Hydrogen in the EU: strategies for a low-carbon alternative
Investors and regulators are looking at hydrogen as a promising low-carbon solution for the energy sector. To ensure support for the related technologies, the EU seeks to introduce some common approaches.
The shift of energy consumption towards electricity is portrayed by researchers as the only feasible way to decarbonize the energy sector. Due to this, regulation of electricity is a priority for the EU as demonstrated with the Clean Energy Package of 2018-2019 and the EU Green Deal. In such light, electricity is seen as a mean to meet the ambitious 2050 EU target (net-zero GHG emissions) that echo in the media for quite some time.
But is it possible that there are more than just one option for decarbonizing our societies? That is precisely what the new EU Hydrogen Strategy for a Climate-Neutral Europe and EU Strategy for Energy System Integration consider when they look elsewhere to find alternatives other than renewable electricity and to bolster their case. However, the introduction of hydrogen as a new energy solution, along with these European strategies, raise serious regulatory questions. These go from ensuring the efficient and safe governance of these other alternatives to accommodating them into the broader context of today's EU’s energy markets.
Hydrogen is an energy alternative with plenty of noise and foreseen chances of success. As a fuel, a feedstock and storage, hydrogen finds multiple applications within the energy sector, in addition to other sectors such as mobility, industry, building heating. That is possible because, due to its nature, hydrogen is not an energy source, but an energy carrier. In this role, hydrogen allows to deliver or store a tremendous amount of energy which can be, for example, consumed in a fuel cell.
Hydrogen consists of only one proton and one electron. Despite its chemical simplicity it is not typically freely available in nature and must be produced from compounds in the processes where renewable energy sources may be employed or not.
Despite these promises, and despite the fact that the European Commission's Strategies have recognized it as the necessary element of energy puzzle, it still lacks regulation
Regulating hydrogen – a clear framework?
Taking into account hydrogen’s gaseous state, some could argue that rules regarding natural gas (most importantly, the Gas Directive (EC) 2009/73) should cover it per analogiam. Broadly speaking, this would result in requirements on third-party access (TPA), unbundling as well as tariff calculation methodology and network balancing systems.1
Nonetheless, the risk of a direct application of existing rules to new cases or energy solutions like hydrogen seems apparent. Even if those rules can be an end-goal, it has to be reiterated that the tools of natural gas market liberalization came into force in a well-established, mature market. Furthermore, hydrogen is part of an industry that is just starting to emerge in which the issue of safety, due to risks of explosion and fire, remains largely unaddressed.
When compared to the current emerging hydrogen technologies and very modest demand, resorting to a verbatim application of the rules for natural gas might appear as insufficient or outright inadequate. Regulatory deficiencies can be crucial in hindering the development of new technologies as they give wrong incentive, increase costs or risks or leave societal perceptions unaddressed. One of the reasons for this incompatibility is the deficiency of infrastructure suitable for carrying hydrogen at a sufficient scale. The absence of it or the need to retrofit the existing network requires investments driven by incentives — which is not TPA and unbundling obligations. Another reason stems from a little number of inflows and off-takes from the hydrogen network (where it exists). This should lead to a reconsideration of workable solutions, especially concerning TPA as well as system balancing, which was designed to tackle multiple injections and outflows and ensure system integrity. This might not be the case of hydrogen at present. Finally, two last comments. First, one has to be mindful of the critical issue of hydrogen commerciability and profitability of hydrogen solutions, and whether imposing traditional rules on TPA and unbundling at the industry’s nascent steps may slow deployment. Second, it must be taken into account that hydrogen plays a large role in system integration or sector coupling, rending the situation of hydrogen different than that of natural gas.
The EU Hydrogen Strategy
After the announcement by the European Commission of the Green Deal on 11 December 2019, it was only a matter of time before more specific strategies were adopted. One of them is the long-awaited Hydrogen Strategy for a Climate-Neutral Europe that hopes to prepare the groundwork for the hydrogen maturity by 2050. Despite that the Strategy seems to be overly optimistic about hydrogen demand creation in the coming years and counts on those needs as main driving forces for future development, it managed to highlight some weighty points - in particular, issues regarding financing technology, advancing demand and supply, creating or retrofitting infrastructure and promoting R&I.
