[00:00:02.950] - Jon
Hello and welcome to the episode. Winter is coming is a phrase watchers of Game of Thrones will be very familiar with. And indeed, in Europe, winter is coming. And we're walking into a horrendous winter in terms of energy price rises, driven, of course, by natural gas prices. We hear a lot, we talk a lot about rising gas prices. What we don't talk about so much is what that gas is being used for. And at least in the building sector, the vast majority of that gas is used for heating. So today we're going to focus on what's going on in the heating markets. Are rising gas prices causing big changes in how people are buying appliances and what sort of heat appliances they're putting in? Are people keeping their money in their pockets and not buying new heating appliances? To explore these questions, I'm joined by my Delta-EE colleague and expert, Steven Ashurst. Hi, Steven.
[00:01:02.940] - Steven
Hi, Jon. Thanks for having me.
[00:01:05.340] - Jon
And welcome back. So, Steven, you spend your days talking with the heating industry, working with the heating industry, thinking about the heating sector. In a nutshell, what is going on in the European heating appliance market? Is it boom time, is it crash time? Are we seeing big changes in what's being sold, what customers are buying?
[00:01:28.070] - Steven
Well, firstly, I can't promise I'm going to be as eloquent as Tyrion Lannister, sticking with your theme, but we're in a really unprecedented, in many ways, fascinating time. On the one side of the coin, we have an energy price crisis looming. On the other side of the coin, the European heating market has never been more buoyant, especially as we've emerged from Covid lockdowns based on a number of key drivers that have developed, whether you're looking at established technologies, boilers or emerging technologies, electric heat pumps, and we're seeing record numbers across the board when it comes to sales, where we focus mainly domestic heating appliances.
[00:02:16.380] - Jon
Wow. So good times to be in the heating appliance manufacturing industry today, then.
[00:02:23.270] - Steven
Yes. From that side, there's also the challenges of the ongoing global components shortage, which I'm sure we'll come to. But, yes, in terms of if you're a heating company, your annual report for 2021, most likely it looked really good. And most likely there was the phrase record sales, record revenues, record growth in there, especially among Europe's biggest billion euro plus a year companies.
[00:02:53.210] - Jon
So the Boschs, Vaillants, the Viessmanns, BDR, Ariston, these type of companies, the Daikins yeah, exactly, And what's being sold? Europe still very much a boiler market, a gas boiler market. Heat pumps have slowly, gradually been growing their market share. Are we seeing changes in patterns, in what types of heating appliances are being sold?
[00:03:18.110] - Steven
We are starting to see change, yes. 2021 was a good year across the board because there was a lot of pent up demand where it was for your simple comb boiler swaps. Or your customers who were looking to change to a fully electric air source heat pump or with new build projects looking to again install move more regularly to things like electric heat pumps as well as actually the crossover hybrid heat pumps had a significant increase in several markets last year. So there was pent up demand and there was government responses, the market, which introduced lots of subsidies, which really helped as well.
[00:04:06.850] - Jon
So it's a bit of a rising tide floating all boats at the moment then in the heating sector. So you would think that with the gas crisis, particularly in countries like Germany, which are heavily reliant on Russian gas, I can imagine some customers might be thinking, okay, how do we move away from gas? What's it like to be in the electric heat pump sector at the moment? Are you hearing that companies have got really long order lists or is it a bit better in the same way boilers are up but not a dramatic change?
[00:04:46.390] - Steven
Well, no, I would say that certainly more starting from a lower base. But companies in the electric key pump market have seen 2021 was the most successful year for domestic heat pump sales in Europe. And with the rate 2022 has started, very much looks like that trend will continue there in the situation whereby they can't make enough products to satisfy demand. So at this point in time. If you are a customer. Let's say in Germany or the Netherlands. To take two key examples. If you put in a new order now. It's highly unlikely you'll be having your installation before the end of this year and in some instances you could be well until 2023 before companies are able to satisfy that order because there's issues with components supply making enough systems. There was already a backlog as companies responded as we were able to go about their day to day business after limited working hours, et cetera, during covid. So we see consistently electric heat pump numbers are up on the order of a few tens of percents in each market. And companies we speak with, many are quite confident they could be doing 20% plus more sales based on the level of interest they have from the market at the moment, if they could just make enough systems.
