Heat Networks Delivery Models

8. Preferred delivery models & recommendations

In light of the evaluation results and the stakeholder engagement we carried out, this section provides:

1. a set of general, overarching delivery recommendations and conclusions that are not specific to individual models;

2. for the four highest-scoring models in our evaluation, a further description of the corporate structures, benefits and risks, and a set of recommendations relating to implementation, should Scottish Government wish to pursue any of these models further;

3. recommendations and conclusions in respect of each of the remaining eight models considered in our evaluation; and

4. recommendations relating to the enabling mechanisms described in section 6.4.

8.1. General, overarching conclusions & recommendations

The models can be further refined and the optimal solution, which may include attributes from a number of models, should be developed to support the delivery of Scottish Government objectives.

We evaluated twelve models in total, as described in detail in section 6 above. Each model was then evaluated against the ten attributes described in section 4 above and given a score of 0 – 4 against each attribute, to help determine which models performed ‘best’. Conclusions in relation to the four highest scoring models are set out at section 8.2 below.

In order to be able to evaluate, score and contrast different delivery models in this way, we had to make certain assumptions about existing models and how each ‘new’ model could be deployed. Key assumptions are included in the model descriptions/definitions in section 6.

In practice, there are features of existing models which can (and do) vary, and features of the potential ‘new’ models that could be flexed to support different outcomes or meet different attributes. Where this is the case, we have identified it in the evaluation text and reflected it in our summary conclusions and recommendations below. The inherently flexible nature of the four top-performing models we are recommending for further consideration should be borne in mind when reviewing this section.

If Scottish Government wished to promote a new model, the top four models we identified could be refined, adjusted and adapted to develop an optimal solution and ensure any new model appropriately balanced the most important attributes. We have framed our recommendations (sections 8.2 – 8.4 below) to reflect this flexibility and the range of choices around how new models could be deployed.

Developing a long term ‘Vision’ for heat networks in Scotland

We consider it prudent that the option of long-term consolidation of networks is (where practicable) preserved to retain future flexibility as to how Scotland’s heat network market may evolve over time. Steps should be taken to future- proof current activity to facilitate any potential future consolidation of assets (whether into public or private (local) monopolies) or unbundling of projects. Hence, for example, structures involving assets owned by SPVs rather than by parent organisations, and asset reversion for concession contracts, should generally be preferred.

Whilst we can preserve flexibility in this way without knowing what the future holds, we also consider there would be significant value for Scottish Government in going further and developing a ‘vision’ for how heat networks in Scotland should operate in the long term. For example, does Scottish Government envisage significant ongoing public sector involvement, or a largely private sector owned and operated market? Understanding the ‘vision’, or even preferred outcomes (beyond deployment targets), would help inform decision making around the creation of any new delivery model, and would also help inform the ongoing development of forthcoming regulation under the Heat Networks (Scotland) Act 2021.

Existing models can be optimised in the short term, regardless of any medium or long-term intervention

We recognise that the existing suite of delivery models, both those that are relatively well-established and others that are emerging, will still have an important role to play. Hence, although our focus is on the four models which performed best against the various attributes, we have also considered what, if any, recommendations should be made in respect of the other eight, lower-scoring models. Recommendations include, for example, developing case studies or the preparation of further guidance and templates etc. These recommendations, set out at Table 2 below, seek to optimise and future proof the networks delivered using more traditional routes, or prepare for new and emerging private sector models.

Budget implications and Government risk appetite

Private sector investment is fundamental to achieving the necessary scale of deployment. The highest-scoring models all enable (or could allow for) private sector investment to varying degrees, but at least two would require some degree of central Government investment, either directly or indirectly, via Government owned or controlled entities.

To inform the detailed design for any potential new delivery models it wishes to take forward, Scottish Government should consider and determine its risk appetite for investment in heat networks, and the time period over which it may wish to hold investments. Consideration will also need to be given to balance sheet treatment and in particular whether investments should be categorised as on or off balance sheet. Where investments are on balance sheet it may be appropriate to develop an exit strategy through a sale/disposal of all or part of an investment in a project after a period of time. Understanding these preferences will be essential to informing which models should be taken forward. For example, Centrally Led (DM8) would only be deliverable if Government had significant risk appetite and was willing to hold heat network assets on its balance sheet.

