So much of the heat which surrounds us in our daily lives is wasted. Examples of this include the heat produced by data centres, or ambient heat found in wastewater treatment plants, lakes, rivers and disused coal mines. Heat networks open up exciting possibilities to harness this residual heat as a low cost and low carbon heat provision solution.
If you are the owner of a heat source – or control access to one – you may be considering this opportunity to mine an additional source of revenue (and strengthen your ESG credentials).
But does that heat really belong to you? To put it another way: who actually owns the heat?
In this article, we examine what a heat source owner can sell. We also examine the key commercial and legal factors that heat source owners need to consider before agreeing terms with heat network developers.
Can heat be owned (and does that matter)?
Unlike most other things we buy and sell, heat itself cannot be owned in the conventional sense. However, it can be measured and is therefore capable of being bought and sold. (In this respect, it is similar to electricity.) Heat – like any form of power, refrigeration or ventilation – is considered ‘goods’ for VAT purposes. However, there are some tricky legal questions which have not yet been answered, including whether heat comes under the definition of ‘goods’ for the purposes of the Sale of Goods Act 1979 (which imposes certain warranties and implied terms on the sale of ‘goods’). This matters because:
(1) as the owner of the heat source, you need assurance that the contract you are relying on to generate the relevant revenue is robust; and
(2) the heat network developer needs assurance that it has secure access to the heat it is relying on to operate its business.
As the heat networks sector evolves, these questions will be answered.
Control of access to heat
To address the issues identified above, the owner of a heat source can sell access to the heat rather than the heat itself. This offers a clear analogy to the exploitation of wind and solar power for the generation and sale of electricity. Such exploitation often involves arrangements in which an owner of land with access to wind or solar power sells access rights (to the resource) to the electricity generator.
This can be illustrated by the example of the exploitation of wind power by the Crown Estate (TCE). TCE owns the territorial seabed around England, Wales and Northern Ireland. TCE leases certain areas of the seabed to offshore wind developers for the installation of offshore wind turbines. The leases granted by TCE provide offshore wind developers with access to the seabed, which allows them to install infrastructure to convert kinetic energy in the wind into electrical energy (which the developers then sell). At no point does TCE purport to sell the kinetic energy in wind, or guarantee that it will be available.
In terms of the revenue this arrangement will generate, the rent payable by an offshore wind developer to TCE during the construction phase of a project is often a proportion of the projected electricity output of the offshore wind farm. Once construction has finished, TCE often takes a percentage of the revenue of the offshore wind farm, subject to a pre-determined floor that is based on the projected electricity output. The structure of the payments therefore provide that TCE can take a proportion of the profit that the developer makes, whilst ensuring that project risk remains with the developer.
Similar arrangements, tailored for heat networks, may be considered by owners of heat sources and heat network developers.
Retaining adequate rights
If, as the heat source owner, you decide to sell access to heat, you may need to ensure that you do so on terms which don’t interfere with your ability to continue using your relevant land and infrastructure for other purposes (and which may be essential for you to carry on other business).
Where TCE leases an area of the seabed to an offshore wind developer, it retains a broad range of rights to use the area that is leased to the developer. Although TCE is generally not able to use the relevant seabed (or grant rights to others to use it) in a way which is at odds with the offshore wind developer’s use, there are some exceptions.
One key exception is the ‘oil and gas clause’ that is included in offshore renewable leases. This clause provides that TCE may end the lease, following a request from the Secretary of State, for the purposes of allowing an oil or gas development to proceed.
Similarly, when agreeing the terms on which you grant a heat network developer access to the heat, you are likely to want to retain the right to use your land and infrastructure for the purposes of your business (and to comply with any regulatory requirements to which you are subject).
Key commercial considerations
1: Minimum levels of heat
Where heat is produced as an ancillary part of a business, depending on the source of that heat, the heat source owner may not want to commit to providing minimum levels of heat to a heat network. This may be because the primary business in fact benefits commercially from diverting heat away from the point at which the heat network developer has installed infrastructure to access it.
Alternatively, a regulatory body may require the heat source owner to make changes to their primary business which would impact the provision of heat to the heat network developer. The heat source owner would not want to be restricted from making such changes.
Equally, the heat source owner may not always have control over the amount of heat that is available at any particular time. In this case, they will not be in a position to provide such assurances to the heat network developer.
2: Payment
Unless there are no competing sources of heat, as a heat source owner you will likely have to strike a balance between the reward you get for making heat available and the risk you are willing to take.
Where you do not take any risk regarding the level of heat that is available, the revenue you can expect from the heat network developer will be lower than if you are willing to accept risk on heat being available.
A range of risk-sharing arrangements is clearly possible. Some of the concepts used in offshore wind may be useful points of reference in early heat network pathfinder deals, for example implementing a base payment for access, plus a variable element reflecting revenue.
3: Regulatory restrictions
Another factor that influences the risk that a heat source owner is willing to take in a commercial deal with a heat network developer is that they may be subject to regulatory restrictions dictating certain aspects of the deal.
For an example of the potential regulation which might impact a commercial deal, consider the regulatory powers of Ofwat. Ofwat regulates the financial framework of water and sewerage companies. Its remit includes setting price limits on what can be charged to customers. As a result, any capital investment made - and any liabilities incurred - by the water or sewerage companies that does not relate to the company’s main infrastructure system is not recoverable from customers.
Requirement to Connect
In a previous article, we summarised the “Requirement to Connect” rules that were published by the Department for Energy Security and Net Zero in a consultation document on heat network zoning in England (Zoning Proposals).
The Zoning Proposals state that a broad range of buildings located within designated heat network zones will be required, by law, to connect no later than a specified deadline (subject to limited exceptions). The Zoning Proposals also require certain low-carbon heat sources to connect into heat networks or provide access to heat network developers for the installation of heat recovery equipment.
The Zoning Proposals also state that, if negotiations between heat network developers and heat source owners fail, you as heat source owner may be required by law to enable a connection. This would apply, for example, if a mutually beneficial price can be established without causing significant risk to the business interests of the heat source owner. This could mean that, once the Zoning Proposals are implemented, you have less bargaining power in relation to the price paid by heat network developers.
National guidance will be produced on the typical costs of connection (or access) to the different categories of heat sources. If the value of the heat to the heat network developer exceeds the cost of supplying it, the Requirement to Connect rules are likely to apply.
Conclusion
Subject to the implementation of the Zoning Proposals, heat source owners will be able to decide how best to capitalise on the heat within their control.
As is often the case for the exploitation of natural resources (such as wind and solar), this may involve the heat source owners selling access rights to the heat as opposed to selling the heat itself.
Where heat is produced as an ancillary part of a business, the balance of risk and reward will be a key factor in any commercial deal between a heat source owner and a heat network developer.
Therefore, any risk that you as a heat source owner take should be carefully considered with regard to any obligations you have in relation to – or the impact on – your primary business.
If you would like any further information, or advice related to any of the information in this article, please contact Charles Robson, Sophie Cutler or your usual Burges Salmon contact
Related content
Getting to Net Zero: The potential for heat networks in our communities (burges-salmon.com)