Barriers to a sustainable market for heat pumps
The total number of heat pumps sold in the UK in 2017 was 20,000 – just 8% of the total sold in France (2017) and 20% and of the total sold in Sweden (2016) (GLA, Heat Pumps in London, 2018).
While it is true that any challenge to an incumbent mains gas grid is difficult, other countries are succeeding. More than 20 million consumers use natural gas in both Germany and Italy yet Germans bought 500,000 heat pumps and Italians more than a million up to 2013 (Committee on Climate Change, 2016). More than 180,000 heat pumps were installed in Italy in 2017 alone. According to an assessment carried out by the Committee for Climate Change in 2016, the market for heat pumps in the UK has ‘flat-lined’. The total number of air source heat pumps installed under the domestic RHI by January 2020 was just under 45,000 and the equivalent figure for ground source was just over 10,000 (Ofgem, 2020).
Table 1 – Heat Pumps Sales in Different Countries (Greater London Authority, 2018)
As UK’s domestic consumers account for around 50% of greenhouse gas (GHG) emissions from heat there is a widespread consensus that any plans for a ‘net zero’ balance within the next few decades will be impossible without an overhaul of domestic space and water heating. In the first of our analyses setting out our thoughts on the Government’s Future Support for Low Carbon Heat consultation, we examine why UK’s roll-out of heat pumps is dwarfed by the mass markets developed in other countries.
Taxes and levies
Some analyses blame UK’s system of energy taxes and levies for stifling the market for heat pumps. Barnes and Bhagavathy recently found that a cascade of Government policies over many years have artificially inflated the cost of domestic electricity in comparison to gas with their cumulative impact working against the electrification of heat (Barnes and Bhagavathy, 2020). On the one hand, the Government uses the Renewable Heat Incentive (RHI) to stimulate the heat pump market but, on the other hand, consumers pay for social and environmental policies through levies primarily on electricity bills. These levies, which pay for schemes such as the Energy Company Obligation (ECO), make the economic case for heat pumps less attractive.
The Committee on Climate Change (CCC) analysed these costs in 2016 and came to the same conclusion. It found that a typical household would pay more per year using a heat pump than gas but that the difference was almost entirely explained by the low-carbon support levies and carbon pricing imposed on electricity (Committee on Climate Change, 2016)(See Fig1).
Fig 1: Figures derived from Committee on Climate Change, 2016.
Commenting on the stark economics of the choice between a gas boiler and a heat pump it said:
“This means that it is not possible to recoup the higher capital costs of the heat pump through reduced energy bills.”
The current tax and levy regime creates ‘perverse incentives’ according to the Heat Pumps Association.
“The UK currently has one of the highest ratios of the gas to electricity [prices] across Europe, sometimes known as the ‘spark gap’, with the price of electricity being close to four times that of gas per kWh.” (Heat Pump Association, 2019)
The HPA want the environmental and social costs currently imposed on electricity bill payers to shift to general taxation. “This would see the marginal cost of heat pump operation fall below that of a gas boiler and encourage the uptake of low carbon heat,” it says.
There is no question that the impact of a carbon price and levies imposed on electricity, coupled with the absence of a carbon price on gas, has an impact on the retail price of electricity. But what impact does this ‘spark gap’ have on the market for heat pumps? Are there other problems and barriers in UK’s market stopping consumers from switching to lower carbon options?
Other barriers
In their recent analysis published in Energy Policy, Barnes and Bhagavathy offer some answers (Barnes and Bhagavathy, 2020). The team set out to quantify the impact of electricity taxes and levies on the economic case for heat pumps by comparing the lifetime cost of various heat pump options to the lifetime cost of gas boilers and direct electric heating. The authors focused on two other factors:
the upfront capital cost of heat pump installations; and
heat pump performance (the system’s efficiency).
The modelling found that the upfront cost of a new gas boiler heating system for a typical UK household would be about £1,600 compared to £8350 for a ASHP, £12550 for a GSHP and £9450 for a hybrid heat pump (a heat pump and gas boiler combination). The figures are drawn from a report by Element Energy Limited for BEIS published in 2017 (Element Energy, 2017).
Taking both fuel prices and the seven year RHI subsidy into account, the team calculated the Net Present Cost (NPC) for all technology scenarios over a system lifetime of 15 years. The findings are set out in Fig 2.
Fig 2: Derived from Barnes and Bhagavathy (Barnes and Bhagavathy, 2020). The whole columns indicate the total lifetime costs of the various systems. The costs covered by the RHI are indicated by the dark blue column sections. The black range bars represent the impact high or low efficiencies have on lifetime costs of the heat pump systems. Costs of highly efficient systems would be at the bottom of those range bars. Costs of badly performing systems are likely to be higher than those indicated by Barnes and Bhagavathy as explained below.
