Shifting policy costs on energy bills - revisited

As I said in a previous blog post, the current price ratio between electricity and gas means that switching to heat pumps often means bills increase - a major deterrent to many households considering taking on low carbon heating. Part of the problem is because of the way 'policy costs' are loaded mainly onto electricity bills instead of gas so when you switch to a heat pump you end up paying far more policy costs. However, if we were to change this so that policy costs were evenly distributed between gas and electricity, then heat pumps become cheaper. I have updated my previous calculation with a slightly revised method and based on the current price cap as shown in the following chart.

Chart shows the annual bill split into components: policy costs and other for each fuel. Current uses components as computed by OGGEM, 50% split means the variable policy costs are split between gas and electricity. HP costs are with the gas boiler replaced with a heat pump. Assumptions are explained below. Click on this for a larger image

Using this adjustment:

• The overall bill for a 'typical' household has hardly changed.
• The overall policy costs paid by a 'typical' household hardly changed.
• Considering a 'typical' customer who switches to a heat pump and goes off gas completely (so no longer pays the gas standing charge), instead of paying £38 more (2%), they pay £78 less (4%).
• The heat pump customer pays slightly more policy costs than the gas customer but not nearly as much as without the policy cost split.
• The gas per kWh price increases from 7.33p to 7.78p while the electricity price decreases from 29.3p to 27.5p.

The change is small, but it requires no additional funding from central government, hardly affects a typical customer and tips the balance in favour of heat pumps. Revamping the wholesale pricing regime so that the price of renewables is not so closely tied to the cost of gas will make a bigger improvement. However I fear we will have to wait a long time for that as the issues are very complex and there are many stakeholders involved.

For this chart, I used price caps from the latest OFGEM model, for Jan/Mar 2024 [1], for Eastern region (where I live) with standard credit payment. There are some policy costs in the fixed part of the bill - I left those alone as they are almost the same for gas and electricity as it is. (In the chart these are included as policy costs, not fixed costs). However, for the policy costs on the variable part of the bill, I rearranged these to be the same on gas and electricity for the standard annual bill.

The reason there is a small change in bill even for the typical customer, is that OFGEM is still using the old 'typical' bill sizes for calculating the price caps instead of the new ones. Typical annual electricity use (medium) has reduced from 3,200 to 2,700 kWh while gas used has reduced from 12,000 to 11,500 kWh [2]. This also explains why the policy costs after the split are slightly more on gas than electricity. This could be adjusted for.

For the heat pump bill, I assumed that the boiler was 85% efficient, the heat pump SCOP was 3.0 and the new heating regime increases heat demand by 5%. 

The reduction in bill from switching to a heat pump is sensitive to these assumptions. However, with the policy costs split, you can increase the boiler efficiency to 90% or reduce the heat pump SCOP to 2.8 and still get a reduced bill from the switch to a heat pump. Low use and high use customers also get reduced bills with the switch. The low use customer gets slightly higher savings.

My previous post (Should we shift energy taxes to make heat pumps cheaper to run) explains in some detail what these policy costs pay for. Some are to do with subsidising energy efficiency measures in homes and some are for subsidising renewables - the largest part is funding the Renewables Obligation scheme which is now closed but payments will continue until 2037.

[1] Energy price cap (default tariff): 1 January to 31 March 2024 (OFGEM)

[2] Average gas and electricity use (OFGEM)