We recognise that making these kinds of decisions is challenging. We have therefore identified recommendations to inform and support this process under section 8.2 below, including a recommendation of further work to consider technical classification impacts (i.e., balance sheet treatment) of alternative investment routes (e.g., capital, equity, debt or other form of intervention) in the context of heat networks.

Ongoing stakeholder engagement will be required

We undertook high-level, principle-based stakeholder engagement to help inform our evaluation and recommendations in this report. Based on the engagement undertaken with both public and private sector stakeholders, we think the following attributes (as described in section 4) should be a priority for any new models: potential for private sector investment, ability to respond to current challenges around skills & capacity, ease of deployment and simplifying delivery (in particular to promote improved procurement efficiency).

Further, more detailed, stakeholder engagement (and involvement in development) will be important to inform the design and implementation of any new model(s). Engagement would need to be more in depth, and involve more refined proposals and market engagement. For major changes or interventions, public consultation may be advisable.

8.2. The highest scoring models

We evaluated twelve delivery models in total (each described in detail in section 6 above). Each model was evaluated against the ten attributes described in section 4 above, and given a score of 0 – 4 against each attribute.

Of these twelve, we identified four models that we propose warrant further detailed development/consideration, namely:

1. Regional ESCo (DM10);

2. Local authority led joint venture (DM4);

3. Local authority led delivery, with Scottish Government stake (DM9); and

4. Centrally led (DM8).

These models scored highest in the evaluation. Given the element of subjectivity inherent in scoring against qualitative evaluation criteria, we would not at this stage wish to prioritise these further based on scores alone. Rather, the prioritisation should take into account the evaluation comments included for each model in section 7.

Note that the RAB model (DM12) scored equally with Centrally led (DM8), but has not been short-listed above due to the negative assessment of the potential for the model to be deployed at the present time, given the current regulatory and policy framework.

We have set out an overview of each of the four models below. These include a description of the model, a schematic of the project/corporate structure, and a summary of key benefits and risks.

The next step to pursue any of these recommendations would be to agree and implement programme disciplines including governance, approach, timescales and allocation of resources.

Regional ESCo (DM10)

Overview

Under the regional ESCo model, local authorities and other public (or quasi-public) bodies (e.g., NHS, universities, colleges) would come together (entering into a ‘Territory Partnering Agreement’ to document the joint working arrangements) and jointly procure a private sector partner to deliver heat networks (and potentially other types of energy projects). The successful bidder and the public bodies in the area would form a regional ESCo (“RESCo”), in which the private sector partner takes a majority stake, and the public sector bodies (and potentially Scottish Government / agency) take minority stakes.

In each region, the public sector RESCo partners would be able to use the RESCo to assist with initial scoping and project development and then project delivery. Projects could potentially be delivered using different contracting structures, depending on the public sector project sponsor’s preference (having regard to control, risk, funding availability, etc.). The extent to which the delivery partner is given exclusivity over certain types of projects within each area, and for how long, would be a key consideration.

Corporate structure (example)

Project structure (example)

Key benefits

The RESCo model involves a long-term relationship with a private sector delivery partner. The delivery partner would procure its supply chain, which can be flexed over time. This would promote sustained private investment, supply chain development and capacity building.

The RESCo structure provides a mechanism by which, on a regional basis, a single procurement unlocks multiple projects. These future projects are contemplated in the original, regional procurement, and hence do not require a separate public procurement exercise on a project-by-project basis.

The RESCo partner could potentially support a wider range of investments beyond heat networks via the procurement of a wider “energy partner”, examples of which are growing in England and Wales. This approach could help with co-ordination of wider LHEES delivery across the region, and should better ensure that the most optimal energy solution is identified for each building.

The potential for scale through a pipeline of projects can promote both economies of scale in terms of strategic investments, purchasing power and facilitate access to a lower cost of finance.

The ‘partnering’ nature of the model, where other public sector bodies have a stake in the RESCo (in addition to being named on the Contract Notice) delivers procurement efficiency, but should also help to catalyse development, because it brings to the table a larger number of public sector entities (with responsibility for many potential anchor loads) in a more proactive role. The benefits of this partnering approach have been very apparent in Hub.

The design process and the subsequent regional procurements could draw upon and benefit from the extensive experience and learning from the Hub programme, which has been used to deploy significant investments in community infrastructure across Scotland. Similar challenges to those identified below have been overcome in the Hub model.

