Improving the energy efficiency of our homes has become more topical in recent years as the focus on reducing greenhouse gas emissions has grown. My last blog looked at the role it could play in meeting the government's Net Zero Strategy. This blog uses data on individual properties to ask whether it could not only be good for the planet, but whether it might also be a good financial investment, given the sharp rise in energy prices. The short answer is yes, for many homes.
The blue line in Chart 1 shows how much wholesale gas prices have risen recently. And the orange line uses the futures curve to show the prices that traders currently expect to pay for wholesale gas in the future (as of 14th March). The price households face for gas is commonly measured in pence per kilowatt hour (often described simply as 'units'). As well as the wholesale cost of gas, it includes the networks' distribution costs, energy companies' profits, taxes, etc. Chart 2 uses Ofgem's price cap model, which incorporates all these components, to translate wholesale gas prices into an estimate of the unit cost of gas in the future.
As explained in my last blog, Energy Performance Certificates (EPCs) provide an estimate of the current cost of heating and providing hot water for homes, as well as recommendations for energy efficiency improvements and an estimate of the savings possible from undertaking those improvements. The blue bars in Chart 4 show the distribution of those estimated savings, from a random sample of 1m UK homes. The EPC certificates use current energy prices to estimate savings, but with a bit of work, it's possible to update these savings estimates for the latest energy prices. The orange outline shows how the distribution changes as we plug in the unit cost of gas from Ofgem's latest price cap.
Chart 4 compares these potential savings to the cost of investment using the simple heuristic of the number of years it would take to repay the investment. It shows that while it is still a long time for many households, it shortens dramatically with higher energy prices. But it's a bit too naive to just look at the current cost of gas when thinking about potential savings; if gas prices come down quickly, so will potential savings. So we now return to the prices implied by the gas futures curve in Chart 2 and calculate the internal rate of return to investing in the energy efficiency improvements recommended in EPCs. This is shown in Chart 5.
The IRR is the rate of return that matches the savings from lower energy bills in the future to the cost of the investment in energy improvements today - the higher the rate of return, the better the investment. For households with enough savings to pay for the investment, they can compare this IRR to the post-tax return they can expect to earn on other investments; noting that they will have to pay tax on most financial investments, but don't pay tax on savings on energy bills. Chart 6 shows the proportion of homes for which the rate of return exceeds certain levels. For instance, for around one third of homes, the IRR is 3% or higher, meaning that unless they are confident of getting more than a 3% post-tax return on their savings, they could save money by investing in the energy efficiency improvements recommended in their EPC certificates.
Of course, not all households will have enough savings to spend on energy efficiency improvements. But it is interesting to note that the returns more than cover the interest payments on mortgages for a lot of households, at current mortgage rates. And for some, they even cover the cost of interest and repayment on a 25yr amortising loan. This means it could be profitable for banks and building societies to lend to households for energy efficiency improvements, even without taking into account the extra societal benefit of helping with the transition to net zero. It could also provide a novel, and more friendly, way to deal with the inevitable increase in arrears that will come as as energy bills continue to rise sharply. And for the government, who have an unfunded ambition to reach Net Zero that looks like it will require huge private sector investment, this could be a silver lining in the current energy price crisis.
As ever, we're happy to help businesses or government departments use the property-level data underpinning this analysis. Just get in touch.