• A cold refrigerant collects heat from the surrounding air as it flows through an evaporator. 
• It then flows into a compressor that creates a high-pressure, high-temperature gas. 
• The gas transfers its heat to the water in the storage tank via a condenser, and liquefies again in the process. 
• The liquid then flows through an expansion device that lowers its pressure, partly evaporating it and cooling it further to increase its potential to absorb heat in the evaporator again. 

 There's a number of different heat pump designs:

Air-source heat pump: The heat pump sits on top of the storage tank, forming a single unit. A fan forces air over the evaporator to heat up the refrigerant. The condenser can be a coil of tubing wrapped around the tank (see the diagram) or cold water from the tank can be pumped to the condenser, where it's heated by the heat-exchange fluid. 

Solar-boosted heat pump: The evaporator is located on the roof like a solar collector panel, and the tank is on the ground. The refrigerant is pumped to the evaporator and heated by the surrounding air, solar radiation and even rain. It flows back into the condenser, which is a coil of tubing wrapped around the tank. 

?The heat pump is a separate unit that can be connected to any tank. Again, heat is extracted from air that's fan-forced over the evaporator. Cold water from the tank is pumped to the condenser, where it's heated by the refrigerant.

As a general rule, one person uses about 50 L of hot water each day. If you take very long showers, have a dishwasher or often wash clothes in warm or hot water, you may use more than that -- not to mention if you have a spa bath you use frequently.

Based on a consumption of 50 L, for solar heaters an average four-person household needs about four square metres of solar collector area (two panels) and a 300-360 L tank, to allow for days with lower radiation or higher demand (for example, if you have visitors). If your panels can't be installed in an ideal location, their efficiency may drop and you'll need a larger collector area. An additional panel is usually available.

Heat pumps don't rely on the sun, so a slightly smaller system is sufficient (270-315 L tank for four people).

If you install a new solar or heat pump system to replace an electric one, or if you install a solar system in a new home, you'll be eligible to receive Renewable Energy Certificates (RECs). These were developed by the Australian Commonwealth Government to encourage the reduction of greenhouse emissions from the use of electricity.

The RECs scheme works by requiring electricity retailers to contribute towards meeting renewable energy targets - an obligation they can meet by purchasing RECs.

So when you install an eligible system, you'll be rewarded with a certain number of RECs, between 10 and 64, based on how much greenhouse gas it saves and where you live, as this effects the system's efficiency.

You then either register your RECs and sell them to an energy retailer, or assign them to an agent (often the supplier of the your hot water system) who will register and sell them for you. The value of an RECs varies day-to-day, but is usually around $30. So if your solar system is attracts 30 RECs, you'll earn around $900.

The small print of the RECs scheme is fairly complicated, so consult your retailer or check the Office of the Renewable Energy Regulator (ORER) for more information on how it works.

Also, most state and territory governments (except Tasmania, where electricity is generally hydro-produced), provide rebates. These are generally in addition to the RECs scheme, except in Victoria, where in order to qualify for the state rebate, you have to assign your RECs benefits to the Victorian Government. For more information contact your state government energy authority.