Repost: Europe's hydrogen economy and what it means for carbon prices

In early February I reposted an article from the Carbon Risk archives, one that I felt which many current Carbon Risk readers probably haven’t seen before, but is arguably even more relevant now than the day that I posted it. Following that theme, today’s repost focuses on one of the future drivers of carbon price economics - Europe’s hydrogen economy and the ‘green-grey’ hydrogen spread.

The outlook for green hydrogen (produced using renewable energy) ultimately depends on it being competitive versus conventional grey hydrogen (produced using natural gas via steam-methane). The resulting ‘green-grey’ hydrogen spread, as I call it, is determined by the following:

First, a massive expansion in European electrolyser capacity is required, one that results in economies of scale that drive down the cost of producing green hydrogen below that of grey hydrogen. According to recent projections from Aurora, the levelised cost of producing green hydrogen in Germany in 2030 is likely to be between €3.90 and €5.00 per kg, but that might not be enough.¹

Second, given that the manufacture of grey hydrogen is highly sensitive to natural gas prices and is carbon intensive to produce, carbon prices must compensate for low natural gas prices. Almost one year ago natural gas prices in Europe were over €150 per MWh, and heading higher. Twelve months later and they have slumped by two-thirds to around €50 per MWh.

Although this might swing the short-term power generation economics away from coal and towards natural gas, it has the effect of making it more difficult to switch to green hydrogen.

The price of carbon must move to the point at which it makes sense to manufacture green hydrogen, given expectations over its future production costs. Understanding where that point is now, and where it is moving to, will be key to using the ‘green-grey’ hydrogen spread.

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Central to the decarbonisation of many sectors under the EU ETS is the widespread rollout of green hydrogen as an industrial feedstock.

Up until very recently estimates have suggested that Europe requires very high carbon prices to incentivise the switch away from hydrogen manufactured using fossil fuels, known as grey hydrogen.

However, record high natural gas prices in Europe may accelerate hydrogen's role in industrial decarbonisation, without the need for significantly higher carbon prices.

Carbon traders may have looked to the ‘clean-dark’ spread as a tool for estimating carbon allowance demand, but they may increasingly be looking to ‘green-grey’ hydrogen spread instead as the long term driver of carbon prices.

The hydrogen economy hype cycles

Hydrogen is the most common element in the universe, accounting for three-quarters of its mass. French scientist Lavoisier named the gas ‘hydrogen’ after the Greek name (hydro = water, genes = to create) after discovering that burning hydrogen produces water, and no carbon dioxide. The energy density of hydrogen is higher than fossil fuels, there is three times as much energy per unit weight embedded in hydrogen as there is for petrol, diesel or jet fuel. It has had a long potted history as the answer to human energy needs – one of periodic hype followed by lengthy hibernation.

The idea of an economy powered by hydrogen was first touted in 1970. The so-called “Hydrogen Economy” rose to prominence in response to concerns over oil scarcity and America’s dependence on the Middle East. This accelerated in 1973 due to the Arab oil embargo sparked oil price spike. As energy prices returned to gravity during the 1980’s the hydrogen economy dream faded away. But by the late 1980’s the Cold War between the US and Russia, and the latter’s successful development of a hydrogen powered jet (the Tupolev-155) spurred a race to develop the technology between the two superpowers. A decade and a half later and the Cold War was over but concerns over energy independence surfaced anew. Once again hydrogen potentially offered a solution, only for US crude and gas supply to surge on the back of the shale revolution.