Report

by the Comptroller
and Auditor General

Department for Business, Energy & Industrial Strategy

Low-carbon heating of homes and businesses and the Renewable Heat Incentive

HC 779 Session 2017–2019 23 february 2018

Our vision is to help the nation spend wisely.

Our public audit perspective helps Parliament hold government to account and improve public services.

The National Audit Office scrutinises public spending for Parliament and is independent of government. The Comptroller and Auditor General (C&AG), Sir Amyas Morse KCB, is an Officer of the House of Commons and leads the NAO. The C&AG certifies the accounts of all government departments and many other public sector bodies. He has statutory authority to examine and report to Parliament on whether departments and the bodies they fund, nationally and locally, have used their resources efficiently, effectively, and with economy. The C&AG does this through a range of outputs including value-for-money reports on matters of public interest; investigations to establish the underlying facts in circumstances where concerns have been raised by others or observed through our wider work; landscape reviews to aid transparency; and good-practice guides. Our work ensures that those responsible for the use of public money are held to account and helps government to improve public services, leading to audited savings of £734 million in 2016.

Report by the Comptroller and Auditor General

Ordered by the House of Commons
to be printed on 22 February 2018

This report has been prepared under Section 6 of the National Audit Act 1983 for presentation to the House of Commons in accordance with Section 9 of the Act

Sir Amyas Morse KCB
Comptroller and Auditor General
National Audit Office

20 February 2018

This report examines the objectives of the Renewable Heat Incentive (RHI) and progress against them, its cost-effectiveness, monitoring and evaluation. We also look at whether the Department is learning lessons for the future and its approach to managing fraud, non-compliance and gaming.

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11687 02/18 NAO

The National Audit Office study team consisted of:
Simon Bittlestone, Yan Cheung, Andrea Demurtas, Dimitar Dimitrov, Angie Eagle, Annie Parsons and Elliott White, under the direction of Michael Kell.

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Key facts

Summary

1 The Renewable Heat Incentive (RHI) is a scheme to encourage a switch from fossil fuel heating systems to renewable and low-carbon alternatives in homes and business premises in Great Britain. It supports the government’s approach towards meeting EU renewable energy obligations (by 2020) and UK statutory carbon reduction targets (out to 2050).

2 The RHI pays people and businesses money in the form of a tariff for each unit of heat produced from renewable sources. Technologies supported by the RHI include biomass boilers, heat pumps and anaerobic digestion plants, which produce biomethane injected into the gas grid. The scheme is funded directly by taxpayers, unlike subsidies for low-carbon electricity, which are funded through higher energy bills. Great Britain was the first country in the world to use this type of financial incentive to encourage the use of renewable and low-carbon heat.

3 The RHI is in two parts:

Non-domestic RHI: launched in November 2011 for industry, businesses and public sector organisations, participants receive payments over 20 years; and

Domestic RHI: launched in April 2014 for homeowners, self-builders, private and social landlords, participants receive payments over seven years.

4 The scheme’s objectives are to:

increase the amount of heat produced from renewable sources;

reduce carbon emissions from heating homes and business premises; and

help to grow supply chains which can support a national transition from fossil fuel to low-carbon heating technology from the 2020s.

5 Between November 2011 and August 2017, total payments under the RHI amounted to £1.4 billion. The scheme currently has a budget for new applicants until March 2021. Final payments to these applicants will run to at least 2040-41, by which time these payments are expected to have cost £23 billion.

6 The Department for Business, Energy & Industrial Strategy (the Department) is responsible for the design, performance and overall value for money of the RHI in Great Britain. Ofgem, a non-ministerial government department, is funded directly by the Department to administer the RHI on its behalf. Ofgem is responsible for approving applications, making payments to participants and ensuring that participants’ heating systems comply with the scheme’s requirements. Ofgem provides information on the RHI through its website. The Department mainly targets its marketing activity directly at trade associations who work in the heating supply chain through its Industry Advisory Group.

7 A similar scheme in Northern Ireland is now suspended to new applicants. The Department of Enterprise, Trade and Investment (DETI) was responsible for designing the devolved Northern Ireland RHI scheme, which is administered by Ofgem.

Our report

8 Our report assesses the value for money of the RHI for Great Britain only. The Northern Ireland RHI does not fall within the scope of this report.

Part One sets the context, explains the rationale for the design of the RHI, the Department’s approach to implementation, and take-up to date by homes and businesses.

Part Two examines progress against the objectives of the RHI, the cost-effectiveness of the scheme, and how the Department and Ofgem monitor progress and learn lessons.

Part Three assesses the Department and Ofgem’s approach to controlling costs and managing the impact of fraud, non-compliance and gaming.

We outline our audit approach and evidence base in Appendices One and Two. We compare the Great Britain RHI to the Northern Ireland RHI and alternative policy approaches used by other countries in Appendices Three and Four respectively. We set out our more detailed analysis on cost-effectiveness in Appendix Five.

Key findings

Scheme take-up

9 Take-up of the scheme has been much lower than originally anticipated. The Department’s original long-term strategy for reducing carbon emissions from the heating of the majority of homes and businesses was to replace oil and gas heating with heat pumps and biomass boilers. In its 2012 business case, the Department planned to deliver 513,000 new installations in Great Britain by 2020. It took a phased approach to launching the RHI, and showed appropriate flexibility in its decisions to delay the launch of the Domestic scheme by 18 months to prioritise its limited internal capacity on introducing cost control measures into the Non-domestic scheme. However, its initial assumptions about take-up were too optimistic and the Department could not deliver on its initial plans. As at December 2017, the RHI had delivered just 78,048 new installations in Great Britain. At current rates of take-up, we estimate the RHI will achieve around 111,000 new installations by March 2021, just 22% of its original expectations. (Paragraphs 1.14 to 1.17 and Figures 4, 5 and 6).

Progress against revised objectives

10 The Department has reduced its ambitions for the renewable energy produced by the RHI by 65% and carbon reductions by 44%. The Department has changed its strategy for reducing carbon emissions from heating. It now sees the role of the RHI to be more focused on a smaller number of homes and businesses which are not connected to the gas grid. In 2015, the Department agreed a Spending Review settlement with HM Treasury based on a refocused scheme. Taking this and other changes into account, the Department has lowered forecast lifetime spending from £47 billion to £23 billion (cash terms) and reduced ambitions for producing renewable energy and reducing carbon emissions. As of August 2017, it was on track to achieve these revised objectives. However, the Department has not fully replaced the reduced ambitions of the RHI for renewable heat with equivalent contributions from other sources. Through the implementation of its Clean Growth Strategy, it is exploring other measures which are anticipated to make-up for the reduced carbon savings from the RHI (Paragraphs 2.2 to 2.12 and Figures 7, 8, 9 and 10).

11 The Department has not set specific goals or clear milestones to measure progress on the objective of developing the supply chain for the future. It uses stakeholder engagement and management information to make judgements on progress and to adjust the scheme to support specific technology supply chains. However, the Department has not set specific goals, established a monitoring plan or defined clear criteria for making adjustments to the programme in support of this objective. We are therefore unable to determine whether or not the Department is on track. Measuring against the four areas it has identified as important for preparing the supply chain, we find mixed progress. The Department recognises this position and is undertaking reforms to the scheme (Paragraphs 2.13 to 2.17, and Figures 11 and 12).

12 The cost-effectiveness of the RHI in producing renewable heat and reducing carbon emissions is uncertain. Using the same key assumptions as the Department, our estimate of the cost to taxpayers of each megawatt hour of heat produced under the RHI scheme is £49 compared with the Department’s latest target of £51. For carbon reductions, we estimate the cost to taxpayers for each tonne of carbon dioxide equivalent saved is £142. But our assessment found some of the Department’s assumptions are optimistic. In particular, they do not take account of installations which may have occurred anyway, regardless of whether a RHI was launched, and assume large ‘upstream’ carbon savings from biomethane and biogas technologies. As a result, the actual cost-effectiveness of the RHI is uncertain, but likely to be worse than the Department’s estimate (Paragraphs 2.18 to 2.22, Figure 13 and Appendix Five).

