The concept of a Renewable Heat Obligation has been gaining steady momentum over the past year. It has always been an anomaly that electricity produced from renewables has been incentivised, whilst heat has not. Kilowatt-hours of electricity may be easier to count, and therefore an obligation is easier to implement and administer, but a similar obligation for renewable heat is possible.

DEFRA commissioned Ilex Energy Consulting to quantify the potential market for renewable heat and investigate the policy options of increasing it and the resulting report – which recommended a renewable heat obligation – was published in December 2003. The Royal Commission on Environmental Pollution also recommended a renewable heat obligation in its report on Biomass published in May this year.

The obligation envisaged below got on the RPA’s agenda in the spring and the RPA was one of a number of organisations, behind the tabling of an amendment on the subject to the Energy Bill. Whilst not making it onto the statute book, the debate raised the profile the then Energy Minister Stephen Timms, who said that the idea should be given “serious consideration”, and drew from him a commitment issue that the Government “do some serious analytical work”.

As well as benefiting heat-only renewables such as solar water heating, biomass heat boilers and geothermal applications, it would also benefit electricity generators capable of operating in CHP mode. CHP generators that use renewable fuels have an incentive to increase electricity production, and this can be at the expense of heat, thus lowering their overall thermal efficiency. A heat obligation would remove this anomaly. It would also encourage generators to use their waste heat wherever possible. Such an obligation would be a great boost to our beleaguered biomass industry.

Proposal for a Renewable Heat Obligation

Energy for heat makes up approximately a third of the UK’s demand for energy. The Government recognises the contribution of renewable heating systems to the UK’s climate change programme, but has not introduced a dedicated policy to support this low cost and proven carbon abatement option.

This paper makes the case for extending the concept of the renewable obligation to create a separate obligation for renewable heat, creating a similar incentive for the heat industry to that operating within the electricity industry. This idea was similarly conveyed in the Royal Commission on Environmental Pollution’s report on biomass as a renewable energy source, and strongly recommended in a research study produced for DEFRA.

This Briefing provides background to the Heat Obligation proposal which is being assessed by the DTI in parallel to the Renewable Obligation review process currently underway.

1. Introduction
Like electricity suppliers, coal, gas and oil suppliers should have an Obligation to supply an increasing proportion of their business from renewable energy sources. For ease of terminology this proposed mechanism is referred to as a Heat Obligation, with a market in Heat Obligation Certificates (HOCs).

The existing Renewable Obligation has two distinct features:

  • – an obligation on licenced electricity suppliers to source a rising percentage of their supply from renewables; and,
  • – an accreditation process that grants generators of renewable electricity with certificates matching their metered output in any given month.

It is possible to recreate these two features in the market for heat:

  • – the obligation would be placed on suppliers of fossil fuel heating fuels e.g. gas suppliers, coal, coke and oil suppliers. There is no one license that identifies these bodies, however, they are limited in number and easily identified as all have a relationship with Customs and Excise that would allow for their easy identification (see below). Retailers of small volumes of heating fuels i.e. garage forecourts, would not be included in the obligation.
  • – certified suppliers of renewable heat. A list of accredited sites, similar to that used in the Renewables Obligation could be set up for all metered sources of renewable heat, administered by OFGEM. Any site could be accredited providing adequate metering systems are in place

Defining the obligated market

2.1 Gas and coal
Industry currently pays a Climate Change Levy (CCL) on each unit of electricity, natural gas, and coal used. The Levy is collected from suppliers of fuel, who pass the costs of the levy on to their customers. Because there is a difference in the amount of levy payable on fuels used for electricity compared to those used for heat, suppliers of gas and coal are already required to record sales of their product into the heat market. Domestic heating fuels are exempt from the levy and can similarly be identified because of this differential.

2.2 Oil
Oil is also currently exempt from the CCL. However oil sold for heating purposes can easily be identified:

  • – 90% of domestic heating oil is kerosene (similar to jet fuel, but not subject to the same stringent quality specifications). This is not dutiable and has a chemical marker (but is not dyed) to avoid road vehicles using it.
    The dyeing/marking of these fuel oils is conducted at a very limited number of bonded locations (refineries and import points) and additionally, can only be sold through Registered Dealers in Controlled Oils (introduced in 2003) who must declare quantities and end receivers in an attempt to prevent abuse.
    Quantities of oil leaving bond as marked, low duty exempt heating oils could therefore be very easily included in a heat obligation.
  • – The remaining 10% domestic demand, plus light industrial and farm use is provided by Gasoil (similar to diesel, indeed often diesel, but not subject to the same quality specifications). It is dutiable at a much lower rate than road transport diesel (4.22ppl compared to 47.1ppl) and is both dyed (Red) and chemically marked to prevent its inclusion in road fuels.
    As it is difficult to identify whether ‘red diesel’ is used for transport or heating and currently represents a small portion of the total market, for ease of administration it could be excluded from the proposed renewable heat obligation. An alternative would be to develop a labelling system similar to that used in France, where diesel being sold for heat and transport purposes is separately labelled.

