Plans to shift green surcharges from household electricity bills to gas bills are an overdue and welcome reform. With the necessity to shift consumption away from gas to low carbon power, taxing electricity but not gas has been perverse. In particular it conflicts with policies to shift residential heating to electricity-based systems, especially heat pumps. It was one of several key recommendation of the 2019 report, on network tariffs for a low carbon future, that I prepared for Energy Systems Catapult. So it’s satisfying to see the proposed change.
However this shift is probably not enough on its own to
provide a clear incentive for consumers to switch from gas to electric systems,
including heat pumps, even if the present surge in gas prices is sustained. A
more fundamental recasting of the structure of electricity tariffs will be
essential, notably a significant change towards recovering far less of the
fixed costs of network infrastructure through the kWh charge. This is a profound
change, and may require additional measures to prevent the regressive effects
of a larger burden on lower income households. But it can be done in ways that
are consistent with equality or levelling up agendas.
The flaw in current tariffs
The incremental costs of supplying energy are the right
basis for any price and tariff comparisons that consumers make when choosing a
heating system. Costs should ideally include all environmental costs and these may
be expressed for example as a carbon price. Energy costs are however only a
part of the story for the tariffs faced by consumers. For residential consumers,
up to 50% of total costs reside in the fixed costs of the networks, concentrated
in the local distribution networks. The marginal cost of accommodating extra
throughput is, at least in uncongested networks, very low. But the fixed cost
still needs to be recovered. How best to do it poses some difficult questions
in terms of reconciling considerations of equity and income distribution, on
the one hand, and the efficient allocation of economic resources on the other.
Current UK practice for smaller retail consumers is simply to average most fixed costs over all units of energy sold. This seems fair, and prima facie results in those who consume most (and might broadly also be those with higher incomes) paying the most towards the fixed costs. However it distorts the economic message, that the actual marginal or incremental cost is much lower. This leads to at least two major problems.
1. It exaggerates the incentive for individual consumers to instal their own forms of power generation, even if these incur high resource or environmental costs, simply in order to avoid network charges. There is no saving in overall fixed cost and, while individual consumers with own generation may benefit, a larger share of fixed public network costs is then picked up by others. Total societal costs increase. Incidentally, this also tends to benefit the wealthier households who are more likely to instal their own generation.
For household consumer, a higher fixed charge in the tariff,
and a lower unit energy charge, transforms the choice between using the low
carbon solution (electric heat pumps) and traditional fossil fuels (gas or
oil). I examined this in my 2019 report,
but it is worth recalculating in the light of recent price trends. Assuming 10,000 kWh per annum consumption, a
coefficient of performance (COP) of 3 for heat pumps, and 90% efficiency for
modern condensing boilers (both slightly optimistic), the message is clear.
|
Economics of
Heat Pump vs Gas [Energy Cost Only] |
elec tariff p/kwh |
Elec useful
heat p/kWh |
Gas tariff p/kWh |
Gas useful heat
p/kWh |
Heat pump saving £ pa |
|
Current tariffs[1] |
14.50 |
4.83 |
3.86 |
4.29 |
-54 |
|
Current
tariffs and + 1p/kwh CO2
tax on gas[2] |
14.50 |
4.83 |
4.86 |
5.40 |
57 |
|
Reform
tariffs + CO2 tax.[3] |
7.50 |
2.50 |
4.86 |
5.40 |
290 |
|
Reform
tariffs + CO2 tax + permanent high gas price[4] |
7.50 |
2.50 |
8.00 |
8.89 |
638 |
With current tariffs, heat pumps struggle to be
competitive with gas even on running costs. A 1p per kWh carbon tax on gas, or
its equivalent, helps to shift the balance (to a small advantage for heat
pumps). Tariff reform has a much larger impact (2.5 times), and this is of
course hugely reinforced if we assume permanently higher gas prices. This takes
us at least part of the way to compensating households for the higher capital
costs of heat pumps.
Disadvantages to poorer consumers
We noted above that some wealthier consumers benefit from
current tariffs through the arguably excessive implicit subsidies to own generation.
Other beneficiaries include second home owners with very low annual
consumptions. However the regressive impact of a necessary tariff reform cannot
be ignored. But there are many different options available.
One is to change the basis for applying standing charges
to consumers. One proposal put forward has been to collect contribution to
fixed costs through tariffs based on property values, akin to traditional approaches
in water based on rateable value, or property tax band.
Another is to limit the application of the lower tariff
rate to consumption for heating, but not for other purposes. Modern technology makes
separate metering, as well as the detection of any metering fraud, a very plausible
option.
………..
The conclusion must be that tariff reform will be an
essential component of any national strategy for the decarbonisation of the heat
sector.
[1]
Average kWh rate for UK, and recent variable rate British Gas tariff for gas.
[2]
Set at 1.0 p/kWh as first approximation to likely impact of transferring environmental
cost burden to gas. I used a higher number in the original report
[3] Assumed
future average wholesale power cost of 7.5p/kWh
[4] Assumed
winter gas price of 170 to 210 p/therm, deduced from recent reports
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