13 There are gaps in the Department’s monitoring of progress. We found some examples of good practice. For example, the Department uses a benefit realisation tracker and budget reports to monitor progress on scheme objectives and spending. We also found gaps. The Department does not include measures on developing the supply chain in its benefit realisation tracker. The key performance indicators it has agreed with Ofgem focus on the number of applications and the speed at which they are processed rather than on their quality. There are also no targets for audit work to reduce levels of fraud and non-compliance (Paragraphs 2.23 and 2.24, and Figure 14).

Non-compliance and cost control

14 The Department cannot reliably estimate the amount it has overpaid to participants that have not complied with the scheme’s regulations. Non-compliance includes generating heat for ineligible uses (such as heating domestic swimming pools), using unsustainable fuel sources and inaccurate metering. The Department needs to measure the impact of non-compliance to assess the costs and benefits of the RHI, as well as being able to assure Parliament of the regularity of expenditure. The Department relies on Ofgem to estimate the impact of non-compliance. Ofgem has conducted audits on a sample of scheme participants since 2015-16. In May 2017, Ofgem estimated that overpayments were worth 4.4% and 2.5% of Non-domestic and Domestic RHI expenditure respectively, equating to £3 million in 2016-17. But we found significant weaknesses in Ofgem’s estimate. The financial impact of non-compliance could be higher, although it is not possible to say by how much. The Department did not review Ofgem’s estimate and was unaware of its unreliability (Paragraphs 3.10 to 3.15 and Figure 16).

15 Ofgem could be more effective in how it is aiming to reduce the rates of non-compliance. In addition to its sample audits, Ofgem targets audit on participants it deems to be at highest risk of non-compliance. The Department and Ofgem have also changed regulations, issued new guidance and updated processes with the aim of reducing non-compliance. But there are ways of making these activities more effective. In particular, Ofgem could do more to pinpoint the root causes of non-compliance and target its activities accordingly. Furthermore, its activities have tended to focus more on the most commonly occurring types of non-compliance, rather than those that have the greatest financial impact. Ofgem’s lack of a reliable estimate of non-compliance, means it cannot measure robustly how effective its actions have been in reducing non-compliance (Paragraph 3.16).

16 Ofgem could improve its management of the scheme by collaborating more effectively with other public bodies. The Environment Agency and local authorities have a remit to monitor and enforce civil and environmental regulations. These public bodies, which operate on the ground, could provide useful intelligence to Ofgem to assist with its audit and inspection programme. Data from Ofgem could also be used by other public bodies to support their wider environmental enforcement action. Ofgem has not been proactive in sharing its data. It is now developing a data-sharing agreement with the Environment Agency and it is exploring what more it can do with local authorities (Paragraphs 3.17 to 3.20).

17 The Department does not know the impact of ‘gaming’ by scheme participants. RHI regulations are complex and provide opportunities for gaming. This is where participants comply with the rules but act in a way that does not align with the scheme’s objectives. For example, participants could be using heat in a way that is not energy-efficient, or installing multiple boilers to take advantage of the higher tariff rate for smaller units. The Department consults stakeholders and works with Ofgem to identify gaming risks, and it has changed the regulations of the scheme to close some known risks. However, the Department has not assessed the extent and potential financial impact of gaming. This means the Department does not know how much gaming reduces the scheme’s value for money, nor whether it has addressed the risks that have the greatest impact (Paragraphs 3.21 to 3.26, and Figure 17).

18 At an aggregate level, the Department has controlled costs to remain within its revised budget. The Department designed cost control measures into the Great Britain scheme to manage the flow of new applicants and spending on existing participants. Key measures include switching participants’ tariff from a higher to a lower rate as the amount of heat they produce increases over pre-defined limits; reducing tariffs for new applicants; and closing the scheme to new applicants if forecast spend exceeds a set amount. The RHI scheme in Northern Ireland did not include similar measures, and has suffered from budget overruns and accusations that participants were abusing the scheme (Paragraphs 3.3 to 3.6 and Appendix Three).

19 Controlling the cost of the scheme will be more challenging once the RHI closes to new applications. The RHI makes payments to participants for up to 20 years. The Department estimates total lifetime costs for the existing scheme of £23 billion, of which £18 billion could be spent between 2021-22 and 2041-42. The Department has fewer cost control measures available to manage its spending on existing participants. It is committed to making payments to participants based on the tariff offered at accreditation, which increases annually in line with inflation; and to Non-domestic participants on the basis of their meter readings. Long-term rates of inflation and the amount of heat produced under the Non-domestic scheme are uncertain. Where rates exceed the Department’s expectations, the higher expenditure will have knock-on effects to the Department’s expenditure and/or the taxpayer (Paragraphs 3.7 to 3.9, and Figure 15).

Conclusion on value for money

20 The Department needed to increase rates of renewable and low-carbon heating in order to meet the UK’s legal obligations. The RHI is a novel approach to making progress against these obligations and identifying longer-term options for eliminating carbon emissions from heat production. The Department showed flexibility in rolling out the scheme, adjusting scheme objectives to respond to a changing strategy and over-optimistic initial planning assumptions and it is learning lessons for the future. Measures it introduced to control the scheme’s costs have enabled it to avoid the budget control problems that occurred on a similar scheme in Northern Ireland. However, the Department has not achieved value for money. It does not have a reliable estimate of the amount it has overpaid to participants that have not complied with the regulations, nor the impact of participants gaming them, which could accumulate to reduce the scheme’s value significantly.

Recommendations

21 The Department should:

a Set clear goals and milestones for its objective of developing the supply chain and develop indicators, in collaboration with stakeholders, which enable the Department to monitor progress.

b Work with Ofgem to develop additional measures that provide further information on scheme delivery beyond the accreditation process.

c Work with Ofgem to improve management of the risk of fraud, non-compliance and gaming, including:

establishing a reliable estimate of non-compliance and factoring this into progress measures on renewable heat production, carbon savings and cost-effectiveness;

introducing measures that enable the Department to monitor and evaluate the effectiveness of Ofgem’s activity to reduce non-compliance;

working more effectively with other public bodies to support its approach to preventing and detecting fraud and non-compliance; and

developing new measures to estimate the extent to which existing and new participants may be gaming the scheme, assessing the consequences, identifying the highest-impact areas of gaming, and prioritising actions to address these, including via changes to regulation where appropriate.

d Provide Parliament with assurance on how the costs and value for money of the RHI will be managed over the whole life of the scheme.

Part One

The Renewable Heat Incentive

1.1 In this part, we:

explain the context of how heating homes and business premises relates to climate change and EU targets;

explain the design of the Renewable Heat Incentive (RHI) in Great Britain; and

assess the approach taken by the Department for Business, Energy & Industrial Strategy (the Department) to implement the RHI and its take-up to date by homes and businesses.

Context

1.2 The UK has ambitious targets for reducing carbon (CO2e) emissions. These targets are underpinned by the Climate Change Act 2008, which requires at least an 80% cut by 2050, compared to 1990 levels. In 2016, the UK had achieved a cut against 1990 levels of 42%, driven mainly from the power and industry sectors (see Figure 1). Total CO2e emissions from the heating of homes and business premises made up 19% of all UK emissions in 2016.

1.3 The Committee on Climate Change advises that meeting the 2050 target may be impossible without a near complete elimination of emissions produced by heating people’s homes and business premises. In its 2017 Clean Growth Strategy, the Department said the elimination of carbon emissions from heating is its most difficult policy challenge in this area.

1.4 There are 26 million homes and 5.6 million businesses in Great Britain, the majority of which are connected to the gas grid. This is a national network of pipes suppling natural gas to buildings. When burnt, natural gas produces heat for industrial processes, gas boilers and cooking equipment as well as CO2e, which is emitted to the atmosphere. The Department estimates around 60,000 non-domestic buildings in England and Wales use oil and liquefied petroleum gas as their main heating source1 and approximately 850,000 households in England use oil heating.2

1.5 In its 2013 document The Future of Heating: Meeting the challenge, the Department set out a high-level strategy for reducing carbon emissions from heating over the long term. It planned to expand the use of low-carbon heat networks in the 22% of households located in dense urban areas. For the remaining 78% of households in suburban and rural areas it planned to:

promote the more efficient use of gas heating for all households connected to the gas grid, with gas use reducing to close to zero by 2050;

support the uptake of renewable heating systems (including heat pumps and biomass boilers) in rural off-gas-grid areas; and

over the longer term, replace oil and gas heating with the large-scale deployment of heat pumps alongside a greater role for heat networks.