3. Defining accredited generators

3.1 Fuel based renewable heat generators – e.g. biomass heating boilers

These forms of generators typically meter their output making accreditation straightforward. This is included as standard in the pumping and heat output control system in order to assess heat losses and reductions in efficiencies which might point towards faults in the system. For any biomass heating system where there is more than one heat load, individual heat meters are also used to allocate costs to these heat loads. As in the RO a proviso can be included that any fossil fuels are only used for control purposes and are less than 10% of the total fuel input in a given month. Heat meters are now available cheaply and with a high degree of accuracy.

3.2 Non-fuel based renewable heat generators – e.g. heat pumps, solar thermal

As discussed above, the obligation should only credit metered systems. However, metering of even small-scale non-fuel based systems is possible and relatively cheap. For solar this is estimated at around £100 per system.

3.3 Co-firing of renewable heating fuels

Where a renewable fuel is being used in conjunction with a fossil fuel to provide heat (e.g. biogas blended with natural gas or biomass blended with coal) rules similar to those governing co-firing for renewable electricity would need to be developed. Certification would continue to be at the point of generation.

However, the biofuel content of the fuel would need to be verified to enable output to be calculated. Generally where solid biofuels are being blended with coal, there will be a weighbridge ticket available so that the supplier of the biofuel can be paid by the user. Hence the biofuel input can be measured and a paper trail is available. For co-firers such as Slough Heat and Power for example, weighbridge tickets plus independent analysis of the energy content is carried out to give accurate assessments of the energy content of the biofuel. For biogas, meters again are generally in use to allow accurate payments and also ensure that the right mix takes place.

3.4 Renewable heating fuels in CHP
The use of renewable fuels to generate both heat and power is a highly efficient form of carbon abatement. CHP units meter both electricity and heat output and would therefore qualify for both for ROCs and HOCs if a heat obligation were introduced.

4. Designing the Obligation

4.1 The principle

The Renewables Obligation provides an incentive ten times greater than the Climate Change Levy to stimulate renewable electricity generation. The idea of a renewable heat obligation is to ensure that heating fuel suppliers are required to supply an increasing proportion of their customers demand for heat from non-fossil fuel sources (just as electricity suppliers are required under the RO).

Each fuel supplier’s Heat Obligation would be a percentage of its fossil fuel sales. This Obligation would be met by the surrendering of Heat Obligation Certificates (HOCs) purchased from accredited renewable heating schemes. An appropriate authority (such as OFGEM) would register qualifying schemes, and issue HOCs on basis of their monthly metered heat output.

4.2 The Obligation level

Details relating to what percentage the obligation should be set at initially, and the future
target it should seek to attain, need further consideration, and should be underpinned by capacity assessments and subject to public consultation. As with the Renewables Obligation, the target and profile of the obligation needs to be clearly set out in advance, to send a clear signal to the industry and encourage investment. However, it is likely that the target would be set at a relatively low level initially and then build up over time as the industry grew.

4.3 On whom should the obligation be placed?

The Obligation should be placed on suppliers of fossil fuels for heat. The volume of fuels sold for heat (as opposed to electricity or transport) is easily determined as suppliers are required to fill in detailed records in order to comply with the requirements of the Climate Change Levy. Oil supplies being sold for heating purposes would need a separate administrative system but this should be achievable and is already practiced in France for example. The administrative systems for a heat obligation for industrial and commercial customers are therefore relatively straightforward.

4.4 The buy-out price

As with the existing renewables obligation a buy-out price would be set to limit the cost of the scheme to consumers. Because of the lower emissions per unit of output associated with generating heat, the Climate Change Levy on heating fuels is roughly a third of that on electricity (0.15p/unit compared with 0.43p/unit). Following the same logic the buy-out price of a HOC could be around £10/MWh (i.e. one third or the current level for the Renewables Obligation.)