[00:06:15.650] - Steven
So another really interesting trend that we've seen over the last few months, six months is the announcement of massive new production capacity from your lakes of Viessmann, Daikin, Vaillant, Nibe, which take time, obviously to come to help address this backlog. 2024, 2025 is most likely when there will be this European wide step change and availability of heat pump products in particular.
[00:06:53.720] - Jon
So it really is more demand for electric heat pumps than the market can supply at the moment. Long term, it looks like that will be solved. How much of the lack of supply at the moment is due to putting it clearly not enough factories or enough factories, but shortages of components.
[00:07:20.110] - Steven
The components is the big issue at the moment and the knock on consequence of how much, whether it's individual component or even the raw materials, if you are manufacturing yourself, prices are dynamic, varying wildly, they're up 100% or more from typical levels. So being able to produce, we also have on the supply side, the installer capacity, especially with regards to electric heat pumps, still an emerging profession industry, whether it's UK, Germany, Netherlands, so happy days. If you're a heating installer at the moment, your order books are filled way out and you can afford to be quite selective with the types of installations you do. You can go for the really high end ones, people who are getting a whole heating distribution system replacement as well, taking out radiators, putting in under floor, new buffer vessels, new hot water tank, everything else. So it's a really high cost installations versus people who are perhaps a bit more renewable ready. It's a less valuable installation for the installer. So installers in our really strong position, those that have already made the transition to qualify with heat pumps.
[00:08:50.190] - Jon
So it sounds like challenging for most parts of the supply chain at the moment from the sourcing of components, the capacity of the factories to build and assemble heat pumps. Distribution of heat pumps I imagine is not too bad. But then they install a part of the supply chain is another bottleneck.
[00:09:14.510] - Steven
That's right. I am talking generally companies, a company, those manufacturers that have more of their supply chain in house are doing better and are able to turn around new orders more quickly than, say, those who source a lot of their components, whether it's from Southeast Asia or just elsewhere in the supply chain. So the more vertically integrated companies are able to adapt, they are a bit less impacted by the long delays or the significant increases in component costs. Some companies we've spoken to have told us if you want to guarantee an order, you need to be booking it for 2024. Now really, if you're looking for sizable volumes of a core component that you want, but also other competitors in the market would want as well and be happy to pay more for whether it's a pump or a fan or those kind of components.
[00:10:19.590] - Jon
Well, that reminds me of a conversation we were having, Steven, with one energy retailer, I won't say where or which country, but they're building a heat pump business and their biggest challenge wasn't creating demand, it was actually throttling or managing the demand they have.
[00:10:38.770] - Steven
Yes, you mentioned earlier, I don't think answered, but I can answer it now. As we've come out of lockdowns and as European governments have tried to stimulate activity in the economy, subsidies for low carbon heating have generally got better and better. So in Italy, for example, we're seeing record numbers of installations because they've got their 110% super bonus. In France, subsidies were increased. That was already a strong market for electric heat pumps. In Germany, up until very recently, you were able to get 50% of the fully installed cost of an electric heat pump. So of course, that really catches customers interest. They were worried about running out of money, so they have scaled back the grant levels in Germany. But there's compelling arguments for customers who want to do something which is environmentally motivated. There is increasing instances whereby an electric heat pump could challenge gas boilers on your monthly OPEX costs not everywhere. And energy prices. I'm sure we'll come onto that later. But there's still a wide diversity of spark spreads across Europe. Although the trend has been for these to narrow. Which all this is in the favour of electric heat pumps. But the environment so the kind of social motivation.
[00:12:13.090] - Steven
What can I do with gas prices? I'm not sure that we're seeing people making the decisions on those grounds, really coming through the market numbers, yet, largely as a consequence of the fact that demand had such a backlog. Anyway, it's probably into next year when we're going to see just how much of an uptick these socially motivated decisions to switch from fossil fuels will have, because the gas boiler market is still strong in Europe as well.
