Green Heat Finance Taskforce: report - part 2

7. Conclusions, Recommendations and Next Steps

7.1 Conclusions

In striving to achieve clean heat throughout Scotland, the cost of living is perhaps the greatest near-term challenge. High energy costs are outwith Scotland’s control given that electricity market costs are set by UK market design and currently driven by the cost of gas^[61]. However, what is in Scotland’s control is how much energy we need to use to keep houses warm, more cheaply than now. Through innovation in regulations, financing and technology adoption by people and communities, we can deliver both social and economic benefit, build resilience against future energy price shocks, and support climate change mitigation.

While acknowledging the costs and damage of climate change, the substantial economic and social opportunities associated with successfully transitioning to clean heat should not be overlooked. Throughout this report we have sought to set out the positive case for taking action to address one of the key sources of emissions – heating – by explaining where and how these benefits can be captured, noting that many will be distributed at a local level.

In doing so, we have also sought to underscore that it is a lack of consumer demand (and complexity for consumers wishing to take action) that represents the greatest barrier to achieving the Scottish Government’s clean heat ambitions. Steps to boost the demand for clean heat are, therefore, essential and must be taken forward in parallel with the measures recommended here. Public and private sources of financing will be required to cover the overall cost of the transition to clean heat. Also, as we outlined in our Part 1 report, a range of finance options will be required to enable individual property owners to access the solution that is best suited to their circumstances.

This Part 2 report is about the action that is needed to drive progress in the installation of clean heating systems at scale within and across Scotland. It is only by taking concerted action and purposeful steps – as we outline here – that property owners in Scotland can successfully install clean heating systems at scale. And it is only by removing emissions from heating properties that Scotland can achieve its wider net zero targets and capture the associated economic opportunities.

It is worth reiterating again, though, the need for immediate actions which create market and consumer confidence by providing clarity around clean heat and energy efficiency requirements. Regulatory and policy certainty is central to providing this confidence and we are disappointed at the pace of progress in providing this clarity over the past eighteen months. We urge the Scottish Government, as a priority, to set out its way forward in providing the legislative, regulatory and policy direction required to drive forward action on this, including to set firm timescales.

Similarly we urge the UK Government to take prompt and decisive action to create a wider regulatory environment that balances reducing emissions with stimulating economic growth, and which makes investment in heat an attractive proposition. Rebalancing relative gas and electricity prices should be the priority and would be a game changer in stimulating growth of the clean heat market.

7.2 Recommendations and reasoning

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

• Building on demonstrator programmes being developed in places such as Bristol, London and the West Midlands, and individual projects being developed in Scotland, the Scottish Government, in close collaboration with Scotland’s local authorities and CoSLA^[62], should design, agree and publish a project plan to develop and then accelerate a place-based approach to the delivery of retrofit, decentralised clean heat generation and storage and clean heat activity at scale across Scotland.
• This innovation process and delivery plan should clearly articulate:

i. the design of a coordinated Place-Based Demonstrator Programme to explore and develop place-based approaches in a Scottish context with a cohort of Scottish local authorities;

ii. the development funding required to deliver this programme in the most cost effective way, including dedicated support to the cohort of local authorities, funding for a Programme Development Unit to coordinate the programme (see below) and funding available for collective procurement of third party expertise as required;

iii. how it will integrate with and maximise opportunities and approaches from existing social housing and heat projects;

iv. how it will work with all key stakeholders and how it will set the roles of different parties;

v. how finance mechanisms will give effect to this plan; and

vi. all associated timelines to delivery.

• The Scottish Government – with appropriate support from relevant finance experts, and all other relevant parties – should develop a fully operational Programme Development Unit that shall have the capability to deliver this Place-Based Programme, by helping to provide multi-disciplinary technical assistance and nurturing feasible funding streams for place-based projects.
• This Programme Development Unit should also be tasked with ensuring that place-based projects integrate with and leverage heat network and social housing decarbonisation projects referenced in the following two recommendations.

Taskforce Rationale

We believe that there is a need for the Scottish Government to set out a heat delivery plan that clearly articulates the actions required to achieve its ambitions, working backwards from the end point to confirm what steps will need to be taken, by whom, and by when. It will be important that the delivery plan clarifies all associated timeframes in which actions need to be undertaken. The delivery plan should also maximise synergies with social housing and heat network projects, as they can act as a catalyst to explore place-based approaches in a very tangible and practical way. This is what the Strategic Partnerships component of the Warm Homes: Social Housing Fund ‘Wave 3^[63]’ funding was explicitly designed to promote.

