A comprehensive mix of policy instruments is needed to ensure that the EU meets its ambitious hydrogen targets. What should they look like? Pia Kerres, Matthias Schimmel and Corinna Klessmann at Guidehouse quote their study, done in collaboration with Agora Energiewende, for the answers. Industry and long-haul transport should be the main customers for hydrogen. The big challenge is to cut the cost of hydrogen production; it’s too expensive and current policies won’t change that fast enough. The EU must rapidly stimulate the hydrogen market through both supply and demand-side policies. The authors summarise the obstacles before making their recommendations. They point at their study of the regulatory architecture needed for the ramping up green hydrogen in Germany. Other nations can use it as a guide. The EU’s proposed RFNBO (renewable fuels of non-biological origin) targets in RED II are ambitious, but the right policy mix can enable the region to meet its Fit For 55 goals for hydrogen, say the authors.
What are the goals in the Fit for 55 package …
With the publication of the Fit for 55 package in July 2021, the European Commission proposed an extensive set of legislation for achieving the European Union’s (EU’s) target of reducing greenhouse gas (GHG) emissions by 55% by 2030. As part of the package, a revised and more ambitious Renewable Energy Directive (RED) II was proposed. In this directive, the EU’s new target share of renewable energy sources is proposed to increase from at least 32% to 40% by 2030.
The proposal also contains a set of new sub-targets for 2030 and extended requirements for renewable fuels of non-biological origin (RFNBOs, including renewable hydrogen and its derivatives), aimed at achieving Europe’s ambitious climate targets. The requirements for counting RFNBOs as renewables are being extended from transport to other end-use sectors.
For industry, the revised RED II proposal foresees “an indicative target of an annual average increase of renewable energy of 1.1 percentage points and a binding target of 50 percent for renewable fuels of nonbiological origin used as feedstock or as an energy carrier. It also introduces a requirement that the labelling of green industrial products indicates the percentage of renewable energy used following a common EU-wide methodology”. While Member States are responsible for the industry targets, the European Commission is also proposing a 2.6% sub-target for RFNBOs in transport, which is an obligation for transport fuel suppliers. Furthermore, under the ReFuelEU Aviation initiative, fuel suppliers must begin using 5% sustainable aviation fuels (SAFs) by 2030, 0.7% of which must be RFNBOs. The share of SAFs increases to 63% in 2050, 28% of which need to be RFNBOs.
… and what Hydrogen volumes are needed to achieve them?
The new RFNBO targets imply a substantial increase in demand for RFNBOs. For the transport sector, 2.6% of the EU’s energy demand of 3,335 TWh from 2018 corresponds with around 87 TWh of RFNBOs. For industry, EU hydrogen demand is projected to increase to 400 TWh‑500 TWh in 2030, which implies a need for 200 TWh-250 TWh of RFNBOs.
The European Commission’s hydrogen strategy includes a goal of installing at least 40 GW of renewable hydrogen electrolysers and the production of up to 10 million tonnes of renewable hydrogen (equivalent to 330 TWh) in the EU by 2030. Thus, the added requirements for RFNBOs (287 TWh-337 TWh) of the proposed RED II align closely with the previous target from the hydrogen strategy.
Still, these proposals imply that Member States need to significantly increase renewable hydrogen consumption via obligations (e.g., in the transport sector) and support schemes. The fact that additional future hydrogen demand may arise from other sectors such as heating and power generation needs to be considered as well.
The Price Challenge
Renewable hydrogen holds many promises for decarbonisation, so why are industries not using it already? One reason is the price. The study from Guidehouse and Agora Energiewende demonstrates that while fossil-based hydrogen alternatives cost around €2/kg, renewable hydrogen costs up to 3 times more at €6.6/kg. Figure 1 illustrates this issue.
The production cost of renewable hydrogen depends on several factors, including electrolyser CAPEX, conversion efficiency, annual operating hours, stack replacement costs, and renewable electricity procurement costs. The cost gap is mainly a result of high electrolyser costs and electricity prices competing against low natural gas and EU Emissions Trading System (ETS) prices.
However, renewable hydrogen production costs are projected to fall with increasing electrolyser capacities and further declining renewable electricity costs. A ramp up in capacities can accelerate the technology learning curve and enable economies of scale; thus, policies should encourage a ramp up in capacities. According to the Guidehouse and Agora Energiewende analysis, renewable hydrogen production costs could be competitive with fossil-based alternatives by 2030 (see Figure 2). However, this development requires significant financial and regulatory support.
Why are the current policy instruments not closing the cost gap?
Informed readers will quickly note that existing policy instruments are already working to close that cost gap. The most important policy in this context is the EU ETS. However, as Figure 3 shows, even prices of €200/tCO2 will not make the average expected price for renewable hydrogen in 2030 competitive with natural gas or fossil-based hydrogen, with or without carbon capture.
Given the existing challenges surrounding the politics of high carbon prices and rising electricity bills in the EU, ETS allowance prices are unlikely to reach such levels anytime soon. Thus, additional support instruments are required to cover the cost gap in the short term. This holds especially true for sectors such as industry, which cannot easily pass higher costs on to consumers and therefore need support policies to cover the cost difference.
What could a policy framework look like?
Stable hydrogen demand is a prerequisite for electrolyser manufacturers to expand production, improve the technology, and enable cost reductions. To ensure such stable demand, demand side policies should be considered for the applications where hydrogen is clearly needed and presents no drawbacks.
These applications include steel, ammonia, and basic chemicals production in the industrial sector; long-haul aviation and maritime shipping in the transport sector; the power sector, which needs long-term storage to accommodate variable renewables; and existing district heating systems, which may require hydrogen to meet residual heat load. Figure 4 illustrates these sectors.