1.6 While the UK remains within the EU, it has a legal obligation to meet a target of sourcing 15% of energy demand from renewables by 2020. In 2010, the Department’s original plan was to achieve this by 30% of electricity demand, 12% of heat demand (compared with 1% in 2010) and 10% of transport demand coming from renewables.3 There are no formal sub-targets for electricity and heat demand, this allows the Department some flexibility to adjust its plans.

RHI design and responsibilities

1.7 The RHI was originally designed to meet EU renewable energy requirements and support the Department’s long-term strategy for reducing carbon emissions from heating. In the Department’s 2012 RHI business case it set out plans to deliver 513,000 new renewable and low-carbon installations (with a range of 133,000 to 675,000) in Great Britain by 2020.

1.8 The RHI offers households, businesses and public sector organisations a financial incentive to switch their fossil fuel heating systems to renewable and low-carbon alternatives. The Department decided to link the financial incentive to the production of heat rather than to the upfront costs of installation.

1.9 The RHI is in two parts:

Non-domestic RHI: launched in November 2011 for industry, businesses and public sector organisations; participants receive payments over 20 years.

Domestic RHI: launched in April 2014 for homeowners, self-builders, private and social landlords; participants receive payments over seven years.

1.10 The two schemes support multiple systems including biomass boilers, heat pumps and anaerobic digestion plants, which produce biomethane to be injected into the natural gas grid.

1.11 The RHI is a taxpayer-funded programme, unlike most other subsidies for low-carbon electricity, which are funded through additions to energy bills. It works by paying a tariff for the production of renewable heat. The initial costs of designing and installing a new system must be financed by individual households and businesses.4 Once the new system is installed, applicants can apply to Ofgem for accreditation on the RHI. Once accredited, applicants then receive quarterly payments (in arrears) based on the heat produced (see Figure 2).

1.12 Great Britain was the first country in the world to use this form of financial incentive for heating. It has been followed by Northern Ireland and the Netherlands. In Europe, countries which have achieved high rates of renewable heating typically started taking action in the 1970s and have used a mix of regulation, capital grants and carbon taxation. A comparison of approaches used in Europe is set out in Appendix Four.

1.13 The Department is responsible for the design, performance and overall value for money of the RHI in Great Britain. Ofgem, a non-ministerial government department, is funded directly by the Department to administer the RHI on its behalf. Ofgem is responsible for approving applications, administering the schemes and ensuring compliance with rules. It contracts out the audit and inspection of sites to Ricardo, a global engineering, environmental and strategic consultancy (Figure 3).

Scheme implementation and take-up

1.14 The Department implemented the RHI in phases. In November 2011, it launched the Non-domestic RHI, with the intention of launching the Domestic RHI in October 2012. The Department chose to delay the launch of the Domestic RHI by 18 months, in order to apply learning from its feed-in-tariff scheme for wind and solar energy, which highlighted the importance of cost control measures to manage the budget.5 This flexibility allowed the Department to focus its limited internal resources on introducing changes to the Non-domestic RHI to ensure spend remained within budget. Due to the delay, the Department extended the length of the Renewable Heat Premium Payment (RHPP).6 This was an interim measure to encourage the adoption of renewable and low-carbon heating equipment in homes. The Department used the lessons from RHPP and the Non-domestic RHI when designing and then implementing the Domestic RHI. This included incorporating measures to control costs from the launch of the Domestic RHI.

1.15 The Department has made other significant changes to the RHI. For example, it has introduced new technologies, revised tariffs and sustainability requirements on the Non-domestic scheme (see Figure 4 and Part Three for discussion of changes to cost controls).7

1.16 The Department has identified multiple financial and non-financial barriers to uptake in the scheme, including high upfront costs, low public awareness and complex installation requirements. Measured against the original objectives of the RHI, the Department was unable to adapt the RHI’s design to make it sufficiently attractive to consumers. It made and is now undertaking additional reforms to the scheme to address some of the barriers identified in Figure 5.

1.17 The delay in introducing the Domestic scheme, alongside barriers to uptake, meant the Department’s initial assumptions of progress were too optimistic. As at December 2017, the RHI has delivered 78,048 new installations. Given the rate of take-up in August 2017, we estimate the RHI will achieve around 111,000 installations in Great Britain by March 2021.8 This is just 22% of its original expectations of 513,000 installations and below its lowest estimate, which assumed the Domestic RHI scheme would not be launched (see Figure 6).

1 The Department’s internal analysis of the Building Energy Efficiency Survey 2016. This estimate is not currently published and there is a high degree of uncertainty attached to the estimate.

2 Department for Business, Energy & Industrial Strategy, Clean Growth Strategy, October 2017. Available at: www.gov.uk/government/publications/clean-growth-strategy

3 Department of Energy & Climate Change, National Renewable Energy Action Plan for the United Kingdom, 1 July 2010.

4 The Department reported the average cost of a small solid biomass boiler on the Non-domestic scheme to be around £60,000 and an air source heat pump on the Domestic scheme to cost between £5,900 and £20,000.

5 The feed-in tariff scheme is a government programme designed to promote the uptake of renewable and low-carbon electricity generation technologies.

6 The RHPP was a government grant scheme available for installing domestic renewable heating systems prior to the introduction of the Domestic RHI. RHPP funding took the form of a one-off grant to help households with the cost of installing a renewable heating system. The RHPP is now closed.

7 For participants accredited to the Non-domestic RHI from 5 October 2015, fuel used for biomass, biogas or biomethane plants must meet greenhouse gas emission limits and land use criteria.

8 74,693 (accredited installations as at August 2017) divided by 14.8 TWh (estimated renewable energy produced by the RHI in 2017-18 as at August 2017) equals 5,034 installations for every 1 TWh. RHI funded renewable heat output in 2020-21 is estimated at 22 TWh. Based on current rates of deployment, this would lead to approximately 111,000 installations.

Part Two

Performance of the RHI

2.1 In this part, we:

describe how the Department for Business, Energy & Industrial Strategy (the Department) heat strategy and objectives for the Renewable Heat Incentive (RHI) in Great Britain have changed over time;

report progress against those revised objectives including renewable energy production, carbon emissions savings and progress in preparing the supply chain for the future;

evaluate the cost-effectiveness of the RHI; and

assess how the Department and Ofgem monitor progress and their approach to learning lessons.

Changes to the Department’s heat strategy and RHI ambitions

2.2 The Department’s long-term strategy for reducing carbon emissions from heating has evolved. Our study has not audited this wider strategy which includes plans for heat networks and hydrogen injection into the gas grid. We have, however, found a clear change in the Department’s direction, in the context of learning it took from the initial implementation of the RHI as outlined in Part One, and new evidence it has collected on alternative low-carbon heating technologies. For example, in November 2015, the then Secretary of State Amber Rudd said:

“There are technologies which have great potential, such as district heating, biogas, hydrogen and heat pumps. But it is not yet clear which will work at scale. So different approaches need to be tested. We need a long-term plan that will work and keep costs down for consumers.”

2.3 In its 2017 Clean Growth Strategy, the Department also highlighted that it was not clear which approach for reducing carbon emissions from heating will work best at scale and offer the most cost-effective, long-term answer. The Department is currently reviewing its evidence on the options for reducing carbon emissions from heat. It plans to publish this review later in 2018.

2.4 The National Audit Office’s (NAO’s) Framework to review programmes9 highlights the importance of major programmes being sufficiently flexible to deal with setbacks and changes in the operating context. The Department responded appropriately to the changes described earlier by reducing its ambitions for the scheme. It is now focusing the RHI more narrowly on homes and businesses which are not connected to the gas grid and are often using oil for heating.10 It is also using the scheme to encourage the production of biomethane, which can be injected into the existing gas grid.

2.5 The Department has reduced forecast lifetime spending for the RHI. In its 2012 business case the Department originally estimated the RHI would spend £47 billion between 2011-12 and 2040-41. As described in Part One, take-up of the RHI was lower than originally anticipated. By 2015, it had accordingly reduced forecast lifetime spending to approximately £37 billion. In November 2015, as part of its Spending Review settlement with HM Treasury, the Department agreed to lower forecast spending by an additional £14 billion to £23 billion. At the same time, ministers decided the Department should change the balance in RHI objectives towards reducing carbon emissions. Taking these changes into account, the Department has reduced its ambitions for renewable heat by 65% and for reducing carbon savings by 44% as measured against its original plans (see Figure 7 and below for further discussion).

