In September 2022, European Commission President Ursula von der Leyen pledged to create a “European Hydrogen Bank” in her State of the Union speech. Further details about the Bank, its tasks and structure were laid out in the European Hydrogen Bank communication in March this year and in August the Commission released the terms and conditions for the initial European Hydrogen Bank auction.
The Bank will initially support the purchase of hydrogen through an overall 3 billion EUR investment from the EU’s Innovation Fund. Since existing cost differentials between renewable hydrogen and its fossil-based counterpart impede the creation of a liquid green hydrogen market, the European Hydrogen Bank seeks to cover and lower the initial funding gap. That is why, the Commission established a two-pillar (“legs”) approach with separate financing mechanisms to account for the design requirements of support schemes incentivising domestic EU production of hydrogen and those incentivising hydrogen imports.
With the European Hydrogen Bank’s goal to provide “increased demand visibility by linking with off-takers [and] parallel Member State initiatives”, the vehicle joins an ever-growing number of instruments, subsidies and policies targeting one of Europe’s first and foremost tools for decarbonisation: the broad market uptake of its hydrogen industry. By bringing more funding to a nascent market, the Bank aims to de-risk investments from political and market uncertainties, leverage private sector investment by increasing investor confidence and enhance price discovery by creating competition for financing.
This blog unpicks what is known and not yet known about the European Hydrogen Bank ahead of the pilot auction on 23rd November 2023 and outlines recommendations for the future of the Bank.
Ramping up European domestic hydrogen production
Europe is betting big on hydrogen as part of its approach to achieve net zero emissions. The European Green Deal identifies hydrogen as a key enabler to accelerate Europe’s clean energy transition and the European Commission’s 2020 “Hydrogen Strategy for a climate neutral Europe” outlines plans for scaling up hydrogen value chains and what is needed to build a hydrogen market. This was followed by a series of policy measures and the EU’s plan to reduce its dependence on Russian fossil fuels, REPowerEU, which doubled the Commission’s original targets to 10 million tonnes of domestically produced hydrogen and 10 million tonnes met through hydrogen imports by 2030. Other initiatives include Important Projects of Common European Interest – Hy2Use and Hy2Tech – that provide a total of 10.6 billion EUR to hydrogen projects focused on large-scale electrolysers, transport and storage infrastructure with the aim to stimulate considerable amounts of additional private investment. However, given that these targets require gigawatt-scale projects while only about 80 MW of electrolysers were installed in the EU last year and global capacity stood at less than 700 MW, CATF urges caution against unrealistic expectations about the availability of clean hydrogen. Europe needs to re-examine its hydrogen targets to develop more realistic estimates and ensure a broader set of climate-friendly technologies is readily available to achieve net zero by mid-century.
The Commission will facilitate the first European Hydrogen Bank auction in November for supporting the production of renewables-based hydrogen. The procedure will be organised as a static “pay-as-bid” auction where successful participants will receive a fixed premium for each kilogram of renewable hydrogen produced over a 10-year period. Bids will be ranked against other bids based on their price and the auction budget is allocated to projects that demonstrate the lowest specific support requirements. Auction winners will then be awarded the fixed premium that they submitted in their bids – in order of ranking – until the auction’s 800 million EUR budget is exhausted. Further, only bids that meet certain qualification requirements – including memoranda of understanding (MoUs) on 60% of the electricity volume needed during the project’s implementation period and MoUs on 60% of the hydrogen production volume which must be secured through a designated off-take and price hedging strategy – will be considered. Selected projects will have five years to enter into operation from the moment that their grant agreement is signed, and bidders are required to provide a completion guarantee covering 4% of the maximum grant amount.
Supply and demand need to evolve in lockstep for successful market formation
It is evident that any near-term instrument or policy needs to tackle two main challenges: the missing liquid market and infrastructure for low-carbon hydrogen. While electricity infrastructure is – in comparison- widely available, reliable and resilient, hydrogen infrastructure has yet to leave its embryonic stage and grow beyond selected and dedicated industry clusters. This is also why the current market situation can best be described as a chicken and egg problem.