Overall, the team found that while taxes and levies do ‘weaken the case’ for a switch from mains gas to a heat pump, the upfront capital cost and the potential performance of the heat pump system have a much greater impact on the economic argument. In other words – when a heat pump performs well (when it has a high Seasonal Performance Factor – SPF), it can be cheaper than mains gas in the long run. But when it has a low efficiency (a low SPF value) it can be significantly more expensive. For example, in their analysis they found that an ASHP with an SPF of 2.5 has a lifetime cost of around £16,240 (allowing for the RHI). This compares to the gas boiler lifetime cost of £12402. At the other end of the spectrum, the best performing installations (SPF 4.1) would result in lifetime savings of around £1000.
Central to the methodology used by Barnes and Bhagavathy is that the ASHP and GSHP calculations are based on the deemed SPF rating of heat pumps sourced from the RHI deployment database (BEIS, 2018)(the mean being 3 for ASHPs and 3.3 for GSHPs). The range extends from 2.5 to 4.1. But it is critical to note that these SPFs are the installer predictions of potential performance and are unlikely to reflect the actual in-situ performance experience by the consumer.
The minimum SPF allowable under the RHI is 2.5 but published field trials show that a significant proportion of heat pumps in the UK operate at lower efficiencies. We also know from other evidence (including, but not limited to, field trials) that installer pre-contractual performance predictions often over-estimate efficiency. What this means is that the lifetime costs shown in Figure 2 (included in the ranges indicated) can, in reality, be significantly greater.
The economic case for a heat pump installation
rb&m’s own modelling of heat pump performance forecasts finds that the economic case for replacing a gas boiler with a heat pump can rest on fragile assumptions. Small changes in the variables can have a profound impact on the economics. Figures 3 to 5 are drawn from one actual installation proposal we recently examined as part of a routine audit. The system cost at £12000 is low for an installation designed for a combined space and water heating demand of around 30,000kWh. In a scenario where the SCOP efficiency is 3.55 (Fig 3) the cumulative benefit of the RHI would compensate for the higher running costs and there would be a net benefit through the lifetime of the system. However, if every variable stays the same but the efficiency is forecast as 3.21 (Fig 4) then the estimate would predict a significant shortfall in meeting the capital outlay. An SPF of 3.21 is significantly higher than the mean SPF found in UK field trials and higher than the mean found in the RHI deployment database.
Figs 3 – 4: Figure 3 is based on an actual and typical installation proposal audited by rb&m. Total heat demand was close to 30,000kWh. The scenario assumes the consumer receives the full MMSP metering allowance and the RHI is CPI linked at 2.3%. The costs assume the heat pump is replacing an existing gas boiler at 92% efficiency. Electricity is assumed to cost 14.5ppkWh and gas 4.2ppkWh. The predicted SCOP is 3.55 for space heating and 1.75 for DHW.
Fig 4: The scenario used for Fig 4 assumes a predicted SCOP of 3.21. All other variables are the same.
Fig 5: Assumes a SCOP of 3.21 but the cost of electricity is 1pence higher at 15.5ppKWh during the lifetime of the system.
Fig 5 shows the dramatic impact fractional changes can have on the actual consumer experience. The scenario is the same as for Fig 4 but we assume the consumer actually spends 1 pence more on the electricity tariff during the lifetime of the system. This makes the cumulative shortfall worse with a gap of more than £3500 by year 16. It should be noted that pre-contractual performance forecasts are very often presented as facts not predictions.
Of further concern is that rb&m have audited several companies who sell heat pump installations through finance. Interest charges eliminate the economic case for switching from mains gas to a heat pump and are often camouflaged in the sales process.
Barnes and Bhagavathy do not comment on the reliability of the installer forecasts drawn from the RHI deployment database but they do mention the fact that the higher the SCOP forecast, the higher the RHI payments. This happens because the RHI tariff amount applies only to the renewable portion of the calculated heat demand. An unintended consequence of the RHI, therefore, is that the scheme (partially) compensates consumers whose systems do not achieve the efficiencies forecast by the installer.
Consumers who sign away their rights to the RHI are not so lucky. Under the Assignment of Rights scheme, any shortfall in the actual efficiency achieved (compared to the installer’s prediction) may also eliminate the economic case for the contract. We will cover that issue in more detail soon.
A granular approach
Barnes and Bhagavathy found that the total fuel costs over the lifetime of a heat pump may represent as little as two-fifths of the total lifetime cost. Overall, they conclude that the taxes and levies imposed on the electricity retail price “do not substantially alter the competitiveness of HPs against gas boilers”. Conversely, they found that “the economic competitiveness of HPs is largely dependent on the SPF achieved” – something the rb&m team has long argued.
According to the CCC, the carbon price and levy issue is just one in a complex web of barriers that combine to suppress the market. For example, in 2019 the CCC identified a range of problems in the UK supply chain including:
performance and compliance issues;
the UK skills gap; and
lack of Government support for quality retrofit (Committee on Climate Change, 2019).
In this same report the CCC said: “The low uptake of heat pumps is symptomatic of low awareness, financing constraints, concerns around disruption and difficulty in finding trusted installers with the right skills.”
