Are the promised heat pump cost reductions a lot of hot air?

The government has committed to reducing the upfront cost of heat pumps by up to 50% in the next four years, but industry is divided on whether the push for mass installations will be enough to bring costs down.

Since the announcement of its ambitious target for heat pumps in the Ten Point Plan at the end of 2020, the government has been bullish in its expectations for the sector.

Not only is it projecting that both customer demand and sector capacity will ramp up by a factor of 20 in just seven years, but it is also promising to slash costs by 2025.

With upfront costs for air source heat pumps starting at more than £4,000 per household, and ground source heat pumps at more than £7,000, the promise that heat pumps will be at parity with fossil fuel boilers by 2030 will be a welcome one to potential customers.

However, while some in the industry, such as Octopus Energy, have been vocal about the potential for cost reductions, even vowing to go further and bring upfront costs down to a similar level to gas boilers by next year, others in the industry feel both the government and industry are promising more than they can deliver.

They point to the fact that heat pumps are a mature technology with much higher penetration in other countries as leaving little room for reductions here, especially in the timeframe given by the government.

Meanwhile, the government and industry claim that moving away from bespoke off-grid installations to focus on better insulated, modern homes where installation can be simplified and completed on a mass scale will bring about reductions.

Such a strategy will rely heavily on consumer uptake, and risks leaving those customers most in need of cost reductions today out in the cold.

A promise to cut costs by up to half

Alongside the publication of the long-awaited Heat and Buildings Strategy, the government announced its plan to drive down the cost of heat, which included the £450 million Boiler Upgrade Scheme.

Under the scheme, 90,000 grants worth £5,000 can be claimed at a rate of 30,000 a year from April 2022 to help cover the cost of installing a heat pump.

The government said it was making the grants available to “encourage” homeowners to install more efficient, low carbon heating systems at negligible extra cost to installing a traditional fossil fuel boiler.

The government also pledged to work together with industry to “help meet the aim of heat pumps costing the same to buy and run as fossil fuel boilers by 2030.”

Despite having already drawn an ambitious line in the sand, government went further by setting a mid-term target of between a 25-50% reduction in just four years.

Business and energy secretary Kwasi Kwarteng said at the time that costs would “plummet” over the next decade as the “technology improves”, a message that was echoed by key industry players such as Octopus, Ovo, Eon and Scottish Power.

High density installations

One of the ways government is set to work with industry is through a new £60 million heat pump ready innovation programme, which it says will reduce costs by focussing on improving efficiencies in high density installations.

High density installations have also been identified by Octopus Energy as the best place to focus its energies to achieve cost reductions.

The energy supplier has invested £10 million to build the UK’s first R&D and training centre for the decarbonisation of heat. The centre includes two full sized three-bed semi-detached houses – one built to 1970 building regulations, and one to modern day – representing around 40% of UK housing stock.

This strategy of focussing on newer properties makes sense in order to pass on cheaper costs.

A report from what was then known as the Department for Energy and Climate Change (DECC)  in 2016 on the potential for reducing heat pump costs said that installing air source heat pumps in new builds is 10% cheaper due to reduced labour costs, slimmer margins due to high density sales and standardised systems.

A spokesperson for Octopus Energy told Utility Week: “Heat pump installations can often be concentrated in the off-grid market, which can be more costly and complex than typical UK housing stock.

“By focusing on the mass market (instead of bespoke jobs), we can make heat pump installations more efficient and standardise hardware – massively driving down costs along the way.

“And like in any other industry – the more competition we have in the market, the more costs for consumers will come down too.”

Cheaper, but not cheap enough

While bulk order such as those that would be made by property developers and simpler installations will be two factors which will bring down the upfront cost, it will not be at the level projected by the government, says research consultancy Delta-EE.

It’s whitepaper on the potential for reducing heat pump costs in the residential sector was published just two days after the Heat and Buildings Strategy and states that the reduction is not likely to be nearly as much as the government has projected and is unlikely to meet its 2025 deadline.

The whitepaper sets out cost reductions in two scenarios. In the central scenario, the UK market will see installs in the low 100s of 1000s – not enough to meet the government’s target of 600,000 installs per annum.

In the optimistic scenario, annual installs will be in the high 100s of 1000s and high sales volumes will mean the majority of market players are able to squeeze margins to sell products at more than 30% below standard prices.

More heat pump installation companies would also be large companies with lower overheads.

But to achieve this kind of figure, and to maximise the strategy of targeting high density, easy installations, mains grid gas customers and property developers will need to be convinced to be early adopters of the technology.

They will need to make a major decision on their heat supply in the next few years, despite the government still consulting on heat networks, and a decision on hydrogen not due to be taken until 2026.

Even if enough customers are lured into making an early decision, the maximum reduction that the whitepaper expects is up to 38% – meaning an 8.5kW air source heat pump would still be more than double the cost of a gas boiler.

