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Oliver Slater, Associate
Bridget Newman, Associate
The proposed introduction of heat network zoning in England will mark a significant development in the heat network sector. The Energy Act 2023 introduces powers for the government to make regulations concerning heat network zones. Following a consultation process, the government now intends to do so.
The government's objective is straightforward: create sufficient demand certainty to unlock private investment in heat networks and accelerate decarbonisation. By designating geographic zones where heat networks are expected to provide the lowest-cost low-carbon heating solution, zoning seeks to convert what has historically been a fragmented and uncertain market into an investable infrastructure sector. However, while zoning addresses some of the traditional barriers to heat network deployment, it does not eliminate the commercial challenges facing local authorities, investors and developers.
Historically, demand uncertainty has been the fundamental challenge facing heat networks. Demand is the critical issue, with customer sign-up risk affecting scale, financeability and overall business case viability.
Heat network zoning is intended to address this issue by mandating certain classes of buildings within designated zones to connect to networks. Government policy explicitly recognises that investor confidence depends upon achieving a critical mass of connected customers.
However, despite mandatory connection, demand risk does not disappear entirely. Significant uncertainties remain regarding:
For investors and lenders, the difference between theoretical demand and realised demand remains commercially significant. Even relatively small reductions in anticipated heat load can materially affect project economics.
Additionally, most viable heat networks begin with a core group of anchor customers, often including public sector assets, major commercial buildings or large residential developments. However, many network business cases rely upon future expansion beyond those initial customers. If that future growth never materialises, then developers may have underutilised assets and weaker-than-anticipated returns. As a result, growth assumptions, customer pipeline management and expansion planning have become central commercial considerations across many current heat network procurements.
Heat networks face an inherent structural challenge. Typically, developers must incur substantial upfront development and construction costs before a fully connected customer base is established.
Whilst zoning improves visibility of future demand, there may still be a significant lag between:
During this period, capital remains exposed to construction risk, regulatory risk and connection risk. As a result, we expect that commercial models may increasingly focus on phased delivery, growth trajectories and mechanisms for managing uncertainty in core areas such as future customer connections and heat demand forecasts.
This financing gap has prompted discussion around whether heat networks should be treated more like other regulated infrastructure assets. Recent indications from government that a regulated asset base (RAB) model could be explored for heat networks are significant. A RAB framework could potentially allow developers and investors to earn a regulated return during the development and construction phase, lowering the cost of capital and reducing exposure to the timing mismatch between infrastructure delivery and revenue generation. For a sector where large-scale network capacity often needs to be built ahead of customer connections, the ability to finance assets on a regulated infrastructure basis rather than solely on projected future revenues may prove transformative.
Whether a formal RAB model emerges remains uncertain. However, the direction of travel reflects a broader policy question: if heat networks are expected to become a long-term strategic infrastructure asset class, then financing mechanisms may need to evolve beyond traditional project-finance assumptions and align more closely with the frameworks used in other regulated utility sectors. Whilst zoning may address part of the demand-certainty challenge, it does not in itself eliminate the challenge of funding substantial upfront capital expenditure before stable revenues are established. A RAB-style approach could provide a potential mechanism to bridge that gap and support heat networks as a mature, investible infrastructure asset class.
The most critical feature of the current market is that heat network developers are investing during a period of substantial regulatory change.
The emerging framework includes:
Currently, the broad policy direction is clear, but the detail and mechanics continue to evolve. As such, those undertaking heat networks projects now are seeking contractual mechanisms capable of accommodating future legislative developments. However, the risk is that this has to be sufficiently broad to respond to if zoning implementation is delayed, does not proceed as anticipated, or if future regulations alter the commercial assumptions underpinning the original bid model.
Regulatory uncertainty is the single greatest barrier to the viability of zoning at present.
Zone coordination bodies: the new form of quasi-regulator
Zones will be overseen by “zone coordination bodies” (ZCB): local bodies established to coordinate the development of heat networks within their area. The government intends for ZCBs to be led by a local authority or a combination of local authorities within the area. ZCBs will be assessed by government prior to operationalisation against certain criteria, including fitness to operate and governance standards.
ZCB functions will include:
Of particular note are the following three specific powers of the ZCB:
These specific powers empower local authorities via the ZCB role. However, these powers will feel alien to most (if not all) local authorities. Local authorities are used to issuing fines and penalties at a lower scale, but 10% of annual turnover is the type of penalty more typically levied by the CMA. These powers present clear commercial challenges to the success of zoning. ZCBs need to be set up in a robust and efficient manner so they can successfully perform the functions conferred on them.
Heat network zoning is designed to increase investor confidence but must also remain attractive to customers. As such, there is a delicate balancing exercise between networks generating sufficient revenue to recover substantial capital expenditure and delivering affordable heating to consumers.
Investors, developers and public sector participants will be particularly concerned that heat networks remain politically and socially acceptable over the long term. In practice, this means ensuring that consumers perceive heat networks as delivering value for money and a reliable service. Areas of sensitivity may include:
For local authorities acting as ZCB or promoter, there is an inherent tension between encouraging investment and protecting consumers. This tension becomes particularly acute where commercial customers negotiate bespoke supply arrangements and where future network expansion depends upon maintaining competitive tariffs.
Heat network zoning has the potential to transform the commercial viability of heat networks in England. By providing significantly greater certainty around future demand, it addresses one of the principal barriers that has historically constrained investment in the sector.
Nevertheless, zoning should not be viewed as a complete solution. Investors, developers and local authorities must still navigate a complex mixture of demand risk, regulatory uncertainty, affordability pressures, financing challenges and governance considerations.
The commercial challenge is no longer simply whether sufficient customers will connect. Instead, it is whether projects can successfully balance investor confidence, customer protection, regulatory compliance and long-term network growth within a rapidly evolving regulatory framework. The success of zoning will depend not only upon the designation of heat network zones, but upon the market's ability to develop commercially sustainable projects capable of delivering both decarbonisation and public value.
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