Europe

More Than Hot Air

Europe’s REPowerEU initiative makes all the right noises about supporting hydrogen, but investors may need more substance.  

On the face of it, European plans for reducing emissions and driving the renewable energy transition already seemed ambitious.  

As the implications of the war in Ukraine for energy security and resilience have become clearer, however, those plans have taken on a more urgent tone. 

With the European Commission (EC) now aiming to reduce reliance on Russian gas by two-thirds by the end of this year, and to have become fully independent of all Russian fossil fuel supply before 2030, a crisis that may initially have seemed to threaten the energy transition could now become a powerful catalyst for change.  

“This absolutely changes the story in respect of renewables, simply through the increase in prices we’ve seen for fossil fuels,” says Markus Zimmer, Senior ESG Economist at Allianz. 

“We expect that the new deliveries of fossil fuels from alternative locations will come with higher fossil fuel prices and that higher prices will last. And there’s nothing better than that for the energy transition.” 

Among the questions facing investors and asset owners considering greater renewables exposure is how the latest developments will affect the overall European energy mix, and particularly hydrogen’s place in it. 

Hydrogen technologies form a key part of the two pillars in the EC’s plan for reducing reliance on Russian gas. What isn’t clear, however, is the extent to which the updated strategy offers an actionable pathway for making hydrogen a bigger part of the renewables mix, or if it’s more a statement of intent.  

Injection of urgency  

The EU had already set out ambitious targets to reduce greenhouse gas emissions by 2030, through 70% reductions in coal use and 30% and 25% cuts to oil and gas use respectively. It therefore expects renewables to be responsible for 40% of all energy use by the end of the decade. 

While that would have replaced almost two-thirds of gas from Russia by 2030, the updated strategy unveiled in March set a target of phasing out the EU’s energy dependence on Russia “well before 2030” by diversifying gas supplies and accelerating the roll-out of renewable gases. 

“They were caught on the hop, but the EU’s pledge to reduce reliance on Russian gas and provide more energy from other sources (especially renewable sources, where you have security of supply) is probably the easiest win there is,” says Randeep Somel, Portfolio Manager at M&G Investments. 

“The fact they are moving on it at all is incredibly powerful. While they know it’ll be difficult, they have shown there will be financial and regulatory support.” 

The new ‘Joint European action for more affordable, secure and sustainable energy’ – REPowerEU – features a more prominent role for hydrogen technologies.  

The EC pledged to work with industry to “promote the establishment of a Global European Hydrogen Facility to boost member states’ access to affordable renewable hydrogen” and to facilitate global and European trading of renewable hydrogen. 

Its proposals include a Hydrogen Accelerator that will produce an additional five million tonnes of green hydrogen (made using electrolysers powered by renewable energy) in Europe and import another 10 million tonnes by 2030, on top of the five million tonnes targeted under its previous plans. In other words, the programme envisions around four times more growth in production relative to prior targets. 

That will require another 90-150GW of electrolysis on top of the 30-50GW required under the existing ‘Fit for 55’ proposals. 

The Hydrogen Accelerator was well received in the hydrogen and renewable natural gas (RNG) industry as a potential growth catalyst, and for good reason, says Sarah Peasey, Director of European ESG Investing at Neuberger Berman.  

She adds: “We should be clear that this initiative is primarily focused on LNG imports from non-Russian sources, with hydrogen and RNG as secondary initiatives.” 

While the European Green Deal announced in 2021 already contained targets for green hydrogen, the adoption curve has so far been relatively low.  

“But the seeds are in place for acceleration and we are seeing evidence of that,” according to Peasey.  

Potential for disagreement 

The question for industry and investors now is whether there’s enough meat on the bones of the updated strategy for it to be meaningful.  

Some frame it as an opening gambit to industry in Europe, asking what the EU can do as a regulator and a facilitator of investment. 

In other words, it may have more impact as a statement of intent than as a roadmap to reaching the targets set out. 

Because while the EC’s strategy for displacing Russian gas highlights the importance of green hydrogen in that context, there is no actual new policy, says Peasey. 

“It will instead be left to member states to drive, creating potential for time-consuming debates and disagreement that Europe can ill afford with both the cost of living impacting the most vulnerable consumers, and the ambitions of net zero really being tested.”  

Ramping up hydrogen production is challenging and complex, requiring technological innovation, regulatory cooperation and global coordination, as well as behaviour changes.  