Key risks

The boundaries of each ‘region’ would need to be carefully considered to balance the need for scale and a sufficient pipeline of projects, whilst ensuring that the private sector partner had sufficient delivery capacity. The potential pipeline and scale of investment for a region (as against a single local authority) may point towards the delivery partner being an investor (with ability to use multiple contractors) rather than a (single) contractor.

As this is a new model for heat networks, it would require multiple regional procurements (although a single suite of documents could be developed), preceded by a significant development period, including more detailed market testing of the concept and to test/gain the support of the relevant public bodies in each area. Hub took around two years to establish, although some efficiencies may be possible in delivering this model if learning from Hub can be applied. One of the first steps would be to develop a detailed programme. Project development under existing models would continue during this development period.

In order to attract market interest in each region, a degree of exclusivity for the private sector partner would likely be required over certain types of projects for a minimum period. Exclusivity would need to be carefully considered in the context of heat network zoning, and in particular the designation of permitted zones, although this interface between commercial/procurement and regulatory processes requires consideration for all models.

The regional public bodies will require visibility of how the private sector partner provides value for money to the RESCo if it contracts services and delivery contracts through its own group companies. This can be dealt with by open book accounting or a requirement (as happens on Hub) to tender sub-contracts.

Depending on the size of Scottish Government’s equity stake in a RESCo, and the degree of control conferred by its shareholder rights, there is potential for projects to appear on Scottish Government’s balance sheet (until such time as its shareholding is sold to a project partner or third party) and therefore reduce funds available to be spent on other priorities. A significant amount of work and preparation went into the Hubs’ balance sheet treatment, and those lessons could be applied here.

Recommendations relating to Regional ESCo (DM10)

1. Draw on Hub experience to help Scottish Government understand how existing Hub model works for community infrastructure. Facilitate meeting with SFT Hub team.

2. Consider how the Hub model could be adapted / refined for heat networks, including how to define ‘regions’ (for heat networks), which public bodies should be included, and what exclusivity requirement would be needed.

3. Consider whether a RESCo model should have the scope to deliver wider energy solutions (to help deliver LHEES), in addition to heat networks.

4. Consider how the regulatory framework (especially the permitting regime) would align with a requirement for exclusivity for the RESCo partner.

5. Explore with Scottish Government and other stakeholders whether there is an appetite for putting resources into the further consideration of this model.

6. Subject to confirmation of Scottish Government appetite, undertake engagement with public sector and market to inform the development of a Strategic Outline Case.

Local authority led joint venture (DM4)

Overview

This model involves a local authority procuring a private sector partner, with whom it forms a joint venture to undertake one or more heat networks and potentially other types of energy projects. The model is not limited to a single local authority; several local authorities could jointly procure a JV partner (one of them would act as lead authority). Other public bodies could also potentially participate in a variety of ways, e.g., as a potential customer to the JV, or as a shareholder, depending on interest, investment / risk appetite, and the necessary legal powers.

Corporate structure

Key benefits

Although there are relatively few examples in the heat network sector, the joint venture model is based on a well-understood corporate structure that can be deployed without requiring any Scottish Government intervention.

The JV partner could potentially support a wider range of investments beyond heat networks via the procurement of a wider “energy partner”, examples of which are growing in England and Wales. This approach could help with co-ordination of wider LHEES delivery across the local authority area, and should better ensure that the most optimal energy solution is identified for each building.

After the initial procurement of a private sector JV partner (usually backed by a well-defined initial project), the JV partner can proactively develop business cases for additional projects, which do not need a separate procurement exercise. Hence a single procurement can unlock multiple projects.

Private and public sector JV partners can each ‘play to their strengths’. The local authority can bring a project pipeline, land (e.g., for energy centres), anchor loads, local stakeholder relationships and supportive planning policy. The private sector brings delivery capacity and expertise. Both parties bring investment, and share in risk and returns.

The risk/return sharing inherent in the JV model tends to promote a collaborative rather than adversarial relationship, in which the partners’ interests are suitably aligned.

The potential for scale through a pipeline of projects can promote both economies of scale in terms of strategic investments, purchasing power and facilitate access to a lower cost of finance.

The local authority JV structure would not impact Scottish Government’s balance sheet.

Key risks

In order to attract market interest, a degree of exclusivity for the private sector JV partner would be required over certain types of projects for a minimum period. The requirement for exclusivity would need to be carefully considered in the context of heat network zoning, and in particular the designation of permitted zones.

