Lessons From the Heat Pump Market

October 16, 2023 Industrial Policy

Executive Summary

The Inflation Reduction Act (IRA) is the centerpiece of the Biden administration’s climate policy, with a key focus on decarbonizing the nation’s 123 million homes by subsidizing the adoption of low-carbon infrastructure and technologies. One such technology is the heat pump, a mechanism for heating and cooling homes that reduces carbon emissions as compared with fossil-fueled heating systems. Currently, only about 15% of American homes (19 million) have heat pumps as their primary method for space heating.[1]

The IRA allocates up to $9.05 billion for heat pumps through funds to be administered by the states, and it provides an additional tax credit of up to $2,000 per year for heat pumps. It is difficult to predict the total number of homes that are likely to be retrofitted with heat pumps as a result of the IRA, but one estimate is 7.2 million from the federal tax credits alone.[2] Substantial demand growth for heat pumps is necessary to achieve the Biden administration’s climate goal of a 50%-52% reduction of emissions from household fossil fuel combustion by 2030.[3] Meeting the climate goal will require installation growth rates of 10%-15% or more per year for the next decade and beyond.

Despite the opportunity to cut carbon emissions, replacing gas, propane, and oil furnaces in approximately 70 million American homes[4] is a daunting challenge. Heat pumps need to be produced and deployed en masse, requiring advanced skills and custom installations. Pushing more money into the sector could lead to more adoption, but depending on how the market is structured, predatory actors in the industry could also raise prices to diminish the value of subsidies, or even render subsidies irrelevant.

This paper tries to answer the question: Will IRA funding lead to sufficiently inexpensive and high-quality heat pumps to meet the Biden administration’s decarbonization goals? Answering this question requires an analysis of the market structure and pricing in the industry, as well as how firms are likely to respond to increased demand.

Our key findings are that, on an annualized basis, the IRA’s heat pump subsidies are dwarfed by the current magnitude of shareholder compensation among the 10 publicly traded manufacturers we analyzed (Bosch, Carrier, Daikin, Emerson, Haier, Lennox, LG, Mitsubishi/Trane, Panasonic, and Samsung). We estimate the combination of dividends and share buybacks from these manufacturers is $16.9 billion in the past year, as compared with the IRA’s $0.9 billion (annualized) – a factor of 18.7 to 1. Even excluding the diversified conglomerates (Bosch, Haier, LG, Mitsubishi/Trane, Panasonic, and Samsung), the four “pure-play” heat pump manufacturers (Carrier, Daikin, Emerson, and Lennox) have compensated shareholders $5.2 billion in the past year, exceeding the IRA’s annual subsidy by a factor of 5.8 to 1. Furthermore, private equity firms are taking an interest in manufacturers as well as wholesalers and installers. This is likely to lead to bottlenecks throughout the supply chain, which will be exploited to the benefit of private equity shareholders, who famously demand outsized premiums.

This paper is also relevant to markets beyond heat pumps. Many of the dynamics of demand-side industrial policy highlighted in this report will likely also apply to other market segments and industries where a similar policy design is applied. For instance, the IRA includes $369 billion in climate spending for many forms of renewable technologies, including solar and nuclear energy, electric vehicle subsidies, advanced manufacturing, and climate-smart agriculture. There are also adjacent policies, such as the CHIPS Act for semiconductor production, and the Infrastructure Investment and Jobs Act for infrastructure spending. Without detailed attention to the market structure of the industry, the subsidies’ effectiveness in increasing production and lowering consumer prices will be blunted by problems of limited competition and investors’ remarkably high expectations for financial returns.

The following recommendations are intended to promote competition throughout the residential heat pump market and put downward pressure on total installed costs:

  • Limit shareholder compensation and promote investments in productive capacity.
  • The $250 million Defense Production Act procurement should be highly targeted to individual components, such as inverters or interoperable controls, and should benefit all domestic manufacturers.
  • Support entrepreneurs who are reimagining heat pumps to reduce installation labor inputs.
  • A government office charged with industrial policy management should collect and analyze market data for all industries targeted by the IRA, including data on market structure, regional coverage, and pricing. Such an office should collect standardized heat pump cost data across the country to guide policymaking through 2030, as well as track labor and supply chain resiliency.
  • Coordinate federal agencies in planning for growth in the HVAC labor market.
  • Mandate interoperability between heat pumps and thermostats to avoid lock-in and promote innovation.

[1] Energy Information Administration, Residential Energy Consumption Survey (RECS) 2020, Table HC6.1, https://www.eia.gov/consumption/residential/data/2020/hc/pdf/HC%206.1.pdf.

[2] David Smedick, Rachel Golden, and Alisa Petersen, “The Inflation Reduction Act Could Transform the US Buildings Sector,” RMI, August 31, 2022, https://rmi.org/the-inflation-reduction-act-could-transform-the-us-buildings-sector/.

[3] Brad Plumer and Nadja Popovich, “The U.S. Has a New Climate Goal. How Does It Stack Up Globally?,” New York Times, April 22, 2021, https://www.nytimes.com/interactive/2021/04/22/climate/new-climate-pledge.html.

[4] U.S. Energy Information Administration, Residential Energy Consumption Survey, 2020, Table HC1.1, https://www.eia.gov/consumption/residential/data/2020/hc/pdf/HC%201.1.pdf.