CMA proposes regulation for heat networks

15th May 2018

On 10 May 2018, the Competition and Markets Authority (CMA) announced its emerging thinking in its heat networks market study and proposed that heat networks should face additional regulation.

The CMA found that, in many cases, heat networks offer consumers an efficient supply of heat and hot water at prices which were the same or lower than other potential sources of supply but that more could be done to protect consumers in a similar way to gas and electricity customers are currently protected by statutory regulation.

Heat networks

Heat networks are systems that heat multiple homes from one central source. Currently around half a million homes in the UK are supplied through approximately 14,000 heat networks, according to CMA figures. Such networks have become increasingly popular in recent years as local authorities and developers aim to deliver lower carbon energy to households. Heat networks can be more efficient than each household having its own gas-fired boiler.

Heat networks are generally currently unregulated and do not face the same level of price controls as gas and electricity suppliers, although there are some regulations in relation to metering and billing under the Heat Network (Metering and Billing) Regulations 2014. Heat network suppliers are sometimes members of self-regulatory schemes such as the Heat Trust Scheme and the CPI Code of Practice, which provide a certain level of consumer protection. Suppliers may also offer ‘price promises’ to benchmark their prices against gas suppliers, providing some degree of comfort to customers about price levels.

The CMA’s emerging thinking

The CMA’s press release states that, for many, heat networks offer prices which are the same or lower than people on a gas or electricity tariff and have comparable levels of customer service. This is often because heat networks prices are set by reference to what one would pay if using an individual gas boiler and a regular gas supplier connected to the gas network.

However, the CMA had concerns that some customers on private networks and in rental properties were paying too much and that customers were not getting the same level of protection as normal gas and electricity customers.

The CMA found three main areas of concern which it will consider further:

• Design and build – some property developers may try to cut the upfront costs of installing a network, resulting in higher ongoing operating costs, usually paid for by customers. Heat networks may also be installed where they are the best way to meet planning requirements, rather than the best solution for customers.
• Monopoly of supply – because customers often have no alternative sources of heat and may be locked into long-term contracts, they cannot hold suppliers to account on price or quality.
• Low transparency – before moving in to a property, people often do not know that their energy will be supplied by a heat network and once people are living in the property, customer bills often fail to set out key information.

Given these concerns, the CMA has announced its provisional view that the heat network sector should be regulated. This will provide additional protections for consumers, further regulation on the design and build of heat networks and possibly rules relating to price, quality and customer agreements.

Next steps

The CMA has published a number of potential recommendations in its report available here and welcomes views on its proposals by 31 May 2018.

The CMA is also seeking views on which regulator would be best placed to regulate heat networks. We would see Ofgem as being the natural candidate given its sector expertise in the area of energy.

The CMA states that it expects to publish its final report in summer 2018. We would then expect it to make detailed recommendations to government for its proposals in relation to heat network regulation.

Comment

Any future regulation of heat networks will need to be carefully considered given its likely impact on existing networks as well as the development of future networks.

The prospect of new regulation may create some uncertainty in relation to new projects. In April 2018, the Government announced that a £320 million funding scheme, the Heat Networks Investment Project (HNIP), is due to open for applications in autumn 2018. This is intended to help to promote investment in heat networks both by local authorities and the private sector. Local authorities and developers assessing project feasibility should carefully follow the CMA developments to ensure that their projects will remain economically viable. In particular, new regulations in relation to the design and build of heat networks may increase capital expenditure costs and any future price regulation may also have an impact on investment returns.

For existing projects, the CMA is consulting on how the implementation of minimum standards should be applied to existing heat networks. If minimum standards were to be applied to existing projects, that could lead to increased operational costs, if improvements to existing networks were to be required. Any future pricing regulation would also likely apply to existing networks so contractual allocation of risk in response to changes of law is likely to be a key factor in where the increased cost burden lies.

In terms of future pricing regulation, the CMA sets out its preference for a ‘principles-based’ approach rather than prescriptive rules on pricing. This would allow for some flexibility in terms of pricing which could include pricing by reference to a ‘cost-plus’ approach or by allowing for pricing by reference to a relevant benchmark (such as the price of using a gas-fired boiler connected to the gas network).

In relation to customer transparency, any future regulation is likely to mirror to some extent existing voluntary schemes such as the Heat Trust Scheme and the CPI Code of Practice. However, we would expect this will go further to ensure that customers are provided with detailed pre-contractual information and heat supply agreements which set out key performance indicators and guaranteed terms of service in particular in relation to response times, customer call centres, tariffs and dispute resolution procedures. Again, this may have the tendency to raise operating costs, but will provide customers with an increased level of protection.

The Energy, Infrastructure and Government Team at Walker Morris advises on issues relating to heat networks specifically and are also working with a number of parties involved in the operation, development and financing of heat networks and heat sources. The Competition Team has extensive experience of advising on CMA market studies and Trudy and Richard have both spent time working at the CMA and its predecessors. For further information on how we can assist, please contact Trudy, David or Richard below.