4.5 Timescales
Every new energy development and investment in the UK that fails to make use of a renewable fuel for both power and heat is a missed opportunity in terms of developing the UK’s low carbon economy. A renewable heat obligation should therefore be introduced at the earliest possible opportunity. The Government has agreed to assess the opportunities and potential impacts of a Heat Obligation in a parallel track process to its review of the Renewable Obligation should aim to launch a public consultation in parallel with its review of the Climate Change Programme in late 2004. If enacted, the Heat Obligation should run parallel to the existing Renewable Obligation with targets being set to 2015.

5. FAQs on Heat Obligation

5.1 Which technologies and fuels would a renewable heat obligation cover?
Eligibility criteria could be the same as currently defined in the Renewable Obligation e.g. solid, liquid or gaseous fuels from biomass, heat pumps collecting stored solar or geothermal energy from ground or water sources and solar thermal and wind (in a small number of cases where wind-based electricity is used to heat water).

5.2 What size is the renewable heat market today?
716 thousand tonnes of oil equivalent of renewable heat were used in 2002. This is equivalent to 8327 GWh(th).. This was mainly heat for the domestic and light industrial market, the majority of which was provided by wood, and some solar thermal.

5.3 What is the potential of this market?
There is a huge potential for additional low cost carbon abatement to be achieved by stimulating and supporting the market for renewable heat. There is enough biomass fuel currently available to fuel 8000MW worth of modern biomass heating systems. This comprises forest residues, roundwood, arboricultural residues, secondary product from the wood
industry, and clean recycled wood. With the introduction of energy crops, this could be tripled.
Solar water heating, can provide 65-70% of (a household’s) annual hot water needs. More than half of the UK building stock is suitable for solar thermal water heating. Water heating makes up 8% of UK energy demand. With around 120,000 new homes being built each year, there is huge potential for renewables to be incorporated. The draft Buildings Regulation consultation document proposes that developers have a choice to meet the new Part L carbon emission standards in buildings other than dwellings either solely through energy efficiency measures or through a combination of energy efficiency and renewables. This should be extended to domestic dwellings. To build up the UK industry from its current rate of 5,000-10,000 units per year to this level would need a measure like the Heat Obligation.

5.4 Isn’t defining the heat market complex?
No. The Obligation is proposed for suppliers of fossil fuels for heat. The reporting requirements of the Climate Change Levy and differentiated duty rates for oil products mean that systems are already in place that can be used to easily define the market and identify suppliers.

5.5 Aren’t there already too many Obligations?
The renewable obligation applies only to the supply of electricity and yet two thirds of our emissions of greenhouse gases come from non-electricity uses of fossil fuels. Proven and cost effective renewable energy technologies are available now to displace the use of fossil fuels in transport and for heat. However, there is no market-based instrument to incentivise their development. If we are intent on achieving a low carbon economy then comparable measures to the RO must be introduced for renewable heat and transport fuels and technologies.

A renewable heat obligation is complementary to the existing Renewables Obligation, and will ensure that least-cost carbon abatement options are fully exploited by, for example, incentivising biomass CHP and biomass fuelled refineries for biofuels.

5.6 Won’t this mean higher heating bills?
The same argument applies to the RO. However, the RO’s costs have been limited by the buyout price which prevents the cost of the obligation from becoming too onerous. In the case of HOCs, the cost of compliance will be roughly a third of that for the existing renewable obligation for the same level of carbon saving, so it represents good value for money. It is inevitable however that some costs will be handed on to customers and that this will cause bills to rise. However, this needs to be taken in the context of rising gas and oil prices. A larger renewable heat market using domestic biomass resources and free heat from the sun and ground will help provide greater security and less exposure to fluctuating international oil and gas prices.

The cost of climate change is so potentially high that a modest rise due to a heat obligation can be easily justified. The Government estimated the costs of climate change in its Energy Paper ‘Our Energy Future – Creating a Low Carbon Economy’ as £70/tC (in a range of £35-£140/tC) and increasing at £1/tC per year. It suggested that these ‘damage costs’, while not setting the limits for the level of investment in reducing carbon did provide a basis for investing in renewable energy and energy efficiency. The suggested HOC price would hence be well within the ‘damage costs’ range indicated by the Government where investment is acceptable to prevent the expensive costs of climate change.

5.7 What about other measures and subsidies for renewables and energy efficiency don’t they adequately incentivise renewable heat?
No. The Climate Change Levy provides a weak incentive for commercial energy users to switch to ‘levy exempt’ forms of energy such as renewable heat. Renewable electricity receives a greater incentive under the CCL and yet it is also supported by an Obligation precisely because the incentive the Levy creates is too weak to encourage new developments on its own. The same is true of renewable heat.

