CMA publishes final report on Heat Networks

3rd August 2018

On 23 July 2018, the Competition and Markets Authority (CMA) published its final report in its market study into heat networks. The CMA conducted a comprehensive seven-month study to assess whether households are “getting a good deal” and found that new regulation is required in order to protect heat network customers in a similar way to existing statutory regulation for gas and electricity customers.

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 and the government is seeking to promote the use of heat networks in the UK in order to meet the UK’s ambitious carbon targets which are likely to require an increase in the market share of heat networks from 2% to 18% by 2050.

Heat networks are generally 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 CP1 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 market study

The CMA uses market studies under the Enterprise Act 2002 as an important tool for examining how well competition works in particular markets and for assessing where it should intervene in the interests of consumers.

The CMA’s market study examined three broad themes:

• whether customers are aware of the costs of heat networks both before and after moving into a property
• whether heat networks are natural monopolies and the impact of differing incentives for builders, operators and customers of heat networks
• the price, service quality and reliability of heat networks.

The CMA’s findings and recommendations

The CMA concluded that the sector should be regulated by a public-sector body given statutory powers to set regulations, monitor compliance and enforce against heat network operators that do not comply with the new regulations. The recommended regulator is Ofgem, which the CMA considers best placed to take on this role.

Andrea Coscelli, CMA Chief Executive, stated that: “there are problems with how some [heat networks] operate, especially for those in private housing. People must benefit from the same level of protection as those using gas or electricity, and not be penalised either by paying too much or receiving a poor-quality service.”

The CMA’s report highlighted a number of issues relating to heat networks

a. Customer awareness of heat networks before and after moving in to properties

The CMA found that there was little transparency for consumers when moving in to properties supplied by a heat network. The CMA recommended better access for consumers to information regarding heat networks before signing a contract, including information regarding the age and ownership of the network, the identity of the operator and the length of the contract. Contracts provided to heat network customers should also clearly detail heat charges and the level of performance that customers should expect to receive.

b. Heat networks as monopolies

The CMA found that heat networks have features of natural monopolies, and as a result customers have no or very limited ability to switch to alternative heating systems.

The CMA recommended that, once a sector regulator is introduced, it should ensure that consumer protection is provided so that customers receive the same level of protection as customers in the gas and electricity sectors, particularly in terms of price transparency and service levels. The regulatory regime is envisaged to have a clear balance between protecting customers from the ability of suppliers to exercise their monopoly power, whilst allowing heat network operators to finance their activities and earn a reasonable rate of return on their investment.

c. The price, service quality and reliability of heat networks

The CMA found that, on the whole, heat networks provided an efficient and environmentally friendly way for people to heat their homes. Overall, prices on the large majority of heat networks were close to or lower than the price of a gas heating based comparator. However, the CMA found that some networks (particularly private networks) offer poor value for money with unit prices and average annual charges above typical comparison gas-boiler heating prices.

In terms of service quality, the CMA identified a number of concerns in relation to customer access to information about their heating, frequency and content of their bills, and consumer redress. The CMA proposes that customers should have access to an ombudsman with the ability to investigate suppliers and make binding recommendations to promote service quality.

The CMA also found that planning requirements can in some cases lead to networks which are expensive to run, meaning this cost is passed on to the customers in higher prices. This is compounded with the lack of enforceable technical standards in order to improve operational efficiency of the networks. The CMA therefore recommends new regulation to protect customers from poorly designed, built and operated heat networks which can be unreliable or expensive to run. The CMA recommends that all heat networks should be held to a new set of minimum technical standards that draw on industry expertise and promote operational efficiency. The new standards would allow for monitoring and compliance with quality standards.

The CMA recommends that the sector regulator should require all heat networks to comply with “principles-based” rules on pricing and service quality. The regulatory framework should also require networks to give consideration to the whole life costs of heat networks during the design and implementation phases, and this will affect prices in the future.

Comment

We would expect the Department of Business, Energy & Industrial Strategy and the Scottish Government will carefully review the CMA’s recommendations with a view to launching consultations regarding introducing a new regulatory regime for heat networks. The timescale for these changes is not currently clear but we expect it may take several years.

Ahead of these regulatory changes being introduced, the CMA has written an open letter to the industry, reminding energy suppliers of their obligations under current consumer and competition law. In particular, the CMA advises that all heat networks suppliers and operators should introduce:

• a priority services register for vulnerable customers and support for vulnerable customers
• a minimum standard of complaint handling
• performance measures for quality of service and responding to supply issues
• access to an ombudsman with the ability to investigate suppliers and make binding remedies.

The CMA has also published advice for existing or prospective heat networks customers advising them to be clear on the costs of heat networks before moving into a property. In particular, customers should request clear information on prices, repair and maintenance costs, service levels and energy ratings.

For new heat networks, local authorities and developers should carefully follow the development of the new regulations to ensure that their projects remain feasible. 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.

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).

How we can help

The Energy, Infrastructure and Government Team at Walker Morris advises on issues relating to heat networks and we are working with a number of parties involved in the operation, development and financing of heat networks and heat sources.

We also have wider experience of advising on heat supply agreements and energy services agreements. For developers and local authorities, we can support you in developing heat networks and reviewing the compliance of your contractual documents with competition law and consumer regulations. We also provide advice for large customers connecting into heat networks.

For further information on how we can assist, please contact David, Ben or Richard below.