Is it fair to shift policy costs from electricity to gas?

The debate over the imbalance of policy costs and taxation between electricity and gas bills is ramping up as the Treasury investigates how net zero should be paid for. As part of our Countdown to COP campaign, David Blackman looks at the arguments for change alongside concerns that targeting gas bills would hit the fuel poor hardest.

It looks, as Greg Jackson bluntly put it recently, “bonkers”.

The Octopus chief executive was talking about the imbalance of policy costs and taxation between electricity generation and gas.

The point was also underlined by EDF in its submission to the Business, Energy & Industrial Strategy (BEIS) select committee’s inquiry into decarbonisation of heating. The company pointed out that social and environmental policy costs, such as those for the Energy Company Obligation (ECO), add £160 and £20 respectively to the typical electricity and gas bill.

Octopus advocates that these extra costs, which it says amount to more than the entire wholesale price of an equivalent unit of gas, should be stripped from electricity bills.

Combining this move with greater uptake of time-of-use tariffs so that customers could avoid using electricity for heating during the peak hours of 4 until 7pm, would make electric heat pumps more economic to run than gas boilers. The shift would be masked for those on dual fuel tariffs who make up the bulk of customers.

It may have made sense to ladle the costs of decarbonisation onto electricity bills when the bulk of generation came from fossil fuel belching coal and gas power stations. But these days, on an increasing decarbonised generation mix, the existing balance of costs and taxes looks ever more anachronistic. As the Energy and Climate Intelligence Unit (ECIU) pointed out in a recent blog, the carbon intensity of the UK’s electric grid has dropped by the nearly two thirds over the past 12 years, from 535g/kWh in 2008 to 181g/kWh.

The issue is currently under the microscope at the Treasury as part of its ongoing review of how the costs of the net zero should be distributed, the interim findings for which were published in December.

Jess Ralston, analyst at the ECIU, says shifting policy costs onto gas bill would provide consumers with a “positive signal”.

In its submission to the BEIS committee’s inquiry, Energy UK says that a review of policy costs across gas and electricity could make heat pumps cheaper to run than gas boilers in many more homes, giving consumers an incentive to switch.

The problem though, as the suppliers’ umbrella body acknowledges, is the “unintended consequences” that this shift could result in.

“We need to think about customers who are fuel poor and put protections in place,” says Simon Markell, its head of public affairs.

‘Fraught with danger’

The drive to decarbonise heat is “fraught with danger for vulnerable households”, says David Blakemore, chair of the Committee on Fuel Poverty (CfP).

According to figures in the GMB union’s submission to the BEIS committee, customers on electric heating are twice as likely to be in fuel poverty (20 per cent) than those who use gas (9 per cent).

Josh Buckland, who worked as special advisor to ex-business secretary Greg Clark, says it makes sense to take those costs off electricity where possible.

“If you decide that you want to incentivise electric power, there is clearly a problem with too many policy costs on electricity bills.”

However, he worries about the impact that an abrupt shift will have on those fuel poor household, who will be further tempted to limit their gas use

“When people are rationing fuel, they don’t tend to turn on heating. If you make gas more expensive, I worry about the long term implications for fuel poverty.”

Peter Smith, director of policy and research at the fuel poverty charity National Energy Action, points out that four million UK households already struggle to heat their homes and many more are teetering on the brink of fuel poverty as a result of the coronavirus pandemic.

It is “difficult to see” how the government can increase the cost of gas without a negative impact on those households living on the lowest incomes, he says.

Octopus’ case is that incentivising customers to switch from gas to electricity will stimulate a mass market in heat pumps, driving down the costs of the technology. Energy UK’s submission says that in some foreign countries, where their uptake is more widespread, heat pumps are half as expensive as they are in Britain.

The problem now though is that it can cost up to six times as much to install a heat pump, together with the attendant work required to upgrade pipes and radiators, than to buy a replacement gas boiler.

Buckland says “The barrier to heat pumps isn’t the operating costs but the upfront cost, if you reduce operating costs marginally, it’s not going to incentivise a whole bucket of people to switch to electricity. The key focus for government policy isn’t electricity bill costs but how to deal with upfront costs.

“It’s not something that a small level of equalisation between gas and electricity is going to drive.

