Getting warmer – What appointing Ofgem as Heat Networks regulator means for building a Market Framework for regulating heat in the UK

On 29 December 2021, the Department for Business, Energy & Industrial Strategy (BEIS) published its “response” (the “Response”) to the “Heat Networks: Building a Market Framework” consultation (the “Consultation”) which sought views on the legislative and regulatory changes required to develop and support the UK’s heat network market.

We’ve taken a look at the key features of the Response and what this tells us about the future regulatory structure for the regulation of the UK heat sector.

A new regulatory regime

As part of the UK’s commitment to reaching Net Zero by 2050, the UK Government has been exploring ways to encourage and support the decarbonisation of heat. The Government has taken a multi-pronged approach which has included consulting on a new market framework for heat networks; publishing a new Heat and Buildings Strategy (our analysis of which can be found here); considering the future role of the gas grid; and investigating the feasibility of using hydrogen to heat buildings. Growing the number of heat networks operating in the UK is one step which could make a significant contribution towards meeting the UK’s Net Zero target. Heat networks are currently unregulated and the new regulatory regime is intended to give heat network market participants new statutory rights to develop heat networks, strengthen consumer protection and promote investor and lender confidence in the market.

Appointment of Ofgem as Regulator

A key feature of the Response is the confirmation that Ofgem is to be appointed as the new regulator for heat networks. This follows broad support for Ofgem’s appointment from respondents to the Consultation.

Ofgem currently regulates the UK’s gas and electricity networks market and can therefore draw on a wealth of experience to regulate the heat networks market, particularly in respect of designing and enforcing consumer protection rules, as well as in designing and setting price controls. Its existing role as gas and electricity network regulator also means that Ofgem can ensure that heat networks are considered as part of an integrated energy ecosystem as the UK aims to transition to net zero.

The intention is for Ofgem to regulate all heat networks in the UK, regardless of size, technology type or ownership structure. This will include both existing networks and any new ones constructed following enactment of the new regulations. Ofgem will also act as regulator for the separate Scottish heat regulatory regime (further information on which can be accessed in our Law Now on the Heat Networks (Scotland) Bill).

Scope of Ofgem’s role

Ofgem’s role will include setting rules and standards on pricing, provision of information, guaranteed service levels and consumer protection. It will also be responsible for reviewing and granting licence applications from heat network suppliers.

Given the breadth of the heat network market, we anticipate that the new rules will predominately be formed of outcome-based standards, so as to apply fairly across the market.

Authorisation Regime and Licence Applications

The Consultation also sought views on whether heat network regulation should be by:

• General Authorisation;
• Full Licencing Regime;
• General Authorisation with obligatory licence above a size threshold and optional licence for rights and powers; or
• General Authorisation with optional licence for rights and powers.

The Response confirms that the Government intends to introduce a general authorisation regime. This will require both heat network operators and heat suppliers (including where both roles are performed by the same entity) to be authorised by Ofgem. Ofgem will set the requirements for authorisation, the minimum technical standards to be met by authorised parties and will monitor and enforce those standards. It is proposed that the minimum technical standards be built on the existing ADE-CIBSE Code of Practice for heat network development and operation and that compliance be demonstrated through an assurance scheme, such as third-party certification from an accredited certification body.

The Government also intends that heat networks be eligible to apply for licences to become statutory undertakers. This will bring heat networks in line with other regulated utilities. Ofgem is intended to be responsible for reviewing such licence applications, granting licences and setting licence conditions. Heat networks that become ‘statutory undertakers’ will then be able to use land/access rights, permitted development rights, linear obstacle rights and street works permits.

Consumer Protection

Another key feature of the incoming regulation will be an enhanced consumer protection package for heat network customers. This will include transparency requirements, such as requirements for suppliers to provide new customers with a minimum level of information and guidance on heat networks and requirements to provide existing customers with minimum levels of information, such as on heat supply agreements and billing. Additionally, Ofgem will have powers to mandate and enforce price transparency. Such powers will sit alongside pricing powers which will give Ofgem the ability to introduce rules on fair and consistent pricing and to take enforcement action to prevent disproportionately high prices. The introduction of price caps is not currently being considered but could be introduced in future if there is evidence of widespread consumer detriment.

It is proposed that Citizens Advice be appointed the consumer advocacy body for heat networks in England & Wales and the Energy Ombudsman is to take on the role of independent ombudsman for consumers. Each organisation will play a key role in advising consumers and addressing compliance issues within the market. Their work will be supported by Ofgem, who will have the ability to share information gathered through its market monitoring powers.

Step-in arrangements will also be introduced within the new market framework to avoid disruption of supply to consumers. There are also plans to introduce a special administration regime to protect consumers against supplier insolvency. This could also include a Supplier of Last Resort arrangement, where a new heat supplier is required to take over supply at short notice because of the revocation of an authorisation or the special administration of the existing supplier. Such an arrangement ensures that consumers are not left without a heat supplier if theirs becomes insolvent or loses a required authorisation.

Enforcement Powers

Ofgem is to be responsible for resolving cases of systematic non-compliance with the new regulatory framework (with the Energy Ombudsmen dealing with individual consumer complaints). It is intended that Ofgem will have enforcement powers equivalent to those it currently has for the regulation of the gas and electricity markets. These include provisional and final orders, financial penalties, consumer redress orders, revocation of authorisations or licences, and powers to address schemes operating on an unauthorised basis. To ensure fairness across the varied heat network market, financial penalties imposed on regulated networks are likely to be dependent on factors such as size of the regulated entity (for example based on the number of consumers served) and scope of non-compliance, to ensure penalties are proportionate to breaches of the regulations. In respect of revocation of authorisations or licences, Ofgem will have the power to revoke an entity’s authorisation/licence for either a specific heat network (if problems are scheme-specific) or for all heat networks held by the relevant entity (if problems are systemic).

Next Steps

The release of the Response and the clarity it brings on the future regulatory framework will be welcome news to stakeholders in the heat network market. However, the proposals in the Response still need to be scrutinised and implemented. This will require significant further technical, financial and legal analysis.

The detailed regulations which implement the framework will be put in place through new secondary legislation, technical standards, Ofgem conditions and guidance. The Government intends to consult in further detail before introducing such secondary legislation. However, it has not yet indicated when such consultation will be released. With this in mind, the legislative agenda set out in the next Queen’s Speech will be watched with interest by the industry.

Ofgem has indicated that an implementation period of some 18 months would follow the enactment of any secondary legislation, therefore we anticipate that the regulatory framework will be in place sometime from early 2024. Regulatory implementation may also be transitional, rather than consolidated and all-inclusive at the outset, with some elements of the regulatory framework coming into force before others.

From a practical perspective , those operating in the industry are advised to become familiar with and take steps to implement current guides on good heat network practice, such as those set out by the Heat Trust and the ADE-CIBSE Code of Practice, as the rules and principles they contain are intended to play an important role in the foundation of the new regulatory framework.