Three years earlier, the CCC identified a range of ‘policy gaps’ where the UK was failing to learn from countries with thriving markets. Just one example relates to UK’s RHI which the CCC argues is ‘not sufficient in itself to create a dynamic market for heat pumps.’ The CCC argues that the market for heat pumps is focused on a limited demographic that have access to capital. The initial cost barrier is, according to the Committee, one of the main reasons for the low uptake when the international evidence shows that alleviating the upfront capital outlay offers a strong consumer incentive (Committee on Climate Change, 2016).
Conclusions
Levies and taxes imposed on the retail price of electricity do represent a barrier to the heat pump market but the evidence presented by Barnes and Bhagavathy, and supported with conclusions in various reports from the CCC, is that the upfront cost and the actual efficiencies achieved are likely to play a bigger role. Barnes and Bhagavathy support their analysis with interesting policy recommendations.
Firstly, like the CCC and the HPA, they highlight the imbalanced tax and levy regime that penalises electricity but fails to impose an adequate carbon price on gas. A critical problem, however, will be finding a method to rebalance the tax and levy regime without increasing fuel poverty. More than 80% of households are on the gas grid and Energy Systems Catapult estimate that pricing natural gas to reflect the social cost of carbon may increase the average household bill by 23% (Day and Sturge, 2018). We think the HPA is right to argue that the environmental and social costs currently imposed on electricity bill payers to shift to general taxation. But that policy shift must be seen within the wider context of market barriers. Just lowering the relative cost of electricity in relation to gas will not, in isolation, stimulate a sustainable market for heat pumps.
Secondly, policies need to recognise that the upfront capital costs of heat pumps act as a formidable barrier. The CCC points to Scotland’s interest-free loans scheme for microgeneration and other international examples of incentives as potential solutions (Committee on Climate Change, 2016). Increased deployment improves the supply chain leading to efficiencies of scale and competition that drive prices down further.
Thirdly, the performance of installed systems must improve. BEIS has tried to focus attention on efficiencies through compulsory metering but, as the Barnes and Bhagavathy note, improved metering depends on:
significant consumer knowledge; and
the consumer willpower to pursue a complaint after installation.
We would argue that policies should aim at improving design and installation practice with a focus on appropriate installations. Consumers won’t be able to make informed decisions until the ‘performance gap’ between predicted and actual performance narrows significantly. Barnes and Bhagavathy suggest a hike in the minimum SCOP allowed under the RHI and the Future Support for Low Carbon Heat consultation includes a proposal to increase the minimum allowable SCOP from 2.5 to 2.8. Such a change is long overdue.
The CCC offers a range of important proposals to improve the market for the energy transition (Committee on Climate Change, 2016)(Committee on Climate Change, 2019) but we would highlight one of those as the fourth recommendation to improve the heat pump market in particular. The CCC identifies information failures as “incomplete or asymmetric information, uncertainty, hidden costs and high transaction costs including the search for knowledge”. Those information failures, including the issue of asymmetric information about performance, are the most important barriers to market growth. Giving consumers the ability to make genuinely informed decisions will build trust and improve the focus on appropriate installation.
Over the coming months rb&m will highlight the information failures that exist with further detail about specific market issues.
Barnes, J. and Bhagavathy, S. M. (2020) ‘The economics of heat pumps and the (un)intended consequences of government policy’, Energy Policy. Elsevier Ltd, 138(January 2019), p. 111198. doi: 10.1016/j.enpol.2019.111198.
BEIS (2018) RHI Monthly Installations, September 2018.
Committee on Climate Change (2016) Next-steps-for-UK-heat-policy-Committee-on-Climate-Change-October-2016.pdf. London. Available at: https://www.theccc.org.uk/publication/next-steps-for-uk-heat-policy/.
Committee on Climate Change (2019) ‘UK housing: Fit for the future?’, (February), p. 135. Available at: www.theccc.org.uk/publications.
Day, G. and Sturge, D. (2018) ‘Rethinking Decarbonisation Incentives; Future Carbon Policy for Clean Growth’, Energy Systems Catapult and Energy Technologies Institute. doi: 10.1787/9789264289635-en.
Element Energy (2017) ‘Hybrid Heat Pumps’. Cambridge.
Greater London Authority (2018) GREATER LONDON AUTHORITY LOW CARBON HEAT: Heat Pumps in London. Available at: https://www.london.gov.uk/sites/default/files/low_carbon_heat_-_heat_pumps_in_london_.pdf.
Heat Pump Association (2019) Delivering Net Zero: A Roadmap for the Role of Heat Pumps. Available at: https://www.heatpumps.org.uk/wp-content/uploads/2019/11/A-Roadmap-for-the-Role-of-Heat-Pumps.pdf.
Ofgem (2020) Public reports and data: Domestic RHI. Available at: https://www.ofgem.gov.uk/environmental-programmes/domestic-rhi/contacts-guidance-and-resources/public-reports-and-data-domestic-rhi (Accessed: 28 March 2020).
