Heat networks – climate emergency medicine?

Many local authorities have declared a “climate emergency”, sometimes committing to carbon neutrality within particular timescales in their authority areas.

One of the issues that is often in the “difficult” box is gas heating, which currently largely relies on individual boilers. Heat networks can be a part of the solution.

Heat networks – what are they?

Put simply; a heat network is a communal system where an energy centre produces heat that is transported through pipes to properties on the network. Heat can be generated in the energy centre using either renewable sources (such as heat extracted from the ground or biomass, which is essentially woodchip) or by more traditional sources such as gas or by recovering energy from waste.

Heat networks are now considered as a good option for any new development or significant regeneration scheme, often as a result of planning requirements or energy efficiency considerations (such as BREEAM). It is a significant piece of community infrastructure, often requiring a very long period to generate any return on capital, so local authorities usually play an important part in making any network happen.

What are the legal issues?

There are many legal issues, from a possible requirement to engage with tenants under the Service Charges Consultation Regulations to negotiating necessary property rights to lay the network. However, this article focuses on procurement and State-aid issues because, in our experience, upfront thinking on these two matters can help to avoid untold delay and frustration.

Procurement

Important strategic procurement choices are required very early on in any scheme. There is no settled “industry standard” way of procuring a heat network. The procurement strategy will depend on how much control and risk the authority wishes to assume in the scheme.

Control over heat networks is important because a statutory regulatory regime is still not yet settled. Heat network customers are essentially subject to a monopolistic supplier, being unable to switch. Unlikely other regulated utilities, there is currently no “supplier of last resort” for heat or statutory protection for vulnerable customers who might be cut off. Whilst there are useful voluntary codes such as the Heat Trust standards, local authorities still have to be wary about retaining a base level of control over the arrangements.

In terms of risk, heat network schemes are usually at the edge of commercial viability. There is often significant sensitivity to phasing and certainty of customers. An energy centre and network are often built to serve a multitude of sometimes yet to be developed facilities or premises. If a particular high-demand facility, such as an extra care or leisure centre, is delayed by a couple of years, this can significantly alter the viability of the whole network. Understanding who is taking and sharing these risks is key.

The main procurement considerations are:

1. The extent to which the authority procures a concession arrangement for either the whole of the scheme, or just for the operation of the network once it is constructed. Under a concession arrangement, the opportunity to exploit the system is granted to an operator who takes on the income, demand and maintenance risks. This might be attractive from a risk transfer perspective, but it is more difficult to achieve the degree of control that many authorities would want;
2. Alternatively, the authority procuring each aspect of the scheme itself through contract arrangements. This would include procuring contractors for the build of the energy centre, supply of specialist equipment, and operation and maintenance of the system. This would allow the authority much more control over how it interacts with customers and operation requirements for the system but is likely to leave most of the commercial risks with the authority. There are various combinations of how the packages of works, supplies and operations can be split, again giving different levels of control and risk transfer.

Authorities will have to engage with either the Concession Contracts Regulations 2016 or the Public Contracts Regulations 2015 (PCR) at the outset. The challenge of either set of Regulations and procurement in general, is to adopt an approach that (1) allows maximum engagement of the market whilst avoiding costly bid processes, (2) delivers value for money for the authority by setting appropriate weightings for well-selected award criteria, and (3) has sufficient flexibility so that if circumstances change (such as the available funding pots), then this does not cause the authority to have to abandon and re-procure. Authorities should consider very carefully which procurement route is best going to achieve its objectives. Under the PCRs, it is worthwhile considering the competitive procedure with negotiation that allows some flexibility to negotiate with bidders to improve bids during the procurement process, but does not carry the reputation of creating high bid costs that are associated with competitive dialogue.

State aid

The purpose of State-aid law is to prevent State resources (including local authority resources) being given to subsidise any business activity that could lead to distortion of the market. There are many “State” resources available to promote heat networks including capital and revenue grants and loans. The Department for Business, Energy and Industrial Strategy runs the Heat Networks Investment Programme under which £320million is being made available to fund capital investment. Other funds are also available for feasibility, together with European Regional Development Fund (ERDF) funding and Renewable Heat Incentive payments. Whilst it is welcome that so much funding is available, using multiple funding sources requires due diligence to check that the funding terms and in some cases legislation (for example the Renewable Heat Incentive Regulations) does not prevent different sources of funding being used on the same project or for the same types of equipment.

Local authorities need to be clear about how any grant, loan or another subsidy can be used as lawful State aid. State-aid solutions can become more complex when local authority SPV or trading subsidiaries are involved. There is a range of routes available to ensure aid is lawful, the most solid of which is found in the General Block Exemption Regulations (GBER). Provided local authorities comply with all the requirements of GBER (which are many and varied), then Article 46 allows a “subsidy” of 50% of the extra capital required to make the scheme more efficient compared to installing a basic system. This is helpful, but reasonably restrictive and sometimes more creative arguments are needed as to why no unlawful aid is present.

Conclusion

Planning and executing a phased heat network project with multiple contractors, suppliers, stakeholders and funding sources is not straightforward. However, as there is no planet B, and as the general population constantly grows in awareness of the need to be good stewards of the Earth’s resources, there will be no alternative for even the least forward-thinking authorities to engage with this agenda. For the more progressive authorities, learning from others and leaving sufficient time to plan and manage risks will lead to a successful outcome.