[00:12:43.510] - Jon
So you talked about numbers being up in the heat pump sector year on year by 10%, 20%, maybe more in some cases. The heat pump industry thinks some manufacturers, they could sell another 20% more. On top of that, we've got the feeding through of those more emotional drivers moving away from gas that you just mentioned. We've got more subsidies. The constraint is the supply chain at the moment and I wonder what that's doing for prices. It sounds like it's a seller's market rather than a buyer's market at the moment. There's lots of hope that heat pump costs will fall as volumes increase, but are we seeing that cost down curve at the moment or is this changed things?
[00:13:40.090] - Steven
Yeah, typically, and this is a really interesting topic, but generally we haven't seen significant cost reductions in heat pumps as they've become more established, certainly outside of Scandinavia and the more gas dominated markets that we are. Not necessarily gas dominated, but northwestern Europe, France, UK, Germany, Italy, Netherlands, for example, and you're seeing close to half a million units a year in France these days. But the average install cost when you take away the effect of grants is still 10% or more. So we haven't seen what you would expect from that 20% learning rate, generalised energy, technology, cost reduction, and over the short term, something that we're expecting to see. There's been already an element of increased prices because of all the challenges we've mentioned. So five to 10%, and it's likely that this will be increased and there will be a delay until additional cost increases from the production side, of course, it cost the gas, these companies use gas in their factories and it's going up everywhere, so that's going to have an impact on the end consumer as well that will be into next year. So I think we'll still be seeing cost increases generally for heat pumps into next year.
[00:15:07.580] - Steven
But this is not just for heat pumps, this is for anything that's produced.
[00:15:11.810] - Jon
Yeah, I guess heat pumps aren’t immune to that supply chain challenge. Installed parts may be a bit unique.
[00:15:20.990] - Steven
We've got more components than the boiler equivalent, we've got more semiconductors than the boiler equivalent. So perhaps adversely affected compared to the market they're trying to take share from.
[00:15:33.040] - Jon
You mentioned these big new heat pump factories being built. I imagine there will be similar investment for the supply chain of components to these factories. And I hope that there'll be the more and more installers seeing which way the market is going and upskilling to work with heat pumps. So it might take a year or two, but we should see if demand carries on increasing in the way it is, we should see more supply available and then at that point, do you think prices will start to come down as competition increases or do you think even then it will be hard?
[00:16:15.130] - Steven
Product? I think there's a better chance that product cost will be pushed down due to competition. I think we're still looking at a shortage of installers for a good number of years. So every mention, the key countries that we tend to focus on with our research, every government is aware that they have an ageing installer population and there's a certain amount of installers that just don't want to gas installers, boiler installers that just don't feel they need to upscale.
[00:16:47.570] - Jon
No, they'll be installing gas boilers for many years, so they'll still have jobs if they want to stay with that sector.
[00:16:53.730] - Steven
That's right. And of course, because of what's looming, there's an increased focus on getting more apprentices through who are heat pump specialists. But this is taking time. So the big question is what the mid career heating installers do and just how long it takes a significant proportion of those, maybe 35 to 45 or something like that, in age to go through the heat pump equivalent training. And from the manufacturer side, they're doing what they can, providing free courses. Lots of the training is online now. Don't even need to go to the training centre to do much of your, at least your product related, your manufacturer product related training. The German government, the new German government is looking to radically shake up the policy and the heating market in Germany and in its consultation, it's got out. At the moment, it fully recognises that there is this massive challenge as much as everything else that's going on with energy is a massive challenge. The German government has said we need to do a lot more to encourage more apprenticeships and installers coming through. So I guess my point is that installers will be in a really strong position for the short to medium term.
[00:18:12.930] - Jon
Anyway, so that's a really hard part of the supply chain to move quickly.
[00:18:19.070] - Steven
[00:18:22.830] - Jon
You mentioned spark spread earlier on, Steven, so for those listeners that aren't familiar with the term in this context, that's a gap between residential electricity prices and gas prices, the ratio of those, and we're seeing electricity and gas prices both increase. But what's that ratio moving in the direction for electrification or against it? Or is it very country dependent?
[00:18:54.850] - Steven
It's very country dependent, but I can share a few examples. So here we are in the UK, the electricity price and the gas price are both going up and essentially maintaining the traditional spark spread we've had. That is about three and a half to four, I think probably has weakened a little bit. But when I look at I know what I'm paying for my electricity and gas just now. And I know what I think I'm going to have to pay once we have our new price gap from the winter. I'm still. Based on the figures I've seen. I'm still looking at a spark spread of at least three in the UK. Which would mean you need a really well performing heat pump to compare with your running costs on gas.