“The question is whether it is justified to put a tax on people when they don’t have an obvious and easy alternative to switch to. There isn’t currently a route for those people to switch to electric heating.

“We should definitely be taking some of the policy costs off electricity but we should think very carefully before placing them onto gas.”

‘Suppliers can take the lead’

Mike Foster, chief executive of the Energy & Utilities Alliance, which represents companies across the gas sector, has previously suggested that suppliers who advocate shifting policy costs onto gas should first produce a case study by increasing the unit price of gas they offer in return for lower electricity.

He says: “I know some energy suppliers want an end to domestic gas supply with a switch to all electric solutions to meet heating, hot water and cooking needs in the home. Two thoughts spring to mind, firstly I wonder what it is about charging 15p a kWh for electric, versus 3p for gas, that these suppliers find attractive about an all-electric future? And secondly, these suppliers don’t have to offer gas to customers. They could stop supplying now if they feel so strongly that piping gas into homes is wrong. But if they continue to do so, their objections are just all mouth and no trousers.”

Another problem is that policy costs are generally handled by suppliers as standing charges.

Smith worries that low-income customers on pre-payment meters, who haven’t topped up during the summer, could be faced with accumulated debt that will be hard to clear when they try to turn on the heating.

Blakemore says: “No-one on the CfP disagrees with the drive to net zero but we have to remember that a lot of households struggle to afford to heat their homes today. If you start to put carbon taxes on oil and gas, it will just make it less affordable to heat homes.”

Smith worries that rushing the shift of costs from electricity to gas could backfire and undermine public support for the transition to net zero.

“Anything that exacerbates or creates new regressive impacts is going to negatively impact on the pursuit of the government’s goal to reach net zero.

“People will start squealing if they are on the wrong side of it, which would ultimately not be good for the transition.”

The utility industry’s preferred solution would be to transfer policy costs from bills to general taxation which by definition is more progressive method.

Ralston points to the Helm review’s suggestion that levies could be put in special legacy bank that could be paid for through taxes.

The results of citizens’ juries, carried out by the IPPR thinktank’s Environmental Justice Commission, shows support for the low carbon transition to be borne by those with the broadest shoulders via taxes system, says its head Luke Murphy.

“If these changes are going to happen, they want to see lowest income households protected so the government needs to find the means to ensure that they don’t lose out. They wont be supported unless the government is prepared to do that.”

‘Upfront grants for the poorest are essential’

Grants for heat pump installations, targeted at low-income households, must be part of the equation if uptake of the technology is ever going to get off the ground, says Dr Richard Lowes, research fellow and lecturer at the University of Exeter.

“We need upfront grants for people to instal measures,” he says.

“Most households don’t have a big enough bank account to buy and fit a heat pump. In the medium term, until at least 2030, and probably until 2050, we will need to provide some form of capital support for households.

Josh Burke, a policy fellow at the London School of Economics’ Grantham institute and author of a recent report on carbon taxes, agrees that there must be a mix of subsidies, taxes and regulation.

“In heating, it is going to be more regulatory levers rather than price because of distributional impacts that fall hardest on those least able to pay,” he says, adding that a pre-requisite of any move to electrify heating will be much better energy efficiency.

“Underpinning everything has to be energy efficiency,” he says, adding that increased carbon prices will complement these other policy mechanisms rather than take the lead.

And shifts in policy costs should happen in a phased way, like the fuel duty escalator is meant to work, going up gradually from a fairly low level over a number of years, says Lowes.

What could be a first step on that journey is EDF’s recommendation that the costs of the ECO programme could be shifted from electricity to gas bills.

Lowes says that any move to harmonise fuel and electricity costs must be part of a larger package of measures, like a phase out date for boiler installations and beefing up building regulations so that all home heating upgrades must be heat pump compliant with bigger radiators.

In the longer term though, shifting costs from gas to electricity is “absolutely the right thing to do,” he says: “We need to reshape the heat market because at the moment it doesn’t support low carbon.”

However, the shift looks like it is going to be a slow burn rather than a big bang.

This article is part of Utility Week’s Countdown to COP campaign. The issue of fairness in the energy transition will be discussed on the first Countdown to COP webinar on Friday (26 February). Click here to register to free to view the discussion.