The local authority will require visibility of how the JV partner provides value for money to the JV if it contracts services and delivery contracts through its own group companies. This can be dealt with by open book accounting or a requirement for the JV to tender sub-contracts competitively.

Recommendations relating to local authority led joint venture

7. Continue to monitor examples such as Midlothian and capture lessons learnt, including engaging with English local authorities who have procured energy partnerships (including heat networks) for their areas/cities.

8. Produce case study based on Midlothian Energy.

9. Produce guidance on procurement of JVs, and standard form documents for JVs, e.g., procurement documentation and shareholders agreement.

10. Consider how best to align the forthcoming permitting process (permitted HN Zones) with local authorities’ use of JV model where JV partner benefits from exclusivity of HN developments and, once regulations finalised, produce guidance.

11. Promote awareness / use of JV model to local authorities through HNSU and make available supporting guidance / templates etc.

Local authority led delivery, with Scottish Government stake (DM9)

Overview

In this model, local authorities continue to lead project development, with Scottish Government both supporting project development and taking an equity stake in projects (either directly or via an agency, and which may be in addition to an element of capital grant). This model shares certain features with, and could be considered a hybrid of, DM1 (locally led project development), DM4 (formation of a joint venture vehicle) and DM8 (centrally led delivery).

Special purpose vehicles would be established for investments into specific projects. By becoming a co-investor alongside the local authority and/or a private sector partner, the Scottish Government would have shareholder rights in proportion to its equity stake, representation on the board and the ability to transfer its stake (by sale of its shareholding) and therefore to recycle capital into other investments.

Corporate/project structures

Key benefits

The reasons for Scottish Government taking an equity stake (potentially alongside capital grant) would be primarily to de-risk a project and allow it to proceed faster and/or at a greater scale than would otherwise happen.

Scottish Government would have a greater degree of control and influence (proportionate to its equity stake) than would be achieved solely via grant funding, and the option to exit and recycle capital into other schemes.

Financial risks and returns would be shared between the parties in accordance with their respective investments. Hence Scottish Government would have the potential to share in any profits and reinvestment them in other projects.

Some authorities would welcome Scottish Government being more closely involved in the success of projects than with a ‘grant only’ structure, and see value in a Scottish Government appointee with suitable experienced being involved in helping to steer the project and ensure its long-term success.

Key risks

Scottish Government’s ongoing role in projects would expose it to reputational risk in the event that the project failed to deliver the desired objectives.

As a shareholder, Scottish Government would risk losing its investment if its equity stake had no value. In this scenario, the Scottish Government investment in the project would in effect become a grant, meaning the risk is more reputational than financial.

Not all local authorities (and potential private sector co-investors) would welcome an ongoing Scottish Government role in projects. Some do not see this as a natural government role, and would prefer intervention to be limited to policy and regulation rather than getting involved in project delivery.

An ongoing role in projects through SPV Board appointments would provide greater insight to Scottish Government of the practical issues facing projects, and may help to guide the company in interpreting and applying any pre-agreed policy objectives, and add value beyond purely profit led decision making. However, if that appointee was a director, any such appointee would be bound by directors’ duties, including to act in the best interests of the SPV. If the appointee was not a director (e.g., an ‘observer’ role), Scottish Government would not have sufficient influence and control in order to protect its investment.

A shareholding in project SPVs risks bringing the relevant project(s) onto Scottish Government balance sheet, thus reducing funds available to be spent on other spending priorities.

Recommendations relating to local authority led delivery, with Scottish Government stake (DM9)

12. Test appetite for Scottish Government investment and ongoing role in projects, in which investment risks and returns are shared.

13. Consider the appropriate nature and size of any Government equity stake; what shareholder rights and duties would be suitable for equity stakes in projects; whether grant and equity could be offered together, and analyse how these elements would impact project investability (including via market engagement, if Scottish Government are minded to explore this model further).

14. Consider process and resources required to establish and manage an appropriate/suitable investment vehicle (including whether such a vehicle would be held directly by Scottish Government or not) and budgetary implications.

15. Consider how the regulatory framework would align with this model, e.g., potential for self-regulation for projects with Scottish Government part-ownership of SPVs that will need to apply to Scottish Government (Energy Consents Unit) to obtain consents/permits etc.

16. Subject to confirmation of Scottish Government appetite, undertake engagement with local authorities (and, if appropriate, COSLA), investors and developers on this model.