Our analysis of this Strategy shows that the Commission treats different hydrogen solutions dissimilarly, and it does so on various levels. What is the basis for that hydrogen taxonomy and the differential treatment following? Simply speaking, it is the well-to-gate greenhouse gas emissions rate. The Commission’s clear favourite hydrogen type is "renewable hydrogen", meaning hydrogen produced with the use of renewable energy sources with life-cycle GHG emissions close to zero. It prevails against an underdog, "low-carbon hydrogen" created with carbon capture technology in place or with GHG emissions reduced significantly otherwise. Where are those differences becoming noticeable in the Strategy?
Preference for renewable hydrogen
When Commission creates a roadmap for hydrogen infrastructure, it focuses on renewable hydrogen exclusively, setting no trajectories for the development of the low-carbon one. What is more, only renewable hydrogen projects are eligible for 'direct, and transparent, market-based support schemes', furthering limiting the economic viability of ‘low-carbon’ hydrogen due to environmental considerations. On top of that, the Commission considers the application of quotas that will include renewable hydrogen specifically.
Overall, under the presented Strategy, EU expects investment in renewable hydrogen to be around EUR 180-470 billion; more than ten times as much as expenditures on low-carbon hydrogen solutions, forecasted by the Commission on the level of EUR 3-18 billion. Should the prospects of low-carbon hydrogen be underestimated to that extent?
What strikes the most from the Hydrogen Strategy's funding design is that with the current technological development, both high-carbon and low-carbon hydrogen is more affordable than renewable one, despite being several times as expensive as natural gas. What keeps the price of low-carbon hydrogen high is the technology of production. According to the definition provided in the Strategy, low-carbon hydrogen production that releases greenhouse gases shall operate with carbon capture in place. That technology, however, is set to be more affordable in the coming years. We reckon opting for renewable hydrogen is a political choice to prevent climate change and pursue climate neutrality. However, in the current stage, imperfect, low-carbon solutions could not be neglected as they are still more economically sound and constitute an improvement over the existing situation.
Both types of hydrogen should benefit from their 'greenhouse gas reduction value they provide' according to ACER (The Bridge Beyond 2025. Conclusion Paper). Indeed, they can profit from carbon contracts for difference (CCfD) as well as the Emission Trading System (ETS, set out in the Directive (EU) 2018/410).
However, those solutions are far from being ideal. The ETS covers roughly 45% of the current CO₂ emissions, leaving aside some very important industries such as aviation, and faces some resistance of the business. Broader industry coverage by market-based instruments can create the scale needed to incentivize industrial actors to contribute to the decarbonization goal - through applying hydrogen technologies. In that regard, the Hydrogen Strategy, as well as the New Industrial Strategy for Europe highlight the problem of the decarbonization of the steel industry that could be addressed by hydrogen to create ‘clean steel'. Eventually, the ETS can also help in lowering the cost of hydrogen technologies, making them price-competitive. In order to achieve that, the Commission has committed to revising the ETS, and addressing the issue of carbon leakage through the somewhat controversial Carbon Border Tax mechanism.
Another way to support hydrogen would be through public support, usually in the form of energy auction schemes, including the aforementioned CCfD. Yet, these forms of aid also display some shortcomings. As a contract between an enterprise producing hydrogen and a state authority, the contract for difference scheme sets the strike carbon price, meaning that if the fixed price is higher than the market carbon price (based on ETS), a state-backed entity has to cover the difference2. Effectively, this scheme support amounts to state aid that could be a meaningful relief for those investing in low-carbon technologies, if duly notified and approved. Yet, the Commission and other decision-makers shall consider the scale of this aid. If the strike prices suggested in the Strategy are compared to current carbon prices, the difference to be covered could even exceed EUR 6 billion on the annual bases.
Hydrogen for system integration
We believe that hydrogen (as the energy carrier which could be produced, mixed with other gases, stored and used directly) is the desired answer to the issue of market integration. The same conclusion can be drawn from the EU Strategy for Energy System Integration. By recognizing hydrogen's role in connecting electricity and gases markets, the Commission promotes further development of the relevant technologies in Europe. Even though it is a big step forward, the industry awaits regulatory framework that can create proper price signals and incentives for investment.
