Levelized Cost of Heating: A Fair Look at Heat Pumps vs. Natural Gas
TL;DR
Overall cost of heating needs to take into account both fuel and system costs over time. In our example we show that despite a huge efficiency advantage for heat pumps, they are not in fact overall cheaper than natural gas systems in most places in the US.
How to compare different heating systems
When comparing heating systems, it's easy to get lost in debates that focus more on ideology than economics. A helpful tool to cut through the noise is the Levelized Cost of Heating (LCOH). Similar to the Levelized Cost of Energy (LCOE) used in the power sector, LCOH provides a standardized way to compare the total cost of different heating technologies on a per-unit-of-heat basis.
Our goal here is to explain the basics of LCOH, focusing on the key cost components – upfront installation and ongoing fuel – and apply it to compare modern heat pumps with traditional natural gas furnaces. This comparison is crucial for making informed decisions, both individually and collectively, about transitioning to newer heating technologies.
(Note: We'll use kWhe for electrical kilowatt-hours and kWhT for thermal kilowatt-hours to distinguish between energy input and heat output, as they aren't always a 1:1 conversion, especially with heat pumps.)
What is LCOH?
The Levelized Cost of Heating is calculated as:
\[ LCOH = \frac{Sum \medspace of \medspace NPV \medspace of \medspace all \medspace costs}{Sum \medspace of \medspace NPV \medspace of \medspace all \medspace heating \medspace delivered} = \frac{\sum\limits_{i}^{lifetime}{C_i} }{\sum\limits_{i}^{lifetime}{H_i}} \]
The numerator includes the initial purchase and installation cost of the heating system (like a furnace or heat pump) plus the cumulative cost of fuel (natural gas or electricity) over the system's lifetime, adjusted for the time value of money (discounting).
The denominator represents the total amount of useful heat delivered by the system over its lifetime, also discounted.
The result is a cost expressed in dollars (or cents) per kWhT. This single metric allows for a direct, apples-to-apples comparison of the total lifetime cost of different heating options, accounting for both the initial investment and ongoing operational expenses, which is often overlooked when focusing solely on fuel prices.
Simple Comparison: Heat Pump vs. Natural Gas in Washington State
Let's look at a specific scenario in Eastern Washington, a region with relatively low electricity costs due to hydropower. We'll consider a homeowner replacing a central gas furnace in a standard single-family home needing roughly 30,000 kWhT of heating annually.
Local Costs:
- Electricity: $0.115/kWhe
- Natural Gas: $1.384/therm (approx. $0.047/kWhT)
System Options (Installed Costs):
- New Gas Furnace: $7,000
- New Central Heat Pump (no ductwork needed): $12,000
Assumptions:
- System Lifespan: 15 years
- Discount Rate (time value of money): 8%
Running the numbers yields the following LCOH:
- Natural Gas Furnace: 7.86 cents per kWhT
- Heat Pump: 8.31 cents per kWhT
Fuel and system cost contribution breakdown for LCOH
Figure 1: Cost breakdown for the two systems by fuel and system contributions to LCOH. Heat pump has lower lifetime fuel costs but considerable upfront costs, the opposite is true for natural gas.
The two technologies are roughly equal in per heat unit costs. While the heat pump is significantly more efficient and has a lower fuel cost (calculated at 3.82 cents/kWhT compared to natural gas fuel cost component of 5.25 cents/kWhT based on furnace efficiency), its higher upfront installation cost ($5,000 more) pushes the total levelized cost slightly above that of the natural gas furnace in this specific case.
This highlights a critical point often missed or omitted in advocacy: the initial investment matters significantly in the overall lifetime economics. In this Eastern Washington example, the costs are nearly break-even. A homeowner prioritizing sustainability could choose the heat pump with significant environmental benefits and face minimal financial difference over the equipment's life. Importantly however, they are not demonstrably better off despite the high claimed efficiency of heat pumps.
Economical Heat Pump Adoption is Geographically Dependent
Repeating this LCOH analysis for other locations reveals that the economics vary significantly based on local electricity and natural gas prices. Most states have higher electricity costs relative to natural gas, thus heat pumps currently do not offer a cost advantage over traditional gas furnaces based purely on grid electricity prices. Interestingly, besides Washington, only Hawaii and Florida show potential LCOH advantages for heat pumps, though one could argue that heat pumps in these states are not even a consideration for space heating.
Loans improve the LCOH of heat pumps more than for natural gas systems
While from a "cash" perspective, the heat pump offers lower financial performance, one could consider how a loan impacts financial performance of these systems. By borrowing and paying installments instead of upfront cash, the cash outflows can be delayed to improve the time value of money issue. If the interest rates are low enough, heat pumps are more competitive across the board, since they can spread higher upfront costs across time than a natural gas furnace investment could.
In our Washington state example above, a loan interest rate of 6% would set the LCOH of the heat pump and natural gas system completely even. There is only so much the loan can do to improve the time-value aspect of heat pump investment, but it gives an idea of how clever financing can sometimes be just as important as good engineering.
Honesty in Policy and Sales Matters
The takeaway isn't that heat pumps are bad, but that their economic viability isn't universal yet. Policies mandating heat pumps, especially in areas where they are demonstrably more expensive on an LCOH basis than incumbent options like natural gas, risk creating justified public backlash.
Government incentives can help bridge the cost gap, but their effectiveness and cost relative to other decarbonization efforts should be carefully evaluated.
Installers, advocates, and policymakers need to be transparent about the total costs involved. Pushing technology using misleading economic arguments or omitting the impact of upfront costs can damage consumer trust and hinder long-term adoption goals.
While heat pumps offer significant potential, promoting them effectively requires an honest assessment of the economics, acknowledging that the right choice often depends heavily on local conditions.