Is the energy crisis really making the business case for heat pumps?

As the current energy crisis is reviving energy security concerns, heat pumps have benefited recently from growing policy momentum in a number of countries, particularly the United States and European ones. Heat pumps are expected to be pivotal to reduce fossil fuel dependency and CO₂ emissions in the heating sector by enabling energy savings and supply diversification.

Many heat pump markets are currently experiencing unprecedented growth. While the recent energy price hikes favour the most energy-efficient technologies, thus enhancing the business case for heat pumps, public initiatives to support investment in heat pumps are most often the primary enabling factor for this market acceleration.

Several obstacles still impede large-scale heat pump deployment. Chief among them is the cost-competitiveness of heat pumps in places where lower-cost fossil fuel alternatives have not yet been banned. Cost-competitiveness is determined by a combination of parameters, including initial investment costs, operating and maintenance costs (including fuel costs), equipment durability and economic incentives. Like most other technologies that exploit renewable energy sources, upfront costs for heat pumps are relatively high, but running costs are generally lower than for fossil fuel-based options.

Soaring energy prices since 2021 have accentuated the running-cost advantage of heat pumps, especially as residential consumer tariffs for natural gas have risen more quickly than for electricity in most major heating markets.1 This is particularly true for countries such as Denmark and Sweden, where the competitiveness of gas-fired boilers deteriorated substantially when gas prices rose during the first half of 2022. However, in most countries the overall cost-competitiveness of heat pumps with gas boilers is still determined mainly by the significant investment cost difference between the two.

Investment costs for residential heat pumps (including installation) are generally higher than for fossil fuel-fired boilers, though the extent of the cost gap varies widely within and across countries, even for the same technology, depending on market maturity. In only a few mature markets (e.g. Denmark, Sweden and Japan) are the upfront costs for lower-cost air-to-air heat pumps comparable with or lower than for gas boilers. Hydronic (air-to-water) heat pumps typically entail higher investment costs than air-to-air heat pumps, while ground-source heat pumps are the most expensive, owing partly to installation of the underground heat exchanger, which can represent more than half of the total system costs.

Plus, switching to a heat pump in an old building can involve additional expense, as the electrical system may need to be upgraded to accommodate a higher power load, or existing radiators may have to be replaced with larger ones or with underfloor heating or a forced-air system to allow more efficient heat pump operation. Such ancillary costs can make up as much as one-third of the total cost of switching to a heat pump. However, some of these upgrades can also improve thermal comfort and reduce heat demand.

High investment costs are a major barrier to heat pump adoption in the residential sector, as financing is a challenge for many households. In the past year, many countries have strengthened investment support for heat pumps or introduced new measures in the form of grants, tax credits, reduced tax rates and specific loan schemes. Some of these measures were taken in response to the energy crisis and, in the European Union, to reduce dependence on Russian gas. Grants are the most common policy tool and are currently available in at least 30 countries that together represent 70% of global space heating demand. Tax credits are also widely available, but in contrast with direct grants and subsidies, they generally reach consumers only after a delay, sometimes of as much as two years.

The level of support sometimes depends on household revenue (e.g. in France and the United States), and for low-income households it can (in some countries) cover most – if not all – of the purchase and installation costs. In many countries, investment subsidies for heat pumps can substantially reduce or even offset the upfront cost gap with gas boilers, sometimes making heat pumps more economical for consumers than gas boilers over their lifetime.

In addition to direct public investment support, alternative business models (e.g. on-bill financing, leasing, energy performance contracts and heat-as-a-service) can also play a pivotal role in reducing or eliminating investment challenges for households. The two latter options can also help overcome split-incentive barriers.

Investment costs for heat pumps are expected to decline gradually over this decade as markets expand, suppliers benefit from economies of scale, and greater competition puts pressure on prices. Automation and standardisation of parts could further reduce component, installation and repair and maintenance costs, while the development of plug-and-play designs could make installation faster and more affordable. However, clear, stable policy signals are needed for manufacturers to commit to investments in process upgrades. Targeting serial installations across similar buildings in the same neighbourhood could also help mutualise logistical costs.

Beyond cost-competitiveness challenges, a number of non-cost obstacles must also be addressed to mainstream heat pump adoption. For instance, information campaigns as well as independent and free audits to inform heating system replacement decisions can raise awareness and confidence in the technology’s potential benefits, while regulatory changes can make decision making and permitting for collective buildings simpler. Finally, depending on the building, application specificities, and local energy source availability, other renewable heat options such as solar thermal and bioenergy may sometimes be easier or more economical to implement.