Summary

Energy transition will be a significant part of climate action for the next decades, and a fundamental instrument for developed economies – which have mostly committed to carbon neutrality at or around 2050 – to achieve their goals and commitments towards a more sustainable future. It poses significant technical, regulatory, financial, and legislative challenges yet to be fully answered.

One of the potential tools in the energy transition toolbox is Green Hydrogen: it takes up surplus renewable power from the grid and can offer long-term storage and / or cross-sector energy delivery; it facilitates greater grid management flexibility; it can directly impact the decarbonization of hard-to-abate sectors such as heavy industry and transportation.

Policy movements towards implementing a Green Hydrogen economy in Europe are relatively recent. Many questions remain on why and how to implement Green Hydrogen projects. Analysing them from a mostly legal standpoint, we will offer some takes on what still needs to be done, and what has already taken place to secure investment interest in this nascent sector.

Part 1: Why hydrogen?

Hydrogen is not new. It is the simplest and most abundant element in the universe; its properties are well known and studied. We have used it extensively for a long period of time: as a reactant in chemical plants, as fuel in specific applications. It shall be borne in mind that global demand for Hydrogen in 2020 was 90 Mt1. Most middle schoolers in the developed world have seen the electrolysis of water as a simple, easily displayed and viewable electrochemical reaction.

Why, then, the renewed interest on hydrogen?

Its material characteristics have long been touted as one, if not the, stabilizing solution to the energy transition. In its Net Zero by 2050: A Roadmap for the Global Energy Sector report, the IEA indicates that 10% of the total final energy consumption by 2050 will be fulfilled by Green Hydrogen. It is energy-dense, easy to transport, has a wide range of potential uses from energy storage and transport, to the decarbonization of hard-to-abate sectors, where it is seen as the key for energy transition. It may also present significant advantages to other means of energy interconnection, allowing for the transport of significant amounts of renewable energy from where it is cheaply and easily generated – i.e., within the global solar belt – to other, less naturally prone locations.

Additionally, the ever-diminishing LCOE of renewable power generation, especially in the 2010-2020 decade, combined with carbon tax and credit schemes, have led us to the moment we find ourselves in: nearing price-parity between natural gas and green hydrogen. Current technologies and market practises are quoting the levelized cost of hydrogen for non-renewable hydrogen (i.e., steam methane reforming) from USD 0.5 to USD 1.7; low-carbon hydrogen (i.e. using CCUS technology) has been quoted at around USD 1 to USD 2; and Green hydrogen at USD 3 to USD 8 per kg2, with innovative project developers promising a much lower price point for their levelized cost of hydrogen, at par with natural gas.

It does, however, bring about its own challenges. Rapidly deploying massive hydrogen generation projects brings along administrative strain on regulating States and demands a legal, economic and tariff infrastructure that simply does not currently exist. Whilst some European Member States have been spearheading efforts for the expedited deployment of utility-scale generation projects, both by passing legislation and regulation to that effect3, there seems to be little consensus on how to achieve a breakthrough moment in regulation, allowing for the safe and efficient deployment of all parts of the value chain – all of them currently lacking capacity for the needs of a 2050 net zero energy system.

The recent proposals from the European Commission contained in the Hydrogen and Decarbonised Gas Package have made a shy, although welcomed, step towards an investor-friendly regulatory framework aimed at bridging the funding gap of Green hydrogen. The forethought given to dedicated hydrogen networks and regulation, the increased sector coupling in EU-wide network planning and proposing to align all EU Member States with first-movers’ efforts to adapt the auditable and well-established certification scheme already known from the 2nd Renewable Energy Directive4, all show great promise in kickstarting private deployment of these projects.

Recent developments in the European energy market have deepened the need for Green Hydrogen5. The current state of European energy markets – with great dependence from third-party states to provide baseload and peaking capacity in power markets, as a result from both the dependency on imported natural gas and policy decisions to expedite nuclear baseload plants going offline -, poses an additional strain on the already existing concerns of the security of supply. The European Commission sees Green and low-carbon Hydrogen (and other gaseous renewable and low-carbon fuels) as one of the tools to mitigate this exposure risk – and Member States should take heed and promote the reinforcement of renewable hydrogen generation capacity.

Green Hydrogen does not therefore come without its challenges. We will try to address some of these challenges from a legal point of view.