Why are the regulation and correct price signals particularly crucial for hydrogen and system integration? In the first place, one has to think about price-competitiveness and commercial viability, as mentioned above. Further, legal certainty is a fundamental component of economic decisions, as is highlighted by ACER. But on top of that, multiple employment of hydrogen (either direct or indirect) and various ways of producing it leaves undertakings with a broad spectrum of choices. For instance, if an undertaking wants to produce hydrogen in the process of steam methane reforming, using water and hydrocarbons, it has to answer multiple questions linking regulation to economic profitability. Depending on the price signals, it could be more beneficial to either create a natural gas pipeline providing hydrocarbon to the steam-reforming facility in the industrial cluster or to produce hydrogen in the steam-reforming facility located elsewhere and then convey hydrogen to the site. Transporting hydrogen and transporting natural gas may vary economically, depending on the legal framework. The same applies to the decision concerning the increase in renewable energy production. Should the excess of it is transferred into hydrogen to store it, the wind farms or solar farms can be extended, regardless of the demand.
Rules on market integration, subsidies, tariffs, incentives and other legal instruments are still to be drafted and are a prerequisite for hydrogen to become a viable commercial energy strategy. It seems, though, that the European Commission favours extending the existing regulatory framework instead of introducing new rules for renewable and low-carbon gases such as hydrogen. The Commission in fact seeks ‘to reduce undue burden to market access’ through imposing some of the existing rules, ensuring the level playing field. Interestingly, avoidance of 'sunk investments and the costs of ex-post interventions later'3 is provided as the rationale for that stance. Nonetheless, in our view, this justification is not an entirely valid argument for applying existing rules. Measures such as the creation of broader (and yet, temporary) exemptions or thresholds to be reached before certain rules would apply can result in the same regulatory outcome while easing the burden to the industry. Surely, the existing legal regime can provide predictability, but it may also prove insufficient to kick-start innovative and costly solutions.
The Hydrogen and System Integration Strategies that were issued this July show some positive steps with some clear targets in the right path towards hydrogen utilization in the energy transformation. The problem remains that for hydrogen to be commercially developed within the provided timeframe, overall directions and lesser impulses from the Commission do not suffice. In addition, we should not forget that the very goal of the Hydrogen Strategy is not to develop hydrogen, as hydrogen is not an end goal itself. The Strategy has been designed to support the decarbonization effort of the EU. That means, however, that the Commission should pay more attention to the transitional outlook, meaning the prospects for low-carbon hydrogen development in the first place.
The current approach, as presented in the Strategy, could be viewed at times insufficient to satisfy the need for energy transformation at present, and would prevent renewable hydrogen from making significant advancement in the future. Why is it the case? Even with State aid and other sources of financing, renewable hydrogen is still a distant vision and will be developed moderately (if not slowly). Therefore, without support for more affordable hydrogen at present, much needed infrastructural investments (both for midstream and downstream) will not accelerate a scale-up of 'clean hydrogen' but only follow the pace of renewable hydrogen as it is now. In our view, other foreseeable weaknesses of the Hydrogen Strategy are stemming from relying heavily upon uncertain, further revisions of the current rules (most notably on State aid and on the ETS), and belief in the significant increase of the hydrogen demand shortly.
1 See discussing these and other matters in length: Mete, Gökce; Reins, Leonie, “Europe’s new Hydrogen Strategy: the questions that still need answering”, https://energypost.eu/europes-new-hydrogen-strategy-the-questions-that-still-need-answering/. For a general overview of rules on TPAs and unbundling in energy see: Herrera Anchustegui, Ignacio, “Transmission Networks in Electricity Competition: Third-Party Access and Unbundling – A Transatlantic Perspective” (April 1, 2018). Ruiz Peris, J.I., (ed) “Competencia en mercados con recursos esenciales compartidos: telecomunicaciones y energía,” University of Valencia (2018, Forthcoming), Available at SSRN: https://ssrn.com/abstract=3159458; Gao, Anton Ming-Zhi. "The Third European Energy Liberalization Package: Does Functional and Legal Unbundling in the Gas Storage Sector Go Too Far?." Competition and Regulation in Network Industries 10, no. 1 (2009): 17-44.
2 See: Richstein, Jörn, “Project-Based Carbon Contracts: A Way to Finance Innovative Low-Carbon Investments”, DIW Berlin Discussion Paper No. 1714, available at SSRN: https://ssrn.com/abstract=3109302.
3 Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of Regions: A hydrogen strategy for a climate-neutral Europe, COM(2020) 301 final, p. 16.