
Residential and commercial heating currently makes up 40% of global energy demand. Decarbonization is a challenge, with fossil fuel technologies that rely on gas and oil dominating the sector and decentralized assets having long lifespans (e.g., boilers). In Germany, the need to decarbonize is shifting demand from high-emission options to cleaner, greener heat pumps, which are quickly becoming the most widely used technology for new installations, with a forecasted increase of 23% in installations through 2034. What does this mean for the German market, and what opportunities does it bring for utilities, investors, and industrial manufacturers?
UNDERSTANDING A COMPLEX ECOSYSTEM
The effective, efficient, safe, and reliable supply of heating is critical to businesses and households and covers heat generation (from boilers and more sustainable sources such as heat pumps), distribution to where heat is needed (through radiators and underfloor heating), and temperature control through thermostats and smart home technologies. Heat supply is a complex process that involves balancing and meeting technical, economic, and environmental challenges, particularly around sustainability and regulatory policy, such as subsidies and carbon prices.
Different methods of heat generation deliver specific benefits, with gas and oil boilers as the traditional choice (see Figure 1). However, regulations mandating renewable options for new installations, energy targets, and uncertainty over future gas availability are all expected to result in the complete elimination of gas heating in future German construction projects.
THE SWITCH TO LOW EMISSIONS ALTERNATIVES
The replacement of boilers as the dominant technology for heating buildings is an ongoing trend, driven by three key factors:
- Tighter emissions controls/mandates and bans on technologies and appliances. To accelerate heat decarbonization, governments are introducing legislation that makes it more difficult or costly to rely on fossil fuel–based heating solutions. In the past, boilers often exceeded the average 15- to 20-year lifespan. Tighter emissions control means this will no longer be possible, creating a need to install more sustainable replacements quickly.
For instance, in Germany, the Buildings Energy Act (Gebäudeenergiegesetz [GEG]) mandates that from 2024, new heating installations must meet strict emissions guidelines, limiting fossil fuel boilers immediately, with a full phase-out of such installations expected over the next decade. It also sets a timeline for phaseout of existing gas and oil boilers installed before 1991. - Government incentives. Governments are encouraging the use of cleaner technologies through incentives or subsidies that make them cheaper or more straightforward to install. In Germany, the Bundesförderung für effiziente Gebäude (BEG) is supporting the adoption of heat pumps through subsidies that offset high purchase and installation costs. The base subsidy is currently set at 30% of the investment cost but can be as high as 70%.
- Economics/cost advantages. As low emissions alternatives become more widely used, these technologies will further decrease in cost, making them economically advantageous. Heat pumps are expected to become the cheapest alternative in many cases in Germany, even without subsidies.
The commercial opportunity of this switch is enormous: in Germany, an estimated 2.3 million buildings have technically outdated heating technologies and will require a new source of heat generation over the next few years. The investment cost of replacing these on a like-for-like basis with new gas boilers would be approximately US $46 billion (€42 billion). However, the up-front cost of heat pumps is estimated to be four times higher, delivering an installation market opportunity of around $184.5 billion (€168 billion).
Comparing costs of traditional & renewable options
As a mature, mass-market technology, gas and oil boilers have low up-front purchase and installation costs. However, ongoing costs are variable, depending on both fuel prices and carbon taxes. Unless gas or oil prices or carbon taxes drop below current levels, boilers are therefore expected to be more expensive over their lifetimes than heat pumps, which have higher installation costs but are more efficient and create no direct emissions. While exact savings depend on the specific type, age, and size of buildings, as well as commodity pricing, this leads to an average 22% lower total cost of ownership (TCO) for heat pumps compared to gas boilers (see Figure 2).
Additionally, as heat pump technologies mature and the German market expands, purchase costs will decrease due to economies of scale in production and further innovation that improves efficiency. That means that even when purchase subsidies are scaled back, the average heat pump will decrease in price from more than $1,098/kW to $830/kW between 2023 and 2034 in Germany. Many utilities now offer heat pump electricity tariffs with specific price profiles, increasing cost advantages. This will result in heat pumps becoming the dominant heating technology, even though there are some technical limits and a potential need for high up-front costs.
UNDERSTANDING HEAT PUMP TECHNOLOGY
While earlier heat pumps were smaller, they have now been successfully scaled to make them viable for all residential/nonresidential building sizes, using air source, ground source, or hybrid technologies.
For heat replacement in existing buildings, the economic case for the shift from gas boilers to heat pumps depends mainly on the electricity-to-gas price ratio and the coefficient of performance (COP) of the heat pump. Three factors impact the economic effects of replacement:
- Cost of renovation. While not normally necessary, renovations can increase the COP and thus reduce TCO.
- Increased rent. Studies show that renovations slightly increase short-term total rent (<10 years) but have major long-term impacts (>20 years).
- Greater efficiency. Heat pumps can operate at lower temperatures, decreasing energy consumption.
THE OPPORTUNITY FOR HEAT CONTRACTING
Switching to heat pumps is transforming the cost profile of the heating market by dramatically increasing the up-front investment required for installation. This means that despite changing regulations, many homeowners or landlords will still not install heat pumps due to a lack of money, a desire to avoid extra work, or amortization timescales being too long. This is significantly accelerating the opportunities for heat contracting.
A heat contractor designs, finances, installs, and maintains heating systems for residential and commercial buildings, providing heating as a service and thus removing the need for landlords to invest in heating assets, such as boilers or heat pumps.
Switching to a heat contracting model, as shown in Figure 3, delivers benefits for all parties:
- Contractors gain new, long-term customers with no risk of churn and the opportunity to upsell new services such as energy management.
- Tenants receive a state-of-the-art heating solution that is fully serviced on a regular basis.
- Landlords can avoid large-scale investments and outsource management, removing overheads — all while passing the costs on to tenants.
Driven by decarbonization, the technology used within the German heating market will transform over the coming years, with heat pumps increasingly replacing fossil fuel boilers. This will require greater up-front investment and installation/operational expertise, offering major opportunities for heat contracting growth.
This ADL Insight is the first in a three-part series on the German heat contracting market:
- “German Heating Market Growth Boosts Heat Contractors”
- “Heat Contracting & Regulation in Germany: Enabler or Barrier?”
- “Opportunities in the German Heat Contracting Market”