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Publications / Blogs

Building a mass market for heat pumps

While the UK has halved its emissions since 1990, this has required little from us as consumers but the next tranche of cuts, however, will require major changes – from our cars to our heating. 

To stay on track, this change needs to be rapid so it will be important to get the approach right first time. Here, it is useful to look at what hasn’t worked so well in the past – and why.  

Double-glazing, loft and cavity wall insulation took off in the 1980s – driven partly by the oil crisis of the 1970s. Now, forty years later, over 90% of homes are double-glazed, but a third of cavities are yet to be insulated and half of lofts are under or totally uninsulated. 

Consumers often state ‘energy saving’ as the reason for installing double-glazing but, as an investment, it fares poorly here with a simple ‘pay-back’ (investment divided by bill savings) of around thirty years compared to two to four years for loft and cavity wall insulation. Yet, despite being more expensive, more disruptive and less effective, double glazing (driven by the private sector rather than government programmes), has all but saturated the available market whilst basic insulation has (pre-crisis) been hard to give away. 

A similar parallel could be made between the smart meter rollout and the uptake of smart speakers (such as Amazon Alexa). The former has been government-led with poor consumer understanding of the value slowing take-up. After eleven (long) years, around 50% of households have a smart meter. A similar proportion is forecast to have a smart speaker in 2022 but with most purchased over the last four. Whilst a smart speaker is clearly easier to ‘install’, the comparison highlights how much more flexible consumers can be, (for example, on privacy and data protection) when it is something they want. 

This highlights the importance of maximising consumer ‘pull’ in rapid change programmes. The private sector is better at ‘storytelling’ and better placed to fiddle until it hits upon an attribute that consumers value enough to move the dial. And as with Alexa, the actual hook might be the ‘amuses the kids for ten minutes whilst I tidy up’ factor rather than the headline on the original business case. 

The lesson here then is that we need to spend more time thinking about what people ‘want’ and how to deliver that. For heat pumps, this is likely to mean an effective and reliable replacement system that delivers lower bills but with no additional upfront cost. 

This means getting to a ‘sweet spot’ in the market where lower bills can finance any residual difference in capital costs. This ratio could be achieved, for example, by reduction in capital costs from £10,000 now to £6,000 along with a £30 per month saving over conventional heating. Here, the £360 annual bill saving would ‘pay for’ the additional (£3,500) cost of the heat pump over the boiler during the ten year warranty[1] of the heat pump. 

Once this ratio is achieved, it will ‘unlock’ secondary enablers – green finance, higher quality and more sophisticated consumer advice (competition will drive up standards). Whilst this ratio works in new builds, we are clearly some way off in the retrofit market. This is where government intervention is warranted – to get the basics to stack up so the market can take over. 

The question for Government then should be how can it best target intervention to get here. In comparison with the previously subsidy scheme, the Renewable Heat Incentive (RHI) again shows us how not to do it. Over a decade, the RHI cost around £23 billion yet failed to significantly grow the market share for heat pumps. This highlights the importance of using subsidies as part of a package of measures and how shorter, more targeted interventions can deliver better value. 

Government has made some good steps to address the capital cost. The proposed mandate, from 2024 on heating manufacturers to produce heat pumps, will, if sufficiently robust on both quality standards and non-compliance, reduce capital costs, as will the support to grow UK manufacturing and the removal of the 5% VAT rate.  

More however, could be done on building a secure demand pipeline to reassure investors. Earlier action on new build was a missed (and low-cost) opportunity. Other options are supporting social housing providers and off-grid communities to go further, faster (both areas where adequately signalled ‘phase-out dates’ for new fossil fuel systems could benefit consumers if sufficient support is provided). 

In contrast, there has been little intervention on running costs. The Affordability and Fairness Call for Evidence on policy levies has been kicked into the long grass by the gas crisis and when change does happen, it is likely to be gradual. A greater focus here is needed as the more than running costs can come down, the less pressure there will be on capital costs (which could take longer to fall) to make the all-important ratio work.  

A £50 per month saving, for example, provides a £6,000 saving over the ten years of the heat pump warranty, meaning that providers able to offer this level of saving could offer an upfront loan to consumers (that could be repaid via these savings) when heat pumps dropped to around £8,500. This suggests that the conditions for a mass market could be reached faster with a stronger focus on running costs. 

What other options are there for reducing running costs other than moving the policy levies off the electricity price? Emerging flexibility markets could be interesting here. Whilst static or dynamic time of use tariffs can help cut running costs (early data from UKERC, Carbon Trust has suggested a 23-46% reduction can be possible), they only pass on the lower wholesale costs. This means that the wider system benefits that the heat pump user is providing (by their demand shifting) are going largely unrewarded. As these markets open up, however, there will be more opportunities for aggregated domestic demand (including from heat pump users) to access new revenue streams. 

Providers who are able (either individually or with partners) to optimise and stack the various potential revenue streams (from savings via energy efficiency to new flexibility revenues) and pass that onto the customers are likely to have a key advantage in future heat markets. 

It is these providers who will be able to give customers what they want (lower running costs and no additional capital cost) earlier than their competitors.  

Whilst simpler than Heat as a Service models (the finance and supply/ flexibility contracts could be separate), this approach could be compelling enough to get people to switch. The separate contracts would also leave customers free to switch to another provider if the competitor ‘set out a better stall’ on how they could cut running costs. 

So, in summary, establishing a mass market rapid needs to be driven by what consumers want. For heat pumps, this is likely to mean systems that deliver good bill savings and can be provided at no additional upfront cost. Whilst Government is making positive moves on reducing capital costs, there has been little intervention to reduce running costs. Providers with the reach to both support customers and play in emerging flexibility markets could be best placed to deliver higher savings to consumers, giving them a potential advantage in future heat markets. 

[1] Whilst heat pumps can often run for 15-20 years, the longest warranties currently are around ten years.