Implicit gas subsidies are counter-productive to the UK's energy transition
Last week, the UK Chancellor pulled ‘Winter Fuel Payments’ support from most British pensioners. These supports are de facto gas subsidies. Yet all homes implicitly use subsidised gas in the UK. If the Chancellor were bolder on net zero plans, she’d scrap this instead and redistribute any proceeds to those who need it most.
In the UK, we levy “clean energy” taxes on electricity more than we do our gas, which distorts our preferences for how we use energy at home. This makes it harder to decarbonise heating, almost one third of UK emissions.
Government programs to support renewable energy, “green gas” and vulnerable households already make up 12% of our energy bills. However, these “policy costs” are borne disproportionately by electricity, at 17% of electricity bills versus 6% for gas.
Gas is also implicitly subsidised because its carbon emissions are not taxed. Domestic gas use is excluded from the UK’s Emissions Trading Scheme (ETS), a mechanism we use to tax carbon produced by our electricity generators[i].
This tax cost electricity, aviation and industrial emitters £5.8 billion in 2023. A further £3.6 billion in tax is forecast for 2024/25, or £120 per household. Since this tax predominantly applies to electricity generators, and 34% of electricity consumption is domestic, a chunk of this tax feeds directly into household bills via higher wholesale prices.
Applying the ETS carbon price to gas use could be game-changing for energy efficiency investments and emissions reduction. Theoretically, the current ETS price[ii] would raise household gas bills by £80 per year on average[iii], or over £2 billion per year. A London School of Economics paper on extending the UK ETS to heating suggests that it could reduce economy-wide emissions by 10% by 2040[iv]. Crucially, it levels the playing field between gas and electricity prices, making heat electrification more cost-effective.
£80 per year sounds small, but relative price changes could tip the scale towards more low-carbon investment. Take heat pumps, for example. Electric heat pumps cost thousands of pounds to install. Yet even with significant and increasing capital subsidies, uptake is dismally low in the UK. Subsidies are now £7,500 (40 to 50% of the government’s installation price estimates), yet c. 0.7% of homes have installed one.
Given heat pumps’ success across Europe (as high as 40 to 60% of homes in Nordic countries), it cannot just be the cooler climate or poor building insulation holding us back. Our electricity and gas price ratios make energy bill savings unlikely. Why install a more expensive heating system if it then costs more to run?
Gas boilers consume between 3 and 5 times more energy than a heat pump depending on the system design and building conditions[v]. However, electricity is 4.1 times as expensive as gas per unit. The higher relative price of electricity negates the energy saving benefit of switching to a heat pump if it operates on the low end of its efficiency range.
Adding a carbon price to gas could change this ratio to 3.6 based on current ETS prices, or 3.0 based on ETS’s peak in 2022. Companies like Octopus also offer cheaper tariffs for heat pumps, because they can be switched on during hours with lower electricity prices. This price re-balancing could help homeowners to justify energy-related upgrades if there is a higher likelihood that they will save money on energy bills.
Space heating is just one way we use gas. Electric water heaters could be used during periods with cheap electricity. If a home disconnects completely by switching to electric cooking and hot water, they could also save on fixed standing charges, currently £115 per year.
One drawback of a gas carbon tax is that switching to electricity is not an instant substitution. Home upgrades are expensive, and take time and trained technicians to install. Furthermore, over a third of people are renters and have limited, if any, control over their gas and electric systems. Companies could offer rental or leasing services to homeowners make the switch cheaper, like Egg for electric vehicle chargers in the UK or Reliance’s water heater rental model in Canada.
Another problem is that increasing taxes on energy is tougher on low-income families relative to high-income ones, because energy makes up a larger portion of their expenses. To fix this, the proceeds of the tax could be given back to families who need it, whether through bill top-ups or support for cleantech investments. LSE found that redistributing the tax back to households had very little impact on the emissions reduction potential from a gas carbon tax.
The pensioners’ winter fuel payment supports around one sixth of the UK population to continue using gas. It takes the sting out of energy prices and reduces the incentive to invest in energy efficient homes. Instead of taking support away from the elderly, the Chancellor could tax gas to reflect its environmental cost. This makes home electrification upgrades more appealing and ultimately supports Labour’s goal to achieve net zero emissions. It could also help her find the money to keep our pensioners warm this winter.
[i] Other mechanisms include the Climate Change Levy, which does not apply to residential customers
[ii] c. £40 per tonne of emissions (July 2024)
[iii] Gas consumption emits 183 grams of carbon emissions per kilowatt-hour Department for Energy Security and Net Zero, equating to over 2 tonnes of emissions per year for the average household (11,500 kWh of gas).
[iv] Low range ETS estimate of £40/tonne, Heat only, page 24.
[v] Most heat pumps can operate at an efficiency of 300-400%, sometimes as high as 500%, while boilers at 90-98% depending on their age (Energy Savings Trust, The Eco Experts, Catapult Energy Systems, The Boiler Guide, British Gas)