Progress against revised objectives

2.6 The RHI’s revised objectives in Great Britain are set out in a 2016 business case:

Deliver growth in renewable heating in the UK, to help the UK meet its legal obligations under the EU Renewable Energy Directive for sourcing 15% of energy demand from renewables by 2020.

Contribute to the UK’s statutory carbon emission reduction targets (also known as carbon budgets) between now and 2032, by supporting the deployment of low-carbon heating.

Help grow supply chains to prepare Great Britain for a mass transition from fossil fuels to low-carbon heating from the 2020s, to support longer-term decarbonisation of heating.

2.7 As of August 2017, the Department reports it is on track to achieve these revised ambitions for producing renewable heat and reducing carbon emissions from heating. It reports 72% of all installations on the Domestic scheme are located in households not connected to the gas grid. No equivalent figure is available for the Non-domestic scheme (see Figure 8 and Figure 9).

Renewable energy obligation

2.8 The RHI’s reduced ambition means its contribution to achieving European renewable energy obligations will be lower than initially intended. This is partly compensated for by an increased estimate of renewable heat produced from sources which are not eligible for the RHI. By 2018, the Department had almost quadrupled its initial estimate of this ‘baseline’ renewable heating from 10 TWh to 37 TWh per year. This mainly takes into account higher than expected use of household wood-burning stoves, open fires and reversible air-to-air heat pumps.

2.9 We estimate that the combination of these changes will enable the UK to increase its share of heat demand fuelled from renewable sources to 10% in 2020. This is two percentage points short of the Department’s original plan of 12%.11 If the government does not meet the renewable energy obligation it risks a fine. The options available to make up the shortfall are:

increase renewable heat output, for example by increasing RHI funding;

look to make additional progress on power and transport (see Figure 10); or

buy surplus renewable production in the form of ‘statistical credits’ from other EU countries.

2.10 Given the UK’s intent to leave the EU in March 2019, it is not clear whether the UK is still required to meet the EU Renewable Energy Directive. The Prime Minister has proposed, in the context of the UK’s overall negotiations with the EU, a transitional period of around two years where the UK would work within the existing structure of EU rules and regulations. The EU Renewable Energy Directive target falls in 2020 (within the proposed transitional period). Member states are not expected to report final progress against the EU Renewable Energy Directive target until December 2021.

Carbon budgets obligation

2.11 The UK’s statutory carbon emission targets (also known as ‘carbon budgets’) are provisions of the Climate Change Act 2008.12 Carbon budgets set emission reduction targets over five-year periods. The RHI is on track to reduce carbon emissions from heating by 7 MtCO2e per year from 2020-21 (approximately 1.5% of total UK carbon emissions) (see Figure 9). These savings have already been factored into the Department’s projections for carbon budgets 4 (2023–2027) and 5 (2028–2032). The RHI is unable to produce additional carbon reductions over current plans due to budget constraints.

2.12 In its 2017 Clean Growth Strategy, the Department reported its forecast position against carbon budgets. It estimated surplus positions for the first three carbon budgets, but deficit positions for carbon budgets 4 and 5 (an average of 23 and 33 MtCO2e per year respectively). The Department is currently exploring other measures which it thinks can provide additional carbon savings.13

Growing the low-carbon heat supply chain

2.13 In December 2016, the Department revised its objective on preparing the market for the mass roll-out of low-carbon heating technology from the 2020s onwards.14 In its response to a consultation on a reformed scheme, it said it wanted to support supply chain growth and challenge the market to deliver.

2.14 The Department monitors progress on this objective by collecting intelligence from equipment manufacturers, trade bodies and the wider supply chain. It combines this intelligence with data it collects on payments made to participants, new applications and accreditations to the RHI, and research it commissions. To make adjustments to the scheme, the Department uses its own judgement based on the range of evidence it collects, in the context of the budget it has available to spend. In Figure 4 we set out some of the adjustments the Department has made to the RHI using this system.

2.15 Our Framework to review programmes highlights the importance of clear, high-quality reporting on progress. It also highlights the importance of systematic reporting against clear criteria to reduce reliance on individual judgement. We found the Department has not set specific goals or clear milestones for this objective. It does not have a monitoring plan though it does use clear criteria for making adjustments to the tariff rates available to new applicants.

2.16 In its 2013 business case, the Department considered four changes which were necessary to prepare the supply chain for the future. These were:

building sustainable renewable heat supply chains;

improving the performance of renewable heating technologies;

reducing costs of installing renewable heating technologies, through deployment at greater scale; and

reducing some of the non-financial barriers, especially the perceived risk and lack of awareness of renewable heat technologies in the general public.

2.17 We are unable to determine whether the Department’s progress on this objective is on or off track as it has not set specific goals or milestones. Measuring against the four areas it identified as important for preparing the supply chain for the future, we found mixed progress (see Figure 11 and Figure 12).

Cost-effectiveness of the RHI

2.18 Cost-effectiveness can be measured in various ways. One of the more straightforward measures is the amount of taxpayers’ money spent to achieve each unit of desired output. In the case of the RHI, we use this measure of cost-effectiveness to calculate the money spent by the taxpayer (through payment of tariffs) to produce one megawatt hour (MWh) of renewable heat, and to reduce carbon emissions by one tonne (t/CO2e).

2.19 A number of assumptions have to be made in these calculations, as we explain below. When we use comparable assumptions to the Department, we estimate that the Department will spend an average £49/MWh (2018 prices) in Great Britain to produce renewable heat over the lifetime of those installations accredited to the scheme by September 2017. This is in line with the Department’s 2013 and 2016 estimates of £49/MWh and £51/MWh respectively (Figure 13).

2.20 However, this in part reflects the fact that the RHI has supported a different mix of technologies than the Department expected, in particular biomass rather than heat pumps. Biomass boilers receive the most payments under the RHI. They produce the most renewable energy in the scheme and are cheaper per unit of heat produced and carbon saved than some heat pumps (see Figure 22 in Appendix Five). Our analysis found significant cost reductions have been achieved in the installation of biomass boilers in the Non-domestic scheme. We found no equivalent trend for heat pumps (Figure 12). The Department recognises the long-term strategic importance of heat pumps to reduce carbon emissions from heating. They have consulted on changes to the RHI to increase tariff rates available for heat pumps to stimulate demand.

2.21 Regarding carbon emissions, using the Department’s key assumptions we estimate it will cost the taxpayer £142 per tonne of carbon dioxide equivalent saved.15 The Department uses a different measure of cost-effectiveness which is not comparable to our metric. It measures carbon cost-effectiveness as the net cost to the economy, a ‘resource cost’ measure.16 Using this measure, in 2016 the Department estimated it will spend on average £56 per tonne of carbon dioxide equivalent saved.

2.22 In Appendix Five we set out our more detailed analysis of cost-effectiveness. Our ‘base case’ estimates of cost-effectiveness aim to match a number of the Department’s assumptions. Our sensitivity analysis around those assumptions shows the actual cost-effectiveness of the RHI is uncertain, but likely to be worse than the Department’s estimate.

Our base case estimates assume significant upstream carbon savings for biomethane and biogas plants as a result of food waste being diverted from landfill sites. We have not audited this assumption and are unable to conclude on its validity. But our estimate of carbon cost-effectiveness is highly sensitive to changes in this assumption. A more pessimistic assumption about upstream carbon savings from biomethane and biogas plants would mean our carbon cost-effectiveness estimate for the RHI deteriorates from £142 to £160 per tonne of CO2e saved.

Our base case estimates assume none of the accredited installations would have occurred had the RHI not been launched. The Department does not have a robust counterfactual it can use to measure the additional impact of the RHI. But surveys undertaken by the Department provide some evidence of the potential for ‘deadweight costs’ in the scheme.17 These surveys found that 25% of participants in the Non-domestic scheme and 24% of participants in the Domestic scheme stated that they would have installed a renewable heating technology anyway, even if the RHI had not existed. Using this data to form a less optimistic assumption about the additionality of the scheme, our heat cost-effectiveness estimate deteriorates from £49 to £65 per MWh and carbon cost-effectiveness from £142 to £189 per tonne of CO2e saved.