As laid out in this report, we believe the potential of a place-based approach for this heat delivery plan is significant. It can:

• reduce the upfront costs through economies of scale;
• create a more attractive narrative for communities and households;
• aggregate funding requirements, allowing the application of innovative blended financing to transform the financial impact on households; and
• create a strong, local demand signal to help mobilise the supply chain.

However, a place-based approach requires the management not just of the flow of finance, but a range of other closely related factors, including supply chain capacity, skills availability, trusted information provision and quality assurance of work. Action is required across all these areas and in a coordinated way. Sequencing is also important, as the right factors need to be in place at the right time. Even when looking at the finance component in isolation, for the successful development of blended finance models the sequencing of activity matters. Considerations around legal and governance structures, market engagement, operational management, solution procurement, and communications, amongst others, all need to be taken into account in the development of blended finance structures.

There is currently a critical gap within the project delivery landscape, which relates to the lack of fully developed projects that are investment-ready. Full project development is a detailed undertaking, one that will require technical, legal and financial input. The necessary skills and expertise are something that project sponsors – often a local authority – may lack, or at the very least be limited in their capacity to focus on clean heat projects. This constraints the degree and / or speed at which projects can be developed.

We believe that a key role the Scottish Government can play in fostering a pipeline of investible heat projects is through the establishment of a coordinated Place-Based Demonstrator Programme that would be designed to explore and develop place-based approaches in a Scottish context with a cohort of Scottish local authorities.

As part of this Programme, the Scottish Government should establish a central Programme Development Unit as a key operational arm of the Clean Heat Delivery Plan. The aim of the Unit should be to work with project sponsors within this cohort to develop deliverable projects, secure delivery financing, and to collate learning from the testing of different place-based delivery models. This process should also include detailed consideration of how delivery governance structures can best ensure a fair split of risk, responsibilities, and benefits between parties. Such a Unit would also provide a valuable focal point for engagement with investors, and could play an important role in streamlining engagement between investors and project sponsors at the right stage in a project’s development.

Our recommendation is that the Programme Development Unit initially focuses on a selected cohort within the wider heat programme, while the methodology is being developed, rather than try to support all projects across Scotland. Otherwise, there is a risk that a Programme Development Unit would be overwhelmed by the number of projects it is asked to support. As methodologies become more established, support can be provided more broadly as the Programme scales and is replicated across Scotland.

We would see the Scottish Government as being best placed to lead on creating this Programme and Unit, particularly to ensure that the existing public landscape of funding and support (including SFT, and the Economic Development Agencies) is integrated into the programme. However, the Programme and Unit must draw on the financial expertise available through the SNIB and others, such as GFI, 3Ci, Living Places, Great British Energy and the National Wealth Fund, as may be helpful.

2) Accelerate the development of heat networks

• The Scottish Government should establish a forum bringing together industry, cooperatives and the wider public sector, to address heat network policy gaps at pace, including planning to implement the outstanding regulatory levers under the Heat Network Act, and set out a long-term vision that will help to ensure Scotland’s heat network market remains competitive and attractive to investors.
• The Scottish Government, in collaboration with the UK Government, local authorities, regulators and others, should agree and articulate how best to simplify heat network delivery pathways, including encouraging consistency in project development and by specifying and promoting preferred approaches in partnership with places that are pursuing those approaches.
• The Scottish Government should commit multi-year funding over the next five years to provide certainty on financial and advisory support for heat networks to 2030, so as to provide greater confidence to the market, thereby enabling it to develop, finance and deliver projects securely. Building on this the Scottish Government, in collaboration with the industry and key financial sector stakeholders and public funding bodies, should explore alternative financial mechanisms that could support the deployment of heat networks in the long-term.

Taskforce Rationale

The Taskforce believes that much more can be done in this area at pace. Increased policy support is essential if we are to make investing in heat networks attractive to investors. Action must be taken quickly and the Scottish Government needs to establish a long-term vision for heat networks in Scotland; a masterplan with a strategy setting out how these are going to be delivered.

To achieve this we believe that some sort of forum and development support is urgently needed. A quick win could be to set up an industry forum to strengthen engagement with the heat networks industry. More generally the Scottish Government must set out its aims and intent to reengage with stakeholders.

As part of the mission approach we suggest in this report – we strongly advise that Government colleagues must immediately consider the role of heat networks in a holistic approach to the energy system of the future and build it in from the start. Heat solutions cannot be pushed into the background with a view to tackling later. We need whole energy system planning and SG and UKG alongside NESO and ScottishPower Energy Networks to work together to integrate heat into energy system planning.

As public confidence more than investor confidence is needed in the low-carbon heating technologies we discuss here we also strongly encourage the Scottish Government to prioritise making progress with commitments set out in its Heat in Buildings Public Engagement Strategy which was published shortly after our Part 1 report.