At the same time, supply-side instruments are required to allow the electrolyser capacity to grow in unison with demand.
However, measures to encourage the growth of supply and demand will likely not be enough. To ensure the sustainability of used RFNBOs, strong criteria should be applied for GHG and renewable energy sourcing to ensure that hydrogen delivers the positive climate impacts it promises. Without these regulations, reliance on hydrogen could induce even higher GHG emissions due to increased electricity demand or higher natural gas consumption. The European Commission will further define the GHG accounting and RES sourcing requirements for counting RFNBOs as renewable energy in two delegated acts, which should be published by the end of 2021.
Hydrogen infrastructure and market regulation are indispensable components of a regulatory architecture because they connect supply and demand. Investing in a European Hydrogen Backbone will likely be essential to facilitate the creation of a European hydrogen market. The potential topography of such a hydrogen backbone has been analysed by Guidehouse in a recent study for the Gas for Climate Consortium. The discussion on the appropriate refinancing mechanism for this infrastructure is ongoing.
Regulatory architecture for Germany
In their recent study, Guidehouse and Agora Energiewende propose the regulatory architecture for the ramp up of green hydrogen in Germany in Figure 5, which also reflects the European regulatory context. Other Member States could adapt this architecture to their own needs. The following paragraphs describe the main building blocks and measures of the proposed architecture; further details can be found in the study itself.
As part of the proposed regulatory architecture, Guidehouse and Agora Energiewende foresee a mix of demand and supply-side instruments. Supply-side instruments can help make renewable hydrogen more competitive by decreasing costs. Proposed instruments include investment aid to support the deployment of electrolysers, exemptions from electricity taxes and levies to reduce the cost of electricity, and hydrogen supply contracts to cover the price gap for qualified renewable hydrogen demand. A special feature of this last instrument is that it would cover both the supply and demand sides of the market.
Under the proposed instrument, the price gap is identified in a two-stage auction, with one stage for supply and one for demand. The producer offering the lowest price and the offtaker with the highest willingness to pay would be awarded financial support for a certain time period. Although this instrument can facilitate the uptake of hydrogen in applications that need it, it cannot guarantee that such uptake will occur. Hence, demand side instruments are also crucial for encouraging demand in desired sectors.
Guidehouse and Agora Energiewende propose to implement Carbon Contracts for Difference (CCfDs) for industry. CCfDs are closely correlated with the EU ETS price. The CO2 mitigation costs of new technologies often exceed €100/tCO2. Therefore, the current EU ETS price of around €55/tCO2 does not trigger the needed investments. The CCfDs could cover the difference between the effective CO2 price and the mitigation cost of the new technology and thus create investment certainty.
We also propose a power-to-liquid quota on kerosene distributors for aviation. This suggestion is already reflected in the SAF quota proposed by the European Commission, even though the proposed percentage is lower than the percentage in our study.
Besides transport and industry, the power sector is one of the applications that needs renewable hydrogen. Thus, we propose to support the future use of renewable hydrogen as a combined heat and power fuel source, initially through production support and later through a renewable hydrogen quota in gas power plants. Furthermore, green lead markets could help create a business case for investing in renewable hydrogen. We propose supporting this development with a labeling system. This suggestion is already reflected in the RED II proposal.
As shown in this article, renewable hydrogen is significantly more expensive than fossil-based alternatives as of 2021. Thus, a demand switch to renewable hydrogen requires not only policy measures but also a coherent refinancing mechanism.
But what is the right choice between direct obligations (i.e., quotas) on fuel suppliers and support schemes (e.g., a CCfD) implemented by Member States? A key consideration is a sector’s ability to refinance the additional costs. In the aviation sector, costs can be passed on to costumers easily while primary industry, such as steel and chemicals, requires more safeguards due to international competition and carbon leakage concerns. These considerations should be reflected in the selection of the policy instrument and guided the policy recommendations of our study.
So, what do we conclude?
The proposed RFNBO targets in RED II are ambitious. They entail a significant increase in volumes. New policy instruments are required to ramp up renewable hydrogen supply and demand in parallel and in due time. We propose to implement a mix of demand and supply-side focused policy instruments for the sectors that need renewable hydrogen the most.
Besides the support instruments, we suggest considering the broader context for renewable hydrogen. This includes infrastructure, market arrangements, sustainability criteria, and system integration considerations. This holistic view should enable a coherent regulatory architecture capable of getting the renewable hydrogen economy on track for the new targets of the Fit for 55 package.
- Agora Energiewende and Guidehouse, Making renewable hydrogen cost-competitive, August 2021, https://static.agora-energiewende.de/fileadmin/Projekte/2020/2020_11_EU_H2-Instruments/A-EW_223_H2-Instruments_WEB.pdf. ↑
- “Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL,” European Commission, July 14, 2021, https://ec.europa.eu/info/sites/default/files/amendment-renewable-energy-directive-2030-climate-target-with-annexes_en.pdf. ↑
- Eurostat, Energy Data, 2020 Edition, European Union, July 2020, https://ec.europa.eu/eurostat/documents/3217494/11099022/KS-HB-20-001-EN-N.pdf/bf891880-1e3e-b4ba-0061-19810ebf2c64?t=1594715608000. ↑
- Final energy demand in the transport sector may decrease toward 2030. ↑
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- Guidehouse, Analysing future demand, supply, and transport of hydrogen, European Hydrogen Backbone, June 2021, https://gasforclimate2050.eu/wp-content/uploads/2021/06/EHB_Analysing-the-future-demand-supply-and-transport-of-hydrogen_June-2021_v3.pdf. ↑
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