Utility infrastructure is critical for any new development or regeneration scheme. That may be increasing the capacity of existing infrastructure - such as a new or upgraded electricity substation or transformer - or providing new supplies.
In our experience, private investors’ and developers’ ESG goals are often aligned with the government’s target to achieve net zero by 2050. Developers of new commercial and large residential buildings are increasingly avoiding gas, preferring instead to use low carbon, more sustainable options to generate hot water and heat their buildings. Any investor acquiring an interest in an existing building will be particularly interested in the building’s current and future environmental credentials. Renewable power is part of this solution and Hogan Lovells has for years been advising on the development of this sector, including through our work advising on offshore wind infrastructure.
On many large redevelopment schemes, a district heating network (“DHN”) may be used to supply heat and hot water to buildings. A DHN centralises the production of heat (in the form of hot water) in one or more locations, and this heat is then distributed to buildings via a system of flow and return pipes. Each building then draws heat from the network, typically via a heat exchanger. In the right locations, and with the right technology, buildings can be heated reliably, more efficiently and with a lower carbon footprint than the alternatives.
Utilities regulation
Traditional utilities of power, gas, water, drainage and telecoms are regulated. Other utilities serving buildings, such as DHNs, shared sprinklers or other fire safety systems, and other private supplies, have not traditionally been regulated. Such private utilities have relied on parties making contractual arrangements, which are often hard to negotiate and costly. Given these difficulties it is no surprise that DHNs currently supply only 3% of heat in England.
The Energy Act 2023 establishes the framework for regulating heating networks, and Ofgem will be appointed as the regulator of heat networks across England, Scotland and Wales. The government has already consulted on regulations, which are expected to come into effect in 2025.
The Energy Act also establishes a framework for the introduction of zoning regulations, which could be introduced as soon as 2025 and the government is currently consulting on these.
Zoning
The proposed heat network zoning regulations could significantly impact both developers of new buildings, and owners of existing buildings. Across England, there will be designated zones where many new, and crucially also existing, buildings will be required to connect into a DHN. The Energy Act gives the government powers to introduce zoning regulations.
The government hopes zoning regulations could increase the total heat supplied from DHNs in England to 20% by 2050 – a significant jump from the current 3%. There are some difficult details that need to be resolved in order to achieve this goal. We have picked three aspects of the proposals that will be of particular interest to developers and existing building owners:
- Why create zones?
The proposals introduce a new “Central Authority” which will be responsible for designating zones within England, using a model, to be developed by the Department for Energy Security and Net Zero. This may include areas which have existing low carbon heat sources that could be used to heat a DHN. The DHNs within these zones will then be subject to national emissions limits.
There has historically been only small scale investment in DHNs partly because it is difficult for investors to secure an adequate return. Put simply: why build an expensive network without the certainty that buildings will connect to it? In existing private DHNs, this barrier has predominantly been overcome by community led schemes, local authority led schemes or large regeneration schemes which have a single landowner or master developer that can control which buildings and occupiers connect into the DHN, such as at Battersea Power Station.
The government’s zoning proposals aim to solve this issue by:
i. requiring any new buildings within the zone, which have received planning permission following the designation of the zone, to connect into the designated DHN or be made “heat network ready” if the DHN isn’t ready; and
ii. requiring some existing buildings within the zone to connect into the DHN. These buildings include communally heated buildings, and some non-communally heated buildings, but excluding existing residential building with individual heating systems.
The implementation of a designated zone at a local level will fall to a “Zone Coordinator”, which is likely to be a local governmental function. The consultation envisages that the Zone Coordinator will be responsible for notifying a building owner when it is required to connect into the DHN and what the connection window is. The Zone Coordinator will also be responsible for seeking private heat network developers (via a competitive process) who will have the right to develop the DHN within all or part of the zone, and benefit from the exclusivity arrangement summarised above.
The metrics for determining whether a building has to connect to the DHN, the exemptions available, and what “heat network ready” means are likely to be some of the more difficult questions. Developers will, in particular, be wary about being required to connect into a DHN that may not exist when their new building is finished, and any potential cost and carbon savings will be undermined if developers have to provide an interim dedicated heating system. Conversely, if a new building is required to connect into the DHN, then how this interacts with the development programme, and its financial viability, will be critical.
- Pricing
When appointing a DHN developer, the Zone Coordinator responsible for implementing a designated zone may also impose pricing conditions. However, these pricing conditions are unlikely to apply to large non-domestic consumers. The consultation emphasises the importance of transparency and standardised template documents. The consultation notes that while certain buildings will need to connect into the DHN, “they will not compel buildings to use the heat provided via the connection. The heat network developer will be responsible for setting or negotiating the commercial terms of a heat supply contract with building owners”. This means that buildings could be connected to the DHN but still be heated by traditional sources. In practice, developers will find it unattractive, and potentially more expensive, if they have to design and construct buildings to be heated with different sources. Once a new DHN within a zone is established and pricing more certain, then this should reduce the risks considerably, but there needs to be clarity at an early stage.
- Property rights
One of the current challenges is that the DHN energy centre is often located far away from the building it supplies. As unregulated utility companies, DHN providers currently have no statutory rights to run connections between the two. All of these rights have to be negotiated with individual landowners, which can be difficult, costly and time-consuming.
Ofgem will soon become the regulator for heat networks. Part of its role will be to grant licences to DHN developers which will grant statutory rights to access and use land.
Existing DHN operators may therefore get new statutory powers which are similar to electric, gas, water and telecoms companies. If the number of DHNs is to expand, then these powers will be necessary to reduce costs and delays.
This could also potentially be a concern for existing landowners if a DHN operator wants to install pipes through a private road or other land designated for development. Suitable “lift and shift” rights may alleviate these concerns, and they also may be less problematic than similar issues that arise under the Electronic Communications Code.
The zoning consultation is not directly concerned with how this licensing regime will work. However, it does envisage that if a Zone Coordinator appoints development rights to a DHN operator, they will not automatically be licensed from Ofgem. The grant of a licence may be a pre-requisite before being given such right to develop. These two regimes will need to work together to ensure that DHN operators in zones have the necessary rights to construct the DHN and connect into buildings, while at the same time ensuring there is adequate competition between prospective DHN developers within zones.
What Next?
Documenting existing private DHNs can be challenging because of the wide variety of issues (whether that be building specific, technological or relating to specific land ownership structures). For DHNs to be effectively regulated, and for the number of DHNs to increase, many of these issues with need to be dealt with in regulations. The consultation seeks input on many of these issues, and the deadline for responses is 26 February 2024.
