Green Heat Finance Taskforce: report - part 2

6. Innovation and the role for different parties in heat transition

Innovation

Innovation is driving change - and at pace - in places and in energy markets across Europe. Innovation is happening in technology, in financial products and services, and in approaches to enable adoption of new solutions by individuals, business and communities. Scotland will need to learn from developments elsewhere, and government, working with industry and the wider public sector, to successfully foster innovation to mobilise the private finance to retrofit Scottish buildings at scale.

Scotland’s National Innovation Strategy^[55] set out a vision to transform Scotland’s economy over the next decade by placing innovation at the heart of its economic growth. One of the four key programmes identified in the Strategy is the energy transition, focused on harnessing Scotland’s natural capital, regional expertise, internationally leading research and innovation capabilities and business activity^[56]. All these factors will be relevant for the heat transition.

Experience from elsewhere in Europe shows that delivering systemic change cannot be done by any one actor, or with any one solution. Instead, we need to innovate across the entire system to create the enabling conditions for change. Across Europe – and more recently the UK – the notion of ‘Missions’ is being used to convene relevant actors, to orchestrate and aggregate emerging solutions and to scale the impact at the speed required. This is supported by peer-learning (between local authorities, business and civic actors) of what works and what does not.

One such Mission is the EU’s Mission for Climate Neutral and Smart Cities^[57], aiming to help 100+ cities (including Glasgow) to meet their ambitious 2030 net zero targets. Retrofitting buildings to provide clean, affordable heating systems is one of the major challenges being faced by cities and regions across the continent, and Scotland should look to learn from the innovative solutions being deployed elsewhere, with the aim of adapting successful approaches to Scottish conditions.

6.1 Role of Government

Since the publication of our Part 1 report, a new UK Government has been elected, while the Scottish Government has reverted to operating as a minority government. This is creating new opportunities for joint working, both within the Scottish Parliament and between Scottish and UK Governments.

The current UK Government has reinvigorated the drive for improved energy efficiency and clean heat installations as part of their journey to achieve net zero, with efforts being coordinated across Westminster by the former head of the CCC^[58]. The creation of Great British Energy as a new publicly-owned company to drive investment in clean home-grown energy will support these efforts. As will the establishment of the National Wealth Fund, which will build on the work of the UK Investment Bank and British Business Bank to mobilise billions of pounds of investment in the UK’s clean energy and growth industries.

However, further action is required, including from the UK Government and regulators, to deliver the scale and pace of transformation required to successfully decarbonise heat. In reaching our conclusions, we have sought to identify some clear priority areas for government focus, whilst noting that there are multiple, sometimes overlapping, potential roles for government to play.

One critical avenue for government action is reflected in the UK Government’s Warm Homes Plan, which aims to combine grants and low-interest loans to support investment in insulation, solar panels, batteries, and low carbon heating systems^[59]. A number of positive steps have already been announced as part of this Plan:

• funding for the Warm Homes Plan to upgrade up to 300,000 homes next year;
• removing blockers in the English planning system for heat pump installations;
• boosting funding for the Boiler Upgrade Scheme;
• setting out proposals to raise product standards for space heating;
• introducing a reformed Clean Heat Market Mechanism in April; and
• announcing award recipients for the Heat Pump Investment Accelerator Competition^[60].

In a Scottish context, the Scottish Government should take on a pivotal role of providing leadership and strategic direction, one that instils market confidence and encourages others to act. This means providing visibility on what governments intend to achieve, establishing clear plans including defining who does what and instilling confidence that plans are deliverable.

We would see three key policy objectives for Scottish and UK governments:

1) ensuring a stable regulatory environment: both in terms of financial and energy market design and regulation, so that it encourages investment in green housing upgrades and offers greater clarity on potential project returns;

2) filling gaps in market development: help project developers overcome barriers, including where coordinated and aggregated action represents better value for money than individual action; and

3) improve risk perception of financial actors: by ‘shifting’ risk perception and helping de-risk projects, including through providing public estate anchor loads to underpin project demand or offering first-loss capital.

The main roles for government (Scottish and UK) in addressing the above objectives are as: (a.) financial provider; (b) coordinator or facilitator; (c.) market investor; and (d.) risk taker. Regulation(s) underpins each of these roles.

Finance Provider

• Own resources (grants, loans)
• Facilitate access to capital markets (onlending, ringfenced bonds)
• Concessional vs. ‘market’ terms

Coordinator / Facilitator

• Hubs: information & transactions
• Expertise & development assistance
• Confidence & certification
• Harmoniser (contracts, models)

Market Investor

• Innovation & equity/VC (supply chain)
• Renovation own stock of buildings
• Procurement
• Demonstrator projects

Risk-Taker

• Increased risk appetite
• De-risk guarantees / credit enhancements
• Tranched / blended financial structures
• Demonstrator projects

Source: Dr. Ian Cochran, presentation to GHFT (Nov. 2023)

6.2 Barriers and challenges

As energy and finance are both regulated at a UK level, decisions taken by the UK Government and regulators have significant scope to influence the success of Scottish Government clean heat initiatives. Alongside this, the blended finance structures underpinning the place-based, heat network and social housing options discussed in this report, require clarity around multi-year public funding contributions if they are to successfully attract private investment. This will be difficult to provide as the Scottish Government needs to balance the budget each year and has limited borrowing powers, constraining its ability to make multi-year funding commitments.