Our base case estimates assume no financial loss as a result of fraud, non-compliance and gaming. As we explain in Part Three, Ofgem does not measure the financial impact of ‘gaming’ in the RHI. But it does measure rates of non-compliance. Taking Ofgem’s estimate of non-compliance into account, our estimates of cost-effectiveness deteriorate slightly from £49 to £51 per MWh for heat and from £142 to £148 per tonne of CO2e saved. In Part Three we discuss the validity of Ofgem’s estimates of fraud and non-compliance.

Monitoring and learning lessons

2.23 To improve the RHI and support its efforts to learn lessons, the Department has invested in research, monitoring and evaluation. We found some examples of good practice, including:

the tracking of progress – on renewable heat produced, carbon emissions saved and installations supported – through an internal ‘benefits realisation tracker’, used by the Department’s RHI team to report to senior management in board meetings;

improving its understanding of the user experience and the market through surveys, interviews with different scheme participants and industry stakeholders;

reviewing the scheme following the problems experienced with the devolved Northern Ireland RHI scheme; and

monitoring the uptake of individual technologies, which it uses to manage the budget and enable cost control measures as and when needed (see Part Three).

2.24 But there are gaps in the Department’s approach:

As explained earlier, the Department has not set specific goals or milestones to track progress against its objective to prepare the supply chain for the future. In 2016 it scaled back its measurement of the supply chain, citing challenges around the cost-effectiveness of collecting data and how representative it is of the entire market. The Department is now much more reliant on ‘soft’ market intelligence received from stakeholders and deployment data across the two schemes.

The Department is commissioning a new evaluation programme running to 2020 but it will not be able to determine the additional impact of the RHI (that is, how many accredited installations would have happened anyway, if RHI had not been implemented).

Key performance indicators (KPIs) agreed with Ofgem to monitor its delivery of the RHI focus on the process for accrediting new applications onto the scheme. There is only one KPI linked to the quality of outcomes achieved through the RHI – a measure of customer satisfaction (See figure 14).

There are weaknesses in the design, implementation and use of scheme audit activity, as we discuss in Part Three.

9 Available at: www.nao.org.uk/report/framework-to-review-programmes/

10 Around 4 million households in Great Britain are not connected to the gas grid. The majority of these (2.2 million) use electricity. The remainder use heating oil, LPG, solid fuel and communal or district heating.

11 There is no formal sub-target for heat. This allows the Department to flexibly adjust its plan between heat, electricity and transport.

12 Carbon budgets are set to 2032 providing five-yearly limits on the amount of carbon dioxide the UK is allowed to emit from across the economy.

13 The Department’s Energy and Emission Projections 2017 (published January 2018), include early stage policies and proposals from the Clean Growth Strategy. It shows an average, additional potential reduction, of up to 6MtCO2e and 16MtCO2e per year for carbon budgets 4 and 5. Forward projections for carbon budgets 4 and 5 have also been revised. The latest projections indicate smaller deficits at an average of 13 MtCO2e and 23 MtCO2e per year respectively.

14 Department for Business, Energy & Industrial Strategy, The Renewable Heat Incentive: A reformed scheme – Government response to consultation, December 2016.

15 In Appendix Five we estimate the cost-effectiveness of the Domestic RHI is £128 per tonne of CO2e saved. In our 2016 report Green Deal and Energy Company Obligation (ECO) we reported ECO (an energy efficiency scheme installing measures such as loft insulation in people’s homes) to cost the taxpayer £110 per tonne of CO2e saved between January 2013 and March 2014 and £61 between April 2014 and March 2015, following policy changes to make easier-to-treat homes eligible for the scheme in 2014.

16 The approach is consistent with HM Treasury’s Green Book, but is more complex to estimate than the cost to taxpayers per unit of desired output.

17 Evidence collected by the Department’s surveys relies on the judgement of responders regarding how they would have acted in a hypothetical situation. Some care should be exercised in interpreting the results, since survey responders are not always able to accurately predict how they would act in hypothetical situations. More than a quarter of responders to the domestic survey, did not know how they would have acted without the RHI and are excluded from the analysis.

Part Three

Controlling costs and the impact of fraud and non-compliance

3.1 In Part One we explained that the Department for Business, Energy & Industrial Strategy (the Department) is responsible for the design of the Renewable Heat Incentive (RHI). It is also responsible for ensuring the RHI provides good value for money, has controls in place to stay within budget, and to demonstrate to Parliament that payments under the scheme are regular and in line with Parliament’s intentions.

3.2 In this part we:

explain the Department’s measures for controlling scheme costs, both now and in the future;

assess the approach of the Department and Ofgem, to managing fraud and non-compliance and measuring its impact on the scheme’s achievements; and

assess how the Department is managing the risk that the scheme’s regulations can be ‘gamed’.

The Department’s control of expenditure

3.3 The Department designed the RHI as a demand-led scheme, with funding for successful applicants guaranteed for a long period, to create confidence for investors, and the supply chain, leading to progress against the scheme’s objectives.

3.4 Reflecting the demand-led nature of the scheme, HM Treasury agreed that RHI expenditure would be treated as Annually Managed Expenditure (AME) rather than as DEL spending, which has strict annual ceilings.18 Classification as AME gives the Department some budget flexibility from year to year, and helps to manage potentially volatile categories of spending. HM Treasury incentivised the Department to control RHI spend by requiring any overspend in one year to be repaid through reductions in its RHI allocation in future years, and having to fund a proportion of this repayment from its wider DEL budget.

3.5 The Department introduced and maintains strong cost control measures for the scheme, by managing the flow of new applicants and spending on existing participants. These mechanisms have been effective in keeping the RHI within its budget to date (Figure 15). The main cost control measures are:

tiered tariffs: included in the Non-domestic scheme when it launched, this involves switching participants’ tariff under the Non-domestic scheme from a higher to a lower rate once their heat production reaches a pre-defined limit. This reduces the incentive for participants to produce excessive heat solely for the purposes of financial gain;

deemed payments: included in the Domestic scheme when it launched, for most participants payments are based on the annual heat demand figure listed in the property’s Energy Performance Certificate. This is known as ‘deemed payments’ and predetermines the amount of money participants will receive;

tariff degression: introduced to the Non-domestic scheme in 2012 and the Domestic scheme when it launched in 2014. Degression enables the Department to reduce tariffs for new applicants when total forecast spending on a technology exceeds its pre-defined limit. This measure has led to significant reductions in the biomass boiler tariff since the scheme started; and

budget cap: notwithstanding the intention to provide confidence to the supply chain, the Department introduced this control in 2016. It enables the Department to reserve the right to close the scheme to new applicants with little or no notice when forecast spend exceeds a pre-defined limit.

3.6 Scheme expenditure, take-up and risks to the budget are monitored by the Department and (since autumn 2015) reviewed regularly through a joint HM Treasury-Department governance arrangement consisting of a monthly cost control report and quarterly meetings of a cost control board.19

Future risks to cost control

3.7 There are risks to cost control for the remaining life of the scheme, which is expected to run until at least 2041. The Department is committed to making payments based on the tariff level offered at the point of accreditation, increasing annually by inflation.20 Payments under the Domestic RHI will run until at least 2028, and under the Non-domestic scheme until at least 2041. Around £18 billion (nearly 80%) of the current scheme’s expected lifetime spending of £23 billion will occur between April 2021 and March 2041 (Figure 15).

3.8 The Department will have fewer levers to control expenditure when the RHI is closed to new applicants. Degression and budget caps will not apply to existing participants because the Department has made commitments to make index-linked payments to participants on the Non-domestic and Domestic schemes for 20 and seven years respectively. Tiering will be the main line of defence acting against the over-production of heat in the Non-domestic scheme. In addition, RHI regulations specify participants must not generate heat for the purposes of increasing financial income. For the Domestic scheme, deemed payments effectively pre-determine the income participants will receive.