17. Develop a Strategic Outline Case.

Centrally led (DM8)

Overview

In this model, Scottish Government (or an executive agency of the Scottish Government, or some other centrally controlled public body) takes the lead on development and delivery of projects, without need for local authorities to lead development. The central body could have initial ownership / part-ownership of projects (potentially alongside private sector partner(s)) but with potential for the onward sale or transfer of government stakes in projects once they are operational with established revenue streams.

The rationale for the model is to provide a delivery route for projects in areas for which heat networks have been identified as an appropriate decarbonisation pathway, but where local authorities are not actively taking forward development, and no other organisations are doing so at scale (e.g., on a merchant basis). The model has the potential to unlock development in such places.

Corporate/project structure

Key benefits

A central delivery body could unlock development in areas where a heat network is appropriate, but where local authorities are unable or unwilling to promote projects and private sector merchant models are not materialising.

Consistent and significant central ownership (noting that JVs with a private partner would still be possible) offers the potential for control and future consolidation and the opportunity to focus on wider policy priorities across all of Scotland. It could also remove barriers to expansion and interconnection in the future.

Depending on Scottish Government’s investment capacity and risk appetite, a central delivery body would have the potential to invest ahead of need, for example by making strategic investments in transmission / trunk mains in anticipation of future connections in heat network zones.

A central delivery body would allow significant knowledge sharing and efficient allocation of resources, with a central body of delivery expertise building up over time.

Any investments made by the Scottish Government in projects could have future value, with potential for such investments to be sold in due course (most likely, when projects are operational with established revenue streams), and the proceeds of sale available for reinvestment in other projects.

Key risks

Scottish Government’s role in leading project development would expose it to reputational risk in the event that projects failed to deliver the desired objectives.

An important risk in creating a centrally led delivery body is that those local authorities who are currently active in heat network developments may step back and re-prioritise limited resources on other initiatives. It is therefore difficult to say whether the net effect of a new body would be to increase or decrease the overall pace and scale of delivery.

As a shareholder, Scottish Government would risk losing its investment if its equity stake in a project had no value. In this scenario, the Scottish Government investment in the project would in effect become a grant, meaning the risk is more reputational than financial.

There may be a risk of ‘self-regulation’ in respect of the Heat Networks (Scotland) Act 2021, where Scottish Government is developing and operating networks, whilst also holding regulatory functions in respect of heat networks. This issue could be reduced if a separate statutory entity was set up to hold the heat network assets and apply for the relevant approvals, but setting up an independent entity in this manner could require further legislation.

The model assumes local authorities do not have a role in developing or delivering projects – only in offering/connecting their own anchor loads. This would be a move away from the current policy around LHEES, where local authorities are responsible for identifying appropriate heating solutions for their area.

This model would require significant capital investment (assuming that Scottish Government will need to provide capital that might otherwise have been provided by local authorities), and ongoing revenue budget.

A centrally led delivery body would (by definition) look to increase investment in areas where local authorities are not actively developing heat networks. Local authorities that are active in heat networks will be keen to see equivalent Scottish Government investment being made in their areas. Hence such local authorities will need reassurance that subsidy will be available to support their own developments, so they are not adversely impacted by the introduction of the delivery body.

A shareholding in project SPVs risks bringing the relevant project(s) onto Scottish Government balance sheet, thus reducing funds available to be spent on other spending priorities.

Recommendations relating to Centrally led (DM8)

18. Test Scottish Government’s appetite to lead development and delivery of heat networks.

19. Consider how this model might interact with any other models still continuing, including how capital investment is spread equitably between areas in which Government is leading and areas in which others are content to lead.

20. Consider the appropriate nature and size of any Government equity stake; what shareholder rights and duties would be suitable for equity stakes in projects; whether grant and equity could be offered together, and analyse how these elements would impact project investability (including via market engagement, if Scottish Government are minded exploring this model further).

21. Consider process and resources required to establish and manage an appropriate/suitable investment vehicle, (including whether such a fund would be held directly by Scottish Government or by a dedicated investment vehicle) and budgetary implications.

22. Consider how the regulatory framework would align with this model, e.g., potential for self-regulation for projects with Scottish Government ownership (or part-ownership) of SPVs that will need to apply to Scottish Government (Energy Consents Unit) for consents/permits etc.

23. Subject to confirmation of Scottish Government appetite for this model, undertake engagement with local authorities (and, if appropriate, COSLA), investors and developers on model.

