Heat Networks Delivery Models

3. Challenges to achieving pace & scale

The following summary of challenges to achieving greater pace and scale of deployment of heat networks has been informed by SFT’s own experience, and engagement with a range of stakeholders from local authorities, contractors, investors and advisers during the preparation of this report. Within each stakeholder group, a variety of views were expressed, so there is no single or dominant local authority perspective, contractor perspective, etc. However, the points noted below represent themes that emerged during the engagement.

3.1. Multiple & competing policy objectives

Heat networks support multiple policy objectives: developers promote heat networks for a variety of reasons, including decarbonisation / emissions reduction; security of supply and certainty around future energy costs for the sponsor’s own estate; fuel poverty alleviation; as a redevelopment / regeneration project; and as a commercial investment.

Increasingly, national and local planning policy is driving low carbon development. This, when combined with sufficient scale and anchor loads, enables business cases for heat networks serving new developments to be cost competitive with a building-level low carbon counterfactual (typically, air source heat pumps). However, the lack of clarity around a backstop date by when existing buildings will need to switch away from gas (combined with continuing uncertainty around the potential future role of hydrogen for heating) impedes the ability of such heat networks to expand beyond the initial development site and connect to nearby existing buildings. By volume and type, existing buildings represent a much greater energy demand than that arising from new development. Building-level decarbonisation options for many existing buildings are limited (e.g., due to building type, space/noise constraints, planning restrictions) and can therefore provide retrofit opportunities for heat networks.

Historically, low carbon heat sources have tended to be more expensive than fossil fuel heating systems, and this trend is likely to return as gas prices fall again. This often leads to a tension between project objectives, where there is a desire to reduce energy costs as well as decarbonise heating supplies.

From a purely economic perspective, until recently the relatively low price of natural gas has favoured the installation of gas combined heat and power (CHP) fuelled networks. These are the predominant type of heat network in the UK. Whilst revenue from both electricity and heat sales can provide a return on investment and cost savings to customers, the decarbonisation of the electricity grid has significantly reduced the potential for carbon savings from CHP, such that this technology is now largely unsuitable for new heat networks with a decarbonisation objective. Moreover, there are a large number of legacy gas CHP networks that will need to switch to a low carbon heat source to meet future regulation.

3.2. Lack of knowledge, skills & capacity

Local authority stakeholders attest to the strong engagement around the Net Zero agenda. Many authorities have set carbon reduction / net zero targets in advance of Scottish Government’s statutory targets. Whilst there is strong awareness of, and political support for, net zero initiatives, local authorities are spreading limited resource across a range of different types of projects, including fabric improvements, EV charging infrastructure, as well as heat networks.

Local authorities have only recently been given statutory duties relating to heat networks. Many are still struggling to build, and then retain, the required technical and commercial knowledge, skills and capacity. LHEES and Delivery Plans are still in development, and there is a recognised gap in proceeding from LHEES / Delivery Plans to project identification.

Whilst all local authorities are required to consider designating heat network zones, there is no specific duty beyond this requiring local authorities to bring forward projects within zones. Some authorities are more willing and able to do so than others.

For those authorities willing to take on a delivery role, project development is seen as a long, complex and costly process. Although HNSU development support is available, alongside extensive guidance, standardised contracts and capital funding, the process is still perceived as long and resource-intensive for authorities; some have little or no engagement in the process.

To achieve projects at scale usually requires the co-operation of multiple stakeholders – land owners, and owners of anchor loads and heat sources. Stakeholders often have different objectives, and different timelines for achieving them, resulting in long project development time frames as the lead organisation tries to gain buy-in to a joint initiative.

In addition to objectives being highly project-specific, authorities’ investment capacity and risk appetite varies significantly. Some authorities are willing to invest in heat networks and own and operate them themselves, whilst others are more risk averse, have limited investment capacity and/or wish to prioritise other types of investments. From a market perspective, this results in a lack of consistency in how local authorities bring projects to market.

Given most authorities’ lack of in-house skills and capacity relating to heat networks, there is a high degree of reliance on a relatively small pool of external technical, financial and legal advisers. A lack of suitable procurement frameworks available to local authorities means it can be time-consuming and inefficient to procure advisers. Some projects require several procurements in order to navigate through the different stages. Retention of key personnel within advisory firms is also an issue.

Although the advisory (and wider contractor) market is aware of Scottish Government ambition and supportive policy for heat networks, the lack of visibility of a clear project pipeline means it is difficult to justify recruitment to build delivery capacity in Scotland.

3.3. Demand assurance to encourage investment

The market can readily identify potential projects from a technical perspective, using the Scotland Heat Map / First National Assessment. For such projects to be investable, heat network developers need certainty that sufficient customers will connect to the heat network when it is available.

Most developers will not invest significantly without customer contracts to provide assurance that there will be sufficient demand to recover their investment. The absence of such ‘demand assurance’ is a key reason that developers can be unwilling to invest in large-scale heat networks. This is generally true for both public and private sector developers, although their objectives, investment criteria and risk appetite tend to be different.

Sufficient demand assurance can be achieved by developers entering into long-term agreements with owners of anchor loads. The most attractive anchor loads are usually large public buildings, where there is confidence in a high heat demand that will be sustained over many years, combined with low counterparty risk. However, the high dependence on public sector anchor loads usually translates to a requirement for some form of public procurement exercise (see further below).

Demand assurance can also be achieved through other means, including:

• planning policy for new development - a requirement for developments within or adjacent to heat network zones to connect to existing or planned networks;
• mandatory connections for certain types of buildings within heat network zones; and
• certainty around a timeline for banning the use of fossil fuel heating systems within existing buildings.

Stakeholders, both public and private, are clear that policy & regulation need to provide greater demand assurance in order to de-risk potential projects and unlock investment at scale. There is, however, no fixed view as to how this should be done: the end is more important than the means.

3.4. Public procurement

Public procurement of heat networks is perceived by many stakeholders in the market as an unnecessarily long, complex and expensive process. Procurements can take over a year, requiring bidders to commit significant resource and cost. Contractors recognise resource and cost need to be incurred to develop designs etc., but consider that too much bid resource is required at a relatively early stage in the process, when multiple bidders can be carrying out design development and financial modelling simultaneously.

The market stakeholders we engaged with perceived the ‘standard’ public-sector led project development process as time-consuming and inefficient, resulting in reference designs developed by local authorities that are expensive to produce, of limited practical value once developed, and seldom adopted by the private sector, who rely on their own designs. There is a strong market demand for procurement to be streamlined and to get the successful bidder appointed earlier in the process so that they can inform design and avoid duplication of effort.

The practical consequence of this is that contractors are becoming increasingly selective when screening opportunities, and will (everything else being equal) favour bidding for projects where the procurement process is streamlined, has a clear timetable and a competent and well-resourced local authority project team. In a market with relatively few contractors and an increasing pipeline of projects, authorities need to think carefully about how to structure not just the project, but also the procurement, to ensure a good market response.

A minority of private sector stakeholders questioned the need for, and benefit of, local authorities designating heat network zones leading project development and/or procuring heat networks. Their preference is for local authorities’ role to be limited to facilitation (through supportive planning policy, granting land rights for energy centres / pipes, and leveraging local stakeholder relationships) and acting as a customer by offering anchor loads. Such contractors question the need for regulated public procurements, long-term concession contracts and/or exclusivity within heat network zones, and would prefer to compete with other heat network operators based on price and service offering.