3.9 The Department is exposed to a number of cost control risks, which it is currently reviewing:

Budgets for the RHI and associated spending rules have been set to 2020-21. The Department is currently required to inform HM Treasury of any forecast overspend and may incur financial penalties if it exceeds agreed control totals.21 The Department is committed to spending beyond 2020-21, with tariffs increasing in line with inflation. Unexpectedly high inflation could mean RHI expenditure is higher than forecast. Unless future spending review settlements with HM Treasury include a waiver for inflation, the Department may be required to offset this elsewhere in their DEL or AME budgets.22

Payments made to Non-domestic RHI participants are based on meter readings. The Department has made assumptions about the expected heat usage when setting its future budget and spending expectations. Changes to a participant’s behaviour could lead to higher than expected costs. In particular, there are a small number of biomethane and biomass installations which produce high amounts of renewable heat. Changes in the usage of these installations could have a significant impact on overall scheme spending.

Over time, the cost of RHI fuel could diverge from the economy-wide inflation rate used to uprate the RHI tariffs, potentially increasing the incentive to burn fuel purely to maximise payments under the scheme. Tiering, which will reduce tariffs once fixed operation thresholds have been reached, will offer some protection. Burning unnecessary quantities of fuel is also against the regulations. The Department will nonetheless need to maintain an effective audit and inspection regime.23

More generally, with a long-lived, complex and geographically dispersed scheme with a plan for more than 100,000 claimants, the Department will need to ensure it retains sufficient market intelligence and an adequate enforcement regime to identify and address fraud, non-compliance and gaming behaviour.

Fraud and non-compliance

3.10 As with any scheme, it is possible for participants to act fraudulently or not comply with the regulations, either deliberately or by mistake. On RHI, examples of non-compliance include:

participants using the heat for an ineligible purpose, such as to heat domestic swimming pools;

participants using an unsustainable fuel source, or not being able to demonstrate that they have used a sustainable fuel source;

participants not providing the correct information about their installation to Ofgem, or not keeping Ofgem updated when they make changes to their installation; and

errors in how participants meter the amount of heat they have used.

Non-compliance can reduce the value for money of RHI because the Department could be paying participants without achieving the commensurate benefits in terms of renewable heat generation and carbon reduction. Where non-compliance is detected, Ofgem has powers to stop payments, claim back any non-compliant payments made and adjust future payments to offset any overpayments once a site is compliant with scheme rules.

Measuring the impact of non-compliance

3.11 The Department relies on Ofgem to estimate the value of overpayments due to fraud and non-compliance. Since 2015-16, Ofgem has audited a randomly selected sample of scheme participants to estimate rates of non-compliance. This sits alongside its more targeted audits, which are directed at participants it considers high risk. In prior years, Ofgem only conducted targeted audits of high-risk participants, meaning it could not make a representative estimate of non-compliance. In 2016-17, Ofgem estimated that the financial impact of non-compliance was 4.4% in the Non-domestic scheme and 2.5% for the Domestic scheme. This equates to a total of £3 million in overpayments in 2016-17. If these rates of non-compliance were maintained for current accredited participants over the life of the scheme, this would lead to overpayments of around £150 million (Figure 16).

3.12 We have identified significant weaknesses in Ofgem’s approach, which mean its estimates are unreliable.

In 2016-17, Ofgem did not ensure its audit sample was representative of the overall scheme population. On the Non-domestic scheme, Ofgem only sampled participants that joined the scheme during the previous year. For its Domestic scheme estimate, Ofgem’s sample excluded participants with payments above a certain threshold. On both schemes, it did not include participants that it had previously audited. Consequently, Ofgem’s audit sample was not representative of the overall scheme population, meaning it cannot be used to estimate reliably the overall non-compliance rate.

We found an error in the Domestic RHI calculation, and that Ofgem’s calculation was based on an incomplete sample, with 39% of audits still open at the time it was made. We calculate that correcting for the error and including all the audits completed up to December 2017 would increase the central estimate of overpayments for the Domestic scheme from 2.5% to 4.5%.

There are weaknesses in key assumptions underpinning Ofgem’s estimate for overpayments under the Non-domestic scheme. Compliance investigations following an audit, which determine the amount that Ofgem has previously overpaid a participant, can take several months. Therefore, in order to provide the Department with a timely estimate of non-compliance, Ofgem estimated the potential financial impact of each occurrence of non-compliance detected through an audit. But these estimates, which the Ofgem audit team has set, are not robust. We found no evidence of routine review of their accuracy or independent validation.

Ofgem reported its 2016-17 estimate of non-compliance to the Department as a single ‘point estimate’, which ignores the significant uncertainty inherent in the sampling methods used. All statistical sampling models have some uncertainty attached to the results, which is normally dealt with by showing a range of possible results. Decision-makers should consider the upper and lower estimates in combination with a central estimate as this could impact their interpretation of the results. Ofgem’s own sampling tool indicated that the upper limit of its Non-domestic estimate was 1.9% in 2015-16 and 9.2% in 2016-17.

Ofgem has not subjected its estimates to sufficient independent review to ensure their accuracy. The part of Ofgem that administers RHI, including accrediting the scheme, is also responsible for estimating rates of non-compliance. There is consequently a risk that it lacked independence and objectivity, particularly as the Department holds it to account on how effectively it administers the scheme, including minimising rates of non-compliance.

3.13 Ofgem is aware of the weaknesses in its approach and is implementing measures to address some of them. In 2017, the Department and Ofgem decided to include all participants in its sampled population for the Non-domestic RHI in 2017-18. It is also considering auditing participants if they are picked in the sample even if they have been audited previously. It is introducing a central assurance team, independent of Ofgem’s RHI team, to provide an independent perspective on its audit and compliance work.

3.14 The Department’s oversight of Ofgem’s estimate of overpayments has been insufficient. As the Department accounts for RHI spending in its financial statements, it is responsible for ensuring scheme expenditure is in line with Parliament’s intentions, with the amount wasted due to non-compliance at an acceptably low level. Given it holds this responsibility, and the risks of overpayment in a scheme which is novel, complex and large scale, the Department has not done enough to ensure Ofgem’s estimate is reliable. It has not reviewed Ofgem’s calculation and the underpinning assumptions, or the quality assurance arrangements Ofgem has put in place to ensure accuracy.

3.15 The weaknesses in Ofgem’s approach mean it is not possible to estimate reliably the impact of non-compliance on RHI’s value for money. The Department cannot adjust its assessment of the scheme’s costs and benefits to take account of overpayments or non-renewable heat generated. Overall, we consider that there is a risk that the actual financial impact of non-compliance is higher than Ofgem has reported, although the weaknesses in its data mean it is not possible for us to say by how much. The rate is very likely to be higher than that which the Department has stipulated as its tolerable level of overpayment, namely 1% for Non-domestic RHI and 3% for Domestic RHI.

Ofgem’s approach to reducing fraud and non-compliance

3.16 We have assessed Ofgem’s approach to reducing fraud and non-compliance against good practice criteria we have identified through our audits of other government policies with similar features to the RHI, such as benefit and tax credit payments.24 While we recognise that Ofgem has less experience with this type of operation than some other departments we have assessed, we have identified a number of areas where it could be more effective at reducing fraud and non-compliance:

Ofgem does not know which types of non-compliance have the biggest financial impact, meaning it cannot know if it is targeting its activities effectively. Ofgem collates statistics on the most commonly occurring types of non-compliance found and reports these to the Department quarterly and annually. Previously, Ofgem has performed targeted audits on participants it considers to be at higher risk of non-compliance, but has prioritised the most commonly occurring types of non-compliance rather than those with the greatest impact. In 2017-18, it is beginning to target participants it considers to be at risk of the greatest financial losses if they are non-compliant, by performing additional targeted audits on high-value biomethane plants.

Ofgem could do more to use its audit and compliance work to pinpoint and address root causes of non-compliance. Where Ofgem has identified non-compliance with a large financial impact through audits, its subsequent actions to address the root cause are often incomplete, and sometimes not present at all. Performing more audits without addressing the root causes of non-compliance is unlikely to reduce non-compliance as the same errors will continue to occur.

Ofgem is unable to measure the effectiveness of the actions it takes to reduce non-compliance, such as issuing new guidance or making changes to the application process. This is because it does not have a reliable estimate of the financial impact of non-compliance to provide a baseline.