There is limited demand for low-carbon – specifically renewable – hydrogen because it is very costly in comparison to fossil-fuel sourced alternatives. Consequently, there is almost no supply of renewable hydrogen beyond pilot and demonstration projects, with only a meagre 4% of potential low-emissions hydrogen production reached FID according to the IEA’s Global Hydrogen Review 2023.
The price of renewable hydrogen, however, can only drop if economies of scale and technological learnings ramp up. To solve this, support on both the demand and supply side is required to ensure both sides evolve in lockstep. The fixed premium scheme can only be effective if it is embedded in a holistic support framework addressing bottlenecks across the entire hydrogen value chain. The establishment of a hydrogen certification system, the embedment of the scheme in other forms of support and mechanisms such as two-sided auctions, the reduction of barriers to infrastructure investment and the promotion of the industrial transformation all remain key policy priorities for market formation.
How the European Hydrogen Bank can be more effective
- Dedicate more funding to support scaling of clean hydrogen production
With the maximum support level now standing at 4.5 EUR per kg of hydrogen produced, the total amount of clean hydrogen financed through this scheme will be low, concentrating subsidies for lower quantities of hydrogen. Considering the proposed maximum bid, an allocated budget of 800 million EUR would directly support less than 2% of the EU’s 10 million tonnes domestic production target by 2030. Completely relying on private sector funding to fill much of this gap significantly increases the risk and cost of projects. This would also mean that distributed small scale hydrogen applications that are dispersed across various processes on industrial sites will most likely stay on their conventional hydrogen production pathways and experience delays in decarbonisation efforts.
Estimates suggest a total green premium upwards of 100 billion EUR will be needed for both domestic production and imports to meet 20 million tonnes of clean hydrogen, already factoring in declining production costs and increasing demand. In this context, CATF recommends that more funding must be dedicated to clean hydrogen production. In addition, the provided fixed premium should also be indexed to inflation to cover for potential cost increases of energy and raw materials. This is a particularly important for covering cost changes between allocation of support and the project’s commissioning date.
- Include low-carbon hydrogen in the European Hydrogen Bank’s scope
A recent JRC Technical Report projects that EU hydrogen demand will reach around 70 million tonnes by 2050 – a ninefold increase from 2020 levels (nearly 8 million tonnes). For perspective, only around 0.2 million tonnes of renewables-based hydrogen is currently produced in the EU.
Achieving scale in Europe’s green hydrogen production faces three major issues: (1) the deployment of low-cost, high-capacity factor renewable energy production, (2) the absence of cost-competitive value chains and (3) the limitations of manufacturing electrolysers at scale. Europe is still in the process of decarbonising its electricity grid. Despite setting ambitious targets for the deployment of renewable energy, capacity expansion is still not scaling at the required rate. The IEA projects that the share of renewables in electricity production will expand to around 55% by 2027, which is well below the 69% share estimated by the European Commission to support its REPowerEU plan. Using scarce, renewable electricity to produce hydrogen in significant volumes in the short- to medium-term, while Europe’s grid is not fully decarbonised, is a counterproductive approach to resource deployment, particularly as electricity demand is expected to increase in other sectors of the economy.
Renewable hydrogen will not be available in substantial quantities any time soon. This necessitates the efficient deployment of other, scalable low-carbon hydrogen production based on proven technologies – such as steam methane or auto-thermal reforming (SMR/ATR) with carbon capture and storage and high upstream methane emissions control and other forms of hydrogen production from low-carbon energy sources such as nuclear power. These alternative low-carbon production pathways should be considered key intermediary solutions to rapidly ramp-up capacity and bridge any existing gaps.