24. Develop a Strategic Outline Case

8.3. Conclusions & recommendations in relation to the other delivery models

Of the remaining eight models not described above, we reached varying conclusions.

For some established models (i.e., Public Sector Led (DM1), Concession (DM2) and Private ESCo (DM3)) we have concluded that they still have a role, can be supported, and that their delivery could be optimised or improved.

For some other ‘new models’, we recommend that they should not be actively promoted or supported at this time, but that ‘watching brief’ type actions could be considered (Merchant model (DM7)), or consideration given as to how they might be used in the future (Unbundled (DM6) and Regulated Asset Base (DM12).

We do not consider that the PPP model (DM11) or Community Led (DM5) would offer any delivery advantages, and recommend that they should not be pursued.

The following pages summarise our evaluation conclusions in relation to these 8 remaining models, and sets out any proposed recommendations for each of them. The following sections are ordered to reflect the remaining models’ evaluation ranking (out of 12) based on scoring against the attributes, noting that the top four scoring models are already described above. The section on each model includes:

• the ranking of the model (full scores are provided in Appendix B);
• a summary of the model description;
• whether the model is considered ‘new’ (or not) in relation to heat networks;
• a summary of our evaluation conclusions in relation to the model; and
• proposed recommendations in relation to the model.

There are recommendations relating to the need to consider further the interaction with forthcoming regulation; updated guidance for local authorities for delivering various models; contract templates for various models; and horizon watching/capturing lessons learned from developments / projects across the UK. Various recommendations relate to more than one model, hence could be ‘packaged’ accordingly.

Regulated Asset Base (DM12)

Model Description

A private sector ownership model in which heat network assets are constructed, owned and operated by a monopoly supplier on a long-term basis. Investment plans, operating performance and returns (which are capped) are subject to regulatory oversight.

Ranking 4 (joint)

Model type New Heat Network Delivery Model

Recommendations and potential next steps

Current market and regulatory arrangements would not support the immediate roll out of this model. However, we recommend that both existing and any new delivery models should be future proofed to retain this option and to facilitate any future consolidation (whether into public or private (local) monopolies).

The Regulated Asset Base model offers a good long term regulatory model for large infrastructure that operates in a monopoly environment. There is significant experience of this model from other sectors. It supports investment in assets by providing a guaranteed return for investors on approved investments, and mitigates demand risk by spreading costs across the entire customer base. However, it requires a large asset base to support the model, is time and cost intensive to regulate, and is not compatible with forthcoming regulation.

Recommendations

Develop a long term ‘vision’ for heat networks in Scotland, including determining whether consolidation of certain types of heat network assets (such as distribution pipes) into (local) monopolies under common ownership (whether public or private) is desirable as a long-term structure.

If long-term consolidation of ownership is deemed to be desirable, consider how both existing and any new delivery models could be future proofed to facilitate this outcome. For example, use of SPVs to hold projects assets, and asset reversion on expiry/termination of long-term concession contracts.

Service concession (DM2)

Model Description

The heat network is owned and operated by the private sector under a long-term service concession tendered by a public body, where the public sector offers anchor loads, and the concessionaire takes demand risk.

Ranking 6

Model type Existing / well-established HN delivery model

Conclusions and potential next steps

Promote awareness of the concession model and, where there is an appetite to use it, provide support to deliver a better outcome for the procuring authority.

The concession model continues to offer a successful route to the procurement and delivery of heat networks for authorities which are less willing to take on any investment risk. They are well-understood and offer a relatively straightforward route for bringing in private investment. Although procurement can be lengthy and costly, there is potential to improve this.

Concessions offer only contractual control for the procuring authority, meaning it can be harder to manage wider policy objectives over the longer term.

Developers and investors will generally seek a higher rate of return to reflect the greater amount of risk being passed on to them. This tends to require higher levels of grant.

We believe that there is scope to provide guidance and support that ensures better long-term outcomes for the public and procuring authority, and to ensure that concessions contribute to (and do not detract from) any longer-term vision developed for heat networks in Scotland.

Recommendations

• Monitor examples of concessions from across the UK and, where relevant, internationally. Capture lessons learnt.
• Where local authorities are minded to use a concession, encourage long-term / strategic approach to ensure to ensure that the procurement unlocks significant investment (e.g., multiple projects / zones / sites from one procurement).
• Consider how best to align permitting process (permitted HN Zones) with local authorities’ use of the concession model.
• Produce standard form documents for concessions, e.g., procurement documentation and shareholders agreement.
• Promote awareness of the concession model to local authorities and make available supporting guidance / templates etc.