Collaborating with other public bodies

3.17 Ofgem could improve its approach to non-compliance by collaborating more effectively with other public bodies. It has a range of tools to ensure participants comply with RHI regulations. These include checks at the accreditation stage, offering information and advice, targeting inspections and, in serious cases, suspending payments, issuing financial penalties or removing participants from the scheme. Local authorities and the Environment Agency have a wider remit and access to more information, which they use to monitor and enforce civil and environmental regulations.25 This information could provide useful additional intelligence to Ofgem to support its audit and inspection programme. Likewise, data from Ofgem in relation to RHI sites could help other public bodies direct their environmental enforcement activities.

3.18 One example relates to the 28,000 biomass boilers accredited to the RHI spread across Great Britain. These installations mainly burn wood and emit smoke to the air. We found weaknesses in the monitoring of these emissions. We attended two site visits during our study and an environmental engineer from Ricardo (the firm to which Ofgem has contracted out site audit work) explained to us that the quality of emissions from biomass boilers is likely to deteriorate over time, particularly if equipment is not well maintained. RHI participants are required to comply with air quality rules to receive RHI payments. Ofgem’s audit and inspection programme checks evidence of performance from an emission certificate, environmental permit, and/or the plant is operated in accordance with the manufacturer’s requirements. It does not currently undertake any emission testing of pollutants which can damage local air quality, despite this being a condition to receive RHI payments.26

3.19 We are aware of instances of alleged serious smoke pollution from sites running biomass boilers that have received RHI payments. Local authorities are responsible for handling air quality complaints from citizens under statutory nuisance legislation.27 We found Ofgem was not proactive in sharing its data to assist local authorities, data which these organisations could use to assist their monitoring and enforcement activity. We are aware of one local authority that had to formally request data from Ofgem using the provisions of the Data Protection Act.28 The local authority now plans to use this data to prioritise its monitoring and enforcement activity.

3.20 Ofgem does not currently cross-check RHI applications with environmental permits which regulate waste management or planning permission applications. This is potentially valuable third-party data and information it could use to improve its approach to monitoring compliance and targeting its audit and inspection programme. Ofgem is now setting up a new data-sharing agreement with the Environment Agency to fill this gap. It is also exploring what more it can do with local authorities.

Gaming risks

3.21 RHI regulations are complex and provide opportunities for participants to game them. Gaming occurs where participants are generating and using heat eligibly according to the regulations, but in a way that does not meet the intentions of the scheme, such as by not being energy-efficient or environmentally friendly. Instances of gaming, while not against the rules, reduce the value for money of the scheme. The RHI could be vulnerable to gaming as its complexity and novelty present a challenge to drafting regulations that are clear on what is and is not compliant.

3.22 There are indications that some participants might be gaming the RHI regulations. For example, on the Non-domestic scheme there is a pronounced ‘bunching’ of boiler installations of precisely 199kWth (Figure 17). This reflects the more generous tariff rate that was available for boilers up to that size. A participant could install multiple boilers sized up to 199kWth, with a combined capacity above 200kWth, yet still receive the more generous tariff rate. We found more than 1,000 sites which have installed two or more biomass boilers, with 161 instances of five or more biomass boilers installed at a single site.

3.23 The use of multiple installations at a single site can be for legitimate purposes. For example, using more than one installation to serve multiple buildings or provide a back-up source of heating should the primary source fail. However, the Department has not assessed how many multiple installations could be purely to exploit the scheme’s regulations.

The Department’s management of gaming risks

3.24 The Department relies on Ofgem alongside its market intelligence and discussions with trade associations to flag up instances of gaming. The Department keeps a ‘gaming register’, which lists potential risks identified through Ofgem’s audit programme, and the measures it is taking to mitigate them. An internal review in 2017 highlighted how the Department relies primarily on Ofgem to flag potential instances of gaming, but that Ofgem’s audits focus on compliance with the regulations. There is less guidance from the Department on what Ofgem should report when “compliant but unforeseen activities” are observed.

3.25 The Department has used this system to identify and implement a number of changes over the course of the scheme to address gaming risks. For example, in 2017 it revised tariff rates available to new applicants for Non-domestic biomass boilers to a single band. The Department has also consulted on additional changes intended to tighten regulations on eligible and manufactured heat use, environmental permitting, incidental Non-domestic heat use and multiple installations. Based on its understanding of the scheme, the Department considers that the major remaining gaming risks will be addressed through these changes.

3.26 However, the Department does not know how prevalent gaming is across the RHI. It does not know the impact gaming has on the scheme’s achievements to date, which types of gaming have had the most significant financial impact or whether the reforms it has introduced have been effective. Without knowing which types of gaming are most prevalent the Department cannot prioritise its future actions to address gaming effectively.

18 Departmental Expenditure Limit.

19 The Department’s system to detect risks to increases in budget includes liaising closely with industry and forecasting future spend.

20 Participants who received accreditation before 1 April 2016 have their tariffs indexed by the Retail Price Index. All other participants have tariffs uprated by the Consumer Price Index.

21 Current spending arrangements specify that where the actions or inactions of the Department increase spending beyond control totals, HM Treasury assumes the increase in spending will be funded by reductions in the Department’s DEL budget, or by identifying firm savings in AME. HM Treasury may waive these financial penalties if overspends occur as a result of factors which are outside of the Department’s control, for example as a result of unusually cold winters.

22 HM Treasury’s Consolidated Budgeting Guidance set out rules applicable to different categories of expenditure. For AME spending, where expenditure is expected to come out higher than forecast, departments should be prepared to discuss what steps should be taken to offset these increases.

23 For the Renewable Obligation the Department partially reformed the scheme midway through implementation. It decided to stop grandfathering tariff rates for some biomass co-firing and small-scale solar projects and instead grandfather tariff rates based on a target rate of return. There is no equivalent framework in place for the RHI.

24 Comptroller and Auditor General, Fraud and error stocktake, Session 2015-16, HC 267, National Audit Office, July 2015.

25 Regulations include planning permission, air quality, statutory nuisance and environmental permitting.

26 Air quality requirements are for biomass boilers accredited onto the RHI from September 2013. These requirements set maximum permitted emissions for particulate matter (30 grams per gigajoule (g/GJ) net heat input) and oxides of nitrogen (150 grams per gigajoule (g/GJ) net heat input). For sites accredited pre-September 2013, these requirements do not apply.

27 Environmental Protection Act 1990.

28 Data Protection Act 1998, section 29-3.

Appendix One

Our audit approach

1 See Figure 18.

Appendix Two

Our evidence base

1 We have reached our independent conclusions on the Department for Business, Energy & Industrial Strategy’s (the Department’s) implementation of the Renewable Heat Incentive (RHI) and whether the scheme has cost-effectively increased the generation of low-carbon heat in homes and businesses following our analysis of evidence collected between July 2016 and February 2018.

2 Our audit approach is outlined in Appendix One.

3 We reviewed the context and design of the RHI programme (Part One).

We reviewed the Department’s documents including business cases, impact assessments and consultations to understand the design of the RHI. We also reviewed published information from external stakeholders, including Committee on Climate Change progress reports.

We interviewed staff at the Department and Ofgem, as well as external stakeholders, to understand roles and responsibilities, changes made to the RHI since its launch in 2011, the barriers to uptake and policy proposals developed by the Department to tackle these barriers.

We analysed management information and statistics to measure payments and the number of participants accredited to the RHI.

We compared the government’s approach on low-carbon and renewable heat with other European countries (see Appendix Four).

4 We assessed the RHI’s progress against objectives, cost-effectiveness and approach to monitoring and learning lessons (Part Two).

We reviewed the Department’s documents and management information to understand how objectives have changed; the progress made against the revised objectives; associated costs both incurred and expected; and the expected contribution of the RHI to wider obligations on renewable heat and carbon budgets.

We used a market management toolkit and management information to assess progress in developing the supply chain for low-carbon and renewable heat.

We held workshops with the Department to understand its own assessment of the cost-effectiveness of the RHI. We then used an anonymised dataset from Ofgem, to produce our own estimate of the renewable heat and carbon cost-effectiveness of the RHI (see Appendix Five).

We conducted workshops with colleagues from the Department and Ofgem to understand their approach to mapping the customer journey and improving customer service. We analysed management information to determine progress against key performance indicators.

We interviewed staff in the Department and Ofgem to assess how lessons are learned and whether those lessons influence planning and policy development.

