Decarbonising homes and businesses is a priority for helping the UK achieve the Climate Change Act (2008) net zero greenhouse gas emissions target for 2050. The government has its sights set on heat pumps playing a key role in replacing polluting fossil fuel boilers, but this is an expensive option, and it is not the only one, writes Jeremy Weltman.
The government wants to increase the number of heat pump installations from 55,000 per year in 2021 to 600,000 by 2028, ensuring that the UK becomes one of the largest markets for heat pumps in Europe.
The aim is to install at least four million heat pumps by the end of the present decade, thereby reducing carbon emissions by up to 70% compared with the use of gas-fired boilers. But for cost reasons and other doubts, the take-up has been very slow to date, putting these ambitious targets in some considerable doubt.
The slow burn of demand reflects a good deal of caution over the renewables technology, with some critics arguing, with good justification, that they do not achieve suitable heating temperatures. The mechanical fans that are required for ventilation are also described as offputtingly noisy.
There is also the problem that many buildings may well have had their old gas-fired boilers replaced with newer, more efficient models only recently, and for a fraction of the cost of the renewables option. The purchasers will naturally wish to enjoy the benefits of these new boilers longer-term, without having to incur any unnecessary additional replacement costs.
Green energy transition
To encourage the energy transition, the government announced in one of its spring budgets a temporary cut in the value-added tax (VAT) rate on the purchase of energy-saving materials, from a reduced rate of 5% to zero-rated from April 1, 2022, until 2027, at which point the plan is to return to the pre-existing 5% rate. The tax cut is applicable to the purchase of heat pumps, wood-fired boilers, turbines and solar panels, etc, as an all-encompassing decarbonising measure.
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There are also grants available through the Boiler Upgrade Scheme (BUS) through to April 2025, and the EC04 Energy Company Obligation that replaced EC03 in April 2022, through to March 2026, obliging energy companies to deliver energy-efficient measures to domestic buildings. There are other schemes that are available only in Scotland and Wales.
The Home Upgrade Grant Scheme (worth £950 million), Social Housing Decarbonisation Fund (£800 million), Heat Network Transformation Programme (£338 million), Public Sector Decarbonisation Scheme (£1.425 billion) and Flexibility Innovation Programme (£65 million) together highlight the breadth of government funding that has been made available, on top of which there is a total of £450 million to be handed out under the BUS.
This provides grants of £5,000 for air pumps or biomass boilers, and £6,000 for ground/water-source pumps, although this generally covers only the purchase cost of the pump unit. It is estimated the total cost of completing the work required for an air source heat pump is in the region of £8,000 to £18,000, inclusive of the system design and installation, with a ground source heat pump costing anywhere between £14,000 to £45,000 when the costs for the extensive digging work is also factored in.
Hydrogen- or part-hydrogen-fuelled boilers are not yet a feasible option, but are expected to come to market eventually with an expected cost that will be about the same as a traditional gas boiler. This, of course, is an added disincentive to invest in the more expensive heat pump option, especially since natural gas will no doubt be available for many years if not decades to come.
British Gas has indicated that a 20% hydrogen-blend gas will be used at first, probably from 2028 onwards, and that most gas boilers will be able to function normally on this, including all of the new gas boilers that they supply. Full hydrogen-ready boilers remain in the development stage, with the government’s decision on the use of hydrogen as an alternative fuel unlikely to be made until 2026. Hydrogen-only boilers are to be sold later, probably from the mid-2040s onwards.
With the government’s policy decision hotly anticipated, that makes a heat pump much less attractive, and certainly the more expensive outlay for residential users. Small businesses, too, which are already operating on tight profit margins, or even at a loss, with their costs elevated by inflation running above 8% per annum, and borrowing rates that have ratcheted on the back of sequential Base Rate rises from the Bank of England, will be wary of selecting the wrong option. This would only make it costlier in the long run.
“We support the adoption of heat-pumps as a means to green the housing stock, but there isn’t a strong economic case at present for homeowners, or SMEs,” says Ian Bhullar, principal of strategic and sustainability policy at UK Finance, the banking and finance trade body. “There is also a paucity of suppliers,” he adds, “meaning there are long lead-in times, and as a result the uptake is low”.
“Many small businesses are also renting their premises, so this is a problem more for landlords than business owners,” he says. This demands better engagement with landlords to achieve business sustainability goals, as well as an enhanced role for government, which will need to step-up to support the energy transition with more incentives, he explains.
The larger the property size, the bigger the bill, plus it has been also pointed out that some properties might require two heat pumps to make the building sufficiently warm enough. The added expense of improved walls and/or roofing insulation could be a necessary additional outlay, not least to obtain the funding. This includes upgrades to existing pipes and radiators, as heat pumps require enhanced insulation to be fully effective. This will not only bump up the costs involved but also make the investment more complex and potentially disruptive given the work involved.