Much will depend on what governments across Europe can do in terms of guaranteeing market regulation, bridging the cost gaps and supporting particular sectors (through measures such as subsidies).  

In particular, infrastructures and operational processes for green hydrogen remain expensive. Even if hydrogen costs decline to meet consensus expectations of US$1.50-2 per kg, Morningstar said last year, carbon taxes well above consensus expectations would be needed for the market to be economical, and thus more appealing to investors. 

But the Ukraine crisis has altered the outlook. The Hydrogen Council and McKinsey had predicted in a 2021 report that price parity between green and grey hydrogen (produced from unabated fossil gas) would be reached between 2028 and 2034. Yet natural gas prices have now climbed to the point that green hydrogen is cheaper than grey hydrogen in Europe, China and the Middle East and Africa.  

In the meantime, carbon prices and, where necessary, carbon contracts for difference (CCfDs) will play a vital role.  

CCfDs are designed to ensure that the carbon price is sufficiently high to make decarbonisation projects more viable. By covering the gap between the CO2 strike price and the actual CO2 price, CCfDs make projects more palatable for investors by removing some of the pricing uncertainty. 

“We need sufficiently high carbon prices to have a business case for hydrogen in the near term, until the economies of scale bring down hydrogen costs to a level needed for the technology to further penetrate markets by itself,” says Zimmer.  

“So anything making a direct fossil fuel competitor more expensive or hydrogen cheaper is helpful in that respect. CCfDs are a very good way to go and are a developed tool.”  

Building the case 

The EC is one of several administrations ramping up hydrogen infrastructure initiatives and investments.  

The US Department of Energy has established the Bipartisan Infrastructure Law’s US$9.5 billion Clean Hydrogen Initiative, including US$8 billion for Regional Clean Hydrogen Hubs to expand the use of clean hydrogen in the industrial sector. 

In Australia, the Federal Government recently set out funding for the country’s first public New Energies Service Station, boosting the uptake of heavy hydrogen fuel cell electric vehicles. 

With China announcing in March that it plans to ramp up to 200,000 tonnes of hydrogen a year by 2025, momentum is gathering for a significant global increase in capacity.  

Such a global expansion of hydrogen capacity further changes the story for hydrogen, according to Zimmer. 

“Hydrogen cost declines are largely proportional to the total installed capacity of hydrogen production,” he explains. “We consistently see this in renewable technology, particularly in solar PVs, wind and batteries. There’s no reason to assume this relationship is going to break even if we see scarcity of some rare earths or other resources.” 

A major advantage of hydrogen is that it can also act as a storage solution, converting other energy sources into hydrogen to be converted back when needed, helping solve issues with renewable power such as its intermittency. 

Yet much more needs to happen across political, regulatory and technological spheres for green hydrogen to play a bigger role in the renewable energy mix. 

“Hydrogen holds potential for solving some of the technological challenges of the climate transition,” says Paul Lee, Head of Stewardship and Sustainable Investment Strategy at Redington. “But there is a good deal of work to be done to convert the early stage technologies into something of industrial scale.”  

Generating the investment needed to achieve that depends largely on making investment viable and giving investors greater certainty of returns, through regulation, frameworks, incentives and carbon pricing.  

But while the tipping point remains some way off, higher volatility in fossil fuels helps to make alternatives a safer bet in relative terms – not just for asset owners and governments, but also for multinationals. 

“Huge increases in energy prices and concerns on supply means companies understand that if they don’t transition now, they could be at a competitive disadvantage,” says Somel. 

That puts the companies leading the innovation of cutting-edge technologies in a stronger position.  

Somel cites Ceres Power, currently developing hydrogen electrolysis cells and which counts Weichai Power and Robert Bosch as its biggest investors.  

“Large machinery and engineering companies such as Robert Bosch are big investors in the company because they see the technology as cutting edge and they are also the largest customers,” says Somel. 

Sending a message 

While the EC’s transition plan offers little in terms of policy measures, it does give investors more confidence that the political will is there for green hydrogen to play a clear role in a diverse energy mix.  

“With continued policy support, a greater emphasis on energy security following the Russian invasion in Ukraine and more competitive pricing for renewables, the backdrop remains supportive for continued adoption of hydrogen across multiple applications,” Peasey notes. 

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