Part 2: The woes and pains of first-movers, or administrative licensing for hydrogen projects

Traditional, non-renewable, hydrogen generation is based on a well-known and established steam methane reforming, which poses no great challenge to legal and administrative systems in what regards their licensing: it is a simple industrial endeavour, which is subject to both the regulation of economic activities and environmental regulations.

Low-carbon hydrogen also poses little to no issue: the implementation of CCUS technology in steam methane reforming plants is not a legally innovative process; the techniques, technologies and their risks are known and established, and economic actors have knowledge on how they can proceed.
Green hydrogen generation, especially when obtained through the electrolysis of water using renewable power, however, has shown to be particularly troublesome for regulators and administrative entities alike.

Whilst industrial regulation and legislation should show itself to be flexible enough to allow for innovative products and processes to be deployed within their legal system, complexities can be found in the unending tendency of environmental legislation to adopt strict taxonomy systems for regulation. Taxonomy – especially when enshrined into law – has a significant disadvantage in regulating highly innovative and ever-evolving fields of industrial endeavour, and the well-known in tech phenomena of “law lags behind” is showing, once again, in the energy sector.

Diving into a specific European legal regime as an example: the Directive on Industrial Emissions, or the Integrated Pollution Prevention and Control Directive6. This legal system, which has to be mandatorily transposed by all Member States, intends on laying down “rules on integrated prevention and control of pollution arising from industrial activities” and also “designed to prevent or, where that is not practicable, to reduce emissions into air, water and land and to prevent the generation of waste, in order to achieve a high level of protection of the environment taken as a whole”. A noble and desirable goal in itself, it opted on taxonomizing all industrial activities subject to it and only exempting “research activities, development activities or the testing of new products and processes”. As a consequence of said taxonomy, the “production of inorganic chemicals, such as (…) hydrogen7, whenever “on an industrial scale”, is always subject to the Directive on Industrial Emissions.

Imposing compliance with this Directive (and its legal transposition into national legal frameworks) means demanding additional licensing and reporting obligations: from obtaining an environmental permit to operate, to proving, inter alia, that best available techniques are applied in the design, deployment and operation of the industrial endeavour, and subjecting them to emission limits for polluting substances.

By its sheer definition, the electrolysis of water using renewable power does not seem to entail any emissions of any polluting substance whatsoever: generating the necessary power has no emissions, and the only by-product is oxygen, with the industrial installation being, by design, incapable of generating any other substances. Any emissions-related regulation has therefore no purpose or fit in a simple electrolyser facility; and applying it is a prime example of the concept of deadweight loss of regulation.

The most simplified investor handbook prepared by administrative authorities in regulators currently applicable in the European Union economic area regarding this matter was issued by the Portuguese Directorate-General for Energy and Geology and the Portuguese Environmental Agency8, where the applicability of the Directive on Industrial Emissions is expressly recognized for all projects. Other environmental agencies across Europe are taking a similar stance on the issue.

Whilst merely illustrative, this example allows us to shine a light on how legal systems may struggle with innovation, especially when towards a greener energy system as a whole. Legislators and regulators shall take into account the specificities of regulating innovation and make haste in avoiding taxonomy as the panacea for all ills and pains they find in their day-to-day activity. States must quickly adopt innovation-friendly frameworks which allow for the 2nd Renewable Energy Directive’s target of a two-year full licensing period for power plants to be also applicable to utility-scale hydrogen projects.

The proposals from the European Commission contained in the Hydrogen and Decarbonised Gas Package do not significantly contribute to this regard – and it is easily understandable, given the complex regulatory process typically adopted by the European Commission. The field of innovation regulation has been starting to pick up steam in European legal scholarship, and while it still feels nascent, it can provide key takeaways on how to provide a stable and future-proof regulation which withstands innovation, simultaneously providing for economic efficiency and other public policy goals.

Part 3: Paradigm shifting, or sector coupling as the answer for an under asked question

A high renewable energy source penetration in the power mix demands innovative measures to ensure grid stability and quality, in light of the innate variability of these energy sources. This has been touted as the main cost-driver and challenge to network operators, system planners and regulators alike: how to reach a balance between cost-effectiveness of measures and quality of supply?

We believe even here Green Hydrogen is able to earn a place in the toolkit those market actors can refer to in order to tackle those challenges.

