The heat pump market is only just warming up…

June 2021

Heat pumps are expected to play a pivotal role in the decarbonisation of heat in the UK. But how can investors make the most of the growing market? In a follow up to Ronan O’Regan’s blog (The UK’s £11bn opportunity to decarbonise heating), Jonathan Massam and Tom Wellingham explore the investment opportunities.

A market poised for significant growth

The heat pump market, despite not being new in terms of technology or availability, remains relatively nascent and undeveloped in the UK with only 30-35,000 heat pumps sold in the UK in 2019. This is set to change dramatically over the coming years as part of the government’s plan to decarbonise heat and reduce building emissions by targeting 600,000 heat pump installations per year by 2028.

Accelerating infrastructure projects

The policy landscape is becoming clearer

The future regulatory and policy landscape around heat pumps is slowly coming to light. Despite existing schemes failing to translate into wide scale adoption of the technology, the Government’s recent release of the Heat and Buildings Strategy is expected to be an important turning point. An ambition to reduce the costs of heat pumps by at least 25-50% by 2025 and towards parity with boilers by 2030 go a long way to making heat pumps a compelling alternative, while £5,000 grants as part of the Boiler Upgrade Scheme will act as the catalyst to achieving momentum in the short term. It remains to be seen exactly how far the grants will go in terms of the total heat pumps installed but we expect the continued push from Government should see heat pumps play a major role in the push to achieve net zero.

“It’s moving quickly, and by the end of this year it will be an avalanche.” This is how one investment manager describes the growing awareness across real estate that the industry must deal now with the impact of carbon emissions from the built environment.

PwC Global Emerging Trends in Real Estate 2021

How can investors play in this market

As this market rapidly expands we anticipate there will be opportunities for investors right across the supply chain in what is currently a very fragmented market.

Transaction activity has been limited to date, with Legal & General Capital's acquisition of specialist ground source heat pump provider Kensa in 2020 providing an early example. With increased regulatory clarity, we expect to see increased transaction activity from financial and strategic investors alike as the push to deploy heat pumps into housing and commercial properties ramps up. In this blog we explore some specific investment opportunities that exist in both the retrofit and new build housing markets.

New build

New build housing, of which there are some 160,000per annum will likely be where we see the fastest uptake of heat pumps (both Air Source (ASHP) and Ground Source (GSHP)) in the short term as developers look to secure solutions before the looming ban of the gas boilers currently expected in 2025 under the Future Homes Standard. 

GSHPs present an interesting proposition for long term investment if developed under the right commercial model. A shared-loop heat network consisting of a communal distribution system servicing multiple properties (e.g. retirement homes) requires significant upfront capex which developers will be keen to mitigate. 

A commercial model where external finance is used to fund the upfront cost on the infrastructure in return for receipt of a stream of end user charges over the life of the asset could attract longer term infrastructure and broader Real Assets investors. 

Last mile connections and adoptions businesses are well positioned in this market as they already hold existing relationships with developers and can help supplement the coming reduction in new gas connections.

Retrofits

If the government is to reach its 2028 target then it is the household retrofit market that will need to contribute a majority of the 600,000 annual  installations. The expectation is that retrofits will be best serviced by ASHPs as a direct replacement for the existing gas boiler market. There were a reported 1.7 million gas boilers installed last year and with well over 20 million residential buildings currently still using a gas boiler there are no doubts about the size of the addressable market. 

One of the obstacles we see to deployment is a general lack of awareness of heat pumps. Incumbent energy retailers have an existing customer relationship with the end users and as such are well positioned to capitalise on this. We are already seeing energy retailers move away from simple energy supply business models as they recognise the inherent value in these customer relationships as opportunities to offer their customers complementary products. Further transaction activity might involve larger established retailers acquiring or investing into installers to secure installer capacity market share. Alternatively  manufacturers and installers could partner with retailers to gain access to customer relationships and secure an end market for their goods and services. 

We also see scope for tailored financial packages to support adoption (particularly with the relatively higher upfront costs). Our recent survey of UK households reveals growing public awareness and willingness to invest in energy efficient and sustainable homes, however upfront costs are one of the main reasons preventing households investing in energy efficient upgrades.

Seizing the opportunity

Whilst a lot depends on the right government support, the market fundamentals for significant growth in the short term are there. We expect multiple opportunities for both financial and strategic investors either by developing new commercial propositions or making the right acquisitions. As momentum in the market builds quickly, heat pumps will become increasingly commoditised and so moving early to capture market share will be imperative to success.

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Jonathan Massam

Jonathan Massam

Partner, Corporate Finance, PwC United Kingdom

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