6.3 Route to unlocking opportunity

The UK Government has an important role to play and has already taken some promising steps. For example, the establishment of Great British Energy, backed by £8.3 billion of new money should help drive delivery of clean power by 2030. Given it will be headquartered in Aberdeen with offices in Glasgow and Edinburgh, it should also provide fresh opportunities for the collaborative commitments of both UK and Scottish Governments to be put into action. Amongst its functions is investing in energy systems alongside the private sector, as well as leading projects through their development stage. Both are relevant to challenges identified and recommendations made in this report around delivering place-based clean heat projects at scale.

The National Wealth Fund should also support this as it seeks to partner with the private sector and local government to increase investment and drive growth across the UK, supported by almost £28 billion for investing. The Fund deploys capital based on where project pipeline opportunities emerge, and does not ringfence capital geographically. However, it does have offices in each devolved nation headed up by a local director solely responsible for project origination.

The Scottish Government should therefore work with both Great British Energy and the National Wealth Fund to explore how Scottish projects can draw on the funding and support services available, while the UK Government should ensure that both organisations seek to achieve a geographic spread on where they invest.

We have noted those conclusions from the First Minister’s Net Zero Investor Panel’s report which were most relevant to our work, principally that: (a) providers of infrastructure capital are conservative, have long-term horizons and a defined risk appetite; (b) scale matters for reasons of return and costs of transaction; and (c) there is limited appetite among investors for complex or piecemeal transactions.

We also wish to highlight the important role that public procurement can play across all the roles for government, noting that it is a key lever government can use to support market development. Building momentum early is important, rather than focusing on the overall cost or potential scale for the market (as it will not reach that potential without the initial momentum). This means that government funding support – both Scottish and UK – is going to need to be front loaded, with greater short-term contributions than may be required once markets have become more established.

It is also worth reiterating again here that one of the key steps the UK Government must take to encourage an acceleration in the uptake of clean heat installations is to rebalance gas and electricity prices. While care would be required with any rebalancing to ensure people who remained on gas were not pushed into fuel poverty, lowering the relative costs of electricity could have a transformational impact on stimulating demand for clean heating systems.

Recognising that our Part 1 report recommendations tended to cluster around the coordination role for government, we have sought in this report to draw out more recommendations that relate to the roles and responsibilities of wider actors.

Key roles and responsibilities of different parties

Scottish Government

• Demonstrate leadership by setting explicit goals for delivering clean heat and energy efficiency upgrades, as part of adopting a Clean Heat Mission designed to foster market confidence, enabling local authorities and communities to ‘forward engineer’ plans to deliver at scale.
• Regulate the use of fossil fuels and energy performance requirements for heating to create demand for uptake of alternatives, while supporting a just transition.
• Provide leadership in engaging with the public to demystify the clean heat customer journey.
• Work with local authorities, experts and stakeholders to aggregate place-based solutions that can be rolled out at scale.
• Support development of a framework for investing in place-based projects alongside private financing, including supporting enabling regulatory change.
• Collaborate with organisations, such as Local Energy Scotland and Home Energy Scotland, to promote community-led projects and provide tailored advice, support, and retrofit delivery services that align with local goals.
• Provide clarity on future policy and delivery pathways for heat networks, as well as certainty over multi-year funding over the remainder of the decade to offer developers confidence to invest.
• Act to deliver the recommendations made across our two reports.

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 (e.g. scaled green loan markets, aggregated demand models) working in collaboration with others to leverage expertise in designing market-based approaches to scaling home energy retrofits.
• Ensure blended financing funds, including activity of the National Wealth Fund and Great British Energy, are fully accessible to Scotland.
• Establish the regulatory framework which enables institutional investors to invest in retrofit projects, without breaching capital buffer levels.
• Ensure that consumers have access to free and independent access to redress covering both public and private sectors.

Local Government

• In coordination with others, deliver local advice and information campaigns to educate individuals and local businesses around the actions required and benefits of decarbonising heat.
• 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 providing anchor loads by committing to connect local authority buildings.
• Collaborating across neighbouring authorities to join up on heat plans at an appropriate spatial level, while agreeing planning projects to prioritise.
• Partner with community-focused organisations - such as Local Energy Scotland, and retrofit delivery providers such as Home Energy Scotland - to align efforts in reaching local goals and engaging effectively with communities.
• Continue to deliver energy efficiency and clean heat projects across the social housing stock under local authority ownership.

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.
• Work across industry and with others to develop and communicate consistent messaging around clean heat, with the aim of growing the overall market.
• Work together to leverage expertise and insights into market-based solutions for scaling decarbonisation.

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.
• Commercialise innovation in product and service development and deployment.

• Members of trade associations working together on shared concerns.

Third Sector and Academia

• Support local authorities and community organisations in the development and delivery of place-based solutions.

• Provide technical and delivery support to communities, local authorities and other groups seeking to advance projects.
• Partnering with local government to increase the development of heat networks.
• Foster innovation in technologies, processes and delivery models.
• Help educate and inform consumers, including through provision of trusted advice, explaining the benefits of clean heat technologies.
• Ensure Third Sector organisations are adequately resourced to provide advice and support.