Case Study Hero

Regulated Asset Base for Financing Low Carbon Heat

It is very evident that equipping homes to become low carbon homes is dependent on:

  • government intervention to kick start the process and drive down supply chain costs;
  • capturing the value of flexibility intrinsically available with more capital-intensive low carbon technology could significantly reduce transitional and long-term operating costs;
  • capital market engagement to provide continuity of funding;
  • digitalisation so that consumer equipment behind the meter is capable of engaging in energy markets;
  • energy markets rewarding owners of assets beyond the meter that participate in avoiding future capacity costs and increasing asset utilisation levels upstream of the meter; and,
  • existing asset owners upstream of the meter transferring value to digitally engaged consumers for providing flexibility services.

PassivSystems has reviewed Dieter Helm’s presentation on Regulated Asset Base (RAB) and we would like government and the energy industry to consider adopting RAB as a mechanism for financing the deployment of low carbon heat as an infrastructure investment under a government administered RAB scheme. We have set out below an approach for including low carbon heat in the government’s COVID recovery plan? Our approach recognises that government currently does not have access to all the information needed to make a decision about the long-term role of hydrogen and therefore we are proposing hybrid heating systems are supported under the scheme because they:

  • are compatible with the larger scale deployment of hydrogen in the distribution network that may/may not materialise at scale over the course of the next decade;
  • address an immediate need, as flagged by the CCC, to make material progress on heat decarbonisation, especially as we approach the 4th carbon budget (2023-2027), which represents a step change in emissions reduction, with an assumption some of this is provided through decarbonising homes;
  • offer least cost and therefore best value for money, have been demonstrated to be liked by consumers and provide a no regrets approach to the counter-factual of investing in 1in20 year security of supply capacity, failing to deliver momentum into the heat pump market and bringing down the cost of low carbon heat in particular heat pumps (1)

Basic Principles:

  1. Supported by predictions made by National Grid’s Future Energy Scenarios and The Climate Change Committee, HMG accepts that in the 2020’s deployment of more than 5 million heat pumps is a justified national infrastructure investment.
  2. RAB creates a mechanism whereby the vulnerable and fuel poor can be targeted ensuring they are the primary beneficiaries of some of the benefits that are expected to accrue to early adopters.
  3. Support for a nationwide market will allow scale economies to be realised in the most costeffective way early on, and allow for the RAB to be tapered off in time. It will step down the country’s carbon footprint on the way to a final, carbon free, solution in +20 years, and at the same time generate jobs – greening the recovery.
  4. HMG accept that a RAB model is the cheapest and easiest way to get the low carbon heat market mobilised and that it should be universally implemented – i.e. on all eligible homes (other than those supported by or to be supported by heat networks or with all electric heating).
  5. The cost of the scheme becomes self-funding over time through supply chain efficiency improvements and value creation from equipment fitted with grid aware controls capable of increasing energy system asset utilisation rates and reducing protecting security of supply costs. The energy industry has put forward numerous proposals to BEIS and ofgem of ways in which the market can be reformed to realise the value of flexibility. The FREEDOM project (2) identified potential savings per household of £250 and £500 per annum. HMG needs to ensure these reforms are implemented in parallel with RAB.

The financial process:

  1. Installers install to a specification (see “Regulation”, below)
  2. The asset and its cost of installation is then transferred to the RAB when the installers are paid.
  3. The RAB is financed by HMG in the first instance.
  4. A return in the RAB is set by Ofgem. This return is set as a Weighted Average Cost of Capital (WACC) based on 80% debt and 20% equity.
  5. The RAB is depreciated over the life of the assets (say 15 years).
  6. Both the RAB return and RAB depreciation are added to electricity bills, on the basis of a “per customer” charge rather than a usage charge. (See comments in “Implementation” below how to structure the implementation to support fuel poverty).
  7. The amount added to electricity bills is collected by suppliers and then handed on the HMG’s paying agent.
  8. All of the above are calculated in real terms.
  9. As and when it suits HMG can auction off part or all of the RAB to repay the cost of the infrastructure.
  10. The WACC should be set using the rolling cost of debt mechanism Ofgem use for DNOs for the debt portion. For the equity portion, Ofgem should set a permanent Equity Risk Premium (ERP) at the start and then update the cost of equity by adding the ERP to the
    Index Linked Gilt Yield for the Gilt due at the end of the average remaining life of the RAB.

