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At the limits of energy efficiency policy, energy providers see opportunity

Energy providers have spotted an opportunity in the heat pump sector after the UK released its much criticised energy strategy, but investors may need some convincing

Campaign group Scientists for Extinction Rebellion says the British new energy security strategy (ESS) has betrayed its climate ambitions, with members glueing their hands to the windows of the UK’s Department for Business, Energy and Industrial Strategy by way of protest.

“They are basically committing to policies that are going to completely run counter to our international policies on climate change. The UK government calls itself a climate leader – well, guess what? Climate leaders don’t invest in fossil fuels,” says ecologist and campaigner Dr Aaron Thierry.

However, energy and policy analysts consider the ESS – a mixture of policies for reducing dependence on Russian energy, including new drilling for oil and gas in the North Sea, but also substantial investment in renewables and nuclear power – as something of a doubling-down on the UK’s climate policies.

Some of them have also wondered whether this supply-focused policy has left major savings on Russian gas, and fossil fuels in general, on the table in the form of omitted energy efficiency measures. With government support for tackling housing emission limited, energy companies are having to find their own ways to drive adoption.

Hooked on gas

The ESS launch on April 8 acknowledged that 90 per cent of UK homes are heated by gas, accounting for a third of the country’s use of that fuel source, and creating both a major dependency for a net importing nation and a climate action point.

The ESS does include some proposals to combat this. In addition to existing measures, support for the Energy Company Obligation on providers to promote efficient heating solutions increases to £1bn per year until 2026; a 2035 target has been set for phasing out the sale of gas boilers; and VAT will be removed on new insulation and low-carbon heating. A £450mn boiler upgrade scheme will be introduced; low-cost financing for green home upgrades is promised; and a £30mn heat pump investment accelerator competition will aim to have 600,000 heat pumps a year installed by 2028.

The strategy relies on the “pragmatism” of the British people to take care of improving insulation issues, drawing stinging criticism from Eon’s UK chief executive Michael Lewis, while others say the policy disappoints overall on efficiency measures.

“Energy efficiency is a gap already in the government’s net zero strategy,” says Mike Thompson, director of analysis at the Climate Change Committee, an independent group of advisers to the UK government. However, he says: “The reason there’s a gap is that it’s difficult. This is not an area to just knock up a policy and rush it through.”

Few policies in the strategy are new, he says – more progress on financial support could have bought time to work on longer-term strategy, and the budget currently set aside for the upgrade scheme, funding around 30,000 heat pumps per year, “is not going to get us where we need to on its own”.

Heat pump hopes

In the space left by the country’s limited incentivisation of home energy efficiency, providers are taking up the slack. Clean energy supplier Octopus Energy announced on April 12 that it had acquired Renewable Energy Devices heat pump manufacturing company based in Northern Ireland, with plans to expand the factory to produce 1,000 heat pumps a month.

Octopus CEO Greg Jackson says the primary driver for the move has been the company’s sustainable ethos and brand. “Eighteen months ago we observed that although we’re meant to be a clean energy business, we sell one or two billion pounds-worth of gas a year to our customers, and if we’re going to decarbonise society, we need to do something about that. And so we looked at how you get off gas.”

Heat pumps are the obvious choice for replacing gas, he says, saying that green hydrogen still being discussed for this purpose is “utterly bonkers”. While Octopus believes hydrogen electrolysis could be a useful use of surplus renewable electricity loads, its efficieny pales in comparison the the 3 kilowatt hours of heat produced by heat pumps for every 1 kilowatt hour of electricity.

But there are also strong economic factors at play for both businesses in the sector and consumers, despite the government’s packages only currently achieving cost parity on the installation of a heat pump versus a gas boiler.

Jackson says the typical heat pump cost of £3,000 involves components worth around £1,000, so “there’s a dramatic cost reduction opportunity”. He says that the company’s goal is to drive down the cost of heat pumps, potentially to the point that no government grant is needed.

As well as these savings being passed on to consumers, he says, “being able to make heat pumps work in a way which is sympathetic to energy grid systems” will allow further savings. Octopus is planning to incorporate “smart grid” technology into its pumps, to exploit the spare capacity on the grid and reduce load at peak times.

Investors struggle to play

If providers like Octopus have spotted a green commercial opportunity in energy efficiency projects, such propositions look trickier for outside investors.

“We’ve looked at a number of energy efficiency-type schemes and they’re difficult investment proposals because they’re really small,” Phil Kent, director at Gravis Capital, says, adding that “on a relative effort basis it’s far easier to put some money into a windfarm.”

A the other end of the scale, Kent says that offshore wind projects such as those announced in the ESS are increasing in size, distance offshore and complexity, making them a difficult proposal for all but the largest infrastructure investors.

Despite his positive view of how the regulated asset base model (to be used to share risks on nuclear development) has been employed previously, he characterises most opportunities as mega-projects relative to the size of his GCP Infra FTSE 250 investment trust.

“There wasn’t anything in there which made me think ‘this is going to be a massive investment opportunity’,” he says.

A service from the Financial Times