…but they are not financially attractive. Why is this? And what can be done about it?
Jake Barnes & Sivapriya Mothilal Bhagavathy
In Europe, space and water heating account for approximately 80% of final energy use in the domestic sector. To meet the legally binding targets of reducing emissions to below 80% of 1990 levels by 2050, we need to critically reduce the emissions associated with this heating demand.
We can do this by:
- improving the energy efficiency of buildings, so that less fuel is needed to achieve the same level of heat and comfort;
- reducing the carbon intensity of gas by changing or blending with hydrogen; and
- generating heat using electricity, while also reducing the carbon intensity of electricity generation. The carbon intensity of UK electricity generation is quite close to that of gas and will be lower than gas before 2025.
We can generate heat from electricity using electric radiators, electric storage heaters, and heat pumps. Electric heat pumps (HPs) are common in many European countries, and the further electrification of heat provision in this way, is a promising decarbonisation pathway.
In the UK however, heat pumps are not common. Natural gas is the most common fuel used in the UK for space and water heating.
The need to move off gas has been raised at the highest level, with the government proposing in 2019 that gas will be banned in new homes from 2025 in a bid to tackle emissions. The then Chancellor of the Exchequer, Philip Hammond, stated that new standards will be imposed, “mandating the end of fossil fuel heating systems in new homes from 2025 delivering lower carbon, and lower fuel bills too”.
Sounds good! What’s the problem?
Taxes and levies placed on electricity in the UK have received considerable attention in the last decade for their social and distributional impacts. Now there is concern that they may be working against our need to lower carbon emissions from domestic heating.
The Committee on Climate Change agree and states that because the full carbon cost of using fossil fuels for heating is not reflected in their pricing, the existing UK tax and regulatory regime creates “perverse market incentives that work against low-carbon [electrified heating]” (CCC, 2016, p68).
This is because, due to various policy choices, taxes and levies are applied more heavily on electricity bills than gas bills. While the net effect of these policies on energy has been to lower domestic bills, it is true that current taxes and levies are applied more heavily to electricity than gas bills.
These are the reasons why taxes and levies are higher on electricity than gas:
- Taxes: The EU Emissions Trading Scheme (EU ETS) and carbon floor price in the UK, impose a carbon price on electricity but not on gas. These taxes are passed through to consumers within the wholesale market price of electricity.
- Levies: Levies are placed on UK energy suppliers to pay for a range of environmental and social objectives, such as the winter fuel payment. The cost of these levies is passed through to households via domestic energy bills.
These policy choices have the unintended consequence of making low carbon or electrified forms of heating (such as heat pumps) financially unattractive.
While many people would want to decarbonise their heating, the low affordability of low carbon technologies is possibly the most important barrier facing many households.
Residential gas and electricity price components 2016, 2020 and 2030 (p/kWh) (based on CCC, 2017).
The cost of heat pumps vs. gas boilers
Taxes and levies are not the only reason why heat pumps are less financially attractive. Their upfront cost and performance are also important.
Our analysis of costs and annual fuel bills, shows that efficient heat pumps would cost less to run than gas boilers, if it were not for the taxes and levies on electricity.
However, if we consider the whole lifetime costs of heating systems then the situation changes. The impact of taxes and levies is relatively small when considering the very large upfront costs of heat pumps compared to gas boilers. These large upfront costs make heat pumps very unattractive to consumers from a cost perspective. This is especially so when occupants think they will not live in the property for a long time.
We also looked at the performance of heat pumps. The efficiency of a heat pump is expressed by its seasonal performance factor (SPF). The annual energy bill for a heat pumps with a high SPF can be up to 25% less than that from a gas boiler. Heat pumps with lower SPFs however, have higher bills than gas boilers.
The cost of domestic heating systems: installation, maintenance, and yearly fuel expenditure. GSHP is ground source heat pump; ASHP is air source heat pump.
What can be done?
We recommend the following interventions:
- Increase the roll out of heat pumps in order to reduce the upfront costs through economies of scale, competition, and lower labour costs (through greater experience). This could be done in a number of ways:
- increased public procurement to encourage further market development
- Foster demand through national campaigns or awareness raising
- Collaboration between government and industry to simplify installation procedures and accreditation
- Free training for installers to learn about the new technology and installation best practices
- Provide capital grants or loans to those wishing to install a heat pump
- Improve the performance of heat pumps. This will reduce running costs and the impact of higher electricity costs. This could be done by setting a minimum efficiency standard for all heat pumps akin to boiler standards, that would increase performance and remove the worst performing heat pumps from the market.
Let’s do it!
We need to move to low carbon forms of heating urgently. Removing these unintended impacts of government policy and supporting the deployment of heat pumps will help us get to net zero by 2050, and hopefully sooner.
You can read more about this research and findings in our paper:
Barnes, J and Bhagavathy, S (2020) The economics of heat pumps and the (un)intended consequences of government policy, Energy Policy, vol 138, March 2020. https://doi.org/10.1016/j.enpol.2019.111198