However, action can also be taken to instil confidence in the heat network sector which in turn can help encourage investment and development of networks. As development and construction of heat networks is a multi-year undertaking, the current lack of clarity around future Scottish Government funding support can been seen as a constraint on developing heat networks. It will therefore be important to provide the sector with some certainty over future funding availability to provide the confidence necessary to encourage projects to be brough forward.

Clarity on the future development of heat networks, both in terms of locations where they will be built and the timing of their development, is important in supporting the wider heat transition. Knowing if and when a heat network will be available can help plan whether or not alternative technologies like heat pumps should be considered for a property. While this will be true at an individual household level, it is particularly relevant for social landlords in planning their upgrade programmes as they will want to ensure they do not install heat pumps in properties that could subsequently have been connected to a heat network at a lower cost. In turn the potential anchor loads from social housing or groups of individual properties could support the business case for a heat network, although developers will still require confidence that government funding support for the heat network will continue to be available.

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

• The Scottish Government should set out plans to establish a Social Housing Project Support Unit and identify the practical steps it will take in partnership with social landlords to start testing the deliverability of the most promising blended finance models for retrofitting socially rented homes.
• The Scottish Government should conclude and publish work with the Scottish Federation of Housing Associations (SFHA) and others that will provide a robust evidence base supporting business case development for retrofitting social housing across Scotland, including around the variation of costs and reasons for this, as well as the scale of energy savings resulting from upgrades and other social and economic benefits, which can support blended finance approaches.

Taskforce Rationale

This report has highlighted potential financing models that could support retrofit for social housing. However, the list is far from exhaustive, and we have not considered the suitability of different models for different types of social landlord, although note a recent report by SFT has looked at a wider range of models^[64].

However, in line with a common theme we have raised throughout this report there is now a need to find practical and pragmatic ways to move from model theory to testing of potential approaches. This will require partnership working across government, social landlords (including their representatives, such as SFHA and the Association of Local Authority Chief Housing Officers - ALACHO) and we look to the Scottish Government to set out a credible plan for how that can be taken forward.

This recommendation’s call to establish a Social Housing Project Support Unit very much echoes our first recommendation which is focused on the need for such a Unit to support wider place-based programme development. However, a social housing specific Support Unit will also be helpful as it can provide expertise that is relevant to the particular challenges facing the sector. It may also potentially be quicker to set-up and could therefore act, alongside the existing Heat Network Support Unit, as a testing bed for the structure of a wider place-based support unit.

Social landlords differ by size, their geographic location, and the property archetypes. Average cost figures for upgrades therefore are likely to disguise the actual costs social landlords are incurring in different circumstances. Understanding these variations will help inform which financing models might be most appropriate for different social landlords, as well as the degree to which public funding might need to be varied to make blended finance models viable within the sector. This includes considering the impact that varying public funding within a blended finance model might have on the risk private lenders attach to their contributions and therefore the interest social landlords will need to pay to access a blended finance package.

We also think it would be helpful to evidence the levels of energy usage savings delivered post upgrade as, all else being equal, reduced energy usage would generate reduced energy bills. This could create a potentially useful revenue stream to repay any upfront financing costs. If this is possible, it could mean that tenants are better-off financially post-upgrade, even if rents were increased or a service charge was raised to cover repayment of financing costs. Creating a new sustainable, longer-term revenue stream for social landlords could open-up an expanded range of private and / or blended financing models to the sector and also create a market for testing heat as a service models.

4) Develop a ‘Clean Heat Mission’ approach starting with clear goals and a coordinated delivery plan for the clean heat transition

• The Scottish and UK Governments should adopt a more proactive and coordinated ‘mission approach,’ to demonstrate collaborative leadership working between government, civic and business leaders, with a view to creating a platform or framework(s) that will bring otherwise disparate actors together to test new financing solutions and learnings across the range of sectors required to deliver the energy transition covering all tenure types and integrating energy efficiency, generation, storage and heat.
• The Scottish Government should tabulate lead heat-related institutions and local authorities including the sources of capital they have access to.
• Work with all interested parties to create targeted and agile mechanisms designed to provide dedicated resources for the provision of coordinated retrofit, clean power and clean heat project and infrastructure delivery.
• 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.
• The Scottish Government should research or collate existing consistently evidence and communicate ensure consistent communications on the financial and non-financial benefits of retrofit, clean and affordable power and clean heat, including articulating the savings for owners and tenants across the domestic and commercial sectors, but also considering a wider range of potential beneficiaries. Following on from this, the Scottish Government should explore how these benefits can produce revenue streams and other returns necessary to secure upfront blended finance investment.
• The UK Government and Ofgem should, as a matter of urgency, explore how to effectively redesign the UK’s electricity market, to rebalance the relative gas and electricity prices at a UK level, and, in a way that will stop electricity prices being driven by high cost imported gas.
• Streamlining and synergies - In the light of the above, the Scottish and UK Governments should agree a Memorandum of Understanding to take an integrated approach across Clean Power 2030 and a new Clean Heat 2030 mission, with common aims and solidify a partnership approach to optimising delivery of clean heat support in Scotland.