The Energy Efficiency Commitment (EEC) is an obligation on domestic energy suppliers to assist electricity and gas customers to take up energy saving opportunities. A consultation paper has been published on the extension of the existing EEC, however, radical changes would be required to effectively support renewable heat, are these are not anticipated. IN addition EEC only applies to domestic markets. The Energy Efficiency Commitment (EEC) could be modified to create greater incentives for biomass and solar heating (there is a grant available to switch from coal to gas central heating but none for switching to biomass heating from coal) but this would only impact the domestic sector while the Heat Obligation is intended to impact all sectors.

The Clear Skies Programme and the Scottish Community and Household Renewables Programme do give grants to cover the installation of solar thermal, ground source heat pumps and biomass systems. However, these are relatively small scale programmes covering a much wider range of renewable technologies so that the proportion awarded to renewable heat projects is smaller still. Additionally, they are due to end in March 2005.

The Community Energy Programme which gives grants to refurbish or extend existing community heating schemes install new schemes. Again this covers fossil fuel fired systems as well and is due to end in March 2005.
The Warm Front, the Welsh New Home Energy Efficiency Scheme and the Scottish Central Heating Programme could all feature small renewable energy heat schemes but these schemes will not influence the industrial and commercial markets for heat.

5.8 Would the HOC incentivise both industry and domestic use?

Yes. Domestic space and water heating accounts for approximately 75-80% of household emissions. The proposed Obligation would apply to suppliers of fossil heating fuels to both industry and domestic customers. Similarly domestic and industry heat generation that is metered and aggregated could be accredited to receive certificates.

Concerns have been raised about incentivising domestic biomass with the accusation it might encourage low efficiency, polluting fires. However this could be simply countered by stipulating that only stoves and boilers which are accredited under the Clear Skies programme and which have minimum efficiency/performance standards can be accredited.

5.9 What about the corner shop or petrol station selling bags of coal or camping gas – would there be administrative burdens on them?
The proposed Obligation is not intended to apply to retailers of small volumes of fossil fuels and so there would be no administrative burden. The supply of coal to customers would be captured upstream at the point of supply where duty is paid.

5.10 What about coal merchants – wouldn’t this measure adversely affect them?

No. In fact this sector is a contracting industry and biomass fuel provides an opportunity for diversification and survival. Already a number of coal merchants supply wood pellets and the trade association, the Coal Merchants Association, supports the growing role of biomass fuels

and are members of the Biofuels Alliance. Some modest capital support for the sector to invest in this new industry would help their transition.

5.11 Are you sure that copying the renewables (electricity) obligation is really the best way of stimulating heat? Aren’t there criticisms of the RO?
Certificate based trading schemes like the RO are effective in that they provide both a carrot and a stick in one measure, and can encourage innovation. For that reason industry prefers them to taxes and “command and control” regulation. They have also found approval with NGOs. The RO has proven to be an effective market based mechanism for supporting the development of renewable electricity.

There will always be improvements that can be made as when it was introduced it was an innovative measure. The scheduled review in 2005/06 will provide an opportunity to make any improvements.
The RO mechanism approach can be easily applied to renewable heat and will have the advantage of delivering carbon savings for approximately a third of the cost to the consumer.

5.12 Is the proposed obligation compatible with Government targets for CHP?
CHP plants delivering renewable heat and electricity would qualify for both HOCs and ROCs therefore providing a strong incentive for investment in renewable CHP technologies, as well as running CHP plant efficiently. At present, biomass CHP operators are incentivised to run the plant for electricity output as much as possible at the expense of overall thermal efficiency. The new approach would encourage operation at higher overall thermal efficiency and would also contribute towards the Government’s CHP target.

5.13 What would be the impact on other policies which aim to tackle fuel poverty?
The major energy demand for households experiencing fuel poverty is for affordable warmth. This is at present extremely difficult to achieve for those living in ‘hard-to treat’ properties. The renewable heat obligation will assist the Government deliver its Fuel Poverty Strategy by reducing the energy costs of low income households living in such properties, particularly in off-gas-network areas. It will also encourage the developers of urban community heating schemes to use renewable sources of heat such as biomass, solar thermal and geothermal.

5.14 Would an obligation represent good value in terms of carbon savings?
On the basis of a buy out price of £10 per MWh an RHO compares favourably with the RO – see below:
Resultant Costs at certificate price:
ROC @ £30/MWh displacing CCGT: 283 £/tC
HOC @ £10/MWh displacing Natural Gas: 163
Kerosene: 127
Diesel Oil: 123
LPG: 14
Coal: 84
Indicative off-grid mix 1147

Related Sites:
Renewable Power Association
The Amendment –
Ilex Report

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