Why is electricity comparatively more expensive than gas and why does this matter so much for the UK's net-zero targets? A story in three charts.

Three key reasons why electricity is more expensive than gas

1. The cost of electricity tracks the cost of gas because gas generation sets the marginal wholesale price

The wholesale price of electricity is set by the cost of producing the last unit of electricity needed to meet demand. This is nearly always a gas power plant with high marginal costs.

Put simply, when demand for electricity is high – when the sun sets and lights are turned on – gas-powered energy plants step in when other forms or electricity generation, like wind, are low, or supply is otherwise disrupted.

2. Electricity is subject to carbon taxes, whereas gas used for heating is not

Electricity is subject to carbon pricing – a tax per tonne of CO2 emitted – through the UK Emissions Trading Scheme and the Carbon Price Support. That means consumers are paying carbon taxes on electricity used at home. But there are no carbon taxes applied to gas or oil for residential use.

3. The government has tended to load ‘policy costs’ onto electricity bills

Government generates funds for some social programmes that tackle fuel poverty and promote renewable energy generation through levies on consumer bills.

Historically, most of the charges that fund these programmes have been placed on electricity bills, rather than on gas bills. For example, back in winter 2020, levies added around 5p to electricity unit prices, while the effect on gas unit price was negligible. Using Ofgem's price cap methodology, levies on electricity bills would come to £140 a year from 1 April 2023, while levies on gas bills would be just £34. At the moment, with the Energy Price Guarantee in place, these social programmes are being funded through general taxation rather than levies on bills.

How lowering the cost ratio of electricity to gas permanently would help make heating greener

The government's support for householders in the form of the Energy Price Guarantee not only kept energy bills down, but helped them to be greener.

This is partly because as the ratio of electricity-to-gas prices fell, it has made heat pumps relatively cheaper to run.

One way to improve the electricity-to-gas cost ratio is to move the levies so they are paid for through general taxation instead of electricity bills. Under the Electricity Price Guarantee, levies have been removed from bills – the Government just needs to make this change permanent.

Returning to previous electricity-to-gas price ratios would hold the UK back from decarbonising homes because it would discourage consumers from opting for greener options that run on electricity not gas, like heat pumps.

How a green ratio of 2.5 to 1 would make a heat pump cheaper than a gas boiler over the same lifespan

The chart below takes an example home and demonstrates how the running cost of a heat pump compared to a gas boiler could be affected by different electricity-to-gas price ratios, upfront costs, efficiency or the cost of gas.

With energy prices as they currently stand, and the Boiler Upgrade Scheme in place, a heat pump might cost around £110 more per year across its lifetime than a gas boiler – as shown by the blue bar.

With the Boiler Upgrade Scheme grant still in place, if the electricity-to-gas price ratio came down to 2.5 to 1, a heat pump in this example would be £110 cheaper per year – as shown by the green bar.

When the Boiler Upgrade Scheme ends, under the same assumptions, heat pumps would be more expensive, around £180 per year more than a boiler.

Relatively small changes in heat pump costs could make a big difference. If upfront costs were reduced by 20%, for example, a heat pump would cost just £30 per year more than a gas boiler in total over its lifetime.

With a high-quality installation that improves average efficiency further, alongside an upfront cost reduction, lifetime costs of heat pumps and boilers even out, even when gas is relatively cheap.

It is worth noting that in this model, heat pump running costs are much cheaper than for gas boilers – around £830 vs £1,300 per year for energy used for heating.

There are other ways to get heat pumps to be cheaper over their lifetimes, for example, further improving the efficiency of heat pump installations in situ, making use of electricity when it's cheaper, keeping them in use for longer, and lowering maintenance costs relative to boilers. Government could also consider smaller incentives to switch, such as electricity standing charge discounts, while energy suppliers could offer 'heat pump tariffs'.

Upfront costs could also come down further than we've modelled here, although high-quality installations pay back with better efficiencies, so racing to the bottom on upfront costs might not be the best strategy. It's worth remembering that a key reason why upfront costs are higher for heat pumps than boilers is that while most new boilers are like-for-like replacements, fitting a first heat pump often involves some other upgrades, for example to radiators and water cylinders. Future replacements are likely to be simpler – and cheaper.

What needs to change

To accelerate household decarbonisation and reach net-zero emissions by 2050, the government should reform policies governing energy bills to make them both cheaper and greener.-

If electricity prices were no more than 2.5 times the cost of gas, heat pumps could more easily cost less than boilers over the same lifespan, paving the way for a phase-out of boilers altogether.

This reform could be accompanied by other reforms to energy bill policies, such as a variable carbon levy on gas usage to offset the associated carbon emissions. The money raised through a carbon levy on gas could be passed on to low-income households to support them with the cost of their energy bills. An even more progressive energy bill policy would see customers paying different amounts depending on their previous year’s consumption – with the lowest rate set at zero to incentivise energy efficient practices.

The end of the Energy Price Guarantee gives the Government a golden opportunity to update our outdated policies on energy. It’s time to shape our bills according to what’s best for people and the planet.