CATF advocates for the European Hydrogen Bank to incentivise all forms of low-carbon hydrogen production, where cost-efficient and ensuring that they are compatible with the ‘do no significant harm’ principle. This means that the production of hydrogen is not restricted to specific production pathways but evaluated against its greenhouse gas emissions savings. Any definitions, standards and thresholds should be based on a full and transparent lifecycle analysis (LCA) and a robust emissions accounting methodology (see CATF’s ‘H2DLAT’ LCA tool). Further, due to their different cost and pricing structures, renewable and low-carbon hydrogen should be incentivised in separate, dedicated bidding rounds.
- Prioritise hydrogen deployment in ‘no-regrets’ sectors
Hydrogen is already produced and consumed in large quantities today, so the EU must fund efforts and projects that support the decarbonisation of existing hydrogen production and consumption as a first priority.
Crude oil refining, ammonia manufacturing, (petro)-chemicals and methanol production all require large quantities of hydrogen to decarbonise their operations. Thus, a comprehensive framework must be in place to guarantee reliable and constant hydrogen supply to these sectors where the highest abatement costs occur where no other efficient decarbonisation option is available.
Within these industries, hydrogen and its derivatives (such as ammonia) may be needed due to their specific chemical properties and/or their high energy density. Hence, the European Hydrogen Bank should guarantee that low-carbon hydrogen products find their way into these markets at a competitive price to facilitate domestic market development and to enable the uptake of decarbonised, value-added production processes (e.g. fertiliser production) in Europe. Currently, companies are very reluctant to invest in the deployment of clean hydrogen applications that will entail higher production costs compared to the conventional fossil fuel comparative as there is no market that would pay a green premium.
While the pilot auction design does not include any offtake restrictions, not even as a ranking principle or as a tiebreaker rule, successful bidders in future auctions should be restricted from selling any subsidised hydrogen volumes for subsequent utilisation in lower priority sectors and applications – such as residential heating, power generation, or light-duty vehicles – where other more energy- and cost-effective decarbonisation pathways are already available (e.g. electrification). These restrictions would guarantee that subsidised low-carbon hydrogen is funnelled into those sectors that are most challenging to decarbonise and require hydrogen the most in order to reduce/eliminate their emissions.
- Include sector-specific Contracts for Difference and Carbon Contracts for Difference in the European Hydrogen Bank’s framework
CATF supports the implementation of Contracts for Difference (CfDs) as an effective tool for underwriting investment in capital-intensive renewable and low-carbon hydrogen projects. This provides price certainty for investors, producers and consumers, and provides long-term revenue certainty for projects. CfDs should be tendered on a sector-specific basis to promote technology competition within specific industries and to ensure continuous innovation. Awarding supply-side hydrogen CfDs in later auctions could be based on an index that consists of different price references depending on different electricity procurement strategies or a reference price based on SMR costs coupled with natural gas prices (e.g. the Dutch Title Transfer Facility) and variable carbon abatement cost components. Further, reference price uncertainties could be addressed by incorporating price review provisions in offtake contracts.
Rapid implementation of Carbon Contracts for Difference (CCfD) — where governments or an EU institution will offer long-term contracts to account for the agreed strike price — will also be vital to opening up Europe’s hydrogen market, as it strengthens the case for commercial investment in low-carbon technologies. CCfDs are a relatively new concept and would hinge on hydrogen project developers or producers and state or EU-level regulators agreeing on a long-term carbon price (most likely via an auction process) that would make the project economically viable. Implementing CCfD’s within the European Hydrogen Bank should be explored in future funding allocations, as they can target the aforementioned no-regret sectors where low-carbon hydrogen is the lowest cost option for emissions reduction and help hedge against carbon price fluctuations by providing a direct link to emissions reductions and the EU ETS. Further, they can also account for other market volatilities via additional risk hedging, such as electricity and/or gas price indexation, to minimise price risks for hydrogen producers. CATF recommends the implementation of a CCfD system across the EU hydrogen market as soon as possible.