The usual financing options are available of course, with bank borrowing and invoice finance most likely to be favoured for lower-cost alternatives, along with the use of any credit balances, savings, or personal injections of finance by business owners. There are low-cost loans becoming available too, Bhullar says, for secured bank depositors.
The government is meanwhile considering raising the maximum grant level. This is because the current grants are based on dated research concerning product availability and the costs they carry. The funding involved is, moreover, less than that which was made available under the Domestic Renewable Heat Incentive, which ended last year after being introduced in 2011 for all types of replacement boilers using renewable sources.
Fortunately, competition in the marketplace appears to be driving down the installation costs. For small businesses, too, the government’s Business Finance Support hub details numerous types of grants, vouchers and other incentives that can be applied for, with the emphasis clearly on obtaining any type of investment finance that can be secured for such purposes, not just the financing that is specific to decarbonising schemes.
Heat pump leasing in Germany
That makes leasing an option, too, and it is something that has already taken off in Germany. Thermando, the country’s largest installer of heating solutions, joined forces with manufacturer LG Electronics of South Korea last summer to offer heat pumps on a contract basis, costing €159 per month. The lease includes a two-year maintenance deal complete with remote diagnostic support for any faults which may occur.
Leasing a heat pump can be highly beneficial for the purchaser. It involves fixed monthly payments that are both inflation-proof and tax deductible, plus the VAT cost incurred after the zero-rated scheme expires can be spread over the contract term, unlike an up-front cash purchase.
The energy savings too can be offset against the leasing fee, the purchaser does not incur any large debts that would increase their operating risks, and there is always the added option for the lessee to upgrade to any newer technology should it become available. This, in turn, gets around the problem of hydrogen boilers eventually becoming the cheaper, go-to option.
Besides heat pumps and hydrogen boilers, other options include biomass heating, which uses wood, plants, or even manure for energy. However, the average cost of an installed system is around £16,000, putting it on a par with air source heat pumps.
Others include electric, or even infrared radiators, complete with their own thermostats powered by solar or wind energy to reduce carbon footprints. Yet another option is a separate electric water heating system. This can be paired up with an electric boiler solely for heating, with electric radiators.
Keith Bastian, the CEO of electric heating company Fischer Future Heat encourages residential users and SMEs to weigh up all of the choices. He says, “there’s no question that heat pumps will play a part in helping us to net zero. But heating homes [and small offices] in the UK is not a one size fits all solution.
“The government needs to put just as much effort into highlighting other forms of zero-emission heating – giving consumers greater choice to suit their circumstances.”
However, as with heat pumps, the same questions arise over how efficient these systems are, given that some may not be powerful enough to heat up homes, or business premises sufficiently, and they may take time to reach the desired heat levels.
There will be also maintenance and repair costs favouring leasing arrangements, not least with the high up-front costs involved, while promising longer-term energy savings.
In its Heat and Buildings Strategy of 2021, the government was cognisant of the upfront costs of financing the transition and recommended a portfolio of green funding and financing options from private finance suppliers to complement the available public support.
The report noted that upgrading homes to an Energy Performance Certificate (EPC) band C by 2035, “where practicable, affordable, and cost-effective” will require mobilising up to £65 billion of investment for the UK. For non-domestic buildings, it is estimated that it could require around £20 billion in investment to deliver the government’s Clean Growth Strategy.
The report acknowledged that this could include “infrastructure-type approaches for very long-life assets that may be shared between multiple beneficiaries, such as ground arrays for certain types of ground source heat pumps, where the asset may last up to 100 years and be shared across properties.” This, it says, would enable long-term investments (such as pension funds) into the financing space.
The report mentioned that in the non-domestic sector, while there are existing finance products for energy efficiency in larger buildings, for smaller properties, particularly those occupied by SMEs, the availability of finance for such projects is limited and is a general challenge for SMEs.
In the latest SME Finance Monitor by BVA BDRC, the consumer and business insight consultancy, for Q4 2022 (released in March 2023), some 17% of SMEs expected to take steps to reduce their carbon footprint, with the share increasing according to the size of SME. However, this was a lower proportion than that recorded for Q4 2021 (25%), when this question was first surveyed, with many SMEs citing their higher operating costs, concerns about the economic climate more generally, and political and government policy uncertainty as barriers (noting the fact a general election is scheduled next year).
The present government has been working to understand the types of financial products that will be most effective for businesses, particularly SMEs, and in 2019 through to March 2020, it launched the Boosting Access for SMEs to Energy Efficiency: Competition, which offered up to £6 million in funding for innovative solutions reducing transaction costs and introducing economies of scale for lenders investing in small-scale energy efficiency. It also aimed to attract SMEs to use external finance through simple online platforms.
For both residential users, landlords and SMEs the biggest problem is knowing which product will be the more effective for generating heat, when is the right time to invest in decarbonising technology, and which is the most cost-efficient option. That makes leasing quite possibly the lowest-risk financing means.