[00:19:37.770] - Jon
So you might get a broadly equivalent heat running costs. It might be a bit higher or a bit lower, depending on your performance of the heat pump and the boiler comparison, but broadly similar at three to one.
[00:19:49.520] - Steven
Yeah. And then could well come down to how well the building is insulated and if that installation has already been done, or if the installation is also a factor in your decision making. But on the other end of the extreme, in Germany, which has traditionally had a spark of four and a half, five, there's been a few things that we are underway for the last couple of years before we got into this energy crisis situation. So the government had been looking to reduce the green levies from the electricity bill, so it's done this gradually. But in July, it took the remaining about $0.03 off the price of electricity. For the last few years, they have introduced a new tax on fossil fuels, which also added to gas supply. And it's the gas customers that pay that. So over the last few years, we've seen a gradual narrowing of the spark spread in Germany, although it's still been quite wide. But now, because of the significant concern of gas supply shortages in Germany this winter, because of the Nordstream One pipeline supply, german gas suppliers are having to look elsewhere. They're not getting gas as cheap, they're worried that they won't be able to meet their costs.
[00:21:12.960] - Steven
So there's a new levy that's being introduced to another one on the gas price in Germany, which is going to see about a two and a half cent per kilowatt hour increase in the gas supply, further narrowing the sparks. But ultimately, we're in a situation in Germany a year ago, the spark spread was about five. Now we're looking at being less than two and a half.
[00:21:32.050] - Jon
Wow, so if you've got a heat pump performing at a decent level, it's going to be, quite a bit cheaper to heat your home with a heat pump than it would be a gas boiler.
[00:21:44.190] - Steven
Certainly with an aging gas boiler. Yeah. On a monthly opex basis.
[00:21:49.670] - Jon
[00:21:50.830] - Steven
[00:21:52.370] - Jon
Yeah. There are not many markets where there aren't really markets where heat pumps have electric heat pumps have taken big market shares away from gas boilers in the existing building market, are there? But do you think Germany could be going that way?
[00:22:10.130] - Steven
Like I said, it remains to be seen, but I think there's definitely - due to this situation. Also, as I mentioned, the new German government has taken quite a shift in course. Traditionally, subsidies for heating in Germany, haven’t discriminated. As long as it's a new highly efficient appliance, whether it's a fuel cell, a gas heat pump, a hybrid, or a purely electric system, or indeed a pellet boiler, whatever, subsidies have been good across the board. But now with green leading coalition, they've really pivoted and announced that all subsidies for any gas using system will go. I think most of them have actually gone already as of, as of August. And then yeah, that's going to make the customer decision making different. If you're weighing up, well, I'm on gas just now. I could put in a new condensing boiler that will cost me that much. I'm not getting a grant for it anymore, but it's still the most commoditized unit. Even if I go for a hybrid heat pump, I'm not going to get a grant. Okay. So that means I could go for a pure electric heat pump, and that's the system which I will still receive the highest subsidy for, whether it's an air source or a ground source.
[00:23:38.430] - Steven
Actually, in fact, if you're a ground source or a water source in Germany, you'll get a boost to your base subsidy, air source won't.
[00:23:46.180] - Jon
So that's going to push the demand for electric heat pumps. Yet another ingredient pushing the demand for electric heat pumps in Germany up. Yeah, I think it's interesting because we were chatting the other day, Steven, that we already see in the market responding to this by renting heat pumps. So a couple of companies I know you said are renting heat pumps to German customers, I believe, with a long contract. But that means you can rent a heat pump and save money on your energy bill and be better off compared to just sticking with a gas boiler and running an old gas boiler into the ground.
[00:24:25.950] - Steven
Yeah. So we've been looking into this, and my conclusion thus far is that, it's never been more of a compelling option. If you've been interested in installing low carbon heating, electric based in particular, but you've not had necessarily the funds available to do so. You've been worried about your monthly running costs. That's certainly been key in the point up to now where we haven't really seen any rental models. But now, as we've mentioned, with the spark spread changing, with the added geopolitical dimension, especially in Germany, you still have the challenges as a supplier of relatively low awareness about electric heat pumps and the challenge to convince someone to sign up to, say, ten years or longer, or longer contract. But you can also make the case that your monthly costs, running costs will be a lot lower than your base case option or your alternative option.