Regulation

  1. The Regulator (Ofgem) would construct a specification sheet, as a standard quoting tool. Standard costs for the tool to be determined by Ofgem (and their consultants).

    This would cover:
    a. Eligibility – this should confirm that the property is not heated by a “dry” electricity system or existing approved low carbon heating alternative e.g. heat network.
    b. Heat demand (determines size of heat pump and type of installation depending on thermal performance of building e.g. hybrid or pure heat pump).
    c. Installation cost and materials.
    d. Digitalisation – the requirement for equipment to be installed with Grid-aware controls (3)

  2. To make sure that no house can be done twice, the DNO’s Meter point administration system (“MPAS”) should be amended to include a yes/no with respect to whether a heat pump has been approved for that property/meter, and a yes/no as to whether the heat pump has been installed.
  3. Once a quote meets the standard quoting requirements in (1) above, and MPAS confirmation is received that no heat pump exists or has been approved, work is authorised.
  4. Checking the quoting system and MPAS can all be done electronically – it’s a data flow.
  5. DNO staff should inspect each installation at commissioning and then, if satisfied it is safe, make the change to MPAS to confirm installation.
  6. Ofgem would have responsibility for delivering the rollout.

Implementation

  1. Any approved contractor can do the installation provided that they use approved parts etc (see Resourcing below).
  2. Installers compete to deliver RAB approved assets in a particular region/area through a tender process. However, because the savings from the heat pump accrue longest to the earliest installations, Ofgem may want to specify who gets installed first i.e. all vulnerable
    customers/social housing first: that way the socialised cost of the national installation program is not borne by those least able to pay – they get the benefit of lower fuel bills first.

Resourcing

  1. Local academies will need to be set up or adapted in partnership with industry to retrain the workforce.
  2. The grid-aware heat pumps should be UK manufactured, under licence if necessary, in order to be approved parts for installation. (By either existing or new manufacturers). This will take time to establish and therefore manufacturers will need to be given time to fully comply (subject to any regional grants the government feel useful to apply to stimulate economic growth in particular regions).
  3. Procurement of all other parts including software components and services needed to meet the specification should place an emphasis on UK produced and delivered content.

Summary process:

  1. Ofgem set the quoting parameters, and tender out chunks of the works.
  2. The trades respond to the quote, and whoever wins sends details to the DNO for MPAS and orders the equipment from approved suppliers.
  3. Installation happens.
  4. DNO signs off.
  5. HMG paying agent sends trades the money on invoice.
  6. Trades pay the suppliers when they receive the money. (No credit risk to Ofgem or HMG).

 

Colin Calder
CEO & Founder
colin.calder@passivsystems.com

 

(1) DECC Potential Cost Reductions for Air Source Heat Pumps 2016 – 12kW 50-60% reduction in non-equipment cost in a mass market scenario compared to 2014.

(2) An Ofgem NIA funded project – Freedom Report

(3) Grid-aware control is the ability for grid connected equipment to behave in a way that creates value for the consumer and / or energy system in response to price, carbon or any other type of signal provided by an energy system actor (e.g. TSO, DNO, Supplier, etc.). To
achieve this the controls must be able to:
(i) forward predict energy generation / demand;
(ii) learn consumer and equipment behaviour; and,
(iii) respond to weather conditions.
The control outcome must take into account and deliver upon consumer preferences and be capable of participating in an aggregated demand response.