From a technical standpoint, the added long-term storage flexibility provided by gaseous fuels, such as Hydrogen, and the multiplicity of potential off takers in different economic sectors and value chains, bring with them significant added value to Hydrogen as a product. Additionally, as consumer-response mechanisms are integrated into energy markets across Europe, electrolysis shows great potential at quickly and efficiently participating in those markets, being flexible enough to expeditiously answer curtailment commands from grid operators.

Electrolysers are also at the border between power and gas markets. They are showing to be potential accelerators of sector coupling, with the multiplicity of Power-to-X solutions currently being designed and implemented. Because of that, the European Commission and other stakeholders have taken definite steps towards facilitating market entrance of these equipment.

In the aforementioned Hydrogen and Decarbonised Gas Package as presented by the European Commission, we’ve seen progress towards integration, with a proposal to unify and further take into consideration all grids – power, natural gas and dedicated hydrogen, if existing – when designing and implementing the European Ten-Year Network Development Plan. Additionally, the original European proposal for a revised Regulation on the guidelines for trans-European energy infrastructure (the TEN-E Regulation) made strides in its final version as approved by the Council, allowing both the coupling of the TEN-E and TEN-T (trans-European transport infrastructure) networks and the implementation of projects of common European interest in a decentralized, heavily coupled way, breaking new ground in allowing transnational projects to go farther than the traditional pipeline and interconnection lines paradigm. Those decisions are fully in line with the principles already enshrined and in force in the 2nd Renewable Energy Directive and the European Power Markets legislative revision of 20199.

Independent regulators have heard the call and are adjusting tariff and other regulation. One of the immediate challenges promoters face in modelling on-grid electrolysers, in order to capture surplus power and provide network services to grid operators, are grid connection and operation tariff systems capable of meeting the financial needs of this type of projects. Specifically, in the Portuguese market, ERSE10 has approved specified tariff mechanisms for standalone storage facilities, including electrolysers coupled with stationary fuel cells, which through granting several exemptions level the playing field, encourage private investment and reduce or ultimately eliminate discrimination.

Furthermore, legislative commands given by European legislators, in a direct manifestation of the energy efficiency first principle and as a contribution for the economic efficiency of grid planning exercises, make new grid capacity essentially a last-resort investment, instead favouring investments in short and long-term storage, capacity markets and other mechanisms for a flexible and functioning grid. Legislators took those instructions to heart and are enshrining those instruments in law – even though some relevant markets, such as Portugal11, Germany and the Netherlands, do not seem to have transposed the relevant European legal instruments as of yet.

Sector coupling has a relevant contribution towards the viability of Green Hydrogen projects, by multiplying the markets in which generators can act, diversifying products and / or offtakers, providing more investment safety for all participants through increased reliability and market liquidity – and legislators and regulators alike seem to have picked up their cue and are implementing definite measures to encourage investment and private party interest in these markets. The outlook appears favourable, with political statements and engagement from all stakeholders providing comfort to this strategy.

Part 4: Bridging the gap, or what support schemes and mechanisms are being sought

The novelty of massified hydrogen markets combined with the innate capital intensity of energy sector investments requires significant commitment by private parties to become first-movers in the Green Hydrogen subsector. Thus, the European Commission has tasked Member States with developing a healthy and competitive hydrogen market.

How can States and other actors improve effectiveness and attractiveness of this nascent market to private investors? As previously mentioned, cost-parity outlooks are favourable to Green Hydrogen, which has a relatively stable cost structure, when compared to both non-renewable hydrogen and to natural gas; but how do we make investors whole considering the current price gap between Green Hydrogen and the energy sources it seeks to displace?

The investment profile in the Hydrogen submarket is not dissimilar to other, renewable energy markets: significant upfront CAPEX investment and a relatively long-life equipment. The specific identifiable risks are related to the novelty of the market: will offtakers be there in the mid to long-term of electrolysers, will these offtakers pass the credit rating test, will there be robust medium to long term offtake contracts or a sufficiently liquid commodity markets for Green Hydrogen, or will investors end up with stranded assets or even worse: projects that are not bankable and will never go beyond well intended drawing boards?

Traditional CAPEX support mechanisms may not be enough. While the EU and Member States alike have been offering such support mechanisms – often including subsidies for the upcoming industry – 12, investors have been calling out for diverse public support to bridge the funding gap and decrease the natural risk exposure for these kinds of investments.

