Balancing Act: The implications of transferring policy levies from electricity to gas bills

Balancing Act: The implications of transferring policy levies from electricity to gas bills 432 KB

The way we heat our homes has a significant impact on our greenhouse gas emissions. Housing accounts for nearly a fifth of all carbon dioxide emissions in the UK, and the main source of this is the use of gas for heating and cooking.

Low carbon alternatives exist, such as the use of electrically powered heat pumps. But the take-up of that technology has been slow, and is discouraged by a range of financial, informational and practical barriers. One of the biggest of these is that it is typically more expensive to run a heat pump than a gas boiler due to the relative price difference between electricity and gas - though customers on innovative tariffs may already be enjoying lower running costs.

Currently, a range of social and environmental policies that seek to encourage low carbon power generation, improve the energy efficiency of homes, and subsidise bills for fuel poor households, are paid for through levies on electricity bills. The Government is considering whether there is a case for moving those levies to gas bills instead, in order to make the electrification of heat more attractive.

Our analysis suggests that such a change would be enough to alter the relative economics of heat pumps versus gas boilers, such that the former would be cheaper to run than the latter. But there would be significant distributional impacts associated with this, as access to the gas grid is less universal than access to the electricity grid. 

Around 85% of the population are on the gas grid, and these households would see their bills increase slightly (by around £22/year on average) in order to fund the costs of those off-gas grid users who were now exempt (and saving around £123/year on average). The impacts on fuel poverty are potentially complex, as around four times as many fuel poor households are on the gas grid as off it, but the severity of fuel poverty is deeper in households that are off the gas grid.

As more and more households move off the gas grid, the costs of policy would be spread over the increasingly small number that remain on it. This may not be politically or socially sustainable.

Moving levies from electricity to gas will have knock-on impacts on the relative economics of other low carbon technologies. These may be positive, such as in the case of electric vehicles which should become cheaper to run, and negative, as household solar generation takes longer to pay for its upfront costs. 

Running costs are only one of a range of barriers to the adoption of heat pumps. The upfront costs of installation are significant for some homes, the technology is unfamiliar to many, a large number of households do not have control over the heating method for their home, and the process of finding an installer and getting a heat pump installed is currently often more complex than the gas boiler equivalent. These barriers will need to be collectively addressed if we are to enable the electrification of heat. If they aren’t, then moving policy levies from electricity to gas may simply redistribute costs without delivering real change to how we heat our homes.

Because not everybody is on the gas grid, there is a fairness question that policymakers will need to address if they decide to move policy levies from electricity to gas. These levies pay for policies that are trying to deliver common public goods - a decarbonised electricity supply, warmer homes, and tackling fuel poverty. Exempting some households from paying towards these aims may be considered unfair, particularly by those who are not exempt. It may be perceived as particularly unfair by those who are unable to act on the incentive to electrify their homes because, for example, they cannot afford the upfront costs. 

We explore a range of ways in which the gap in running costs between gas boilers and heat pumps could be closed. None is without downside, and all have distributional implications. We conclude that the fairest approach would be to move the recovery of policy costs from bills into general taxation.

We also note that developments in the retail market may outpace the case for intervention, as specialist tariffs are offered that make heat pumps cheaper to run anyway.