Public sector (non-Scottish Government) in-house delivery (DM1)

Model Description

The heat network is wholly owned and operated by a public body (either directly, or via a wholly-owned arm’s length entity), usually based on self-supply arrangements (e.g., local authority buildings, or a public sector campus).

Ranking 7

Model type Existing / well-established HN delivery model

Conclusions and potential next steps

Do not actively promote but provide support where there is an appetite to explore a transition into different ownership models.

We recognise that this model will continue to play a useful role for those authorities with the skills & resources, investment capacity and risk appetite to develop, own & operate networks.

Given local authorities’ limited investment capacity and competing priorities for investment, this model is highly unlikely to result in the scale of investment necessary to contribute meaningfully to deployment targets. Hence, we do not recommend that this model be actively promoted further by Scottish Government.

Recommendations

Where local authority projects are finding it difficult to expand – e.g., due to operational challenges, competing priorities and limited resources – Scottish Government / HNSU should work with the projects to explore whether a different ownership model would be more advantageous, and how to transition.

Merchant model (DM7)

Model Description

A private sector heat network operator contracts with off-takers to supply existing buildings, without having either being appointed by a private sector landowner / developer in connection with a particular development site, or having followed a public procurement exercise.

Ranking 8

Model type Existing HN delivery model / limited examples

Conclusions and potential next steps

Do not actively promote the Merchant model.

We do not recommend that this model is promoted by Scottish Government as a means to achieving a step change in pace and scale of deployment of heat networks.

Whilst we recognise the potential for private sector investment under the merchant model, we do not believe this will lead to the development of large-scale strategic heat networks aligned with intended policy outcomes.

This model carries a significant risk of ‘cherry picking’ of anchor loads, resulting in uncoordinated and small-scale developments, misaligned with Scottish Government policy ambitions. It risks first-mover advantage in an area, potentially inhibiting future, larger-scale, development (e.g., in areas likely to be designated as permitted heat network zones).

This model may have a limited role for towns or suburban residential schemes (e.g., shared ground loops).

Recommendations

Further analysis should be undertaken to identify the potential for this model in certain locations, and whether/how it should be accommodated in forthcoming wider commercial and regulatory arrangements (including LHEES, zoning and related exclusive permitting).

Third party ESCo (DM3)

Model Description

The heat network is owned and operated by a private sector third-party ESCo appointed by private sector landowner / developer, generally to serve new development.

Ranking 9

Model type Existing / well-established HN delivery model

Conclusions and potential next steps

Do not actively promote this model beyond promoting policies that are supportive of new heat networks.

This model (as defined) does not involve any substantive role for the public sector beyond regulation. It is generally limited to smaller, contained sites in order to respond to planning conditions requiring the construction of a heat network.

While it is positive to see this kind of network being developed for new development, and it should be encouraged for new developments, this kind of project does not generally expand or serve existing buildings and so will not deliver the pace and scale of development that is required.

Recommendations

• We recommend that the Scottish Government continues to promote planning policy that supports the installation of new heat networks or connection to existing or planned heat networks for new development.
• In practice, this will require local authorities to develop pro-heat network policies at a local level and Scottish Government may wish to consider how this can be further encouraged/supported e.g., sharing of experiences and best practice examples from elsewhere in the UK via the proposed HNSU ‘strategic heat network planning’ initiative.

Unbundled model (DM6)

Model Description

A family of models involving separate ownership of generation, transmission / distribution and supply assets, e.g., where heat generators contract directly with customers and pay a use-of-system charge to the owner of heat transmission / distribution infrastructure.

Ranking 10

Model type Existing HN delivery model / limited examples

Conclusions and potential next steps

Promote the futureproofing of delivery models to facilitate any potential future unbundling of networks.

Other than in cases where there is an obvious industrial / third-party heat source, the development of new networks, or unbundling of existing networks, (in which generation, distribution and supply are operated as separate businesses) is generally only practicable where sufficient scale has already been achieved. It would therefore be premature to promote this delivery model in a relatively immature HN market such as in Scotland.

