Reallocating electricity policy costs to incentivise low carbon heating technologies

Funding the cost of decarbonising the power system has mainly been through the consumers’ electricity bills. In fact, in 2020-21 these costs amounted to a whopping £10bn. But is this method of raising revenue for decarbonisation still fit for purpose when faced with the need to decarbonise the nation’s heat? This topic is discussed in our latest Insight paper – Who pays for supporting the net zero transition?

As the UK heads toward net zero in 2050, we will need to decarbonise how we currently heat our homes. This will mean switching away from the traditional gas to a low carbon source. However, the report’s authors found that the current status quo of policy cost recovery is a significant disincentive for households to electrify and transition to new low carbon heating technologies.

While initially policy costs were applied to electricity bills for very good reasons, this disincentive is a barrier for the UK to meet its net zero target. Driving the right financial incentives for consumers to choose low carbon options while managing the impact on the public purse by reallocating policy costs elsewhere will be key.

The Insight paper considers three options for policy cost reallocation:

  • A transition to or cost partitioning with the gas bill
    • This methodology would reallocate policy costs, in whole or part, to the gas bill and has the most dramatic impact on the relative economies of gas-fired central heating and electrically fired technologies.
  • A transition to general taxation
    • This option would move much, or all the wider policy costs presently included in the electricity bill into general taxation (or another suitable funding source). We would expect this to significantly reduce electricity unit rates, incentivising greater use of electricity.
  • Recovery as a fixed “residual cost.”
    • This option converts the volumetric p/kWh policy costs into a fixed charge, in much the same way as Ofgem’s Targeted Charging Review (TCR) has shifted the sunk costs of the network into a fixed charge.

Each reallocation method comes with its own range of risks and opportunities and should not just be considered on its own but rather as a suite of tools policymakers can use to hit carbon budgets.

There are a range of wider benefits that can be achieved through reform in the area, including simplifying the retail landscape, alignment with the regulatory desire to reform the Supplier Hub and reducing the impact of supplier failures. However, any inaction by the government would result in a lost opportunity for the government to pull another and perhaps better policy lever to support the net zero transition.

Speaking about the research, Lead Consultant Dan Starman said: “we believe policymakers should utilise an assessment-based framework to support the disentanglement of policy costs and the electricity bill. In doing so, this will support the government in meeting its targets, facilitate innovation and stronger pricing signals in the electricity market, and support consumers in making more appropriate choices for the net zero transition”.

For a free copy of the insight paper – Who pays for the net zero transition? – click here.

FIND OUT MORE AND REQUEST A COPY OF THE PAPER HERE

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