent years by war in Europe. Getting off carbon intensive gas should be a priority for our energy transition and energy security.

g) Finance is one part of an interconnected set of changes required: finance provision is one of many factors influencing the overall rate of conversion to clean, affordable heat. Factors discussed in our Part 1 Report such as supply chain capacity, skilled installer availability, quality assurance of work and confidence that correct measures are being installing are all important. Alongside this, regulatory certainty that is carefully balanced so as not to constrain economic growth opportunities is necessary to drive an increase in the level of clean heat installation.

Partnership approach

Our Part 1 report focused on financing solutions for individual property owners. This report focuses on mechanisms for collective groups of properties through place based approaches, heat networks and social housing options. However, no one organisation or stakeholder grouping can create a thriving market for clean heat and energy efficiency. Successfully delivering the scale of change required by the heat transition will require coordinated and collaborative activity across parties. Key responsibilities for different actors are noted below.

Scottish Government - Demonstrate leadership by setting explicit goals for delivering clean heat and energy efficiency upgrades as part of adopting a Clean Heat Mission to foster market confidence:

• Regulate the use of fossil fuels and energy performance requirements for heating to create demand for alternatives, while supporting a just transition ;
• Provide leadership in engaging with the public to demystify the clean heat journey;
• Support development of a framework for investing in place-based projects, alongside private financing and provide clarity on heat network delivery paths.

UK Government - Rebalance relative gas and electricity prices:

• On the energy side -
  • Ensure electricity and gas market design and the Clean Power 2030 Mission are aligned with Scotland and UK delivery of clean heat and economic growth;
  • Ensure that regulatory decisions act to support and not stymy economic growth and investment in the clean heat transition.
• On the finance side -
  • Support development of a regulatory framework that encourages development of innovative consumer finance solutions;
  • Ensure blended financing funds are fully accessible to Scotland;
  • Establish the regulatory framework that enables institutional investors to invest in retrofit projects without breaching capital buffer levels; and
  • Ensure that consumers have access to free and independent routes to redress, covering both public and private sectors.

Local Government - In coordination with others, educate individuals and local businesses on actions required:

• Building on LHEES, coordinate and sponsor development of place-based projects, seeking out opportunities to aggregate projects into programmes;
• Explore opportunities for developing heat networks alongside industry partners, including by providing anchor loads;
• Collaborating across neighbouring authorities to join up on heat plans at an appropriate spatial level, while agreeing planning projects to prioritise; and
• Continue to deliver clean heat projects across their social housing stock.

Private Finance Community - Accelerate the development and testing of innovative retrofit finance products:

• Train intermediaries and customer facing staff on the features and benefits of existing home upgrade financing products;
• Collaborate with government and public bodies to de-risk investments in clean heat and energy efficiency through mechanisms such as blended finance; and
• Work across industry and with others to develop and communicate consistent messaging around clean heat, with the aim of growing the overall market.

Industry and Supply Chain - Deliver boiler replacement plans and scale-up low carbon heating installations, including providing targeted homeowner advice on clean heat benefits;

• Support the development and maintenance of heat networks, including partnering with local authorities in their development;
• Ensure quality installations, warranties, and workforce upskilling; and
• Commercialise innovation in product and service development and deployment.

Third Sector and Academia -

• Support local authorities and community organisations in the development and delivery of place-based solutions;
• Foster innovation in technologies, processes and delivery models;
• Help educate and inform consumers, including through provision of trusted advice;
• Ensure Third Sector organisations are adequately resourced to provide advice and support.

Conclusions and next steps

We reiterate the importance of establishing a robust legislative, regulatory and policy framework as soon as possible in order to provide lenders, people and installers with the clarity and confidence necessary to drive market development. This is essential to enable development of the financial products and models discussed across our two reports.

We do though have concerns about the pace of policy delivery, as well as the degree to which recommendations from our Part 1 report have been acted upon. We note that Scotland was regarded as being ahead of the rest of the UK only a few years ago. This is no longer the case. Moves to develop and test place-based financing models are already happening in English metropolitan areas and across Europe. As such, we underscore that delays in delivering these changes are having, and will increasingly have, negative impacts on people’s lives across Scotland.

While there is an imperative and responsibility on us all – individuals, business, public and third sector organisations and investors – to act, success will require clear and coordinated leadership across all layers of government as it is government that sets the rules within which we all operate.

As we believe the key leadership role must fall to government, we look forward to the Scottish Government’s response to our reports along with the strong action which must follow promptly if potential environmental, economic, health and societal benefits which can be delivered by the clean heat transition are to be realised. We stand ready – as individuals and organisations as well as collectively – to fully play our part.