[00:25:33.540] - Jon
Yeah. And the emotional attraction, as you said earlier, of being independent of gas. That's a big part which is coming from Russia. It will be interesting, I think, this winter to see if we see further interruptions to gas supply to Europe. Effectively, whether we see gas being politicised or weaponized by Russia in the ongoing conflict in Ukraine. If that happens, then that will be an even bigger acceleration for demand for electric heating. And that must be giving these manufacturers that you mentioned, that's what's giving them the confidence to build new heat pump factories and invest in the supply chain.
[00:26:18.610] - Steven
That's true. I do believe that over the next few years we will see replacement of Russian gas supplies from alternative sources. LNG from the US. More coming from the Middle East, potentially Norway. Yeah. There will be a rebound and availability, but on the whole, it could be an inflection point in electricity heat pump uptake in certain markets. We've not talked so much about the Netherlands in France or some really interesting things happening there, too. But in terms of the major markets, the one that's under the most pressure and strain is definitely Germany. So Eastern Europe in a very precarious position. We haven't as yet seen the same level of significant policy change with regards to accelerating from gas alternate options.
[00:27:23.470] - Jon
As you said at the beginning of our discussion, it's a good time for the heating appliance industry per se. Across the board at the moment, it's a rising tide floating all boats, so there's still a lot of gas boilers being installed across Europe. Steven times getting the better of us. So let's bring out the talking new energy crystal ball. And I want to set the dial this week to just three years ahead to 2025. Let's keep it quite short term. I want your view. In 2025, what will be the biggest - will we still be constrained in the supply of heat pumps across the whole supply chain? Will we still have challenges, long lead times? People have been told we can have a heat pump, but not for six months? Or will that not be the case where we have plenty of capacity across the whole supply chain? And if we do have constraints, what part of the supply chain will the biggest constraint be in?
[00:28:31.490] - Steven
I'm just thinking the best way to form my answer. I think we've never been in this position before whereby there's been more demand and supply of electric heat pumps. And we've talked about the various reasons why it's such an inflated level of interest just now. So there's a chance that could gradually receive. But I believe that in three years time, there certainly won't be a shortage of supply in Europe. Some companies are talking about quadrupling, for example, their production capacity. We've got this timeline.
[00:29:12.600] - Jon
So we've got enough heat pumps being made, being sent abroard. What about installer capacity? Will that be keeping up with demand? Or do you think there will still be a constraint in three years?
[00:29:23.730] - Steven
I think that'll still be a major constraint in three years. Okay. And it differs across different segments. So in the new build market, where electric heat pumps have been strongest, and I think they will still be strongest in two years time, you need less qualifications so that market can move faster. And retrofit is you don't know what you're necessarily going to be dealing with, building to building up. So you need installers, need more certifications and skills. It's going to take quite a lot of time, I think, to bring through this new generation.
[00:29:58.970] - Jon
And that's a challenge for the heat pump industry, but also for governments and everyone involved in that sector. We better leave it there for today. It's been fascinating discussion, Steven, about what I think is I'm still slightly baffled how neglected this area is in terms of the energy price crisis. We talk, rightly, a huge amount about the cost of supplying gas to buildings, to households, but there's so much that can be done in terms of how we heat our homes, cost of gas and electricity to households. But we should be focusing so much more on what we do with that and how we use that gas and electricity to deliver the comfort that we need. So thanks a lot for your time and sharing your views.
[00:30:53.370] - Steven
No worries. Thanks Jon. It was a really interesting chat.
[00:30:56.920] - Jon
Thanks to everyone for listening. Hope you enjoyed the discussion. I wonder if it's making you think about your heating system, if you haven't done so already, or at least I'd encourage you, if not the appliance, to make sure your controls are up to date and you're using your heating system in the most efficient way.
[00:31:15.330] - Steven
Check your flow temperature.
[00:31:16.330] - Jon
There you go. So I look forward to welcoming you back to the next episode of Talking to Energy next week. Thanks and goodbye.