Recommendations

• Supply of surplus / waste heat from environment / industry into networks (e.g., Stirling Forthside, Glenrothes, Clyde Gateway, Millerhill energy-from-waste) should be encouraged and facilitated (e.g., by use of the template supply agreement we are currently developing). This can be done via the HNSU.
• In due course, heat networks may reach a scale at which unbundling becomes commercially viable. With this in mind, Scottish Government should promote the futureproofing of delivery models to facilitate any potential future unbundling of networks (e.g., by holding assets in SPVs).

Community led project (DM5)

Model Description

A community leads heat network development and owns the network, subcontracts O&M, supplies buildings within community.

Ranking 11

Model type Existing HN delivery model / limited examples

Conclusions and potential next steps

Do not promote Community led model as a means to achieve scale.

Although community led projects can have very positive policy outcomes for local communities when delivered successfully, community led projects tend to be small, challenging to deliver and often harder to fund. They can absorb skill and resource (including Government grant and advisory support) without delivering projects at scale.

Whilst we recognise there may be other policy reasons for promoting community led projects and that they are likely to have some role to play, we do not recommend that this model is promoted by Scottish Government as a means to achieve scale and pace of deployment of heat networks.

Recommendations

• If encouraging community involvement in projects is a priority for Scottish Government, case studies / guidance could be prepared.
• Scottish Government may wish to investigate and promote alternative ways in which communities could be engaged in heat networks, other than ownership (e.g., via the development of a community fund, funded by the heat network operator). This could take the form of ‘best practice’ guidance for delivering community benefit, which could feed into larger procurements. This guidance could be developed via the HNSU.

Public Private Partnership (PPP) (DM11)

Model Description

The heat network is operated by the private sector under a long-term contract tendered by a public body, where the public sector retains the majority of demand risk, but availability risk lies with the PPP contractor.

Ranking 12

Model type New HN delivery model

Conclusions and potential next steps

Do not promote PPP as a model for the delivery of heat networks.

The PPP model has many features similar to a concession model, and no additional advantages in the context of heat networks, but is more costly and complex to deliver than a concession.

We therefore do not consider this model as suitable as a means for the deployment of heat networks at pace and scale.

Unlike the merchant model, we are not aware of any market actors promoting or suggesting this model, and therefore no further steps are recommended.

8.4. Conclusions & recommendations in relation to enabling mechanisms

In section 6.4, we described a number of enabling structures / mechanisms that share some, but not all, of the characteristics of a delivery model, but which could complement and/or enable the implementation of one or more delivery models described in sections 6.1 to 6.3 above. We included section 6.4 in order to comment on structures or mechanisms which are potentially relevant for heat networks, and were raised in our stakeholder engagement, but which do not warrant full review as a ‘delivery model’.

We have concluded that there are a number of enabling structures / mechanisms which, if implemented, would also help to increase the pace and scale of delivery of heat networks. These mechanisms would, to a large extent, apply independently of the choice of delivery model for a particular project. These supportive mechanisms relate to demand assurance and procurement efficiencies.

In section 6.4 we described the various ways in which demand assurance could be achieved, and its fundamental role in de-risking investments in heat networks from a developer perspective (both public and private sector). As part of the on-going work to develop policy and regulation, we recommend that the Scottish Government should continue to seek opportunities to provide greater demand assurance to projects. Although stakeholders we spoke to were not universal in their views on which form of demand of assurance would be most welcome (e.g. support for mandatory connections appeared to be reducing), there was clear feedback that more could be done to reduce risks around demand assurance, and that steps taken did not need to be radical. For example, some stakeholders suggested that clearer policy advising that public sector buildings should connect to heat networks would go a long way to encouraging anchor loads to connect.

In section 3 we outlined stakeholder concerns about procurement efficiency, including procurement procedures, timescales and associated bid costs. In section 6.4 we described a range of approaches intended to increase the efficiency of procurements. We recommend t he Heat Network Support Unit should facilitate the development and implementation of procurement efficiency on a project-by-project basis. This could include, for example, piloting a two-stage procurement process on a live project, evaluating the outcomes and disseminating lessons learnt via a case study.

For the other enabling mechanisms considered in section 6.4, we do not consider that these merit any specific recommendations at this stage. In relation to Heat as a Service, we will continue to maintain a watching brief on how business models in this area evolve. For the ‘private company with public purpose’, this could have a potential future role in the longer term, for example as a corporate structure to manage large consolidated networks, if Scottish Government were to establish a Regulated Asset Base Model (DM12). We are not recommending either of these as short- to medium-term interventions.