Written evidence submitted by OVO Energy
OVO welcomes the Public Account Committee’s exploration of how the exchequer departments manage and utilise environmental taxation in support of the Government's environmental goals, including its Net Zero by 2050 target.
One of the greatest challenges the UK faces in achieving Net Zero by 2050 is cutting the carbon footprint of heating our homes. With around 85% [CCC] of the UK’s heating in buildings currently being supplied by natural gas, we need to make rapid progress this decade if we are to put the UK on a trajectory to reach Net Zero emissions by 2050.
OVO is calling for a greater sense of urgency. Last year, we published Plan Zero, our response to the climate crisis and strategy to achieve Net Zero carbon emissions across our operations by 2030. This includes our commitment to support our five million members in eliminating their household emissions.
We fully support energy efficiency measures, combined with smart electric heat devices, as no-regrets, scalable solutions that will cut carbon at a cost-effective rate for consumers. Heat pumps specifically can be immediately installed in off-gas grid and new build properties to kick-start the mass transition away from gas boilers.
However, the uptake of energy efficiency upgrades and electric heat technologies is running far behind the pace of delivery needed to deliver Net Zero, and environmental taxation and tax reliefs have not been harnessed to support the transition.
As a result, carbon is not being priced into the use of natural gas for heat (either through carbon pricing or policy cost distribution across energy bills) and VAT on green home upgrades is high. As the National Audit Committee recently reported, the Government has shown “limited understanding” of how the tax system can support Net Zero and has not attempted to identify new tax reliefs that could impact on its environmental goals [NAO].
OVO would welcome the Public Accounts Committee calling on the Government to harness new methods of environmental taxation as a route to encouraging the much needed mass consumer adoption of energy efficiency retrofitting and electric heat technologies.
Currently, the environmental damage of fossil fuel heating is not factored into natural gas prices in order to steer consumers’ consumption choices in a more eco-friendly direction. In fact, heat consumption using renewable electricity is currently much more expensive than using natural gas and the current approach towards energy pricing as a whole is actively preventing the mass switch to electric heat needed to decarbonise.
This is largely due to the fact that Government environmental and social policy levies - such as (ROs, FiTs, CfDs), which are essentially decarbonisation costs - comprise around 23% of the average electricity bill and 2% of the average gas bill [Ofgem]. This distribution of policy costs across electricity and gas bills is not reflective of the higher carbon intensity of gas compared to electricity and creates the perverse incentive of discouraging consumers from using electricity to meet their heat demand due to higher costs. Unless the 23 million households that are currently connected to the gas grid and the 250 million households who are considered to be in fuel poverty [BEIS] can see a clear financial benefit in the form of lower electricity costs, it is unlikely that electrically powered, low carbon heating systems will be adopted at the scale Net Zero requires.
Environmental taxation change needs to be implemented in a way that incentives and rewards electric heat consumption, ensures the price of gas consumption for heat acts as a signal of carbon intensity and does not exacerbate issues of fuel poverty.
As such, the Public Accounts Committee should call on the Government to undertake an urgent review of the impact of the distribution of policy costs across electricity and gas bills on consumer adoption of low carbon heat and how this can be amended to support environmental and fuel poverty objectives.
The Public Accounts Committee should also call on the Government to accept the Zero Carbon Commission’s recommendation to introduce a carbon charge on all heating fuels (including gas and oil) that reaches a minimum of £75/tCO2e by 2030 and is charged on energy companies and included in energy bills. We agree that the Government should announce its trajectory for carbon pricing for domestic heating immediately to give time for homeowners to reduce their reliance on gas and other heating fossil fuels such as oil - including through the uptake of energy efficiency measures - before the charge is introduced.
To ensure that the cost of this carbon charge does not fall disproportionately on lower-income and fuel poor households, and that all households are supported in reducing their fossil fuel usage before the charge comes into place, we also support the Zero Carbon Commission’s recommendation for:
Households in the bottom three income deciles to be compensated for increased costs above their current energy bills and;
For all households to be supported in bringing the cost of their carbon charge down with adequate access to funding for energy efficiency measures and low carbon heating installs [Zero Carbon Commission, 2020].
OVO would also welcome the Committee in calling on the Government to harness forms of tax relief as another means to encouraging mass consumer adoption of energy efficiency retrofitting and electric heat technologies.
One million homes will need to be retrofitted each year for the next thirty years to meet Net Zero [UK Energy Research Centre, 2020]. The Government has clearly identified the need for action, with the Prime Minister recently committing to deploying 600,000 heat pumps a year by 2028 in his ’10-point plan for a Green Industrial Revolution’.
However, only 27,000 heat pumps were deployed in the UK in 2018 [EHPA] and the rate of installation of the energy efficiency measures required to meet Net Zero has dropped to 12% [Institute for Public Policy Research, 2020]. The majority of new build homes are also being connected to the gas grid, meaning an ever-increasing proportion of UK homes are heated by fossil fuels [UK Energy Research Centre, 2020].
An urgent and concerted effort will be required to dramatically scale up electric heat deployment and energy efficiency upgrades in the UK, supported by a comprehensive policy framework.
The most directly comparable policy framework needed is the one that has been put in place for EVs. This includes a range of measures, all focused on tackling different barriers to consumer adoption, including upfront and running cost. Notably, this framework has harnessed tax relief measures as a key route to reducing EV adoption barriers for consumers and accelerating market investment.
For example, EV adopters benefit from tax relief incentives including VED discounts, corporate tax write offs and no requirement to pay Fuel Duty. In comparison, VAT on heat pump installs and energy efficiency materials was raised in October 2019 from 5% to 20%, despite the hugely significant role they have to play in reaching Net Zero. The higher rate is charged where the cost of materials exceeds 60% of the installation cost, with exemptions for some cases of social need.
We estimate that cutting VAT on heat pump installs to 0% as standard would reduce the upfront cost of heat pump adoption for consumers by around £2,000. This price reduction is much needed considering that our estimates show that the average heat pump install costs the consumer around £8-12,000, which is significantly more expensive than the average gas boiler install at £2-3,000. The cost of heat pump installation is heavily impacted by a lack of economies of scale within the supply chain, as well as the fabric upgrades that are required on a home to support a heat pump installation. This large upfront cost is a major barrier to consumer adoption.
The Environmental Audit Committee has recently called on the Government to reduce VAT on green home upgrades to incentivise more consumers to install low-carbon heat technologies and improve the energy efficiency of their homes [Environmental Audit Committee].
We fully support the Environmental Audit Committee’s recommendations and urge the Public Accounts Committee to call on the Government to include in its upcoming Heat and Buildings Strategy a list of the tax relief measures that it will bring forward to support the take up of energy efficiency upgrades and electric heat technologies in UK households.