Supercharging electrification with dynamic tariffs

The 4:1 ratio of electricity to gas price in the UK is often said to be too high for all but the most efficient heat pumps to be cheaper to run than a boiler. While in some cases this may be true, there is a risk it is an oversimplification that could deter people from installing heat pumps, while they wait indefinitely for changes to energy taxation and electricity market reform.

The important detail here is that electricity is not priced like gas. Wholesale electricity prices vary constantly depending on the generation mix, interconnectors, storage, and demand, and many buildings can of course generate their own solar electricity. Prices are generally cheap or even negative when it's windy and sunny and demand is low. Prices increase when renewable energy is scarce and demand is high.

Historically, these pricing trends could be passed on to domestic consumers via simple time-of-use tariffs like economy 7 and economy 10, through the use of specialised meters. The advent of smart meters means that a wider range of tariffs are now available, which have been specifically designed for heat pumps, electric vehicles, or simply to track wholesale prices.

An important characteristic of these tariffs is that they provide efficient mechanisms to encourage people to use more energy when it is abundant, and less when it is scarce. This, combined with the ongoing growth in intermittent renewable energy sources means it is likely to be a long-term feature of UK energy pricing, rather than a short-term fad. Bloomberg have forecast significant increases in the number of hours of negative pricing will occur over the coming years.

As professionals working in the built environment, we need to understand this. Everyone from property portfolio holders, social housing providers, and local authorities, to those designing and modifying buildings and their heating systems. Dynamic pricing fundamentally affects how buildings and their systems need to be designed to minimise operational energy costs.

Most promisingly, dynamic pricing and solar can also flip arguments against electrification of heat on their head. Rather than being seen as a potentially expensive liability, electrification can be the key to permanently reducing costs and making meaningful progress on reducing fuel poverty.

Introducing Agile Octopus

In February 2018, Octopus Energy introduced the UK's first fully dynamic tariff for domestic customers, Agile Octopus. Prices on this tariff vary every half hour, with the next day's prices published here around 4pm every afternoon. The half hourly price is around twice the wholesale price, which provides margin to cover distribution costs, plus a peak-time premium of around 12p/kWh is applied between 4pm and 7pm. The peak price is capped at no more than 100p/kWh. Octopus provide a more detailed explanation here.

Between January and November 2024, the average Agile Octopus rate was 28% cheaper than the price cap rate, even if you used energy continuously without avoiding the peak pricing period. In 2023, the average Agile price was 47% cheaper than the price cap rate - almost half the cost!

Active participation is not required

A common misunderstanding with time-of-use, and particularly dynamic pricing, is that active participation is required. The reality is that following fixed daily schedules can deliver massive savings, and these can be implemented using simple timers, which are often built into heating appliances. That provides a solid baseline for most households, while retaining excellent potential for motivated households to go even further. Automated demand flexibility implemented by groups like Kensa and Octopus can make dynamic tariffs work for normal people as well as energy geeks.

This is illustrated in Figure 3, which compares 2024's average price cap rate with average Agile Octopus prices for five fixed daily schedules. Each schedule is designed to use the cheapest electricity available, based on average annual half hourly prices. Typical scenarios these schedules could represent are summarised below, with savings relative to the price cap rate indicated in brackets:

1. 24 hours - heat pump running continuously (-28%)

2. 22 hours - heat pump running continuously with a two hour setback (-33%)

3. 20 hours - heat pump running continuously with a four hour setback (-36%)

4. 16 hours - heat pump running on a daytime schedule, with late afternoon setback (-39%)

5. 2 hours - heat pump or immersion element heating a hot water tank overnight (-48%)

Electricity to Gas Price Ratio

Figure 4 shows how dynamic tariffs can totally disrupt conventional wisdom on electricity to gas price ratios. With the exception of the energy price crisis, Agile Octopus has offered ratios from less than 2:1 to 4:1, based on a 24 hour schedule. This falls to just over 1:1and 3:1 for a 2 hour schedule. At these ratios, heat pumps are significantly cheaper than gas or oil boilers.

It also highlights some element of risk posed by dynamic tariffs under the current regulatory environment. Pricing for the Agile tariff was able to increase significantly above the price cap rate during the energy price crisis, however in practice people were able to switch to a fixed tariff that was protected by the price cap and then switch back to Agile once the prices fell. Prices have also increased toward the end of 2024 due to an extended period with well below average wind speeds.

Despite these bumps, the long-term picture is a steadily reducing reliance on imported gas (Drax Electric Insights reports ~26% of UK electricity was from gas over the past 12 months) as deployment of renewables continues to grow. The combined effect of these appears to support an increasingly competitive role for dynamic tariffs in the future.

Conclusions

Heat pumps powered by dynamic tariffs are already significantly cheaper than gas or oil boilers for a good proportion of UK households. By failing to understand and account for this potential, we are continuing to use boilers even where good economic cases exist to scrap them before end of life. This has several implications:

1. Needlessly increasing greenhouse gas emissions and air pollutants, and actually paying more to do so.

2. Unnecessarily funding the fossil fuel industry, whether through buying gas and oil, or supporting boiler supply chains.

3. Missing valuable opportunities to empower fuel-poor households to reduce their energy costs for little upfront cost.

On this last point, while there appears to be good potential for dynamic tariffs, several challenges need to be overcome. Existing prepayment meters may not allow access to dynamic tariffs, which could become a significant social inequity, and practical advice on how to save money using dynamic tariffs will need to be available for normal people who otherwise have no interest in energy markets. While internet access and a basic level of computer literacy are also required to make best use of dynamic tariffs, use of simple fixed schedules could mean it is not essential.

References and useful links

https://www.linkedin.com/pulse/how-domestic-energy-flexibility-could-improve-crisis-george-dawes/

https://www.linkedin.com/pulse/price-cap-spark-gap-richard-warren/