A new study has found that reforming energy tariff pricing could encourage the switch from gas boilers to low carbon heating.

The Cost Reflective Pricing study investigated whether or not the fixed charged components of energy bills – for network, environmental and social costs – are efficiently distributed between the standing charge and unit (per kWh) price of electricity and gas tariffs.

These largely fixed costs pay for maintaining and upgrading transmission grids and distribution networks, balancing demand on the system, and supporting social and environmental policies.

Working with the Oxford Martin School of Oxford University, Energy Systems Catapult found the arrangement of fixed and volumetric charges within electricity and gas tariffs, may inadvertently distort market behaviour towards favouring investment in decentralised generation technologies, like solar PV and diesel, over demand technologies like heat pumps.

Ensuring energy pricing is more cost-reflective would improve the overall efficiency of the electricity system and reduce costs.

The Cost Reflective Pricing study found different consumers pay different contributions for the same fixed costs of making energy supply available, such as transmission and distribution charges because costs are recovered through the unit price.

Key points

• Consumers installing generation assets on their own premises, such as solar PV or diesel generation, under-paid their correct share of fixed costs (including ‘feed-in-tariffs’ through which they benefit). This is because they avoid many of the costs recovered in unit pricing by generating their own electricity;
• An artificial incentive has been created to build small ‘on-site’ generation vs large generation;
• Consumers installing low-carbon demand technologies, such as heat pumps, over-paid their correct share of fixed costs recovered in the unit price because they used more electricity. As a result, an artificial barrier has been created to the deployment of incremental demand including low carbon technologies such as heat pumps and electric vehicles (although this disadvantage is small compared to the advantages EVs enjoy through tax treatment and current subsidy).

This meant that overall consumers are:

• Under-charged for the fixed costs of making energy supply available;
• Over-charged for the units of energy they consume; and
• The fixed costs avoided by those with generation on their own premises have to be recovered in the bills of other consumers, including those in fuel poverty, increasing their energy bills.

The Cost Reflective Pricing study also found:

• Rebalancing fixed and volumetric charges, into the standing and unit prices respectively, would recover fixed costs more equitably across each bill-payer;
• If the cost of social and environmental policies were removed from energy bills and recovered through general taxation, the marginal cost of operating a heat pump would be lower than a gas boiler;
  • However, even spreading the environmental and social costs more evenly between gas and electricity would lead to a more efficient allocation of costs.
• “Time of use tariffs” that reflect the variable cost of delivering electricity at different times, would encourage the charging of electric vehicles (and other non-time critical demand) outside of peak periods and a more efficient electricity system;
• There was value in driving up the load factor of the electricity system, with technologies such as hybrid-heat pump/gas boilers potentially reducing the highest electricity peaks by switching to gas during peak periods.

Energy Systems Catapult, Power Systems Practice Manager, Phil Lawton, said: “With heating and transport acc­­­ounting for around two-thirds of UK carbon emissions, growth in heat pumps and electric vehicles will be important in meeting our 2050 targets.

“We need to make sure the way we charge for the fixed costs in the energy system reflects these exciting changes in technology and does not discourage consumers from taking them up.

“And we need to make sure consumers that generate their own electricity, through solar PV or diesel, are not over-rewarded, by avoiding some of these fixed costs at the expense of those who use the grid all the time, including vulnerable households.”

The study also found that the gas network may have a valuable role in future in meeting short duration peaks of demand via the use of hybrid heat pump/gas boilers. This would take advantage of the existing gas network asset, rather than investing in additional capacity in electricity generation/networks that will only be used rarely.

Cost Reflective Pricing examples:

The following tables compare typical real tariffs from 2016 with sample cost-reflective tariffs:

Table 1: Sample Tariff for Electricity

* Peak surcharge of £66.42 to reflect network costs driven by load growth. This is recovered over times corresponding to 18% of typical consumption.

Table 2: Sample Tariff for Gas

Table 3: Impact of Cost Reflective Tariff on marginal cost of Heat, avoiding peak surcharge

* This table illustrates the impact that cost-reflective pricing would have on the economics of heat pumps versus gas heating. It should be noted the table is true for a single additional heat pump in the current market. Widespread adoption of heat pumps could require more peaking power capacity, tending to drive system costs up, although this would depend on the efficiency of time of use pricing and other factors.