In the central scenario, the predicted cost reduction is just 25%.

Lindsay Sugden, head of heat at Delta-EE, said: “While overall the grants announced in the Heat and Building Strategy are a step in the right direction to decarbonising a crucial area in the UK’s overall emissions, these proposals are not sufficient to achieve the government’s decarbonisation goals.

“Our research suggests reaching a 25-50% cost reduction, as proposed in the Heat and Building Strategy, is unlikely to be met, especially by 2025 as is currently suggested.”

Higher installs on the continent

One of the main supplier voices missing from the subsidy announcement was British Gas.

As the largest installer of heating systems in the UK, it is the energy supplier who could arguably segue into heat pump installations most easily.

And yet, despite committing to installing 20,000 heat pumps per year by 2025 in British Gas’ parent company Centrica’s Climate Transition Plan, which was launched during COP26, chief executive Chris O’Shea is far more reserved in his expectations for cost reductions.

While giving evidence to the Industry and Regulators Committee for their enquiry into Ofgem and Net Zero, O’Shea pointed out that the plan to reduce costs is reliant on customer uptake, which is difficult to incentivise and encourage, as seen by the smart meter rollout.

“If you industrialise the issue and incentivise it properly, it is easier, and we saw that with wind versus smart meters.”

He also questioned why the cost of heat pumps would reduce just because the UK was installing more of them.

“Some people will argue that they will get the costs down because it is new technology, but …. this is not new technology; it is existing technology, and I am not sure why an additional 500,000 heat pumps in the UK will drive the price down—and that is what France is doing already today.”

DECC’s heat pump report aligns with O’Shea; “Heat pump technology is essentially a mature technology, despite low market penetration in the UK.”

It adds that the equipment cost element of a heat pump, which makes up 60% of the total cost, is not just reliant on the UK market but is affected by the wider European and global industry.

As O’Shea stated in his evidence, heat pumps are not a new technology – they have been around for decades, with many parts already being industrially produced as they are shared components with the air conditioning industry.

But there may be areas for the development of UK specific solutions that will help reduce prices, as suggest by DECC’s 2016 report.

“There is high technical potential to increase efficiencies and identify lower cost materials for heat pumps,” it says.

Octopus Energy is also positive about the opportunity to be gained from UK-specific development.

“Good solutions already exist for the mass market, but tech innovations will drive improvements and solutions for other property types too (e.g. high-rise flats with limited external space), enabling heat pumps to work in almost all homes.

“This is true for all markets, but in the UK we have particularly homogeneous heating systems and housing stock and a relatively temperate climate, which enables mass take up of these solutions,” the company says.

As well as launching its R&D centre this year, Octopus Energy has also filed 30 patents – many of which are likely to relate to heat pumps, adding weight to their argument.

However, if UK-specific solutions are going to be a key element of cost reductions by 2025, then it will be from a standing start.

A recent report looking at “Greener Buildings and Heat Pumps” published by the Intellectual Property Office stated that “at present” there are “relatively few” patents directly relating to heat pumps which are being filed in the UK, and that this lack of activity “does not reflect” worldwide activity.

What can we learn from the French rollout?

O’Shea pointed to the French rollout as an example of why higher installations would not automatically result in lower prices, and how incentives can skew the market in the short-term but not necessarily encourage real market growth.

According to the French Heat Pump Association, the French heat pump market emerged in the 1980s and remained a niche one until 2008 which saw the combination of an unprecedented rise in oil prices and a tax credit which allowed homeowners to claim 50% of the price of a heat pump (excluding installation) as a tax reduction.

Installations went from 51,000 units in 2007 to 131,000 units in 2008, with numbers limited by the fact suppliers couldn’t meet demand.

But after the subsidy was eventually removed in 2010, installations returned to 54,000 units.

Since then, the heat pump market has found a niche in the new build sector, which 40% of new builds being equipped with one.

This meant that the overall market for heat pumps in France in 2018 was between 70,000-80,000 units, and yet the upfront cost for an air-source heat pump is largely the same as in the UK currently.

Cost reductions, but not for the hardest to treat homes

Opinions are clearly divided in the industry over whether the government’s 600,000 heat pump installation target is achievable, especially given where the UK is starting from.

Even if it is achieved, the level of reductions this can be expected to bring about is still up for debate.

If the UK was to learn any lessons from the French rollout, it is that subsidies and modern, well-insulated homes are needed to encourage uptake of heat pumps at a mass scale.

This is clearly the government and industry’s plan, and while it makes sense from a commercial perspective, and means the government cannot be criticised for failing to take action in the short-term, it does risk asking customers to make decisions before the full suite of options is available to them.

While some modern homeowners will be early adopters, it will be those five million customers for whom heat pumps will be the only option who will be most keenly anticipating cost reductions, and yet they will be the least likely to benefit from them in the short-term.