Taskforce Rationale

A collaborative ‘mission approach’ acknowledges that there is no one actor that can solve systemic challenges, hence the need for collaborative leadership working between government, civic and business leaders. It is precisely because no one organisation has all the answers that points to the need for a formal platform or framework(s) to facilitate the testing of new financing solutions and learnings through peer learning coupled with substantial and substantive capability / capacity building.

Recognising that they do not have all the answers or the funding to solve the issue of getting clean heat into all buildings, the Scottish and UK Governments should use their (combined) substantial convening powers to bring otherwise disparate actors together to test new financing solutions and learnings. By establishing structures to enable ongoing engagement such a platform would be well-placed to identify collaborative and collective steps that will help to drive clean heat uptake.

Developing a clean heat delivery plan should be an initial focal point of establishing a coordinated ‘Clean Heat Mission’ approach. Steps to develop a Plan include:

• Setting explicit goals for delivering clean heat and energy efficiency upgrades:
  • recognising the different mixes and timeframes for clean heat and retrofit delivery, including building on LHEES to create holistic clean heat delivery plans for an area;
  • identifying infrastructure needs (pipes, wiring, networks) as well as gaps, for example those that may arise in taking an integrated place-based approach;
  • exploring views on costs, benefits, opportunities and risk allocation; and
  • Spatial element – identifying the locations which provide an opportunity for early and rapid testing of place-based models which can then be learnt from with lessons applied to model roll-out more widely.

There are currently a range of delivery schemes available across Scotland along with advice services as well as both national and local level strategies. However, what clean heat and energy efficiency means at an individual property level is not well understood by the majority of the public, making starting their clean heat journey a daunting prospect for many. The Scottish Government therefore has an important leadership role to play in educating people and demystifying the clean heat journey irrespective of someone’s starting point. Part of this will involve communicating the scale of benefits, relative to costs for different types of property, as well as across urban and rural areas.

Understanding the benefits and returns at an individual level will be important in developing the blended finance models that will underpin place-based delivery as it will help to evidence the scale of benefits which can be achieved as well as the potential scale of a revenue stream which could be created to repay upfront costs over time while still leaving property owners better off. This in turn will help provide confidence for institutional investors that any funding models they help captialise would create a sustainable revenue stream over the medium-to-longer-term.

Energy and finance are both regulated at a UK level, meaning that the decisions taken by the UK Government and Regulators have significant scope to influence the success (or otherwise) of Scottish Government clean heat initiatives. A key regulatory barrier to delivering clean heat cost effectively is the UK’s electricity market design. Fundamental change to the UK’s electricity market design should be addressed by the UK Government with the specific purpose of bringing electricity prices down to below three times the cost of the price of gas^[65]. Action by the UK Government on this will ensure low carbon technologies are cheaper to run than fossil fuel alternatives, generating a market pull for the likes of heat pumps.

We also note that Clean Energy Industries is one of eight growth-driving sectors identified in the UK Government’s Industrial Strategy green paper^[66], which highlights how the UK’s financial services sector will play a core role in providing the tens of billions needed to finance the net zero transition, alongside providing thousands of jobs in every region of the UK, with emerging hubs in Belfast, Leeds, Cardiff, and Glasgow, and a global centre in Edinburgh, driving regional growth. In this context, we welcome the UK Government’s commitment to partnership with the devolved governments, thereby ensuring this will be a UK-wide effort that will support the considerable sectoral strengths of Wales, Northern Ireland and Scotland. We believe establishing structures to formalise this partnership working would be beneficial.

Next Steps

This concludes this Taskforce’s work. We believe there is a compelling case for clean heat and improved energy efficiency. Action is necessary to deliver on climate targets as well as to unlock the economic and wider socio-health benefits of the transition. As we cannot research our way out of the challenges presented by climate change, it is now time for concerted and coordinated action to deliver the changes required.

We look forward to seeing the Scottish Government’s response to our recommendations. Members stand ready, individually and collectively, to support the delivery of actions which can accelerate the clean heat transition in Scotland.