Portugal has prepared its national legislation to offer lifecycle support to Green Hydrogen projects and laid the groundwork for these to mature. The Portuguese National Hydrogen Strategy plans to offer supply-and-demand CFD auctions, targeted at hydrogen consumers and / or Natural Gas retail sellers, whereas against a firm purchase agreement with a hydrogen producer the national Environmental Fund will co-pay for the difference between commodity-market prices for the fuel they are substituting and the agreed price, on a euro for euro basis. These mechanisms will allow for offtake stability and provide cost-neutrality for end-users in an economically efficient way. The legislation is equally designed for other, innovative financing solutions to be quickly deployed.

EU-wide and States’ aid measures are in force and are expected to be reinforced in the coming years. As the European Commission has often stated, the Green Hydrogen market needs to be built from the ground up – and offering a firm offtake guarantee will allow for greater confidence and bankability for investors and capital markets at large.

In conclusion

Hydrogen is likely to become one very significant part of the answer to the challenges posed by energy transition, given its specific characteristics and despite the identified hardships, simply because there is no current viable alternative to tackle the pressing climate change challenges and to reach Europe’s climate binding targets. As we all feel and see the need for the pace of energy transition to pick up, all involved stakeholders should make strides at taking action on what needs to be changed in legal, financial and regulatory frameworks in order for these projects to be able to take off.

Not everything is done – but some legwork has already taken place. Whilst some legacy regulatory challenges remain and still require attention – even though, it shall not be forgotten, that the current scenario may also provide some welcomed regulatory flexibility for first-movers that may present some opportunities -, investors and promoters alike should take confidence and comfort from constant and positive political attention and will to develop a Green Hydrogen economy. The Fit for 55 renewed ambition for the decarbonization of European economies will take an all-hands-on-deck approach to be fulfilled – and public stakeholders seem to be taking that approach.

Footnotes

1. Source: IEA (2021) Global Hydrogen Review 2021, Revised version (November 2021), All rights reserved.
2. Source: IEA (2021) Global Hydrogen Review 2021, Revised version (November 2021), All rights reserved.
3. With the notable effort Portugal has made in passing both Decree-law no. 60/2020, of the 17th of august, establishing a Guarantee of Origin scheme for renewable and low-carbon gases, and Decree-law no. 62/2020, of the 28th of august, regulating the deployment of renewable and low-carbon gas projects and their mix into the natural gas grids, as the first steps in deploying the National Hydrogen Strategy.
4. Directive (EU) 2018/2001 of the European Parliament and of the Council of 11 December 2018 on the promotion of the use of energy from renewable sources
5. Note from the authors: we opted to refer, for the Reader’s convenience, to Renewable Hydrogen as “Green Hydrogen”, and to any other means of generating low-carbon hydrogen, such as using the output of CCUS natural gas power plants and/or nuclear power plants as “low-carbon Hydrogen”. The use of this nomenclature should not be construed as the opinion of the authors in the ongoing policy debate on whether and how to discriminate between low-carbon power sources for Hydrogen generation.
6. Directive 2010/75/EU of the European Parliament and of the Council, of 24 November 2010, as amended.
7. Annex I, no. 4.1(a) of Directive 2010/75/EU, as amended.
8. DGEG and APA, 2021, Guia do Promotor “Legislação e regulação para a Economia do Hidrogénio”, consulted at https://apambiente.pt/sites/default/files/_SNIAMB_A_APA/Publicacoes/Guias_Manuais/Guia%20promotor_Hidroge%CC%81nio_FINAL24052021.pdf on 31.12.2021 (in Portuguese).
9. Mainly comprised of Regulation 2019/943 and Directive 2019/944.
10. The independent regulator for both the power and natural gas grids.
11. A revision of the power sector legislation, containing the transposition of Directive 2019/944 and which takes into account Regulation 2019/943 has been approved by the Portuguese Government but is not, at the moment of writing, published and in force.
12. Namely the European Commission’s Hydrogen Public Funding Compass, and Portugal’s 2020 PO SEUR (under Horizon 2020) and Recovery and Resilience Plan support tenders.

 

Contributed by Bruno Azevedo Rodrigues, Ivone Rocha, Mariana Figueiredo and Rui Ferreira de Almeida of TELLES.