Accelerating the installation of heat pumps should be a key part of the UK government’s medium-term response to the energy crisis. Heat pumps meet two crucial objectives for government: they significantly reduce carbon emissions, tackling the climate crisis; and they reduce gas use, tackling the energy crisis.

However, even though the energy crisis has slightly improved the financial incentives to get a heat pump, more government action will be required to accelerate their roll out. The direct economic benefits of this action will be significant, including potentially reducing net gas imports by over £1,100 per year for each heat pump installed.

The price of electricity remains far higher than gas, and has risen significantly over the past 12 months. This is primarily because gas prices set the wholesale price of electricity, despite a majority of electricity being generated from other, cheaper sources [1]. Electricity also faces an effective tax - in the form of environmental and social levies that are added to electricity bills but not gas bills - which currently acts as the opposite of a carbon tax.

[1] See Nesta’s 2022 blog post, How green is my tariff? for an explanation of this.

Recommendation 1: reduce the influence of gas prices on electricity prices

The UK government should seek to decouple the price of gas-fired electricity from renewable electricity as far as possible, while still maintaining the influence of overall market demand within renewables. This should make electricity overall much cheaper because renewable electricity is generally the cheapest type of electricity overall. Because renewables output is variable over time, this would also make flexibility in electricity use – another option included below – much more attractive.

There are several mechanisms which can help reduce the influence of gas prices – the pot zero approach, modelled in this paper, is just one limited option – but any effective decoupling should reduce the relative cost of heat pumps. In our analysis, this change could improve the relative lifetime cost per year of a heat pump by at least £70-£160.

Recommendation 2: remove levies from electricity bills

The UK government should remove the environmental and social levies on electricity bills as soon as possible. These levies add around £150 to the average bill under the October 2022 price cap. Shifting the cost of ECO to gas bills, and other levies to general taxation, would reduce the relative lifetime cost per year of a heat pump by £140-£330.

The UK government recently announced that it will be moving levies to general taxation for the next two years. However, we recommend that this change be made permanent, to improve the lifetime case for heat pumps, and that the ECO element of levies be moved to gas bills to provide a further incentive for electrification. Crucially, this shift should not increase bills for most gas boiler homes either [1].

[1] Gas boiler homes are likely to see 2%-5% savings in overall energy bills from the levy shifting proposed here.

Recommendation 3: encourage more efficient heat pumps systems across design, installation and manufacturing

More efficient heat pumps reduce energy bills and are significantly more financially beneficial to customers. The UK government should seek to raise heat pump efficiencies by including efficiency standards in the market-based mechanism for low carbon heating and the Energy Related Product framework. It should also conduct – or require the industry to conduct – more regular monitoring of efficiencies of all heat sources (including boilers and heat pumps) as they operate in homes, making this data more widely available to customers.

Recommendation 4: encourage flexible electricity use

There is significant scope for heat pump running costs to be reduced by using electricity more flexibly. The assumed benefit from flexibility included in our model – a 2% reduction in cost of heating bill for households with heat pumps – is fairly conservative. And while there is scope to realise higher payments from demand response services, there is even greater scope to achieve direct savings from energy consumption reduction with improved system design, energy storage options and controls.

Governments in the UK should promote the use of electric batteries and smart thermal storage more widely alongside low carbon heating. The UK government is right to propose a requirement on all electric heating systems to operate smartly, as this will reduce costs for consumers and for the wider energy system. The UK government and Ofgem should also push for more widespread reintroduction of flexible time-of-use tariffs, either by paying customers to flex their electricity use or encouraging lower tariffs at times where electricity is more abundant.

Recommendation 5: extend subsidies while the energy crisis persists

Given the high upfront costs of heat pumps, subsidies help to increase their attractiveness to customers. Nesta’s research, How to increase the demand for heat pumps, showed a £5,000 subsidy is the single most effective measure to increase demand for heat pumps. Although subsidies are expensive for governments, every heat pump installed will bring a significant fiscal benefit to the UK government for every year the energy crisis lasts, by significantly reducing gas imports. While gas prices remain at very high levels, there is a strong fiscal argument for continuing subsidies beyond the 30,000 per year currently budgeted for under the Boiler Upgrade Scheme. If combined with other policy changes, such as shifting levies or providing low-cost finance, governments could also consider scaling down subsidies to a lower value over time.

Alongside subsidies, governments should also provide or support low-cost financing for heat pumps. Nesta’s research, How to increase the demand for heat pumps, showed this has almost as big an effect on demand for heat pumps as a subsidy and is crucial to make the upfront cost of heat pumps affordable to most households.

Recommendation 6: increase the capacity of the heat pump industry

The supply of heat pump installations is limited and will take time to scale up. Nesta’s work on How to scale a highly skilled heat pump industry estimates there are currently around 3,000 skilled heat pump installers, and that this would need to increase roughly ten-fold in the next six years to keep pace with UK government targets for heat pump installations. Expanding the industry at this speed presents significant challenges, and governments in the UK may need to support training and business growth in the industry.