5 We assessed the Department’s approach to controlling costs and whether fraud, non-compliance and gaming are adequately prevented (Part Three).

We reviewed the Department’s and Ofgem’s documents to understand how it manages the RHI budget, payments made to participants and compliance checks. We also interviewed staff at the Department, Ofgem and HM Treasury to further our understanding of the approach as well as how risks are identified, monitored and acted upon.

We investigated the differences between the Great Britain and Northern Ireland RHI by reviewing Northern Ireland Audit Office reports and public inquiry documents on the Northern Ireland RHI (see Appendix Three).

We analysed management information to measure RHI spending against the budget and expected forecast spending over the lifetime of the RHI.

We reviewed the model used by Ofgem to estimate rates of fraud and non-compliance. We also analysed management information on site audit caseload and the outcomes of these site audits.

We reviewed the management system for managing instances of fraud, non-compliance and gaming. We also visited Ofgem’s two customer care centres where we conducted a process walk-through and interviewed staff to understand the accreditation, administrative and compliance-checking process.

We shadowed on-site visits with scheme auditors to observe the site audit inspection process.

We investigated cases of alleged misuse of the scheme brought to our attention by members of the public.

6 We received independent scrutiny and advice from an expert panel consisting of Jenny Hill (Committee on Climate Change), Zoe Guijarro (Citizens Advice), Keith MacLean (Chair of the UK Energy Research Centre and technical assessor to the Northern Ireland RHI Inquiry), Richard Lowes (University of Exeter), Robert Gross (Imperial College London) and Nick Eyre (University of Oxford).

Appendix Three

The Northern Ireland Non-domestic RHI scheme

1 The Department for Enterprise, Trade and Investment (DETI) was responsible for the Non-domestic Renewable Heat Incentive (RHI) scheme in Northern Ireland.29 The scheme was launched in 2012 based on a similar design to the Great Britain RHI but with significant differences. DETI used different tariff rates to the Great Britain scheme. It also decided to use a single tariff band and not introduce tiered tariffs (which switch participants’ tariff from a higher to lower rate once heat production reaches a pre-defined limit) to control spending for existing participants.

2 In Great Britain, tariff degression was introduced into the Non-domestic RHI from 2012. This cost control measure enabled the Department to reduce tariff rates for new applicants when the rate of applications exceeded pre-defined limits. As a result of degression, tariff rates for biomass boilers sized up to 200kWh in the Non-domestic scheme fell from 8.9p/kWh to 4.2p/kWh between 2013 and 2015.30 Over the same time period, DETI increased tariff rates available for biomass boilers from 6.3p/kWh to 6.4p/kWh (see Figure 19).31

3 DETI did not implement cost control measures until 2015, following an increase in the number of applications as a result of the higher tariffs. It announced that it would introduce the tiering of tariffs, which led to a spike in applications before it was able to implement the cost control reform. This led to the scheme running out of money and being suspended to new applicants in February 2016.

4 Since the suspension of the Non-domestic RHI in Northern Ireland there has been extensive parliamentary scrutiny and in 2017 a public inquiry was set up to investigate and report on the RHI scheme. Through this process, there have been accusations of participants abusing the scheme. As there was no tiering of tariff rates, degression of tariffs for new participants or an absolute cap on the amount of heat a participant could produce, participants were provided with a financial incentive to run their heating system 24 hours a day all year round, even if the heat generated was not used. The Northern Ireland inquiry is looking into these issues.

29 Renamed the Department for the Economy in 2016.

30 Tariffs in 2015-16 prices.

31 See footnote 30.

Appendix Four

International comparisons

1 The UK has lower rates of renewable heating than other countries in the European Union. The Renewable Heat Incentive (RHI) was the first major programme in the EU to increase rates of renewable heating using a tariff-based financial incentive. Other European countries have focused on the use of regulation, capital grants and carbon taxes to incentivise renewable heating (see Figure 20 and Figure 21).

2 Our analysis has found that across 22 countries in Europe in 2013, high rates of renewable heating were correlated with high rates of district heating. District heating or heat networks are distribution systems of insulted pipes that takes heat from a central source and delivers it to a number of domestic and/or non-domestic buildings. The heat source can be a facility that provides a dedicated supply to the heat network such as a biomass boiler or heat pump, or energy from waste plants (see Figure 22).

Appendix Five

Cost-effectiveness of the Renewable Heat Incentive

1 The cost-effectiveness of the Renewable Heat Incentive (RHI) can be measured in different ways. The Department for Business, Energy & Industrial Strategy (the Department) uses a method based on the net ‘resource cost’ to the economy. This compares the cost of installing and running the technology with an estimate of the monetary value (to society) of the carbon saved and renewable heat generated. This measure does not separately identify the amount of money spent by the taxpayer and relies on forecasting carbon prices (market price and non-traded carbon price) more than 20 years into the future.

Our methodology

2 We measure cost-effectiveness as the amount of taxpayers’ money spent to achieve each unit of desired output: one megawatt hour (MWh) of renewable heat and one tonne of carbon emissions avoided (t/CO²e). In our analysis, we estimate payments, heat generated and carbon saved over the lifetime of the heating systems installed up to September 2017.32 As a ‘base case’ we have attempted to replicate the most relevant assumptions the Department has used in its impact assessments and monitoring tools. We then examine the implications of varying these key assumptions.

3 Our results also rely on other simplifications, which means they should be treated as indicative rather than definitive. For example, we extrapolate 20 years of generation and payments from the first five years of the schemes, so small changes in the base data could imply large changes in the results.

4 We used different approaches to estimate cost-effectiveness for the Non-domestic and Domestic schemes.

Non-domestic scheme: payments to participants are based on the amount of renewable heat they produce. This is measured through meter readings participants submit to Ofgem in order to receive payments. We used Ofgem payment records to estimate the average amount of renewable heat each applicant has produced to date, extrapolating this over the 20 year expected lifespan of the technology. For participants with payment records covering less than one year, we used an average load factor (applies to 21% of applications).33 We used a different approach for biomethane plants because they have long ramp-up periods: extrapolating from generation early in the life of the plant would underestimate lifetime generation. To avoid this, we used the Department’s estimate.

Domestic scheme: payments, over seven years, are based on a specified heat demand as set out in the applicant’s Energy Performance Certificate. We used this to estimate lifetime payments, renewable heat produced and carbon emission savings. We have assumed the technology’s lifespan to be 20 years, in line with the Department’s expectations.

Data

5 Ofgem provided the data for our ‘base case’ analysis. It contains anonymised records of the technology installed, application status, tariff rates and payments made to date. The payment data does not take into account accruals.

Base case results

6 Using the Department’s key assumptions, we estimate the Department will spend an average of:

£49/MWh to produce renewable heat over the lifetime of the installations accredited to the scheme up to September 2017; and

£142 per tonne of carbon dioxide equivalent saved over the lifetime of the installations accredited to the scheme up to September 2017.

7 Figure 23 breaks down these estimates by scheme (Non-domestic and Domestic) and technology within each scheme. The Domestic scheme is more cost-effective both in terms of heat and carbon cost-effectiveness. However, the low amount of heat generated by domestic installations (7.7% of the total) means they have little influence on the overall cost-effectiveness of the RHI. Cost-effectiveness, in terms of renewable heat generated and carbon emissions avoided, is heavily influenced by biomass boilers installed under the Non-domestic scheme. This contributes to 52% of the renewable heat generated through the RHI.

Sensitivity analysis

8 Figure 24 sets out five of the most important assumptions underpinning our estimates of cost-effectiveness. Figure 25 and Figure 26 show the sensitivity of our estimates in terms of renewable heat and carbon cost-effectiveness. Our analysis indicates that there is significant uncertainty around our base case estimates, in particular carbon cost-effectiveness.

9 Changing the Department’s assumptions on upstream emissions, additionality, fraud and non-compliance, lead to renewable heat and particularly carbon cost-effectiveness estimates worsening in all scenarios. This indicates that actual cost-effectiveness is likely to be worse than our base case results.

10 Note that the impacts estimated for each of the five key assumptions should not be combined.

32 Our results are in real terms and do not take into account inflation. We have used a 2018 price base.

33 BEIS, Survey of Non-domestic RHI Applicants (Wave 2), January 2016.

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